Strange developments in Caracas continue to point toward a difficult time ahead for the U.S. oil supply, as diverse influences continue to move events toward an uncertain end.
Unrealistic fuel subsidies, external and internal, and the continuing alienation of global oil industry are combining to put Venezuela's government in a box, and threaten the U.S. supply.
Irony Rules The Roost
If the world's oil supply bean counters allowed Venezuela to fully account for its heavy oil, it would likely account for some 270 billion barrels, putting the South American country ahead of Saudi Arabia as the world's number one reservoir of crude oil by some 12 billion barrels.
The problem is that the bean counters aren't going to do any such thing, given the difficulty and expense of getting the sludge out of the ground, processed, and shipped to the handful of global refineries that could do something with it.
Meanwhile, according to Reuters, gasoline in Venezuela, due to heavy government subsidies, sells for 12 cents a gallon, the cheapest price in the world according to a recent report from the International Monetary fund.
According to Reuters: "In Venezuela, the world's No. 5 oil exporter, drivers fill their tanks for less than the price of a cheap breakfast, and love to point out that gasoline costs less than mineral water."
And the subsidies have been extended to other nations: "Flush with cash from high oil revenues, Chavez has also shored up regional alliances by providing low-priced fuel to Central American and Caribbean nations he says have been snubbed by the United States."
Yet, there is a potential backlash in the works, as some in Venezuela are concerned about the long term costs of the Chavez strategy. According to Reuters, some Venezuelan economists suggest that "Venezuela would have taken in at least an additional $8 billion last year -- almost 8 percent of the nation's GDP -- if Venezuelans had paid market rates for fuel."
Meanwhile, a significant black market has sprung up: "The subsidy also encourages rampant fuel smuggling to neighboring Colombia and leads to huge lines of Brazilian drivers waiting to fill up along the southern border."
Production At A Standstill
In a recent article, based on a report from the Financial Times, we pointed out the fact that Venezuela was buying 100,000 barrels of oil per day from Russia, in order to meet its obligations to other clients, and avoid default.
Now, according to Dow Jones Newswires, foreign oil companies, earlier in 2006, stopped drilling, exploring, and producing oil in Venezuela, as a response to the country's abandonment and renegotiation of previously standing contracts with the foreign companies.
According to the report, "Oil companies that recently saw Venezuela scrap operating contracts halted investments leading up to the contract change." Indeed, according to the wire service, citing industry documents, 32 oil fields showed production declines, as maintenance and drilling slowed, enough to "slow down production to 465,202 barrels a day in March, stable from February but down 7.8% from July."
The row involved several major oil companies, with mixed results, but significantly changed the playing field in Venezuela, where the Chavez government reversed deals made in the 1990s with the international players, and now gives PDVSA, the national oil company of Venezuela, a 60% stake in the newly developed joint ventures.
Some of the majors did not go for the deal, such as Exxon, Total, and Eni. According to Dow Jones, Total and Eni had oil fields seized by the government in April, with no compensation offered, essentially nationalizing the fields in a de facto manner.
Looking For Loans
More interesting is this, according to Bloomberg: "Petroleos de Venezuela SA, South America's largest oil company, may seek up to $20 billion in loans from international banks to help more than double oil production by 2012."
The report adds that PDVSA "is in the midst of a $70 billion investment program that aims to increase oil output to 5.8 million barrels a day by 2012, up from its current 2.6 million barrels a day. The Caracas-based company also plans to use the funds to build refineries and develop its natural-gas reserves."
Of the $70 billion, Venezuela is reportedly going to foot the bill for $70%, relying on "PDVSA partners" for the rest. PDVSA's 2006 revenues are projected to be $85 billion, with $45 billion coming from Venezuela based operations. PDVSA owns the Citgo refineries and gas stations in the U.S.
Venezuela's oil production continues to decrease, for multiple reasons, mostly political, while the country is swimming in heavy oil that few are interested in counting, or in taking huge risks to go harvest, due again, mostly to political risks.
The Chavez government continues to subsidize the energy needs of countries like Cuba, and Bolivia, among others, for political reasons.
Somewhere along the way, something will have to give.
The laws of the business Universe are clear. Entities can't continue to antagonize customers, run questionable accounting, and continually subsidize inefficient operations indefinitely.
Many businesses fail when they do one of those three things continuously. PDVSA seems to be doing them routinely, and has been doing them for a long time.
The results have been decreased production, significantly damaged infrastructure, and a great deal of mistrust from the global oil industry, and likely international lending operations.
If Venezuela needs $20 billion to fix, its mostly self inflicted oil infrastructure, no one that we know of, has stepped up to the plate as a potential lender, yet.
Meanwhile, Mr. Chavez has been floating the idea that he will conduct a referendum to see if voters want to keep him in office until 2031.
With gasoline at 12 cents a gallon, the big question for Venezuela drivers might just be, when do we start?
For the world's oil supply, though, the real question is how long can this kind of policy go on?
For the record, Venezuela's gasoline price has historically been subsidized. Attempts to raise prices toward market rates have met with significant amounts of social unrest.
If and when Chavez and PDVSA are squeezed enough to have to raise prices, life in Caracas could get oh so interesting.
Oil And Commodity Summary:
Crude oil was back above $72 a barrel, holding on to gains from 5-10, while gold moved steadily higher and looks ready to test the $710 area, as oil supply data and the Fed fail to change the market's perception of the ongoing global economy.
Crude oil supplies remained stable, and some 4.9% above last year's levels, while gasoline supplies rose a higher than expected 2.4 million barrels according to the U.S. Energy Information agency on Wednesday, as refineries cranked up production and are now operating at above 90% of capacity, the first time it had done so since December.
Supply data will become increasingly important now, as hurricane season nears, and the situation with Iran continues to fester, along with problems in Nigeria, and the ongoing struggle in Iraq.
Reuters reported that New York City residents have been told to prepare for a major storm this year.
Also important remains the fact that the damage to the Gulf of Mexico from last year's hurricanes remains significant. And although no one is saying it, it is possible that some of the infrastructure that was damaged will likely remain off line permanently, or nearly so.
As we noted in this space yesterday, the U.S. government's final report on the damage to the Gulf of Mexico from Hurricanes Katrina and Rita was grim.
According to the data, at www.mms.gov, some 20% of the yearly production of natural gas and crude oil from the Gulf was lost, while some 12% of the daily production of natural gas is still off line and some 20% of the U.S. oil production is gone.
The key in the near term is demand, as high gasoline prices seem to have finally started to affect driving habits.
Crude oil was trading above $70 in pre-U.S. trading.
As we've noted, the $60-$65 area is a reasonable support area for now with $75 offering resistance.
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