There is no question that Maduro is doing all he can to fight to hang on to power. No one knows when (or some still say if) there will be regime change, but we believe the end is closer than most expect because Maduro has dwindling financial assets and cash flow to fund his fight. We outlined this dwindling financial position in our Feb 6, 2019 blog “Part 1 – Maduro Looks To Have Pulled And Whiffed On His 3 Big Levers To Stay In Power” [LINK]. Today’s blog is a followup. There will be an oil supply interruption in any regime change. No one knows how long that will last, but today’s blog outlines why we see that interruption period being minimized given the domestic conditions and the US led international financial support to give Guaido a chance to implement his restoration plan. Most importantly, Guaido recognizes that PDVSA has to be the engine to fund his restoration of Venezuela. Ultimately, the length of oil supply interruption will depend on Guaido’s ability to attract big international oil capital and we believe Guaido has a game changer to do so. The key reason for today’s blog was an overlooked Feb 4 Bloomberg story that noted this game changer – Guaido says PDVSA doesn’t have to be >50% in any joint venture. By removing the >50% rule, Guaido is eliminating one of the two key reasons why big international oil companies avoid some countries – they don’t want the NOC to be operating and have control by having more than 50%. The other big holdup is always government take and we have to expect that Guaido will be having a reasonable government take in light of his need to get oil production growth to provide cash flow. Guaido may not be able to stop an oil supply interruption, but he and Trump are doing all they can to minimize the length of an interruption.
A regime change to Guaido will inevitably cause an oil supply interruption. Venezuela’s oil production is the key to Guaido’s ability to rebuild Venezuela. But it is inevitable that a regime change to Guaido will cause a production interruption. It doesn’t’ make a difference where and when a regime change happens in an oil producing country, there is always an interruption in oil supply and therefore oil exports. How long an interruption and how consistent the production recovery/growth depends on a wide range of key factors, some of which include (i) damage or state of disrepair level of oil infrastructure (ie. if it’s been a war torn situation or if its neglect), (ii) damage or state of disrepair to required supporting infrastructure (ie. electricity grid), (iii) formal international recognition of the new regime to immediately provide for international transactions, unfreezing of offshore assets (ie. gold/cash), (iv) international support for Guaido to deal with the massive Venezuelan debt in some sort of debt restructuring deal. (v) people support, are the people unified in their support for change, (vi) will Guaido have the ability to allocate limited cash flow and resources to country restoration instead of continued internal peacekeeping, (vii) the number of former PDVSA employees that return to Venezuela, and (viii) the ability to attract big international oil company capital.
Libya Regime Change And Oil Supply Interruption
Source: Bloomberg
Iraq Regime Change And Oil Supply Interruption
Source: Bloomberg
The state of disrepair of the PDVSA oil and gas business is unclear given the years of a lack of capital and people. This is the wildcard – what is the true state of disrepair of the PDVSA oil and gas operations. We know that production is going down, refineries/upgraders are operating at low capacity levels, and ports have been damaged. There has also been a rash of electricity grid problems and electricity is needed to power the oil industry. A lack of capital means that PDVSA has been scrambling to do what they can with little capital. It won’t be as simple as going back in to restart a well. There have even been multiple stories of people stealing tools and equipment from well sites to buy food. We would expect there are hundreds of examples of wells needing a new pump, or a sand clean out or some other routine well maintenance that has shut in wells due to a lack of capital. But what we haven’t seen over this period are reports of deliberate damage or sabotage on oil infrastructure. Rather, the oil industry story seems neglect due to a severe lack of capital and not destruction ie. its more a state of disrepair than a state of destruction.
A key requirement will be to get people to come back to Venezuela to fix and grow the oil industry. This expected regime change seems different many in the past because it seems like there will be a united Venezuela between Guaido supporters and many who were probably reluctant Maduro followers. And it doesn’t seem as of yet that a regime change will bring a period of domestic fighting and conflict like has been seen in Libya since the fall of Gadaffi. And if Guaido can attract big international oil capital, these conditions would seem to set the stage for a mass return of population to Venezuela. The UN Refugee Agency estimates over 3 million (10% of the total population) have fled in the past four years. This would have included a wide range of PDVSA people, including key oil engineering and production people who likely had more mobility. Getting these key PDVSA people back will be a critical factor in Guaido’s ability to return Venezuela to oil growth. We believe a key factor will be if Guaido is able to attract big international oil capital.
