A Long, Hard Look at the Venezuelan Oil Industry Today

Igor Hernandez and Francisco Monaldi have taken a deep dive into the financial and operational state of Venezuela's oil industry so you don't have to.

We know things in the oil industry are real bad, but how’s the industry doing really? It’s not that easy to tell. The info out there is scant, sometimes contradictory and always complicated.

Igor Hernández and Francisco Monaldi of Rice University’s Center of Energy Studies at the Baker Institute shed some light on it in a new paper: Weathering Collapse: An Assessment of the Financial and Operational Situation of the Venezuela Industry. I spent some quality time with it and I’m here to tell you: for our oil industry, esta feo pa la foto is an understatement.

For starters, Hernández and Monaldi estimate that PDVSA might end 2016 with a negative cash-flow (money or liquid assets at the end of the fiscal year) of between $7 and $12 billion while producing 360,000 barrels per day less than in 2015. That’s terrible news not only for PDVSA but for the country. Our gallinita de los huevos oro seems to be struggling for survival.

PDVSA’s “esfuerzo propio” (wholly in-house) production has been in something close to free fall.

The underlying trend is that Venezuela’s production mix is becoming heavier, meaning more heavy oil from the Faja or Orinoco Belt and less from Maracaibo and Northern Monagas fields that produce lighter oil, which is easier to refine, transport and sell

Why does this happen? Largely, because PDVSA’s “esfuerzo propio” (wholly in-house) production has been in something close to free fall. Taking West and East together, PDVSA’s esfuerzo propio wells are down by 586,000 b/d between 2010 and 2015.

Meanwhile, the Joint Ventures — the places where PDVSA is in business together with foreign partners — have seen production increase by 357,000 b/d. Of course, almost all the joint ventures are in the Orinoco Extra-Heavy Oil Belt, whereas much of PDVSA’s esfuerzo propio production is in medium and light crude reservoirs. Clearly, without foreign partners around, we’d be facing a proper cataclysm in the industry. As it is, it’s merely a disaster: we are producing less oil that’s less profitable. And los musiues nos están sacando las patas del barro

Financially, PDVSA has just managed to pull through a bond swap, putting up CITGO as collateral. We managed to correr la arruga but the underlying problems remains. For one thing, Financial Debt is just one part of the story. As of 2015, the paper highlights the massive debts with contractors and suppliers, estimated at around $19 billion.

You gotta pay those guys, if you don’t they won’t work for you, and without them almost a quarter of the nation’s oil production is at risk. They also note that default risks remain significant over the next two years. It seems pretty much like check mate, if there are no drastic and immediate reforms, which are unlikely without a change in the company’s governance.

But wait…don’t we produce enough to pay?

In 2016, PDVSA’s poor management along with the regressive subsidies of gasoline will amount to almost 2.5 times the debt payments due all year.

Bad news. In the first semester of 2016, according to Hernandez and Monaldi, net exports generating cash flows for PDVSA “…represented only 1.5 million b/d from a total production of 2.5 million b/d. The decline in production during 2016 had an effect on lost revenue, which we estimate at US 1,776 Billion. Adding the lost revenue from the domestic market to the existence of non-cash generating exports results in total “missing” cash flow of US$ 21 billion in 2015. If we add the cost of oil imports from the U.S., the combined negative effect on PDVSA’s cash flow is of US$ 25.7 billion”. In 2016, PDVSA’s poor management along with the regressive subsidies of gasoline will amount to almost 2.5 times the debt payments due all year.

But not all is doomed…according to Torino Capital’s Francisco Rodriguez.

In a recent report by Torino Capital, Rodriguez states that the situation might not be so bad and makes some observations to the paper. First, he implies that if Hernandez and Monaldi’s assumptions turn to be incorrect on the weight of local currency used in the industry and implies that their cash flow estimates might be terribly wrong. The costs per barrel can vary from 22$ to 6$ depending on which exchange type one uses, which can make a huge difference on cash flow estimates. But then again, distress signals seem to be very clear…Rodriguez just says it might be wrong but does not precise an alternative that backs his claim. Wait, Francisco, is there something we should know?

FRod argues that PDVSA now amount to an agency of the government rather that an independent company, hence it’s a two-way financing scheme. He implies that Central Bank reserves have been used for coupon payment and that PDVSA’s 2035 payment could be paid with the Chinese Fund. Rodriguez notes that “PDVSA’s soft budget constraint works both ways – when it has extra cash it can expect the government to use it for other purposes, yet when it has a shortfall of cash it can expect the government to step in and cover the deficit”. He makes his argument that we should not see PDVSA as an independent company by as part of the state, like a government agency. But, does this makes a significant difference?

I called Monaldi to see what he made of this.

“Our assumptions in this paper were rather conservative,” he told me. “The situation might well be worse than portrayed. In case any transfer was made from the government to PDVSA it would probably be just to reduce commercial debt with operational partners and contractors. The magnitude of the negative cash flow might slightly improve but it will still remain negative.” In other words, the cash flow is going to be negative regardless of what the government does but might be slightly less than estimated if the government decides to aid PDVSA through the Chinese Fund, BCV reserves or any other source of dollars.

For the situation to be so dire as to not being able to pay for a loaded ship of diluent at Curaçao, the cash flow has to be in very bad shape.

Monaldi stresses that the key to survival is production.

“If the government did not help there,” he says, “how is it going to help in anywhere else? For the situation to be so dire as to not being able to pay for a loaded ship of diluent at Curaçao, the cash flow has to be in very bad shape.”

Operating in Venezuela is increasingly difficult. The industry is struggling with rising costs in local currency, wild macroeconomic conditions, a law-and-order meltdown, debt with contractors and lack of human capital.

The paper highlights shortfalls of 70% in the case of valves and other specialized pieces needed in the industry and of 40% of engineering hours to meet the Plan Siembra Petrolera. How handy it would be to have all those guys who got fired in 2003 around just about now.

Some difficulties are structural and will take time to improve. Esto va pa rato.

PDVSA has been severely abused by the national government. Management performance is abysmal by any imaginable measure. According to Hernandez and Monaldi, PDVSA closed 2015 with around 150 thousand employees: a threefold increase from pre-strike levels, which translates into the lowest productivity per worker in 80 years of available data.

PDVSA has also shifted both financial, human and logistical resources to non-oil subsidiaries that also take a toll on the company. The PUDREVAL case is one good example of the oil-company not only dedicated itself to something else but doing so poorly. PDVSA is like an entrepreneur brother that has to support its entire family and loses its company because of that.

Finally, the authors conclude noting that the the massively dismissing of human capital, the nationalization of operators and service companies and over-extraction of resources have led to investment stagnation and production decline.

There is strikingly almost no knowledge of the current industry situation outside some select business and academic circles, which is worrying due to our heavy reliance on oil. Additionally to the political exit to the crisis, we should also be thinking, discussing and planning how to avoid a final crackdown of our main industry. It’s useless anyway to gain power and then have no room to change or finance the change to fix the crisis.