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Does Venezuela need to hit rock bottom to find oil recovery?

For months, the Trump administration resisted calls to sanction crude flows out of Venezuela, fearing the US would be blamed for the ultimate collapse of the South American nation’s once-mighty oil sector.

Venezuela’s oil industry was already teetering towards disaster – there was no need for US policy to push it off the cliff. By the time Trump administration officials unveiled sanctions on PDVSA, Venezuela’s state-owned oil company, in January, the country’s oil output had fallen below 1.22 million b/d, down roughly 800,000 b/d since President Trump’s inauguration and roughly half the level of production when President Nicolas Maduro came to power in 2013.

Since the sanctions were imposed, output has sunk further, dipping to a 16-year-low of 740,000 b/d in March, according to an S&P Global Platts survey. And if the US chooses to impose secondary sanctions, which they also have been considering for months, Venezuela’s oil output could fall to 500,000 b/d by the final quarter of 2019, according to S&P Global Platts Analytics.

Still, the Trump administration continues to stress that the decline is not due to US policy. “This is a problem that is seven years on,” US Secretary of State Michael Pompeo told reporters in April, pinning the blame squarely on Maduro.

The White House, which recognizes opposition leader Juan Guaido as Venezuela’s legitimate president, has said it will not lift sanctions on PDVSA until Maduro is removed from power, an outcome some have speculated may require military intervention as sanctions have yet to significantly weaken Maduro’s grip on the presidency.

But the White House is also wary of the damage a prolonged sanctions campaign could do to Venezuela’s oil industry, fully aware that the country’s success post-Maduro hinges on the health of its oil production and exports. The US has granted general licenses for some US companies in Venezuela’s upstream sector, allowing them to continue their work while sanctions are in place.

Under one such license, Chevron, Halliburton, Schlumberger, Baker Hughes and Weatherford International were authorized to continue work in Venezuela for at least six months. It also phased the sanctions in over time, although requirements barring direct payments with the Maduro regime created the ongoing, de facto ban on US imports of Venezuelan crude.

“Our sanctions are targeted in a way and they’re structured in a way to preserve the assets of Venezuela,” Francis Fannon, assistant secretary for the US State Department’s Bureau of Energy Resources, said in an interview with Platts in March. “We certainly don’t want to see them deteriorate.”

But getting Venezuela’s oil output back to the levels of just a few months ago, forgetting the 2 million b/d threshold the country held steadily above just a few years ago, could be a task measured in years, not months – and billions, not millions, of dollars. The potential rebuilding of the sector may also arrive at an inopportune time. Will investors be keen to return to Venezuela when US shale continues to shatter output records, at a considerably lower risk?

“When you think about the fact that it’s hard to get the majors to even think about investing in the Arctic or they don’t want to do Canadian oil sands, they’re not going to go back and do Orinoco,” Amy Myers Jaffe, director of the Council on Foreign Relations’ energy security and climate program, said in an interview. “That was even more expensive, and it’s in a foreign country with political risk. How realistic is it that these companies would plunk down billions of dollars to go into Venezuela to do heavy oil?”

Output in the Orinoco, which covers roughly 19,000 square miles in central Venezuela and is divided into 36 blocks within four exploration areas, saw an immediate decline following sanctions due to the US embargo on diluent exports to PDVSA. Diluent, specifically naphtha, is used in the production and transport of heavy oil out of the Orinoco.

“Problems range from shortages in diluent used to make the heavy oil exportable, operational issues at upgraders and processing facilities (exacerbated by recent power outages), and a once again disrupted export picture, impacted by the latest round of sanctions,” wrote Andrew Stanley, an assistant fellow with the Center for Strategic & International Studies, in a recent paper. “Absent of major investment and operational improvements (all tied to political change), things will likely deteriorate further.”

Ed Morse, Citigroup’s global head of commodities research, estimates that $20 billion is needed for repairs to Venezuela’s oil sector, including roughly $10 billion for cokers that can process the country’s heavy crude. “Where is that capital going to come from?” Morse asked. “No one knows.”

How to rebuild?

PDVSA-controlled projects at Lake Maracaibo in the country’s northwest and in the Maturin Basin in the east have already been plagued for years by a lack of maintenance and equipment mismanagement, and a steady deterioration of wells, refineries and ports. “Oil fields across the country suffer from a lack of everything – from operational rigs and equipment, to spare parts and experienced personnel for drilling operations,” Stanley wrote.

In addition, it remains unclear who will buy Venezuelan crude if and when US sanctions are lifted. For example, US Gulf Coast refiners have effectively eliminated roughly 500,000 b/d of Venezuelan crude imports. Will replacement barrels become more permanent as time passes? China remains a major export market for Venezuela, but most of the oil shipped there is used to pay down massive debt. India, which remains the last major cash market for Venezuelan crude, has committed to a significant reduction in imports.

The Guaido government has recognized that the most logical first step to resuscitating Venezuela’s oil sector is reversing many of the Chavez-era hydrocarbons laws which dramatically limited foreign investment in oil projects. Ricardo Hausmann, an adviser to Venezuela’s opposition government, said in March that the transition will include the creation of a new hydrocarbons law, which will allow private companies to both partner with PDVSA and to directly invest in oil and gas production projects. Companies with current investment arrangements in Venezuela’s oil sector will be grandfathered into the new system, Hausmann said.

But when that new system will begin or how, exactly, the transitional government will get there, remains unclear at the moment. The future of Venezuela’s chief economic engine depends, US officials have repeatedly said, on how long Maduro chooses to remain in power. With sanctions pressure increasing, Venezuela’s output continues to plummet as it loses available markets for its crude. But has Venezuela’s oil sector hit bottom? Time will tell.
Source: Platts

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