Why is Venezuela’s oil production stagnating?

Turns out when you give away a product basically for free, you run out of money to make more of it.

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I’m sure you’ve read about it somewhere: the cheapest gas in the world. At the astonishing price of 2 cents per liter, Venezuela surely would break the Guinness Record for gas price if such a thing existed. That’s as good a place as any to start looking for an explanation for why the country with the world’s biggest oil reserves can’t seem to boost production.

And it’s true: Venezuela oil output has flatlined since 2004, coming to just 2.3 million barrels per day as of 2014.

Let’s see why:

Freebies: As of 2013, PDVSA (Petróleos de Venezuela) paid $11.40 to extract a barrel of oil, while current Venezuelan basket price is $47.46. But if you set the price of the main by-product of oil at 2 cents per liter in the domestic, you won’t have a huge return of the investment. Historically, Venezuelan governments have refused to increase gas prices because the political cost would be unbearable. It’s “easier” to subsidize gas to avoid undesirable consequences (i.e. riots like El Caracazo). And while discounts to export markets aren’t as dramatic as the domestic gasoline subsidy, the freebies (polite term, “concessional financing”) extended to other countries doesn’t help PDVSA’s cash flow either. The less money you get from gas sales, the less you can invest to increase your production.

Terrible oil: 68.4% of the Venezuelan oil sold in international markets is medium or heavy. And the vast bulk of our oil reserves – estimated at up to1.4 trillion barrels in the Faja del Orinoco area – are extra-heavy. When you picture oil, you probably picture a black liquid – if only! In Venezuela’s case, you should be imagining a thick, gunky clay-like substance. Barrel-per-barrel, Venezuelan crude isn’t expensive to extract – but it’s very expensive to turn into useful products. Since it hardly flows, it’s expensive to get it to a refinery. Once there, you either have to pre-refine it into something like medium crude using a very expensive bit of equipment known as an Upgrader (mejorador), or blend it with expensive light crude from places like Algeria. None of this is simple, none of it is cheap.

Financing woes: With the vast amount of money pouring into Venezuela from oil revenues, our oil industry should have been able to meet increasing demand during the 2004-2014 oil boom, but mobilizing the investment funds has proved impossible. PDVSA used to be able to issue debt on better terms than the Republic, but those days are long gone. As the institutional safeguards keeping the government’s grubby hands out of PDVSA’s tills have eroded, markets have been ever less willing to differentiate Venezuela’s debts from PDVSA’s: the two debtors are now treated largely as one single, undifferentiated mass of financial chaos. Venezuela’s debt obligations due just in 2016 will reach $10,200 million, and markets long since priced in the near certainty of default that year or the next. PDVSA’s borrowing costs are therefore stratospheric: there’s just no way for it to borrow the tens of billions it would need to invest to increase production on anything like reasonable terms.

Brain drain: After a failed coup attempt in 2002 overthrew Hugo Chávez for two days, the government was ruthless in purging PDVSA of political dissidents, because dissent in PDVSA had been at the center of the political crisis that set off the coup. Eventually, only diehard chavistas stayed on the payroll, whether or not they knew what they were doing. Today’s PDVSA is a pale shadow of the PDVSA we had twenty years ago: all the best people left. On August 25th 2012, a leak of flammable gases in Amuay refinery at Falcón peninsula caused an explosion in one of its spherical tanks. The shockwave destroyed part of the equipment near the leak site. The deadliest event of this kind left 55 dead and 156 injured, opening a debate regarding PDVSA’s security protocols and maintenance procedures. Some versions declare that stains in the tanks were visible, as if they had small gas leaks, which were later covered in paint.

Obsolete refineries: Our refineries paint the picture of the general disinvestment in the oil industry. The El Palito refinery has become a byword for stops and malfunctions which hinder its normal production. Santa Inés refinery, announced back in 2006 for completion in 2012, still hasn’t opened. And we already talked about the big one: Amuay Cardon, less refinery than death trap these days. Less gasoline means less revenue from sales and in turn less money to invest and boost our oil production.

