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Venezuela Buys Oil to Meet Contracts

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A Sudden Plunge In Production?

Is Venezuela's oil production rapidly waning? One source reports that the world's fifth largest oil producer is showing signs of a rapid decrease in production, one of the key tenets of the peak oil theory.

Venezuela is buying oil from Russia in order to avoid defaulting on deliveries to clients. The situation raises serious questions about the country's oil production and the future of PDVSA as a major oil producer, and increases the risk to the U.S. oil supply should the country's oil production suddenly plummet.

According to the Financial Times: "Venezuela, the world's fifth-largest oil exporter, has struck a $2bn deal to buy about 100,000 barrels a day of crude oil from Russia until the end of the year. Venezuela has been forced to turn to an outside source to avoid defaulting on contracts with "clients" and "third parties" as it faces a shortfall in production, according to a person familiar with the deal. Venezuela could incur penalties if it fails to meet its supply contracts."

The news has so far been very much inside baseball, as it has not made the mainstream, due to competition from more sensational stories such as the illegal alien marches, and the media's obsession with oil company profits.

But, as these things go, we may be on the verge of a major developing story.

Are There More Irregularities Hidden Inside PDVSA?

PDVSA is a center of financial and political intrigue, as it is the hub of Mr. Chavez' political ambitions. The Venezuelan government uses the proceeds from oil sales to finance Chavez' Bolivarian revolution, in essence the spread of the hybrid Socialism espoused by Chavez and Fidel Castro.

Yet, despite the secrecy, over the last few years numerous questions have been raised, not just about PDVSA's actual oil reserves and production capacity, but also about PDVSA's finances.

In 2005, we wrote about "Venezuela's oil receipts," and the significant questions being raised, including a "shortfall in PDVSA cash deposits to Venezuela's central bank" of "perhaps by as much as $2 billion."

The trail of that story grew cold, but the questions did not. In fact, little has changed. In 2005, we reported that the alleged shortfall was "not totally verifiable, since PDVSA has not filed papers with the SEC in at least two years."

Indeed, no one really knows what PDVSA's books really hold. As we reported recently, Venezuela is no longer going to report PDVSA's finances to the U.S. Securities and Exchange Commission.

The Times article confirms several points we made in May 2005 in our Marketwatch.com article, titled "Running on empty."

In the article we noted: ["Stratfor.com estimates that since Chavez became president, starting in 1998, "PDVSA has lost about 1.5 million bpd of its net crude oil production." The main reasons have been the replacement of capable engineers and workers who disagreed with Chavez's revolutionary views, with inexperienced, and in many cases incapable replacements, and the lack of attention to infrastructure maintenance and improvement. The result of the bad management and neglect, has been the steady erosion and near incapacitation of a major oil-producing region of Venezuela, the Western portion of the country, where as many as 10,000 wells have been estimated to have been rendered mostly useless. Venezuela is nominally the world's fifth largest oil producer."]

One year later, the Times reports: "The move suggests a growing gap between Venezuela's declining domestic output and its expanding contractual obligations to international customers."

According to the Times quoting "Under President Hugo Chávez, PDVSA's oil output has declined by about 60 per cent, a trend analysts say has accelerated in the past year because of poor technical management."

In our article Marketwatch article we suggested that Venezuela had a "potential inability to meet delivery of its oil contracts." Now, the Financial Times notes that "Mr Chávez's push to extend his influence throughout Latin America and the Caribbean with promises of cheap oil for friends and allies may be overstretching PDVSA's finances."

In that article we asked: "If Chavez' own oil production is only 50% of what it is supposed to be, where is all the money going to come from to pay for all his revolutionary adventures?"

Two possibilities came to mind:

1. "First, is a massive asset liquidation, including U.S. bonds, and U.S. dollars."

2. "Second, is the specter of a Yukos-like nationalization of foreign oil company assets in Venezuela. Such a debacle would have huge ramifications across the oil industry, and could further increase the market's volatility, as it would put a big chill on global oil production and investment everywhere and increase the worry factor for international companies and the financial markets."

Interestingly, our predictions have already come partially true, since Venezuela has recently tightened the screws on foreign oil companies, renegotiating royalty contracts and raising taxes, prompting Exxon Mobil to essentially give up on its Venezuelan stakes, while others have reluctantly gone along.

Conclusion

The Venezuela oil purchase report is indeed landmark in our opinion, since it offers multiple possible lines of thought, not the least of which is the possibility that it is a sign of the peak oil phenomenon.

To be sure, Venezuela's government is increasingly adroit in the financial markets, as Mr. Chavez has reportedly shown interest in using PDVSA and his government in ways similar to hedge funds, by timing markets and moving assets rapidly from one arena to the other.

Thus, this could be a shrewd business move aimed at cutting transportation costs to some of PDVSA's clients.

That seems to be the party line. According to the Financial Times: "PDVSA would not confirm that it was buying oil from Russia but said a statement would be issued on Friday (April 28). The company said it would be "logical" that the Ruhr refinery was sourcing some of its oil from Russia because it would be cheaper than transporting it from Venezuela."

Yet, the other side of the coin, which must be given a fair airing, is that Venezuela's oil production is rapidly dwindling, or that at least Chavez' gifts to Cuba and other left leaning South American countries, in the form of hundreds of thousands of barrels of oil, are starting to take their toll.

If indeed some 10,000 wells are off line, and Venezuela's technical expertise is near rock bottom, then the latter is more likely.

Somewhere in the midst of those two extremes is the truth. Unfortunately for the oil markets, and perhaps the global economy, we are not likely to find that truth until it is upon us, or more likely, until it has been in progress for months to years.

One thing is certain, though. If PDVSA, and Venezuela are running out of oil, the news will eventually leak out, and the situation will gather steam, with significant consequences to follow.

Dr. Joe Duarte's Market IQ appears daily at Joe Duarte. Dr. Duarte is author of the book "Futures And Options For Dummies," which is available at the Rigzone Book Store.

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