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Venezuela Will Be The First Sovereign Oil Producer To See An "All-Out Collapse"

Venezuela’s anti-government protests are growing increasingly violent, with the death toll from clashes between protesters and government forces that began in May topping 100. Despite the country’s increasing political instability, and US President Donald Trump’s half-serious threats of an invasion, President Nicolas Maduro has decided to press ahead with his vote to create a rubberstamp constituent assembly that will allow him to amend the country’s constitution.

With the country’s finances looking ever more precarious, Bloomberg warns that that this decision could bring about the first collapse of a sovereign oil producer. Venezuela has the largest natural oil reserves of any country on Earth, yet the decline in oil prices that began in 2014, coupled with years of economic mismanagement, have been enough to bring the country’s economy to its knees.

“We may be about to see the first sovereign producer to unequivocally fail. The oil producer in question is Venezuela, and that assessment comes courtesy of Helima Croft, who is global head of commodity strategy at RBC Capital Markets and formerly worked with both the Council on Foreign Relations and the CIA. In a global oil market mired in excess inventory and low expectations, Venezuela is the most tangible of wildcards. Its tragic and volatile mix of a failing, oil-dependent economy, political gridlock and simmering unrest is well known at this point.But things are building to a head, partly due to the relentless logic of the bond market and partly due to the more proprietary logic of U.S. foreign policy.”

While many oil dependent nations are working to diversify or ride out low oil prices in other ways, it seems unlikely that the crisis in Venezuela will be reversed anytime soon. Here’s the full fiscal breakeven needed by OPEC producers, including Venezuela, to help normalize things:

The country’s fate, as Bloomberg explains, is largely tied up in the bond market, where yields on Venezuelan bonds recently soared to 36% as Maduro renewed his calls to rewrite the Constitution. With the US threatening sanctions, investors are worried that the situation could reach a crisis point by Christmas.

“Venezuelan bonds, which haven't looked rock-solid for a few years, crashed this week as embattled President Nicola Maduro renewed calls to rewrite the country's constitution, which would effectively disenfranchise the millions of Venezuelans who oppose him and entrench his regime. The U.S. has warned it may impose much tougher sanctions if Maduro goes ahead with his plan.

 

Whether Maduro will, and what those sanctions might be, are the big unknowns here. But there's an awful confluence of factors that could quite easily push this toward a debacle by the end of the year.”

Regardless of what happens to the Maduro regime, the country’s citizens are already living in hyperinflationary hell. As we recently reported, Venezuelans are paying 1000x more for dollars than they were in 2010. The collapse in social services like police has created lawlessness reminiscent of the Mad Max film series, where members of the public routinely lynch suspected thieves, and gangs of bikers waylay merchants carrying commodities to market.

The country’s economy is in free-fall: By the end of this year, it will have shrunk by 32 percent compared to where it was at the end of 2013, according to International Monetary Fund forecasts. Also by the end of this year, the government is on the hook to pay back more than $5 billion in debt - including bonds owed by the state-owned oil company, Petróleos de Venezuela S.A., or PdVSA - plus billions more in interest. As of this week, Venezuela's international reserves stood at less than $10 billion.

Meanwhile, mismanagement, a lack of investment and re-nationalization of foreign oil companies have caused Venezuela's oil production to slump from around 3.3 million barrels a day a decade ago to about 2 million now. Even allowing for the fact that domestic consumption has dwindled along with GDP, Venezuela's surplus of oil available for earning export dollars has shrunk considerably.

Compounding this is the fact that the country must devote a lot of its output to paying off loans from China and Russia, further reducing the actual amount it can use to generate cash. Francisco Monaldi, a fellow in Latin American energy policy at Rice University's Baker Institute for Public Policy, estimates that could be as little as 800,000 barrels a day.

While the US and Venezuela have for years traded hostilities as part of the leadership’s rhetoric, the two countries have enjoyed a lucrative business relationship, with the US buying hundreds of thousands of barrels of Venezuelan oil a day. Even under the late socialist firebrand Hugo Chavez, who never missed an opportunity to antagonize the US, business was steady.

But by pursuing sanctions against Venezuela, the US risks pushing it closer toward Russia’s sphere of influence.  

Further isolation of Venezuela, or a sovereign default, could easily push the country further toward the embrace of Moscow. Rosneft Oil Co. PJSC, Russia's national oil company, loaned money to PdVSA last year collateralized with a 49.9 percent stake in Citgo Petroleum Corp., the U.S. refining and marketing business owned by the Venezuelan oil company. Rosneft is now said to be negotiating swapping that collateral for stakes in Venezuelan reserves and a fuel-supply agreement instead, according to a report from Reuters on Thursday. Swapping valuable downstream assets on U.S. soil for reserves under Venezuelan soil wouldn't look terribly rational from a purely economic point of view. So if this were to happen, the rationales could range from an expectation on Rosneft's part that U.S. sanctions against Russia, and national security considerations, might stymie any chance of actually taking possession of a Citgo stake to a desire to further cement Russian influence in Venezuela on the ground.

According to Bloomberg, allowing Moscow set up camp in Caracas would appear to violate the Monroe Doctrine. Moreover, blocking Venezuela's relatively heavy inflow of oil would squeeze the margins of US refiners set up to process it, and likely lead to higher gasoline prices. Two unattractive options for any president.