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Venezuela feels the heat

Punishing US sanctions will continue to inflict heavy losses on the country’s oil sector

The Venezuela oil industry has been on a death spiral since 2016, with is roots in the short-sighted policies of presidents Hugo Chavez (1999-2013) and his successor Nicolas Maduro—made worse by the oil price fall of 2014. Both presidents destroyed the national oil company by politicising it, firing its most qualified workers and over-extracting resources from it. The partial expropriation of private operators and service contractors discouraged foreign investment in new projects.

In 2019, the collapse trajectory was exacerbated by the imposition of oil sale sanctions by the US. In the last quarter of 2019, production had fallen to c.650,000-700,000bl/d, about half of the 1.3mn bl/d a year before, and a huge decline from a peak of 3.4mn bl/d reached in 1998. Shockingly, this happened in a country with one of the largest oil endowments in the world and in the aftermath of a sustained period of price windfalls.

Increasingly harsh US sanctions have been imposed due an escalating conflict between domestic opponents and the Maduro regime, which the vast majority of Western democracies consider illegitimate due to his fraudulent re-election in 2018. However, Maduro is still supported by key allies— Russia and China—that have helped the regime cope with sanctions.

The US imposed financial sanctions back in 2017, limiting Venezuelan debt issuance. Those restrictions had a negative effect on oil investment, but did not affect the sale of oil. The ‘nuclear option’ was deployed in January 2019, with the US declaring the Venezuelan government and its national oil company Pdvsa, as subject of sanctions, forbidding any transactions with US entities.

As a result, more than 500,000bl/d that Venezuela was exporting to the US had to look for other markets. In addition, Venezuela had to stop importing more than 100,000bl/d of products from US refiners, making it costlier to supply its domestic market and to dilute the extra-heavy oil that it exports. However, the US has not sanctioned non-Venezuelan operators within the country and has even given Chevron and some American service companies licenses to continue operating there.

Significant setback

The closing of the US market was a major blow to Pdvsa. Not only was the US its most profitable market, due to its proximity and large extra-heavy refining capacity, but it was the source of most of its cashflow and home to refiner Citgo, its largest downstream subsidiary. Venezuela’s two other largest export markets—China and India—are less profitable and generate limited cash because a large fraction of the oil sold there is used to pay off Chinese and Russian debts. A cash squeeze in turn resulted in lower investment, leading to yet lower oil production.

The US tightened the sanctions regime as of August 2019, threatening secondary sanctions on any buyer or carrier of Venezuelan oil. A number of Asian buyers, including, most prominently, the Chinese ‘big three’ state-owned oil firm CNPC, suspended their purchases of Venezuelan oil, while some companies even halted hiring tankers that had previously transported Venezuelan oil. In the second half of 2019, Pdvsa thus accumulated massive crude inventories, as its binding constraint became less the ability to produce than to sell.

Venezuela and its oil industry have become embroiled in the multilevel geopolitical conflict between the US and its two leading geopolitical rivals

Venezuela and its oil industry have become embroiled in the multilevel geopolitical conflict between the US and its two most proximate geopolitical rivals. Over the last decade and a half, China lent more than $60bn to Venezuela, of which around $16bn is still outstanding. When, concerned about the risks, China reduced its exposure, Russia stepped in. Rosneft, the Russian national oil company, provided loans for $6.5bn, of which only $800mn were outstanding in September 2019. Rosneft has been able to get Venezuela to pay off its debt because, for several months, it has controlled the marketing of about two thirds of Venezuela’s oil exports, a benefit of being one of the few firms willing to defy US sanctions.

Rosneft and CNPC, along with Chevron, are the main foreign oil reserve holders and operators in Venezuela, but they have been recently cautious, not risking more money. Rosneft recently got access to some of Venezuela’s most promising gas reserves, which could be exported through Trinidad, but it has been reluctant to invest. CNPC started an expansion of an extra-heavy oil project, but recently suspended it.

Slow recovery

How far is production going to decline? It depends mainly on how much the US government enforces secondary sanctions on Russian, Chinese, and Indian buyers of Venezuelan oil. That, in turn, is part of the wider geopolitical contest between the powers. It also depends on how much oil buyers can get out of Venezuela without being detected. There are widely disparate estimates about Venezuela’s current exports, partly because some of the higher estimates account for up to 20pc in additional exports to Cuba and Malaysia, undetected because tankers turn off their transponders.

If things remain the same, 2020 production is likely continue to decline, but at a slower pace than in 2019, to some 500,000bl/d. But it could be a much worse picture if sanctions’ enforcement gets stronger.

Of course, the picture could change significantly if there is a political transition in Venezuela and sanctions are lifted. Production would rebound and could go back to 800,000-900,000bl/d within a year. In the longer term, investments of more than $100bn, and close to a decade of time, would be needed to sustain an additional 2mn bl/d of production.

Francisco Monaldi is a fellow at Rice University's Baker Institute for Public Policy

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