The Major Risk That Oil Markets Are Underestimating
The U.S. campaign for regime change in Venezuela could drive up oil prices.
The oil markets barely budged last week when the Trump administration first recognized Juan Gauidó as President of Venezuela, and prices hardly moved even after follow-up reportingshowed that the U.S.’ effort to topple Nicolas Maduro was a lot more coordinated than it may have seemed at first glance. Oil prices also largely shrugged when American sanctions on PDVSA were announced earlier this week.
However, by Tuesday, oil traders finally woke up to the fact that the U.S. campaign to topple Maduro by essentially issuing an embargo on Venezuelan oil exports could lead to major disruptions in the market. WTI and Brent both rose sharply.
Even as U.S. sanctions simply bar American entities from doing business with PDVSA, the measures could wreak havoc on Venezuelan oil exports. U.S. refiners import around 500,000 bpd of Venezuelan oil. American sanctions also dictate that any revenues from oil sales would be put into an escrow to be managed by the government of Juan Gauidó. Maduro would obviously not want to fund his opposition, so oil exports to the U.S. will essentially cease going forward.
Those shipments can be rerouted to other buyers around the world, but PDVSA will have to endure a heavy discount. Even then, there are only so many refiners capable of processing Venezuela’s heavy oil.
Moreover, Venezuela’s heavy crude must be blended with diluent in order for it to be an exportable product. To date, PDVSA has been importing diluent from the U.S. That will no longer be allowed, so it is unclear how Venezuela will manage this disruption. “If Venezuela fails to find a substitute, oil production will have to be scaled back,” Commerzbank wrote in a note.
On top of that, Venezuela’s shipments to the U.S. were the only ones that earned the country hard currency. The bulk of its shipments elsewhere – mainly to China and Russia – are sent as repayment for past loans. In other words, PDVSA does not take in cash for its oil shipments to those countries. Presumably, additional shipments to China, Russia or India in lieu of the lost market in the U.S. Gulf Coast could be sold for cash, but Maduro’s government is without leverage, which means the discounts will be painful.
There is also a power struggle underway to take control of PDVSA. Maduro still has control, but the jockeying for control of both the operations and the bank accounts may throw up unexpected disruptions. The company is already in serious disrepair.
Looking out over the medium-term, some of the analysis around the crisis in Venezuela has been described as bearish for oil prices, since a new government could end the mismanagement of PDVSA and revive oil production in relatively short order. But that is magical thinking. “Even in the event of a peaceful transition of government, we would not expect rapid growth in the output of Venezuelan crude in the near term; it is likely to take years to stabilize output, let alone reverse declines,” Standard Chartered analysts led by Paul Horsnell wrote in a note.
For U.S. refiners, the disruption could be significant. As Standard Chartered points out, the importance of Venezuelan oil comes down to the quality and proximity of the heavy crude, rather than the volume. Venezuelan oil has some of “the lowest degree of potential substitutability by other crude oils,” the investment bank wrote.
Canada offers one of the few alternatives, but is constrained by a lack of pipelines. Canada itself has had to incur production shut-ins because of a shortage of pipeline space. In any event, Canadian oil largely flows to the Midwest, and as such, cannot really replace missing barrels on the Gulf Coast.
But the crisis has implications for the broader oil market. “Production in Venezuela is likely to decrease by more than the shortfall in exports to the US of approx. 500,000 barrels per day,” Commerzbank wrote in a note. U.S. Treasury Secretary Steven Mnuchin did not appeared worried about the potential outages in Venezuela, noting that “many of our friends in the Middle East will be happy to make up the supply.”
His confidence could be misplaced. The U.S. burned some bridges last year with its “friends in the Middle East,” by demanding that they increase oil production in the wake of sanctions on Iran, only to issue a bunch of waivers, leading to a crash in oil prices. Riyadh probably won’t be as trusting this time around.
Indeed, Saudi oil minister Khalid al-Falih said this week that Saudi Arabia would lower its oil production to 10.1 million barrels per day (mb/d) in February and keep it at that level for the duration of the six-month OPEC+ deal. So far, there are no signs that the Saudis have a desire to help out Washington again.
The result could be significant upward pressure on oil prices. “The expected decline in Venezuelan oil production and the problems in Libya will make it easier for OPEC – albeit inadvertently – to rebalance the oil market by cutting production,” Commerzbank concluded.
By Nick Cunningham of Oilprice.com
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