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Introduction

As OPEC’s economically weakest member, Venezuela was one of the organisation’s strongest advocates for cuts in production in order to raise global oil prices. At the end of the first quarter, however, it had the largest production above its allocation of any OPEC member. In the first three months of 2017, it output was just over 2m bpd 2.05mn bpd, some 80,000bpd above its agreed ceiling, compared to a cut of 95,000bpd it had promised in November 2016.

Venezuela’s economic weakness centers on the country’s huge debts, which were mostly run-up between 1999 and 2013 under the presidency of Hugo Chavez, who borrowed extensively to boost the country’s economic growth and to finance a series of social measures, including price subsidies for oil products and other basic.

The borrowing was supported by the rise in global oil prices that occurred between 1999 and 2008 and the secondary rise that lasted from 2010 until 2014. Venezuela is highly dependent on oil. About 98% of the country’s export income comes from oil, which is the responsibility of the national oil company, Petroleos de Venezuela (PDVSA). Under Chavez, the state company was obliged to fund much of the cost of the country’s social measures, depriving it of much of the cash it required to fund its own capital investment.

Latterly, it has even seen some of the money it needs for its current operational requirements diverted to the central government. The result of all this is a deterioration of the state oil sector, leading to a series of problems, which PDVSA does not have the financial resources to tackle.

The most severe of these problems is a decline in the country’s oil production. At the beginning of Chavez’s presidency in February 1999, Venezuela’s production of crude oil and natural gas liquids (NGL) totalled 3.5 mn bpd. In his final year, 2013, it was 2.7 mn bpd. By 2016, it was down to 2.5 mn bpd and this year it could even be below that figure.

The absolute decline in output since 1999 conceals the fact that over the period since then Venezuela’s oil production has become more heavy and therefore less valuable. The reason for this is that the country’s oldest oilfields are in long-term natural decline: and these oilfields are the source of most of Venezuela’s light and medium crude whilst the newest fields, by contrast, are mainly of heavy and extra-heavy crude. The result of all this is that Venezuela’s reserves of oil are now overwhelmingly of heavy and extra-heavy crudes.

Falling Venezuela Oil Output
Falling Venezuela Oil Output

Venezuela’s Heavy Problem

Heavy oil production has been a problem for more than two decades. In the 1990s, Venezuela developed an oil-in-water emulsion from its heavy crude, known as Orimulsion. The aim was to convert a substantial proportion of the country’s heavy crude production into Orimulsion and to have it classified by OPEC as some form of petroleum product. By doing so, the Venezuelans hoped to avoid any future restrictions by OPEC on their oil production by having more and more of it classified as not being crude oil. Since OPEC’s quotas only apply to crude oi, it was hoped that this would be a way to circumvent OPEC quotas, however, Orimulsion failed commercially and ceased to be produced.

Many Venezuelan officials felt that OPEC’s production policies favoured producers in the Persian Gulf at the expense of those outside it and received support from the US for this point of view. There were hopes in Washington during the 1990s that Venezuela might eventually leave OPEC, which successive governments have regarded as a threat to the energy security of the US.

Falling exports

The decline in Venezuela’s production combined with the rising domestic consumption of oil, aided considerably by low, subsidised domestic prices, and has reduced the volume of exports considerably. In 1999, Venezuelan net exports of crude oil and NGL were 2.8 mn bpd. Last year, they were only 1.9 mn bpd, and might have been much lower were it not for a severe decline in domestic consumption since 2013 owing to a severe economic crisis and hyper-inflation in Venezuela.

Venezuela’s main export market has traditionally been the US, but President Chavez began to reduce reliance on the US market, partly for ideological reasons but also for commercial reasons. The US, in turn, has been importing less crude from Venezuela in recent years as its own production has risen.

Venezuela Oil fields
Venezuela Oil fields

Venezuela has therefore switched more of its exports to Asia, especially to China. Last year, Venezuela supplied just over 5% of Chinese imports of crude, with exports of 387,000 bpd. Some of these have been outright sales, but PDVSA is also supplying crude as repayment for debts owed to China. Recently another oil-for-debt loan was signed with India and in 2016, it exported about 470,000 bpd to India of which most is said to be for the repayment of earlier debts.

