21-05-2018

Venezuela’s slump, Iran sanctions, oil prices

Global oil supply will break through the 100 million b/d mark for the first time later this year. Producers the world over, through innovation and risk-taking, have invariably contrived to meet the unstoppable train that is demand growth.

The general upward progress, though, has been punctuated by wild fluctuations in the fortunes of some producing countries. Venezuela is today’s prime example, architect of its own demise.

A country blessed in resource, Venezuela’s 267 billion boe of remaining oil and gas reserves, much of it heavy oil, is behind only Russia and the USA in global rankings. A decade ago, Venezuela’s output was 2.6 million b/d, third in OPEC behind Saudi Arabia and Iran. Today it’s eighth, after five years of decline.

Production was just under 2.0 million b/d last Q3, but has hit the skids in the last six months, plummeting by 0.5 million b/d. Current output is around 1.4 million b/d and we forecast end-2019 output at 1.2 million b/d.

At that rate, Venezuela’s reserve life is a fantastical 600 years, multiples more than Iraq, Iran, Saudi Arabia or even Qatar.

The reasons for the rapid decline are threefold:

lack of investment and maintenance on mature, legacy conventional light oil projects in the Maturin and Maracaibo Basins;
operational difficulties at heavy oil upgraders that deal with 0.5 million b/d of production;
and limited access to the diluent needed to facilitate transportation.

Traders are not prepared to risk bringing these lighter liquids into Venezuela for fear of not getting paid.

What are the ramifications of Venezuela’s oil crisis? First, the country’s own parlous economic position.
Dollar revenue garnered from crude exports has dwindled from the IMF’s estimate of US$32 billion in 2017. Substantial volumes of crude sales are dedicated to loan repayments to China and Russia or ‘soft’ oil for food/medicine deals. There’s insufficient hard currency to pay for imports of the nation’s basic needs, and as a result, the country is leaking people to its neighbours.

The election on May 20th is a critical moment. A priority for the new government has to be to revitalise the golden goose and rebuild the nation’s income from oil and gas. External capital will be needed and the bargaining chips are the giant remaining reserves. But the pool of potential investors is tiny and has a strong negotiating position.

Second, US refining.
The US Gulf Coast is a core market for Venezuelan heavy crude, and it’s been toughest going for the high-conversion refineries configured to process Venezuelan grades. But the overall, impact has been less than expected. There’s plenty of oil around right now, and refiners have sourced alternative heavy crude from Mexico, where domestic demand has faltered, Canada, Colombia, and Iraq.

The ongoing risk for these refiners is continued decline in Venezuelan exports, which would increase the scarcity of heavy crudes, narrow further heavy/light spreads and squeeze margins.

Third, the oil price.
Venezuela’s loss has benefited all other producers, with the leap in Brent from US$50/bbl to more than US$70/bbl mirroring the slump in exports. We’ve regarded the price rally as a short-term squeeze that is alleviated by the surge in new supply from the US coming onto the market into 2019, assuming a shallower rate of decline in Venezuela. We have forecast global supply growth to exceed demand growth by 0.5 million b/d next year, leading to inventory build and a softening price.

Iran changes all that.
There is a risk that US sanctions take 0.5 million b/d of Iranian exports out of the market by year-end, wiping out the supply ‘cushion’. This shifts the outlook for Brent to our ‘Upside risk case’ of US$74/bbl in 2018 (from US$69/bbl) and US$70/bbl (US$64/bbl) in 2019.

The arithmetic for a balanced market is far more challenging if Venezuela continues on its rapid decline rate. That would not only tighten fundamentals, but also make the market even more vulnerable to the potent geopolitical cocktail currently feeding sentiment. It’s a turn of events that would push oil prices higher still, and likely prompt OPEC and Russia to end their production accord.

Source: Wood Mackenzie

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