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.

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  1. This post seriously misrepresents the observations that I raised in my comment on the Hernández and Monaldi paper. My report in fact lauds Hernández and Monaldi for their efforts at creating separate hard and local currency cash flow estimates for PDVSA. I point out that these efforts require heroic assumptions not as a criticism of their approach but simply as a characterization of the acute data constraints faced by researchers studying the Venezuelan oil industry today. My use of different exchange rate assumptions is intended to illustrate not that there is anything wrong with the Hernández and Monaldi calculations but that the problem that they identify – PDVSA’s negative cash flow – could be significantly reduced through a macroeconomic stabilization program that brings the real exchange rate in line with equilibrium. That is why I write “This type of evidence suggests that a macroeconomic stabilization program that brings the prices of goods into line with their equilibrium values would significantly contribute towards reestablishing functionality in the state-owned oil company. “
    My argument about the need to look at the integrated cash flow of the consolidated public sector is not one with which I believe Hernández and Monaldi, or any other reasonable economist, would disagree. One of the main reasons why we care about PDVSA’s cash flow is that we want to know whether the Venezuelan public sector as a whole is unsustainable. I cannot see how a definitive conclusion on this issue can be reached without accounting for the web of cross-subsidies that go from PDVSA to and from the central government and other SOEs. My comment was intended as a reminder that useful, in-depth snapshots of the microeconomy such as the one produced by Hernández and Monaldi need to be complemented by broader macroeconomic analyses that allow us to make sense of the big picture issues. A call not to lose the forest for the trees is not an assault on the discipline of botany.

  2. From 2011 to 2016 FRod was BofA’s principle promoter (shill) arguing that Venezuelan Bonds were a good bet. Earlier this year, BofA and he parted ways and went to work for Torino Capital, a small brokerage firm specializing in emerging markets. I suppose you could spin that two different ways, but my bet is that BofA got very uncomfortable with FRod’s predictions that everything was going to be just fine in Venezuela, and decided to distance themselves from views that were becoming too radically contrary to the industry consensus.

  3. Roy, as somebody who knows F-Rod quite well from industry (I suppose you could spin that two different ways) I will say that our industry values people who precisely come up with their own views regardless of consensus and F-Rod was quite the example of this. Also, I’m pretty sure F-Rod would be quickly hired anywhere whatsoever 🙂 I say this as somebody who has disagreed with F-Rod in the past and in the present yet finds extreme value in discussing these disagreements. So by all means — disagree with F-Rod’s conclusions but engage with his propositions or the relationship between them.

    What do you disagree with?

  4. Congratulations Santiago! I appreciate the significant effort you have made to summarize the 69-page report. The report of Francisco Monaldi and Igor Hernandez goes to a great length in describing the current state of the Venezuelan oil industry. This was not intended to be a paper on the current state of solvency of Venezuela as a whole, and we shall resist the temptation of analyzing everything from that point of view. I agree with Francisco Monaldi on the idea that, if anything, the report is rather conservative. At last, the good thing about reading him and Igor writing on oil is that a) this is their area of expertise, and b) they do not have any other conflicting interested, and therefore their views on Venezuela can be taken at face value.

  5. Thanks for the comments. I told Santiago that my reading of Francisco Rodriguez piece was exactly what my tocayo posted here, and I am glad to hear that it was the correct interpretation. Thank you Francisco R. for your post.
    In fact I do not disagree with what FR said in the piece, he is right that to look at the capacity to pay you have to look at the whole picture and we were not doing that, just looking at PDVSA. He is also right that you have to make many assumptions to disentangle the bolivars from the dollars and what the government will or not transfer to and from PDVSA. We tackled this by trying to be conservative and by showing different scenarios to see how sensitive the results were.
    I also want to thank Miguel for his comments and his support as coordinator of the Harvard project and Santiago for writing about our paper.

  6. Are Pdvsa’s financial problems capable of being tackled solely via monetary measures or do they involve a deep change in its management and operating practices and thus of the organization itself ?? If recommended monetary measures were adopted would Pdvsa scape totally from its current woes or would it still be dragged down to the ground by the kind of managerial and operational problems it faces today ?? Are certain monetary measures a paliative or a solution ….??

    There is the notion that most of Pdvsa’s activities are payd in Bs , but in actual fact more than in other industries oil industry activities are payable in hard currency , the key equipment and materials are imported , the main contractors are international , many of the supporting services are contracted abroad, specially during the exploratory and development face of an oil extraction effort the percentage of foreign currency used represents a very high propportion …are there any hard numbers telling us how many dollars it will take to restore Pdvsa to full operational status……

  7. This excellent paper by Monaldi and Hernandez, together with other recent papers, such as those by Volkenborn (Grupo Orinoco), Francisco J. Larrañaga, Diego Gonzalez, Nelson Hernandez and Sergio Sáez (members of COENER, a Petroleum Think tank), offer a clear picture of the Venezuelan petroleum industry and show the way of the future for this industry to the political leaders that will replace the current regime. I hope these leaders take notice and abandon the religious belief that oil is the solution to our problems and that it should be a state-owned and operated activity. This belief has done the Nation much harm. A new petroleum industry model should emerge in the near future, in order to manage the remnants of the Venezuelan petroleum industry for the real benefit of the Nation, not for the benefit of a gang of thieves, as it has been the case during the last 17 years.
    As the author of this note says, it is sad that very few Venezuelans outside a small circle of experts have taken the time to know about this industry. It has been enough for Venezuelans to live off it.

  8. One of the main reasons why we care about PDVSA’s cash flow is that we want to know whether the Venezuelan public sector as a whole is unsustainable.

    Is there really any doubt about it?

  9. Only about a third of a way through the paper but have a couple of questions. Any explanation for the difference in “growth/shrinkage” between the gasoline and diesel subsidy in table 5? How can the recent decrease in production cost, represented in table 14, be explained? Can not be solely based on the black market exchange rates. Is it just that Venezuela is producing that much less oil and so much more natural gas? Would this, naturally, not have been such a violent shift?

  10. I would love to see a summary cash flow report for the entire Venezuelan government (including PDVSA and all QGOs) for the last seventeen years in USD.

  11. Thank you all for your comments! I believe that in coming days, there will be papers analyzing the country as a whole. Nonetheless, I believe it is only rational to believe that if production has fallen by 360.000 in only 9 months and that PDVSA is not paying its own operational contractors such as Schlumberger or Halliburton, the government does not have much resources. And if the government does have the resources (where? This I don’t know. Chinese fund?) it is either deeply immoral to cut imports the way it has done or is non-strategic as it lets production continue falling.

    On the other hand, any sound economist would and is agreeing on macroeconomic structural reforms for years, especially in what refers to FX. It is absurd to have two official exchange rates that vary so widely, yet this is the case and believing in structural meaningful reforms under the current administration, I believe, is wishful thinking.

    In any case, the intention of this post is to shred in a way as simple as possible the situation of the oil industry according to two great scholars such as Hernandez and Monaldi.


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