Large debts

The repayment of debts with crude oil could prove a problem for Venezuela, especially if it has to reduce its production in order to comply with OPEC’s production cut agreement.
Nearly 1.2 mn bpd of the country’s oil production is reported to be earmarked for this purpose, which is about half this year’s forecast production. Venezuela has a number of other commitments to supply oil this year, including the country’s refining system, heavy oil allocated to foreign joint-venture partners and oil committed under term supply contracts.

When added together, these supply arrangements comfortably exceed Venezuela’s likely production in 2017 by over 500,000 bpd. Part of this deficit may have to be met by imports. PDVSA may also have to reduce deliveries to some of its regular customers. One arrangement that may well be cut is the oil supplied to some 18 Caribbean and Central American countries on concessionary terms under a scheme known as PetroCaribe.

The largest volume goes to Cuba, which has been receiving about 50,000 bpd on barter terms. The other main recipients are the Dominican Republic, Jamaica, and Nicaragua. Deliveries under the scheme have been falling in recent years as Venezuela has struggled to find enough crude oil from its own operations to fulfil its obligations to the PetroCaribe countries. The consequences of this have been that PDVSA has had to buy products from elsewhere in order to supply some of the PetroCaribe members.

Venezuela reserves v Price (1980-2015)
Venezuela reserves v Price (1980-2015)

Investors needed

Venezuela plans to be producing 6 mn bpd by 2019, of which 4 mn bpd is meant to come from the Orinoco Belt. The chances of achieving either figure are zero. Orinoco’s production at present is only about 1 mn bpd and the PDVSA does not have the resources to develop, expand or tap into the 301 bn bbl reserves that are thought to be there.

In addition to providing for the production and processing of the crude, it also needs to extend the pipelines and other infrastructure to transport and export the oil. In all this, PDVSA is considerably handicapped by the need to earmark a large proportion of its earnings to service the debts both of the company and the government. This year, their combined debts will require payments totalling $10 bn to cover interest and repayment of debts maturing in 2017, to be set against PDVSA’s likely earnings of about $30 bn and between them, the government and PDVSA have debts of $71 bn.

Foreign Investment

All this means that PDVSA must rely on foreign investment, not only for the Orinoco Belt but also for its other upstream ventures. Here, though there are three significant problems connected with debt. Firstly, the PDVSA is behind in payments owed to many of its suppliers, secondly foreign companies are handicapped by the economic chaos that exists in Venezuela and finally, there is also growing political opposition to the involvement of foreign oil companies in Venezuela.

A number of politicians opposed to the President object to the government’s policy of selling shareholdings in oil-producing joint-ventures to foreign companies, which PDVSA has been doing to raise money to service its debts. For example, in 2016, Rosneft paid $500 mn to increase its shareholding in another joint-venture, PetroMonagas, from 16.7 to 40.0%. The price was condemned by many opposition politicians as being too low. PDVSA nevertheless has little choice in the matter of selling holdings in joint-ventures and other assets, owing to its need to service its debts.

In December 2016, it agreed a particularly controversial arrangement with Rosneft in which it offered a 49.9% shareholding in its US refining subsidiary, Citgo, as collateral for a loan from the Russian company. The deal caused most alarm in the US, where, amid all the panic about the supposed interference by Moscow in US elections, several politicians expressed concern at the idea of a Russian company being able to acquire control of a large US-based oil company in the event of a default by PDVSA on the loan.

The way forward

The main problem, however, is Venezuela’s reliance on the Orinoco for any increase in oil production, which means developing the most expensive oilfields in order to produce the crude with the lowest value.

There remains plenty of scope for reworking existing light and medium crude fields which could reverse the decline in several of them, producing more valuable crudes at much lower cost than in the Orinoco Belt, as well as providing more light crude as diluent for heavy crudes produced elsewhere in Venezuela. The gains in output would be much less than those planned for Orinoco but far more achievable

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