Venezuela Sells, but Who’s Buying?

The staggering collapse of the oil industry and the economy in Venezuela has left the country in a humanitarian, institutional, and political crisis like no other in recent history. The reasons behind the country’s oil crisis are well documented: a combination of years of underinvestment, operational mismanagement, and frequent expropriations. Baker Hughes’ data indicates that Venezuela did not have a single oil rig in operation during June – unprecedented in the country’s 100+ years of oil history. Production reached 570 thousand barrels per day (kb/d) in May, the lowest level since the 1940s; preliminary reports for June indicate an even lower figure: 280 kb/d.

As we find in a recent working paper, U.S. economic sanctions and lower oil prices only recently contributed to the existing oil crisis. Sanctions minimized the commercial and financial operations PDVSA, Venezuela’s national oil company, leaving few alternatives to export oil or import critical supplies for the industry. With limited oil storage, PDVSA has been forced to shut down several wells. We also found that a low oil price scenario threatens the output of around 85% of heavy crude oil as they have operating costs between $10/b and $20/b. Overall, oil export revenues could be anywhere between 1.5 and 4 billion dollars for 2020, a small fraction of the 93.5 billion Venezuela received in 2012.

Venezuela’s oil woes also affect the domestic energy market, which suffers from a chronic shortage of gasoline, diesel, and natural gas. Years of under-investments and poor maintenance minimized the capacity of domestic refineries. PDVSA sold fuels with massive subsidies under which it could not recoup operation costs. At one point in April, less than 10% of gasoline stations in the country were open. Shut-down oil wells reduce the natural gas supply used to feed power stations. Over 90% of the population that relies on propane for cooking face persistent shortages.

These problems in the energy sector are just a glimpse of the overall state of the country, where high inflation levels and a dramatic fall in economic activity have persisted for several years. COVID-19 hit Venezuela when the health and basic service infrastructure was already crumbling. Meanwhile, the number of protests registered by local NGOs surpassed 1,000 for the month in May, most of them related to public services.

If there is one element that all sectors in Venezuela can agree on right now is on the need to reform the country’s oil and gas industry. On one side, the Maduro regime has reversed some of the policies enacted by the Bolivarian Revolution. A heavily promoted barter operation with Iran to import gasoline and refinery supplies provided an opportunity to partially adjust some of the fuel subsidies that became a staple in the national energy policy. A two-tier system was introduced: each citizen can purchase 120 liters per month at a 2 cents per liter price while any additional consumption is priced at 50 cents per liter. While this system creates arbitrage or corruption opportunities and it will be unsustainable in the long-term, the second tier price constitutes a significant price adjustment.

Additionally, a commission created to restructure PDVSA recently proposed sweeping reforms to: 1) reduce the company’s share in most joint ventures; 2) offer more attractive fiscal and contractual terms for potential investors; and 3) liberalize activities long reserved to the State such as refining and oil transport. These initiatives to attract investors, however, could fail as the Maduro administration has a terrible track record of expropriations, economic sanctions will likely remain in place, and they lack the legal support from the National Assembly.

On the other side, Venezuela’s interim government and the National Assembly have also called for large international investments in the oil and gas. PDVSA’s ad-hoc board presented a plan to mobilize $99 billion in foreign investments to increase oil production to 3 Mb/d in 8 years. The parliament introduced short-term reforms to the current Hydrocarbons Organic Law (HOL) that, in the scenario of a political transition, would immediately reduce PDVSA’s grip on operations and provide better fiscal terms for companies. In parallel, the main political parties and stakeholders have discussed a long-term overhaul that would include a new HOL with institutional, fiscal, and contractual reforms. These reforms follow the patterns seen in Brazil or Mexico and seek to improve the oil and gas sector’s attractiveness for investors. These initiatives could have broad legal and political support but they could only be enacted after a political transition, an elusive target so far.

Despite the interest in liberalizing the country’s oil and gas industry, international investors may not be in a rush to gain more acreage in Venezuela’s oil fields. Recovering Venezuela’s oil and gas industry calls for multi-billion-dollar investments spanning several decades. The more mature fields would need to rebuild the existing infrastructure, which can be expensive. As the political standoff drags on, there is little clarity on the conditions that will rule such projects in 10, 20, or 30 years. Even more uncertain is what type of political resolution will arise from the conflict, or how stable the government will be. As we explain in this paper, many factors hamper a potential political solution, including multiple conflicting interests, severe mistrust among actors, and interference by external geopolitical interests. A longer presence of Maduro in power, in an unstable political regime that fails to offer guarantees, will have an enormous cost for the country in terms of lost opportunities to attract investment.  International oil companies have not shied away from engaging authoritarian governments before, but they may have learned the lesson in Maduro and Chavismo’s case.

Even with an orderly political transition leading to a stable and attractive framework for international investors, Venezuela may struggle to mobilize investments back to the country. Climate change policies may reduce the longer-term need for the large oil reserves that Venezuela offers. The current COVID-19 pandemic has also created uncertainty about the long-term prospect for oil demand and could affect the timing and scale of investment for companies potentially interested in Venezuela. Finally, economic sanctions that drove companies away from Venezuela are not guaranteed to be lifted anytime soon.

Despite these challenges, the oil and gas industry will still be central to any economic recovery plan for Venezuela. The country’s history and the sheer size of its oil and gas reserves are hard to ignore. But it would be wrong to assume that massive oil and gas investments can “save the day”. Policymakers need to reevaluate their expectations in terms of international oil companies’ interest in the country, as well as the reforms needed to improve the country’s attractiveness. More importantly, the country desperately needs a vision of how its economy can diversify its revenue sources and what policies are needed to avoid relapsing into a dependency on oil and gas rents. This may be the most difficult challenge yet.

This post originally appeared in the Forbes blog on July 8, 2020.