Trump looks like he is going to continue to make Maduro’s cash flow squeeze even worse. This would have been in our Feb 6 blog, but its new since then. The US is reportedly looking to effectively eliminate all or most Venezuela oil exports. Post the recent US PDVSA sanctions, Venezuela has been trying to move former oil exports to the US to other markets ie. India and China. The US continues to remind countries to not support Maduro. In response to the Bloomberg story “Venezuela Oil Czar Courts India After $20 Billion Hit from U.S.” [LINK], US National Security advisor Bolton tweeted this week [LINK] “Nations and firms that support Maduro’s theft of Venezuelan resources will not be forgotten. The United States will continue to use all of its powers to preserve the Venezuelan people’s assets and we encourage all nations to work together to do the same.” Then last night’s Bloomberg’s report [LINK] that “the Trump administration is considering blocking foreign entities from dealing with Venezuela’s state oil giant Petroleos de Venezuela SA as a possible next step as it seeks to choke off President Nicolas Maduro’s power” If this happens and he puts the foreign entities on the same foot as US entities, this is huge. (i) It could drive India and China refineries away from taking the PDVSA crude. This would be big to squeeze Maduro for effectively any oil export revenues, not just losing export revenues to US. This could squeeze all export revenues or at least exports to any foreign entity that is fearful of US sanctions impact. We assume it means that the foreign entity can buy Venezuelan crude but the money has to go into the restricted accounts set up by US so the money doesn’t go to Maduro but held for Guaido. (ii) It would also mean that countries are worried about US sanctions wouldn’t send diluent/naptha to Venezuela that it needs to blend with its heavy oil to make it light enough to flow in pipelines to reach ports for export and to meet the buyer refinery oil quality specifications.
But Trump, in particular, has also been doing all he can to lead international formal recognition and the ability for Guaido to control offshore assets and oil cash flow. The international factors determining the length of interruption are just as important and the US led efforts are putting in place the formal recognition and logistics to minimize the interruption period for international flow of funds, banking approvals and control of offshore assets. Trump was instrumental in leading a wave of countries formally recognizing Guaido as the legitimate government. Banks are refusing to ship offshore gold or cash to the Maduro regime, rather are reportedly saving for Guaido. The US (and we suspect others) have set up formal accounts to for transactions with Venezuela, with the accounts being held for the Guaido regime. This international financial support will be critical for Guaido to get control of Venezuela’s cash, gold and financials assets (especially offshore) as soon as possible.
Most importantly, Trump looks to be looking at making sure Venezuela’s debt doesn’t keep Guaido stuck from taking action. We believe one of the key restricting factors for Guaido is how to deal with Venezuela’s debt or else he will get stuck from implementing his program to restore Venezuela. The big news from last night’s Bloomberg report is that Trump is considering “an executive order that would protect the country from its creditors as it restructures debt, similar to one that helped Iraq in 2003 after the fall of Saddam Hussein, according to McCaul and two people familiar with the matter.” We believe that Trump realizes something like this is required to ensure the restoration plan and would be the key support factor for to Guaido in his need for a quick rebuild of the oil sector. As noted in the earlier graph on Iraq oil supply interruption from regime change, the data shows how the US support of Iraq allowed for a consistent return of oil production as opposed to an up and down as seen in other regime changes.
