Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The cold logic of the oil market dictates that crisis usually equals profit. That's because a crisis in oil usually means a supply crisis, as some large producing country becomes embroiled in war or civil unrest or sanctions or some other geopolitical mess.

The country currently occupying the unenviable position of being the likeliest source of a supply shock is Venezuela. The collapse in oil prices has savaged the country's economy and brought political tensions to a head in the form of a constitutional crisis, mass protests and, particularly over the past week or so, looting and fatalities.

From the oil market's perspective, the question is whether Venezuela's intensifying problems will cause an outright collapse in its production, currently running at about 2 million barrels a day. It's a bit more complicated than that, though.

Venezuela's supply has slumped already:

Lost Decade
Venezuela's output has fallen already by almost a million barrels a day since 2006
Source: BP, International Energy Agency
Note: Data for 2016 is an estimate, reflecting IEA data showing a drop of 220,000 barrels a day that year.

But so has domestic demand:

The Other Slump
By 2015, Venezuela's oil demand had dropped 17 percent from its peak in 2013
Source: BP

Put the two together, and Venezuela's surplus production compared to domestic demand looks like this:

Stability (Kinda)
Venezuela's surplus oil production over domestic demand actually stabilized after 2013 even as production fell
Source: BP

So, as of 2015, Venezuela's woes had taken down its production but, by dinging demand, meant excess oil available on the global market had stopped falling. The implication is that, despite the collapse to date, the worst of Venezuela's shock to the oil market is yet to come.

Again, though, it's complicated. Part of the issue concerns Venezuelan demand, which is hard to pin down on a timely basis. Philip Verleger, an energy economist who has been tracking Venezuela's decline for some time, estimates demand there may have fallen another 10-15 percent in 2016.

At the midpoint, that would be another 85,000 barrels a day, offsetting roughly 30 to 40 percent of the International Energy Agency's estimate of the decline in Venezuela's oil production last year. On that basis, surplus oil available for the world market would have resumed its decline, falling to 1.81 million barrels a day.

That figure could really nosedive this year, though. If Venezuela's production remains about 2 million barrels a day this year and demand falls, say, another 12.5 percent, then that would mean roughly 330,000 barrels a day taken off the global market. At just less than 1.5 million barrels a day, Venezuela's surplus would have dropped to its lowest level since 1986.

The question is whether demand collapses even faster. Here are the International Monetary Fund's forecasts for Venezuela's economy. They aren't pretty:

Negativity
Venezuela's economy went into free fall in 2015 and isn't expected to resume growing in real terms for years to come
Source: International Monetary Fund
Note: Change in GDP at constant prices. Data for 2016 onward are estimates.

To get a sense of what the puts and (many) takes in that chart mean for the size of the Venezuelan economy overall, here's how they stack up on a cumulative basis:

Throwback
Venezuela's economy is expected to end this decade at roughly the same size it was at the end of the 1990s
Source: International Monetary Fund
Note: GDP in real terms relative to 1996.

Given GDP is estimated to have fallen by 16 percent last year alone, and is then projected to shrink by another 12 percent over the following 3 years, Venezuela's oil demand could keep falling at a precipitous rate, especially if civil unrest intensifies.

An economy that's reverted to pre-2000 levels could mean demand slips below 500,000 barrels a day. True, the population has risen by almost 40 percent since 1996, but that's no guarantee of rising demand: Oil consumption per capita fell by 19 percent between 2013 and 2015 alone.

Could oil production show any resilience in this scenario? That's the big question. On the one hand, it seems hard to imagine it could, especially given the declines to date. On the other, Luisa Palacios, Head of Latin America macro and energy research at Medley Global Advisors, points out Venezuela's oil production is scattered around the country and offshore. Meanwhile, its refineries can be militarized if necessary.

To be clear, barring an unforeseen jump in oil prices, Venezuela's production can't simply ride out this crisis. In particular, the increasingly heavy nature of Venezuela's oil necessitates blending it with imported light oil -- much of it from the U.S. -- which requires payment in hard currency (see this).

But there is a plausible scenario whereby, before Venezuelan oil production slumps again, further economic collapse and perhaps a breakdown in internal fuel distribution unleashes a demand shock first. Venezuela's tragedy isn't just a wildcard for supply.

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

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net