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Challenges Ahead for Venezuela

What difference will the death of President Chavez make to the oil industry?
This article appeared in Vol. 10, No. 2 - 2013

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Source: José Cruz/ Agência Brasil Oil prices did not react sharply to the news that Venezuela’s President Hugo Chavez passed away in March after 14 years in office. Now an election will be held within 30 days and there is considerable uncertainty. Short term, growing political unrest in Venezuela could drive oil prices higher as the global supply/demand balance is still tight. Longer term, however, the new regime will hopefully ensure that the country fulfills its enormous potential and produces more oil. Although this may help to dampen sharp upward movements in the oil price in the long run, there is a long way to go.

One important reason why the president gained domestic popularity is the massive use of oil money to boost public spending and provide heavily subsidized fuel for the population. Chavez also gained regional approval as Venezuela provided a significant amount of crude oil and refined products to its neighboring countries at below-market prices and has a separate supply agreement with Cuba.

Venezuela’s Economy Highly Exposed

Oil accounts for around 97% of the country’s total exports and the popularity of Chavez benefited from high oil prices in recent years, but this came at a cost. The expensive public spending programs redirected money away from the oil industry. Venezuela has reportedly the largest oil reserves in the world, with proven oil reserves at the end of 2011 of 296.5 Bb, compared to Saudi Arabia’s 265.4 Bbo and Canada’s 175.2 Bbo (BP). Nevertheless, the country’s oil production has dropped by 22%, due to mismanagement, natural declines from mature fields and lack of investment since Chavez came to power in 1998/99. Now the country needs an oil price of more than the current US$110/barrel to balance its budget, versus US$70/barrel just six years ago. High and increasing oil prices have so far compensated for the decline in oil exports.

The country’s dependence on oil makes the economy highly exposed to a sharp fall in oil prices, which in turn could put political stability under pressure. Chavez has contributed to keeping prices high by not maintaining investment and production. Through the declining production in Venezuela, the oil market has become tighter.

The death of Hugo Chavez can become a game changer for the Venezuelan oil industry in the longer term if the new president opens up the oil industry. When Chavez took control of the industry, several oil companies withdrew from the country. A new president might attract more foreign investors, lead to a new opening to the international market and help PDVSA ramp up production once again. The changes will not happen overnight, but increasing the country’s production capacity will help to balance the global oil market in the long run. In the meantime the country will be a price-taker and remain dependent on its fellow OPEC members to balance the market to support the oil price. OPEC’s unofficial oil price target is US$100/barrel.

Challenge from US Shale Oil

Venezuela will also face new challenges going forward. The country’s conventional crude oil is heavy and sour by international standards. As a result, much of its oil production must go to specialized domestic and international refineries. Today 40% of the country’s oil exports go to the US, but with increasing shale oil production there we expect US import needs will fall in the future. Venezuela needs to find new buyers for its oil. One of the fastest-growing destinations of Venezuelan crude oil exports has been China. In 2011, China imported 230,000 barrels of crude oil a day from Venezuela, up from only 19,000 barrels a day in 2005 (EIA). We expect to see more Venezuelan barrels moving eastward in the future.

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