Why the oil market should not misread Venezuela

Why the oil market should not misread Venezuela

For trading markets every tragedy is a business opportunity. That is the spirit in which parts of the oil market are viewing the continuing trauma in Venezuela.

The newly invented Constituent Assembly has stripped the democratically elected parliament of its powers. The former loyalist attorney-general Luisa Ortega Diaz has fled to seek political asylum in neighbouring Colombia and is reported to be ready to expose the corruption of the government she has left behind.

The country’s currency reserves have fallen while debt continues to increase. The US government has told families of its embassy staff to leave. Animals are said to be stolen from local zoos to provide food for the desperately hungry. The country is on the verge of becoming a failed state. But are these events likely to trigger the rise in oil prices that bulls in the market have long been hoping for? Will the implosion of the regime of President Nicolas Maduro and the open civil conflict that could follow push oil prices up to $60, $70 a barrel or even more? I don’t think so.

Venezuela is certainly an important oil producer and exporter. A founder member of Opec and for many years the intellectual leader of the organisation, Venezuela has more oil reserves than any other country, although much of it is heavy oil that cannot be produced economically at current prices. The country produced 1.9m barrels a day in July — the last month for which figures are available. Most of that was exported, with some 780,000 b/d going to the US in the first four months of this year.

The idea that a cutoff of those supplies will trigger a sharp rise in prices is grounded in those numbers. There are good reasons, however, why the reality might be rather different.

First, a complete cessation of production and exports is extremely unlikely. Venezuela depends on oil for 95 per cent of its export revenues. Protecting that trade and maintaining production will be the absolute priority for any government whether under Mr Maduro or his main opponent Henrique Capriles. Oil installations will be guarded by troops if necessary and production will continue.

If any of the producing facilities do grind to a halt the impact is likely to be limited. There could be a spike in prices but that is likely to be temporary. Venezuela is no longer the power in the oil market it was a decade ago, when it produced and exported around 2.5m b/d. Its crudes were an important part of the mix for refineries on the US Gulf coast.

The decline of the Venezuelan oil industry, in particular the once all-powerful state company PDVSA, has left the country in a position where it does not even have the capacity to produce at the level allowed under its Opec quota. Production is now at a 27-year low.

A loss of production of say half a million barrels a day would be inconvenient for the refiners accustomed to relying on the country’s supplies and damaging to the international companies involved, such as Repsol and Chevron, but globally, any such shortfall could soon be matched by increased supplies from elsewhere. Several Opec producers— including Nigeria, Iran, Algeria and Iran — are itching to push their exports up. US sanctions on Venezuelan imports would be disruptive but the market would soon adjust.

Nor would production stay cut off. Any government will need the export revenue and those who have invested in Venezuela or made loans in return for oil supplies also have a direct interest in seeing production maintained. That includes both China, which has stopped lending Venezuela new money but in 2016 still had a reported $20bn of loans outstanding, and Russia, which has recently increased its lending through the state-controlled oil company Rosneft. That debt is secured against the trading subsidiary of PDVSA, Citgo. No government can afford to alienate such powerful creditors.

Whether under the democratic leadership of Mr Capriles or one of his colleagues or in the control of the military, Venezuela would have every incentive to encourage new investment and quickly restore production to previous levels. The poverty of what was once one of Latin America’s most prosperous countries is shocking. It could easily sustain production of 3m b/d or more and, given the existing infrastructure and the experience in what remains of the PDVSA, could probably reach that level within 18 months of a new administration.

Of course there will be volatility. But history suggests that changes of regime, however violent, do not lead to lasting destruction of trade. In countries dependent on oil revenue, production and exports become the imperatives of an incoming government — the way new leaders can secure power.

Venezuela today is a sad and miserable place, its population the victims of dictatorship and mismanagement of the economy. But the market would be wrong to see what is happening on the streets of Caracas as a leading indicator of the next upward wave in oil prices.