Introduction

Rising debts and plunging oil revenues are adding to Venezuela’s already substantial economic woes. Crude oil production is down this year by 200,000 bpd, having fallen steadily for the last decade, cutting oil revenues even further. What is needed to remedy the situation is a significant rise in both the price of oil and the volume of exports; but neither looks likely at present. Higher exports will need higher production; but this will require higher spending by the national oil company, Petróleos de Venezuela (PDVSA), which does not have the money in the first place.

As far as an increase in global crude prices is concerned, the government has been putting its faith in an agreement by OPEC–preferably supported by other countries– to cut the production of oil; but neither OPEC nor any other oil-producing countries are willing to agree on the cuts necessary to produce the kind of increase in prices that Venezuela needs to begin solving its serious economic and energy problems.

Production problems

Venezuela’s output of crude oil and natural gas liquids has decreased by 200,000 bpd since the start of the year and looks set to fall by a further 200,000 bpd by the end of 2016. The decline to some extent is the result of the natural decline of the country’s older oilfields; but the underlying causes have much to do with more than a decade of under-investment and mismanagement by the country’s principal producer, PDVSA.

Falling Venezuela Oil Output
Falling Venezuela Oil Output

The fault does not necessarily lie with PDVSA, however, so much as the government, which for years has treated the state company as a cash cow and systematically used most of its earnings for its political ends rather than allowing the company to retain sufficient funds to enable it to invest in maintaining and increasing production. Indeed, so short has PDVSA been kept of funds that it has been unable to pay many of its contractors and suppliers for upstream services, which has resulted in a fall in investment from the private sector as well as the state oil sector.

Enormous reserves: or are there?

Venezuela has large stated reserves of oil with the official estimate of its proven reserves being 300 bn bbl: sufficient for 342 years at existing levels of production but most of these are of heavy or extra-heavy crude and their exploitation requires resources both of capital and technology that Venezuela’s state-owned national oil company does not possess

The official estimate of 300 bn bbl continues to be widely used by independent commentators, but it almost certainly includes a large amount of unproven and even undiscovered reserves. There is also an important political element to the size of reserves in the context of past negotiations within OPEC over production quotas, which were partly based on reserve levels claimed by each country and which, in turn, almost certainly led to the overstatement of reserve levels by several member countries.

Venezuela Oil fields
Venezuela Oil fields

In the most extreme case, if oil prices remain at $50/bbl for very long Venezuela could have to write down their reserves to where they were a decade ago. That would imply removing ~220 billion barrels from the books. That amount is equivalent to 68% of the global increase in proved reserves over the past decade.

Falling output

Venezuela’s oil production is declining. It reached its highest level as long ago as 1970, at 3.7 mn bpd. Its output then went into a prolonged decline, falling to 1.7 mn bpd in 1985. A revival followed, taking it to 3.5 mn bpd in 1998, after which it began to decline once more, falling to 2.4 mn bpd this year.

A part of the reason for the most recent fall is the natural decline of many of its most prolific oilfields. The decline is occurring mainly in the lowest cost fields, leaving an increasing proportion of Venezuela’s production coming from fields, where not only are extraction costs higher, but the oil is heavier and less valuable, resulting in lower returns per barrel compared with the low-cost fields. For example, The Orinoco Belt is a key part of Venezuela’s plans to reverse the decline in production but it is both difficult and expensive to develop because of the nature of deposits and the remoteness of the region.

Downstream woes

Venezuela’s oil woes are not confined to the upstream sector. There are considerable problems downstream as well. Underlying these is the rising debt burden on the state oil company, which has resulted from a combination of falling export revenues and the use of PDVSA as an instrument of social policy. This has left the company short of funds for its commercial operations.

PDVSA was created to run the country’s oil and gas industry following the nationalization of foreign assets in 1976. PDVSA’s role began to change, however, in 1998, after Hugo Chavez became the President of Venezuela. Chavez began to use the revenues generated by the state oil company to fund social projects in Venezuela as well as providing refined products to the domestic market at subsidized prices. These additional obligations exceeded PDVSA’s ability to finance them out of current revenues, plunging the company ever deeper into debt.

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

Refinery problems

Venezuela has 1.3 mn bpd of crude distillation capacity–all of it owned by PDVSA–which is more than sufficient to meet domestic demand of 0.6 mn bpd.

Last year, utilization rates for the refineries in Venezuela were about 64% and the fall in utilization rates has led to shortages of some products in Venezuela, necessitating the import of both refined products and blendstocks. The principal shortages have been for naphtha, gasoline, and diesel; reports of spot purchases of gasoline components suggest that the problem in PDVSA’s refineries is not confined to crude distillation units but affects some upgrading units as well.

Crude shortages

There are a number of possible explanations for this year’s fall in refinery output; but one important one appears to be a shortage of crude oil: in particular, light crude oil which is required for blending with heavy crude from the Orinoco Belt.

Given its economic problems and the high levels of debt, Venezuela can ill afford to be buying increasing volumes of crude and refined products. Moreover, some oil companies are reported to be nervous about PDVSA’s financial situation to be refusing to provide normal credit terms for the supply of oil to the state company. Venezuela has been pressing OPEC to curb production in an attempt to boost global crude prices but has failed to garner sufficient support for the move. In any case, its problems are too great to be solved by a temporary rise in oil prices. It will need to take drastic measures at home as well.

The next steps for Venezuela

Financial markets have been betting for some time on a Venezuelan debt default, with more than $15 billion worth of debt repayment coming due over the course of 2016 and few ways for Caracas to make those payments. The government has therefore resorted to selling the country’s gold. According to the Central Bank of Venezuela, the country’s total foreign reserves have fallen in the past seven years from $43 billion to approximately $11 billion. With most of its foreign reserves being in gold, and with the government quickly running through this, when the gold is gone, there will be little left to stave off complete disaster. Venezuela, and particularly the new democratic majority in the National Assembly, has difficult days ahead – both in terms of attempting to heal a country that is broken politically, economically and socially.

In order to jump start the energy sectors while simultaneously helping to eliminate the large overhang of dollar denominated government external debt, Caracas should design a debt to equity conversion program modeled along the lines of Chile’s highly successful program of the 1980s. Such a program would enable prospective strategic partners to purchase existing and deeply discounted dollar denominated Venezuelan government bonds in the international capital markets, and use them as part payment to the government for interests in Venezuelan oil and gas fields.

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References
  1. http://peakoilbarrel.com/opec-crude-oil-production-charts/
  2. http://www.forbes.com/sites/rrapier/2016/07/01/venezuelas-oil-reserves-are-probably-vastly-overstated/#562f82a6612c
  3. Oil and Energy Trends, Vol 41, Issue 8
  4. https://ourworld.unu.edu/en/venezuela-the-emerging-energy-giant

 

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