“A lot will depend on interim president Guaido’s ability to convince Russia that a new government in Venezuela will honour any legally contracted obligations. The question is how a new government in Venezuela would address loan repayments to China in relation to other international bondholders,” says David Voght, managing director of IPD Latin America, an energy consultancy.

Despite severe US sanctions, President Maduro is standing firm. But how long can the political impasse last while oil production continues to decline?

Petroleum Economist
Charles Waine
22 February 2019

Venezuela is rapidly heading towards uncharted territory, barely a month after the newly-appointed national assembly (NA) leader Juan Guaido declared himself interim president and called for fresh elections. The South American oil giant must now cope with an escalating political crisis, while also enduring the economic upheaval caused by a new raft of US sanctions on state-owned energy firm Pdvsa.

Venezuela is effectively banned from exporting crude oil to US refiners. In a statement issued by the Treasury department, the US government said the sanctions would remain in place to prevent corruption until the country returned to democratic order. Treasury secretary Steven Mnuchin said the US will “continue to use the full suite of its diplomatic and economic tools to support interim president Juan Guaido, the national assembly, and the Venezuelan people’s efforts to restore their democracy”.

There has been widespread international support for the US stance, while Venezuela’s key allies, Russia and China, still back president Nicolas Maduro. The EU has called for renewed elections.

Raison d’être

Guaido’s supporters say his claim on the presidency is legitimised by the constitution. The opposition claims last year’s election was fraudulent and therefore invalid. Under Article 233 of the constitution, the president can be permanently removed by the Supreme Court of Justice, with NA approval. In response, Maduro accuses the opposition of colluding with the US to orchestrate a coup.

Maduro still largely has the military’s backing. Guaido has alluded to offering an amnesty should he gain its support, but so far there has been limited sedition. “The military hierarchy has very tight control from the top, reportedly with the assistance of highly efficient Cuban intelligence,” says Eileen Gavin, senior Latin American analyst at Verisk Maplecroft, a political risk consultancy. As a show of force, Maduro has carried out significant military exercises and drills.

Guaido has repeatedly called for the military to allow humanitarian aid to cross at key checkpoints across the Colombian border. Earlier, Maduro had prevented supplies from entering the country from the Colombian border town of Cucuta. Guaido has set a deadline of 23 February for the aid to enter the country. But it remains to be seen how he intends to implement this threat without the authority of the military.

While US President Donald Trump has hinted at the prospect of US intervention, Congress has tried to quash any suggestion of deploying troops. Addressing a hearing on Venezuela in mid-February, the Democratic chairman of the House Foreign Affairs Committee, Eliot Engel, said, “I want to make clear to our witnesses and to anyone watching: US military intervention is not an option.”

In response to the crisis, both the US and Russia have drafted rival resolutions at the UN. Russia criticised the US for “threats to use force”, saying the country must find a peaceful solution to the deadlock. UN secretary-general Antonio Guterres offered to broker talks between the two sides.

Despite strong backing from the US, the opposition movement at present has limited practical options. Guaido named a new transitional board of directors at Pdvsa and its US subsidiary Citgo, but they lack legitimate authority or access to assets.

Maduro, for his part, will aim to enact his legal threat against Guaido. Diosdado Cabello, head of the government-led National Constituent Assembly (ANC), an alternative legislature, plans to redraft the constitution so the ANC can replace the NA. The next NA elections were scheduled for December 2020, but Cabello now aims to bring them forward to the end of 2019. Eventually the Maduro administration will likely look to downgrade the legislature’s authority.

Repaying debts

To maintain control, Maduro is dependent on the support of both China and Russia. Chinese investment in Venezuela has soared to around $60bn since 2008, but peaked in 2010 when state China Development Bank loaned $20bn to the Venezuelan economic and social development bank (Bandes) and Pdvsa. Russia also loaned heavily but has struggled to get a return on its investment. In September 2017, Venezuela was forced to restructure its $3bn sovereign debt to Russia, and in March this year is expected to make a payment of $100mn.

Despite strong international support, the opposition has limited practical options

Russia’s Rosneft says that, over the third quarter last year, debt owed to it was reduced from $3.1bn to $2.3bn. In total, the Russian firm has loaned Pdvsa somewhere between $4-5bn. Two years ago, 50.1pc of Citgo was pledged as security for more than $3bn of Pdvsa bonds. The other 49.9% was then pledged as collateral against a $1.5bn loan from Rosneft. Should the company be forced to default on its payments it is unlikely the US would allow the Russian company to take ownership of Citgo, but Rosneft still reserves the right to force a resale.

Given the possibility of the opposition waiving the country’s obligations to repay these loans, China and Russia are both wary of supporting any potential coup. “A lot will depend on interim president Guaido’s ability to convince Russia that a new government in Venezuela will honour any legally contracted obligations. The question is how a new government in Venezuela would address loan repayments to China in relation to other international bondholders,” says David Voght, managing director of IPD Latin America, an energy consultancy.

Surviving the collapse

Paying back these loans and keeping the creditors on side is principally dependent on oil sales, and the outlook is bleak. Since 2015, crude production has fallen from 2.4mn bl/d to just 1.34mn bl/d at the end of last year.

Rystad Energy, an oil and gas consultancy, outlines three potential scenarios for the next two years. The best case scenario sees domestic output dropping to 1.1mn bl/d in 2019 and 1.06mn bl/d in 2020, while a moderate forecast anticipates 1mn bl/d in 2019 and 890,000bl/d in 2020. If Venezuela cannot cope with the effects of the sanctions, and is unable to source new investment, then Rystad predicts a collapse to 800,000bl/d in 2019 and 680,000bl/d in 2020.

For the immediate future, to circumvent the pending crisis, the country also needs to source additional supplies of heavy naphtha. Without diluent from the US Gulf Coast, Venezuela will struggle to thin its heavy crude to transport to export markets. One potential option is India, which could also serve as an export option for its crude. Reliance Industries and Nayara Energy, both Indian companies, are among Venezuela’s most important clients.

Venezuelan oil minister Manuel Quevado met his Indian counterpart Dharmendra Pradhan in New Delhi in February to help boost trading relations between the two countries and increase oil exports. In response, the US quickly issued a warning.

Another potential option could be China. Venezuela’s largest consumer of diluent is Petrolera Sinovensa, a joint venture between Pdvsa and China’s CNPC in the Orinoco belt, which reached production of 130,000bl/d by the end of 2018. To maintain this level of output, CNPC may face pressure to help its subsidiary.