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Venezuelan oil's volatile year

A steep production decline from the country is already priced in, but things could get even worse

Venezuela is the single biggest geopolitical risk for oil markets in 2018. The economy continues to crumble, dragging the oil industry down with it, and a contentious election scheduled for 22 April promises to fuel more political strife in an already bitterly divided country.

As the crisis has worsened, Venezuela has moved up the global agenda. The US has taken the lead, ratcheting up the pressure on Nicolás Maduro's government. Economic sanctions on Venezuela have effectively cut the country off from international capital markets, making it nearly impossible for the cash-strapped government to raise new funds. At the same time, personal sanctions on senior officials in Maduro's government and the military have sought to sow discord within the upper echelons of power.

On a tour of Latin America in February, then US secretary of state Rex Tillerson sought to tighten the screws yet further, saying new sanctions on the oil sector were being drafted. Tillerson went so far as to set up a working group with Canada and Mexico to evaluate ways to mitigate fallout to countries in the Caribbean, as well as US Gulf Coast refiners that rely on Venezuelan crude. Meanwhile, a rightward shift in Latin American politics has turned erstwhile Venezuelan allies in the region like Brazil, Argentina and Peru against Maduro. And as the oil industry's crisis has taken the fuel out of Venezuela's petrodiplomacy, other allies have drifted away. Venezuela looks increasingly isolated.

However, Maduro still has some important allies, namely China and Russia.

'I am sure that he's got some friends over in Cuba that could give him a nice hacienda on the beach'—Tillerson on Maduro

China has pumped tens of billions of dollars in oil-backed loans into Venezuela over the past 15 years, and taken stakes in major oil projects, giving it a strong hand in shaping events in the country. Beijing has publically been supportive of Maduro, though it has hedged its support by declining to extend new credit to Venezuela and maintaining ties with opposition leaders. China, however, would not go along with an oil blockade, which would create a major gap in any sanctions regime.

Moscow's support has been more full-throated. Russia has extended billions of dollars in new oil-backed loans to Venezuela at several critical junctures in recent years and is probably the only reason Venezuela's state oil company PdV has avoided defaulting on its debt so far. Like Beijing, there is no chance Moscow will go along with oil sanctions, which would blunt the pain of any such measures and keep a financial lifeline to the outside world open for Maduro.

But Venezuela's accelerating economic decline and the rapid deterioration of its oil industry shows the limits of Beijing and Moscow's ability and willingness to buoy Caracas.

Any US sanctions on Venezuelan oil are unlikely to come before the April elections. They are a powerful tool of coercion to push Maduro towards holding legitimate elections and taking steps to right the economy. However, if there is evidence of widespread fraud in April's election, as there was in gubernatorial elections last year, the US could see it as a breaking point and push ahead with a tighter oil embargo. That possibility looks more likely now than it did six months ago. Tillerson put forward one potential off ramp for Maduro: "I am sure that he's got some friends over in Cuba that could give him a nice hacienda on the beach."

Then there is the question of default. It appears that Venezuela has embarked on what some in the market are calling a selective default, in which the sovereign has chosen to miss payments on its bonds to conserve cash to keep PdV current on its debts. Unlike the government, PdV has significant assets abroad that could be seized in the event of a messy default. This, and the fact the government hasn't actually recognised its missed payments, has sowed confusion in the market. Bondholders have not pushed for recovery of payment, instead waiting to see how events shake out. Caracas's talk of a broad debt restructuring, meanwhile, has faded.

Oil markets have already felt the effects. The sharp decline in Venezuelan output, which fell an incredible 590,000 barrels a day in 2017, according to figures the country reports to Opec, supported the price rally in recent months.

Further production declines as the crisis deepens look nearly inevitable. Barclays, the investment bank, reckons output will fall another 300,000 b/d or so to around 1.35m b/d by late this year. That is the broad consensus and is baked into the oil price today. The risk of further outages, however, can't be ruled out. A strike or harsher sanctions could push production towards 1m b/d, which would boost prices. But the risk also runs the other way. If PdV somehow manages to put a plug in the losses and at least limit the declines, it could take a critical support out from under the oil price. 2018 will be a volatile year for Venezuela.

This article is part of an in-depth series on Geopolitics. Next article is: Qatar keeps on keeping on

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