Venezuela Will Haunt Oil Long After Vienna

Even a production cut won't cure PDVSA's structural woes.

At this point, the army of frazzled journalists hanging out in hotel lobbies in Vienna just want an announcement from OPEC. Any announcement.

Venezuela's officials can't be so sanguine. Any number of economic measures can illustrate why one of OPEC's original founding five wants some old-style cartel action to cut supply and lift oil prices. But this one of real GDP per capita does the job:

Desperate Times

Venezuela's real GDP per capita has gone from its highest in 3 decades to almost its lowest in the space of about 5 years

Source: International Monetary Fund

Note: Data expressed in constant prices.

Yet even if Saudi Arabia OPEC does agree to cut production to support prices, Venezuela's problems won't disappear. Which means its status as a wildcard in global oil supply won't, either.

Petroleos de Venezuela, or PDVSA, is the national oil company. Its problems are structural, rather than cyclical. The company has never fully recovered from the general strike and subsequent purging under late president Hugo Chavez in 2002 and 2003, with production drifting down even during the boom in oil prices for much of the decade after 2004.

Struck Down

Venezuela's oil output didn't fully capitalize on the bull market in oil

Source: Bloomberg

Part of the problem is that, as is often the case with state-owned oil companies, PDVSA was a piggy bank for the government. Social expenditure outpaced investment in exploration and production pretty consistently over the past decade.

The decline is actually worse than that chart indicates. This is because PDVSA's production has been shifting toward heavier grades of crude oil from the so-called Orinoco oil belt.

Feeling Gravity's Pull

Heavy oil from the Orinoco belt has risen from 38 percent of Venezuela's falling output to almost half

Source: "Weathering Collapse: An assessment of the financial and operational situation of the Venezuelan oil industry." Igor Hernandez and Francisco Monaldi (Harvard, Nov. 2016)

This oil is harder to process, and gets priced at a discount. So along with simply producing fewer barrels, Venezuela gets less for each one. Meanwhile, as its lighter oil production declines, it has fewer of those barrels to blend in with the heavier crude to make it palatable to refiners. The consequent need to import more light oil effectively raises the cost of each barrel and drains the country of precious dollar reserves.

Bargain Barrels

The traditional discount on Venezuela's basket crude oil price versus Brent has widened out even more in the past couple of years

Source: Bloomberg

Note: Data reflect 4-week moving averages.

At this point, PDVSA is straining to keep going. It just got an extension on some debt coming due after weeks of brinkmanship with bondholders. Contractors such as Schlumberger Ltd. -- crucial to holding the line against further declines in oil production -- have reduced activity in Venezuela until unpaid bills are settled. And a large proportion of PDVSA's output is effectively mortgaged to creditors, such as China, or earmarked for subsidized customers, such as Cuba.

For all its tribulations, PDVSA will do everything it can to avoid defaulting on its debts, for fear of what would happen if the bond market were closed to it. If oil prices do increase from here, perhaps as result of an OPEC freeze/cut, then that would provide more breathing room for both the national oil champion and the government.

Venezuela's structural problems mean it needs more than just temporary breathing room, though. As Francisco Monaldi, a fellow in Latin American energy policy at Rice University's Baker Institute, points out, if frustrations with the pace of economic recovery in the U.S. could produce Donald Trump's upset victory, then consider what the wild swings in Venezuelan living standards could provoke.

In an extreme scenario, food shortages, rampant inflation and an unpopular government's effective blockage of a recall referendum could lead to widespread civil unrest and possibly a collapse in both oil production and consumption, taking perhaps 1.5 million barrels a day of exports off the global market. That would be the scale of cut OPEC has talked about -- only a de facto one coming out of Caracas rather than Vienna. If prices plunge again in the absence of a credible OPEC cut, then this potential reality comes a bit more into focus.

Yet, even if Venezuela avoids such chaos, its existing problems will haunt the oil market for years to come anyway. Remember, even when prices were high, PDVSA's output was declining and turning heavier. Having dropped by about 300,000 barrels a day this year, it could easily drop by the same amount next year -- which would equate to one quarter of the expected increase in global oil demand.

That would, in turn, support prices -- but mainly to the benefit of rivals such as U.S. shale drillers and OPEC's more stable members, rather than Venezuela itself.

In fact, the most pertinent aspect of the country's predicament is how it demonstrates the dynamic driving all that bickering in Vienna: In today's more competitive oil market, there is more incentive to step over rather than carry weaker players.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Liam Denning in New York at

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