By John Auers and John Mayes
While developments in Venezuela have long been “top of mind” for global energy markets and particularly U.S. refiners, they have become particularly critical and worrisome over since President Maduro announced his intentions to hold Sunday’s vote for a “Constituent Assembly” to write a new constitution. The opposition, which boycotted the vote, has been holding non-stop protests against the ruling administration since the announcement as they fear that this new assembly would dissolve the existing Congress, cancel the 2018 presidential election and ultimately consolidate total power in Maduro. In an attempt to avoid such a development the U.S. government has been considering and threatening a variety of sanctions, including a potential restriction of all crude imports from Venezuela. While the vote took place on Sunday despite these threats, nothing has been resolved, protests have escalated, and uncertainty about what happens next in Venezuela is greater than ever. Among these uncertainties are how the Trump Administration will respond, with import restrictions still very much on the table. Today’s blog will focus on such a scenario, examining the potential impacts, especially those on U.S. refiners. One thing we know for sure, when it comes to the situation in Venezuela, the old CCR classic, “Bad Moon Rising” seems to very appropriately describe the near term future for that country.
“I See Trouble On the Way” – The Election and Aftermath
Even before the events of the last few days and months, Venezuela’s economy has been locked into a steady downward spiral. Low oil prices have added to the problems, which have been further compounded by performance issues in the industry – declining crude production and refinery operating rates. All of this has led to increasing unemployment, shortages of key consumer goods and out of control inflation.
As a result of the severe economic problems, the ruling Maduro Administration has lost support of much of the populace, including even a significant part of the lower classes, whose support allowed the ascension to power of former President Hugo Chavez. This led to a major election defeat of the ruling Socialist Party in the last elections for the National Assembly in late 2015, an outcome which the ruling government has tried to neutralize in a variety of ways.
The most recent attempt to consolidate power was the election for a “Constituent Assembly” to change the Constitution which was announced by presidential decree on May 1 and held this past Sunday. The opposition only accelerated their protests after that announcement, holding a competing popular referendum on July 16 and boycotting Sunday’s vote. The Trump Administration has also taken a strong stand against Sunday’s election, stating that it represented a line in the sand, and would lead to the death of democracy in Venezuela. In a preemptive strike, the U.S. imposed sanctions on 13 prominent Venezuelans on July 26 but threatened more severe actions if the Venezuelan governmental went ahead with the Sunday vote. There was no elaboration on the nature of the additional sanctions, but restrictions on petroleum product exports to Venezuela and more importantly crude imports from the country have been widely reported as being under serious consideration..
“Don’t Go Around Tonight” – The Threat of Sanctions on Venezuelan Crude Exports
Because of their magnitude, the strongest weapon President Trump could yield in his Administration’s attempt to get Maduro to move away from his attempts to consolidate power, would be restrictions on Venezuela’s crude exports. The most severe version of sanctions could take a form similar to the Iranian sanctions which made it very difficult for Iran to find takers for their crude in any part of the world. This would require the cooperation of other countries, including geopolitical opponents of the U.S. such as China and Russia. Both of these countries have stepped in to support the Venezuelan oil industry as Western companies have moved out and they are likely to continue to do so in the current environment.
A more likely and easier to implement step would be a temporary limit or ban on Venezuelan crude imports into the U.S. Due to their close proximity and configuration, U.S. refineries, particularly those on the Gulf Coast, are the most optimal destinations for Venezuelan crude. Also, despite attempts to diversify markets, the U.S. remains the largest destination for Venezuelan crude exports, accounting for almost half of the total. But wielding this “big gun” could also pose significant harm to U.S. refiners, precisely because of this magnitude and optimal fit within many refiners feedstock slates. As a result, the refining industry, along with other segments of the industry and even free market voices within the Administration have been lobbying strongly against import restrictions and so far have kept that option from becoming reality.
However things could very well change now that the election has been held and Maduro is moving “full steam ahead” towards a rewrite of the Venezuelan Constitution (and his likely installation as President for life). The State Department has roundly condemned the Sunday vote and announced yesterday that Maduro himself has been added to the sanctions list, only the fourth Head of State in that group (joining Assad, Kim Jung Un and Zimbabwe’s Magabe). What happens next and whether oil sanctions will be part of the response by the U.S. is anybody’s guess, but as the situation devolves in Venezuela that possibility is certainly growing.
I See Trouble on the Way” – Impacts of Crude Import Sanctions
The exact mechanism of potential crude oil import sanctions could take many forms. They could be phased in to reduce the negative impact on U.S. refiners or they could be imposed on a specific date. A phased approach would certainly be preferred, allowing time for impacted refiners to seek alternate crude avails.
