The Effects of the Venezuela Sanctions Relief: Q&A with Francisco Monaldi

The Effects of the Venezuela Sanctions Relief: Q&A with Francisco Monaldi

Opportunitas Advisors

October 27, 2023

On October 18, 2023, the Office of Foreign Assets Control (OFAC) of the United States Department of the Treasury issued four temporary general licenses authorizing transactions involving Venezuela’s oil,gas, and gold sectors. These licenses also lifted the prohibition on secondary trading of bonds. This sanction relief is in direct response to an agreement signed between the Venezuela Unitary Platform and representatives of the Maduro regime earlier this month, after months of negotiation.

We asked our Senior Advisor, Francisco Monaldi, to provide insight into the impact of these measures. Monaldi, an expert in energy and oil policy in the region, is the director of the Latin American Energy Program at the Baker Institute for Public Policy and a professor of energy economics at Rice University.

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1. What is the practical effect of the U.S. announcement regarding sanctions?

It is essential to understand that the fundamental impact of this sanction relief relates to redirecting Venezuela’s oil exports, which currently flow into the black market, primarily to China at a significant discount. As revealed by the PDVSA corruption scandals in early 2023, which led to the arrest of more than 50 individuals, these types of exports are not only sold at discounts of up to 40%, but they also face significant challenges, in terms of payment and substantial losses in accounts receivable recovery. All of this indicates that redirecting these oil exports to the Gulf Coast of the United States, in Texas and Louisiana, which are natural markets for Venezuela, will result in a significant increase in government revenues. This means that they will be paid in full, and the funds will be converted into cash, relatively quickly compared to black market exports. This has a direct economic and macroeconomic impact. While the impact will not be immediate, as it cannot be executed overnight, in a few months, oil exports should be redirected to the U.S. It’s worth noting that already 150,000 barrels per day are heading to the U.S. through Chevron’s exports. So, that market has already begun to receive Venezuelan crude oil again.

 

From the perspective of a production increase, this license will not be significant in the short-term, as much of the production set for the next year is independent of this license, and will occur under [a separate] one granted to Chevron last year. This will result in an increase of approximately 100,000 barrels per day over the next year and a half.

 

It is possible that European companies which were already seeking licenses, such as Eni, Repsol, Maurel & Prom, and Perenco, may invest, but I don’t believe they will do so in substantial amounts until they have their own license and a new contract signed with PDVSA, similar to Chevron’s. A six-month license as provided in the sactions relief announcement does not provide the necessary guarantees, in terms of the timeline for making these investments, so we’ll have to wait and see if other authorizations are granted in parallel. If that happens, there could be another production increase of around 70,000-80,000 barrels per day over the next year and a half.

 

Finally, there is the question of what China will do. China currently has a project producing around 100,000 barrels per day, and it could reach a maximum capacity of about 200,000 barrels per day. But we’ll have to see if the Chinese will take advantage of this license, which also allows them to import directly to CNPC, the Chinese state-owned company’s refineries, without going through the black market. We’ll also have to wait to see if they will invest enough to double their production. Some investment will undoubtedly occur, but significant investment might be postponed until there is more clarity on the renewal of these licenses.

2. What does this mean for foreign investment in these sectors in Venezuela in the short-term?

Fundamentally, this does not substantially change the prospects for foreign investment in the short term, as companies would need a license similar to Chevron’s to feel more confident, or wait until these general licenses have a longer time frame than 6 months. What may happen is that European companies will make investments in their oil projects, but this will take some time, and I would only expect it to happen if they have a license and a contract with PDVSA, similar to Chevron’s. As for the Chinese, the key is to understand if they will take advantage of this. I believe it’s clear that they will, in terms of exports, but regarding significant investment in their projects, I assume they will wait for the 6 months to lapse and see how the general license situation evolves.

 

Finally, it’s important to understand that PDVSA still operates a significant portion of Venezuelan production, about 50%, without partners. However, it is unlikely that PDVSA will make significant investments in these fields in the coming months because Maduro has every incentive to extract every last dollar from PDVSA to spend on election-year priorities. Additionally, the benefits of an investment in PDVSA would take some time to materialize, and for the government, the most important thing right now is to use the cash for electoral purposes.

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3. What impact could this decision have on oil production over the next year and on Venezuela's foreign currency revenues?

In terms of the impact on oil production, considering everything, we have a scenario in which Chevron’s production increases by around 100,000-110,000 barrels per day, over a period of one to two years, perhaps closer to one year. European investments could add between 70,000 to 80,000 barrels per day over a two-year period. This would result in approximately 200,000 barrels per day from Western companies. The Chinese could also increase by 100,000 barrels per day, but that depends on whether they invest with this license.

 

The maximum I see in the next two years is an additional 300,000 barrels per day from joint ventures. It’s difficult to estimate how much additional production PDVSA will achieve on its own, but I would say it’s a small amount. PDVSA has struggled to maintain its current production, so I assume it will be less than 50,000 barrels per day. Considering all these factors and the various obstacles, it’s challenging to imagine an increase of more than 300,000 barrels per day over the next two years.

4. Could PDVSA replace oil sales to China with sales to the United States in the short-term? How much could this represent in incremental revenue?

The significant advantage the United States has as a market is that Gulf Coast refineries were designed to process heavy crude oil. As Mexico and Venezuela, the major suppliers of heavy crude, have reduced their production, these refineries have had spare capacity and have had to import products from other parts of the world to replace it. They had partially replaced Venezuelan crude with Russian production that they can no longer import. Therefore, there is a significant appetite for Venezuelan crudes on the Gulf Coast, and it is expected that there will be a substantial capacity to redirect exports from China to the U.S. Obviously, this won’t happen overnight, but we would anticipate a significant increase in what is currently being exported, which is 150,000 barrels exported by Chevron. I don’t believe the total exports to the U.S. will exceed 500,000 barrels per day.

5. What is the effect of this measure on the international oil market, particularly considering the situation in the Middle East?

In terms of the international market, I believe the effect will be minimal because Venezuela can, at most, add 300,000 barrels per day, and the relevant factor is how much additional production there is, not how much is redirected from one market to another because the price of oil is determined in the international market. So, if Venezuela adds 300,000 barrels per day but takes two years to do so, it’s a drop in the bucket compared to the more than 100 million barrels consumed in the market every day. In summary, it does not appear to have a significant effect, and in fact, the announcement of the license has not had an impact on market prices in recent days.

 

In the long-term, if the license is renewed, and the situation in Venezuela stabilizes, there could be a greater increase, but that is not relevant to the market in the next year or year and a half. Where the effects of this license can be relevant is in the Gulf Coast market in the U.S., as it can make the refineries in the area, which are optimized for this type of crude, more profitable. Finally, this could help with the price of diesel in the U.S., since this crude is used more for diesel than gasoline production. Ultimately, the most significant determinant of gasoline prices in the U.S. is the world oil price.

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