With people returning and control of financial assets/transactions, the interruption comes down to a return of oil capital and Guaido has a game changer to attract capital from big international oil companies. Guaido plans a game changer to attract big international oil company capital – PDVSA doesn’t have to be >50% in its deals. The driving force for our Part 1 blog on Feb 6 and today’s blog was an overlooked Bloomberg terminal Feb 4 story “Guaido U.S. Envoy Vows to Open Oil Deals, Restructure Debt”. Bloomberg wrote “Venezuela’s government-in-waiting intends to scrap requirements that state-owned oil giant PDVSA keep a controlling stake in joint ventures as it seeks to revive the oil sector and encourage private investment, National Assembly leader Juan Guaido’s representative to the U.S. said. The move is part of a broader plan by Guaido, who was declared interim president by the assembly last month, to revive Venezuela’s shattered economy by focusing on boosting oil output as soon as possible, said Carlos Vecchio, Guaido’s envoy in the U.S. Currently, PDVSA must have a 51 percent stake in all joint projects.” By removing the >50% rule, Guaido is eliminating one of the two key reasons why big international oil companies avoid some countries – they don’t want the NOC to be operating and have control by having more than 50%. To be fair, the big international oil companies generally don’t want anyone else to operate. But having PDVSA being >50% is a non starter for most big international oil companies. The other big holdup is always government take and we have to expect that Guaido will be having a reasonable government take in light of his need to get oil production growth to provide cash flow.
The size of the prize (return oil production to prior levels) should attract all big international oil companies. We believe removing the >50% PDVSA ownership is a game changer to attract big international oil companies with their deep pockets. The size of the prize is big – Venezuela oil production is down ~1.4 million b/d in the past 3 years due to the lack of capital and we have to believe the oil industry sees the potential to add back over 1 million b/d from low hanging fruit in a short period ie. 3 to 5 years with the return of capital and people. This isn’t like Colombia was in the 2000’s when mid sized producers could lead the charge to increase production by 0.1 to 0.2 mmb/d over a 5 year period. In this case, Venezuela likely wants to add 1 to 1.5 million b/d with 3 to 5 years, which Guaido must know will require big international oil company capital. Growth of this magnitude can’t be led by mid sized producers. There are a number of other attractive features post a regime change that would make it attractive for the big international oil companies, some of which are competitive advantage to the Gulf Coast market, all the biggest service companies have worked in the country, and access to top oil and gas people (assuming they come back to Venezuela).
Venezuela Oil Production – Maduro Elected April 2013
Source: Bloomberg
Trump/Guaido are in a win/win situation. Its a win /win for Trump to do all he can to support Guaido’s goal to increase oil production. It will be a big win for the US as increasing Venezuelan or Mexican heavy/medium into the Gulf Coast should move to widen the differentials (make Maya crude and other heavy oil equivalents cheaper relative to WTI), which will be a plus to Gulf Coast refineries. The Maya less WTI diff narrowed over the past 18 months as PADD 3 imports from the Venezuela and Mexico declined at a time when Cdn heavy/medium oil pipeline capacity to the Gulf Coast is full, and the only option fo incremental barrels being crude by rail. Increasing Venezuelan crude to the Gulf Coast in size should take Maya less WTI diffs back to more normal bigger discounts. If Venezuela comes back, the days of Maya crude trading above WTI will be memory.
Maya/WTI Differentials Vs US PADD 3 Imports From Venezuela And Mexico
Source: Bloomberg
It will also squeeze margins for Cdn heavy/medium oil into PADD III if Guaido can return Venezuela to oil growth and push more oil into key Gulf Coast refinery markets. We have always believed Maduro staying in power is the best thing for Cdn heavy/medium oil as it just means a continuing deterioration of Venezuela’s oil production and exports into the US. And that creates more market opportunity in PADD III (Gulf Coast). Canada dominates US oil imports into PADD 2 (Midwest) because of the Enbridge mainline. But over the past five years, the declining Venezuela and Mexico oil production led to declining US oil imports from them into PADD 3, the key Gulf Coast refineries. Canada has stepped up to fill part of the void by filling all available pipeline space and lately by rail. The vast majority of any increasing oil under Guaido should be going to the traditional Venezuela export markets in the Gulf Coast. And any increasing Venezuela oil to PADD 3 is a negative to Cdn heavy/medium oil trying to compete in PADD 3.
US Oil Imports Into PADD 3 Gulf Coast From Venezuela + Mexico Vs Canada
Source: Bloomberg