Once one of the best run public sector companies in the world, PDVSA is now struggling to stay afloat. There’s not enough money, not enough expertise, not enough competence. Worse, there’s no vision. It’s gotten to the point where even luring back the people who have left will be a tough sell. Even in case of an eventual change in government, 9 out of 10 Venezuelan oil professionals will say, quite simply “ni de vaina!”

16 COMMENTS

  1. Well, at least Chavismo reduced PDVSA’s carbon footprint to ’90s levels, complying with UN and Pope Francis guidelines for a better, greener world.

    I don’t know about you, but if Pope Francis is happy, I’m happy.

    Less greed, more love.

  2. Thank you for a summary of some of the factors affecting not just the fall in production but the precipitous fall in Pdvsa ‘s oil revenues and its current financial straits.

    Not usually mentioned is that to just to keep production going an oil industry needs to constantly invest and maintain its operative capacity , otherwise there is a natural and automatic decline in its production capacity to the tune of about 15/20% per year .It is calculated that for Pdvsa to maintain its capacity it must have spent some 20 billion US$ during each of the past 12 years

    Because Pdvsa had to fund so much of the regimes distributive clientelar programs and populist policies (not to mention the cheap oil supplies to international allies) it was left without the resources it needed to maintain its refining and operational infrastructure in good working capacity which is the reason we see so many accidents happening and such a fall in its production and related revenues.

    Also the investment has to be made with professional intelligence , which has not been the case,not only because of poor management but because political decisions and the dark hand of corruption forced investments to be made in unwise ways or in uncommercial projects.

    • I’d have to make up the numbers but my guess is, Venezuela could have raised a lot of money to invest and boost production by simply cutting away freebies to other countries. Another effective measure: give away natural gas (of which Venezuela has a huge reserve) and increase gas prices.

  3. Congratulations on your first article, Alex. A few comments:
    Stagnation of production in PDVSA has relatively little to do with the cheap domestic prices of gasoline, although it is correct to say that this is a secondary factor. The main factors are: (1), the manner the political system has utilized the record oil income for its own ends, neglecting reinvestment in the company; (2), the use of the company as s social enterprise, abandoning its core business; (3), sacrificing sound operational procedures in the Orinoco area to ideological propaganda, inviting third rate companies and expelling the good ones; (4), corruption and ineptitude in management; (5), supplying about 400,000 barrels per day to Cuba and PetroCaribe countries at great subsidy; (6), giving away about 300,000 barrels per day of gasoline in the domestic market.
    There is a hug deficit of natural gas. The production of natural gas is mostly tied to the production of oil, and is badly lacking. It can not be given away as you suggest because there is no enough of it. .
    1.3 trillion barrels of oil is the estimate of oil in the ground in the orinoco area. Proven reserves would be the fraction that can be recovered. We have said that this fracion is 10-12%. The government said it was 20% without having additional technical data to support this estimate of recovery. This is why we say the proven reserves figure of the Orinoco area given by PDVSA is a fraud.
    Lack of production in the orinoco area has to do with the reluctance of the foreign companies to do all the investing required and having to wait to get paid in future oil production. They don’t trust the government (and they should not) and doubt they will be in power for long.

    • Correct. Pretty much what I wrote on the first comment here. What are 1/ 2/ 3/ 4/ and 5/ other than Massive Corruption?

      Massive Ineptitude is also a by-product, since the Adept Oil people like yourself mostly left, because of the morally intolerable Corruption in the first place.

      Todos los caminos conducen a Roma: Ignorancia y Corrupcion.

    • Given that Venezuela actually invested in the oil industry, a good policy would be to give away natural gas and increasing gas prices at the same time. We actually have a huge reserve (195 trillion cubic feet as of 2012). Thank you for reading, Gustavo.

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