The magnitude of the issue for U.S. refiners is certainly significant. Total crude imports from Venezuela have averaged just over 750 MBPD over the last four years and in the first five months of 2017 they were just a bit below this level at 720 MBPD. Almost all of this crude is heavy and over 95% was processed on the USGC. In fact, refineries in that region buy more heavy crude from Venezuela than from any other source, surpassing No.2 Mexico by almost 150 MBPD. The following table displays Venezuelan crude imports by refinery for the first four months of 2017.
It should be noted that it will not only be refiners that run significant quantities of Venezuelan crude which will be impacted, but all refiners which are geared for heavy crude. The dominant problem, even with a phased approach, is that there is a limited supply of heavy crude and incremental supplies cannot be made available quickly. The vast majority of non-Venezuelan heavy crude produced in the Western Hemisphere is already flowing to the U.S. and much of the rest is committed to customers for some period of time.
Logically potential crude sanctions would lead to a rebalance of the global heavy crude supply. To the extent possible, Venezuelan crudes formerly sent to the U.S. would be redirected to other markets, primarily Asia and to a lesser degree Europe. The displaced volumes from those markets could then be directed back to the U.S. In the short term, replacements for Venezuelan imports would have to come from significantly further afield, most likely from the Middle East, which is problematic considering quota related cutbacks of the heavier grades. These non-optimal trade flows would lead to higher crude costs to U.S. refiners and also result in higher product domestic product prices.
The negative impacts would decrease as more non-Venezuelan Western Hemisphere heavy crude becomes available to for U.S. refiners. Several MBPD of heavy crude from Mexico, Colombia, Brazil and other Latin countries does go to markets in Asia and Europe currently and could be diverted back to the U.S. as contractually possible. Also, some projects in the Canadian oil sands are due to start up in the coming months, the largest of which is Suncor’s Fort Hills expansion. This project is to slated to begin production in 4Q2017 and should reach almost 200 MBPD within 12 months. However, while heavy Canadian output will soon increase, getting these incremental volumes to U.S. refiners is another matter. There is currently a small surplus of total exit pipeline capacity from Western Canada, but the current heavy balance is very precarious. It is highly likely the incremental Fort Hills output will fully constrain the existing heavy system. This would be a significant problem in most circumstances but could become more severe if Venezuelan imports are restricted. It would certainly provide additional stimulus to the Keystone XL pipeline and other proposed pipeline projects.
“One Eye is Taken for an Eye” – Impacts on Venezuela
The potential impact on Venezuela of crude sanction will be substantial. While it could be assumed that a rebalancing of the global heavy supply would simply realign Venezuela’s customer list and its revenue would remain relatively constant, there likely will be a significant impact on cash flows. Sales to the U.S. generate substantial cash revenues for Venezuela, with more attractive netbacks as a result of lower transportation costs. A loss of these customers may result in sales being redirected to less solvent customers or to the Chinese for loan repayments which would generate little or no incremental cash flows. It should be noted that while Venezuelan crude production has recently declined from 2.5 million BPD to 2.0 million BPD, sales to the U.S. have remained flat.
Estimates of crude oil production in Venezuela vary because of a lack of trust in Venezuelan reporting. The EIA estimated production at 2.5 million BPD in 2013 through 2015. As the level of unrest escalated, the EIA estimated 2016 output declining to 2.3 million BPD with February and March 2017 pegged at slightly under 2.1 million BPD. If these estimates are correct, they indicate that U.S. imports represent 35% of Venezuelan crude oil production.
Even as the debate continues, the situation in Venezuela deteriorates. Whether crude oil sanctions become the next weapon depends on many factors. While sanctions of this type would normally be considered an extreme measure with significant negative impacts on the U.S. as well, the Trump Administration may have significant motives in acting decisively. Battered and bruised by the apparent loss in the health care debate, new and more severe sanctions on Venezuela could redirect attention back to foreign policy issues and create a more positive image of the Administration. With the ongoing shakeup in the Administration anything is certainly possible.
Turner, Mason & Company follows and analyzes all the critical factors impacting global and regional oil markets. War, strife, political unrest and other international developments can play key and sometimes defining roles in the markets particularly as they impact crude supply and trade flows. While it is impossible to predict what will happen in Venezuela, the Middle East, North Africa, Russia and other key “hot spots” around the world, it is possible to analyze the effects of given scenarios. Our analysis of these impacts has become an important part of our overall consulting practice and our industry studies. We are currently in the process of finalizing our next editions of the Crude and Refined Products Outlook (C&RPO) and the Worldwide Refinery Construction Outlook (WRCO), both of which are scheduled to be released very soon. In both of these studies we have considered what is happening in Venezuela and around the world and provide a comprehensive forecast of supply, demand and pricing for both crude and refined products. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting either one of us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898.