PDVSA Sanctions: How bad is it?

With sanctions on the Venezuelan oil industry a distinct possibility, here are the ugly and uglier aspects of an unprecedented blow to our economy.

How badly could oil sanctions hit Venezuela?

In 2016, Venezuela made about US$16 billion from its oil exports, basically from five markets: the United States, China, India, Central America and some Caribbean countries.

The last two don’t generate much income: we sell them oil at huge discounts through the Petrocaribe scheme, which allows payments in kind and provides generous financing. Likewise, the oil sent to China does not generate cash flow, since the value of these oil cargoes only serves to pay down the huge debt Venezuela owes them, estimated at around US$65 billion.

For the most part, Venezuela gets cash to finance its expenditures only from oil that goes to the United States and India.

Venezuela became a major supplier to the Indian market after the European Union and the United States imposed sanctions on the Iranian oil sector. India, which imports more than 4 million barrels per day (mbd), has replaced Iranian oil in part with Venezuelan oil: they get 300,000 barrels a day from Venezuela.

The United States, despite Venezuela’s strident rhetoric, remains PDVSA’s biggest customer and receives a daily average of 750,000 barrels. In 2016, from that export volume, Venezuela made about US$10 billion, more than 62% of its total income from oil exports for the year.

For the most part, Venezuela gets cash to finance its expenditures only from oil that goes to the United States and India.

The outlook for 2017 shows that Venezuela will become even more dependent on the US market, as its oil production continues to decline, reducing the exportable surplus. If we assume —in a no-sanctions scenario— that exports to the US remain stable, total oil export revenue in 2017 would be US$14.5 billion, of which the US market would be US$11 billion.

Since oil is pretty much Venezuela’s only export product, we can safely say that about three-quarters of Venezuela’s foreign exchange comes from its oil to the United States. It’s what we live on.

Latest figures from the U.S. Energy Information Administration (EIA) show that the United States imports about 10 mbd of crude oil and oil products. These imports have declined sharply recently due to the US oil production boom and its stagnant demand. Of those 10 mdb, Canada accounts for approximately 42%, by far the most important source of oil for American economy. Saudi Arabia, in second place, supplies 13% and Venezuela ranks third with 7%. Then comes Mexico with 6% of the total, and after that Iraq and Colombia, each with 4%. About 13 countries ship more than 100,000 barrels per day of crude oil and oil products to the US market.

Should the import ban be imposed, the US would have to replace these 750,000 barrels per day by going to the international market or by using its Strategic Petroleum Reserve (SPR).

A reduction of such magnitude for the SPR is unprecedented. However, the US government did propose a reduction in the SPR of 270 million barrels in its 2018 budget.

About three-quarters of Venezuela’s foreign exchange comes from its oil to the United States.

The SPR would be able then to replace only a portion of Venezuelan crude, and most of the responsibility for finding new supply would fall on the importing companies. There are eight companies that import Venezuelan oil to the US: Valero (which purchases 26% of Venezuela’s exports to the US), Chevron (14% of the total), Phillips 66 (13%), PBF Energy, Motiva (a Saudi Aramco subsidiary), Lyondell, Marathon, and —of course— Citgo, the PDVSA subsidiary, which purchases 33% of Venezuela’s oil exports to the United States.

Relative importance of Venezuelan oil supply to these companies’ total import volumes varies. With Valero, for example, Venezuela accounts for 21% of its imports and is its most important source, followed by Saudi Arabia with 16%, Mexico with 14% and Russia with 11%. In contrast, Phillips 66, the third largest US importer of Venezuelan oil, is much less dependent on Venezuela, with Canada being its largest source of oil with 27% of its total imports.

While only Citgo and Valero need Venezuela to supply more than 20% of their import volume, a disruption in oil supplies would hit them hard, as it would force them to almost immediately replace Venezuela’s crude oil and derivatives, which their infrastructure and systems are specifically designed to process.

Once these companies can no longer buy oil from Venezuela and they move on to establish trade relations with other suppliers, it will be difficult for the nation to recover those buyers. The effect of sanctions to the current Venezuelan government could also damage its replacement.

In a ban escenario, Venezuela would have to find alternative markets quickly, due to the huge debt payments scheduled for 2016. The most logical destination for Venezuelan oil would be China and India.

About 13 countries ship more than 100,000 barrels per day of crude oil and oil products to the US market.

Why? First, because of the size of these two economies and their ability to incorporate greater supply with relative ease. China imports about 8.5 mbd, while India buys about 4 mbd from world oil markets. If Venezuela were to divert the 750,000 b/d it sends to the United States to these two economies, it’d be logical to place the greater part in the Indian market, since China would employ any additional Venezuelan oil to the debt.

But is this viable? Remember, India only sought Venezuela as a supplier when sanctions were imposed on the Iranian oil industry. The sanctions have been removed —following the signing of the nuclear agreement— and Iran is regaining its previous share in the Indian market, where it enjoys the significant advantage of geographical proximity. India would likely take only part of the 750,000 barrels, with the rest going to China. No cash revenue.

A second reason is the fact that these two countries are already importing large volumes of Venezuelan oil and the logistics of supply are well understood by all parties. This is not trivial, since Venezuela’s heavy and extra-heavy oil requires special refining infrastructure already in place.

Third, China has huge storage capacity that would be crucial if its economy does not absorb the incremental supply immediately. This country has more than 2,000 tanks of commercial and strategic reserves that add up to an unofficially estimated total capacity of 900 million barrels. The idle capacity of these tanks is estimated at 300 million barrels, enough to store a significant portion of Venezuelan oil diverted from the US.

While only Citgo and Valero need Venezuela to supply more than 20% of their import volume, a disruption in oil supplies would hit them hard.

However, these options exist only if the sanctions are limited to the US import ban. If, as has been reported, they expand to include financial penalties for the Venezuelan oil sector that, for example, prohibit PDVSA from making transactions in US dollars or penalize US banks that carry out transactions with PDVSA in dollars, Venezuela would be forced to look for intermediary banks outside the United States for the trade with Asia. It wouldn’t be simple since, as Reuters reports, the banks most capable to carry out these tasks outside the US are in Europe, and the European Union would surely follow the US in imposing sanctions.

Another wrinkle: in addition to exporting oil to the United States, Venezuela also imports products from the U.S. These imports are mainly used to dilute heavy crude from the Orinoco Belt and reach an average just below 100 thousand barrels per day. In case of a ban on trade and financial relations, Venezuela would be forced to buy diluents from other suppliers, probably at greater cost and without being able to use dollars for the transactions.

The effects of these measures would be devastating for the Venezuelan economy, and would go far beyond their declared objective of punishing the Maduro government. The measures would make it impossible to continue the already heavily diminished imports of food and medicines and would seriously risk the government’s ability to pay off debt, which, as we’ve seen, has become its main macroeconomic objective. The country would lose —perhaps forever— its best buyers and would be forced to sell its only export product in markets with lower yields for longer than the duration of the sanctions.

In short: yes, it would be a huge blow to the economic stability of this government —though, as Moises Naim argues, perhaps not to its political stability. Venezuelans would see their lives worsen even further and the future of the country would be even more uncertain.

Steep price that we’ll be paying long after chavismo is gone.

Carlos Sucre & Ramón Espinasa

Ramón and Carlos are economists interested in Venezuela's and Latin America's oil and gas industry. They also teach graduate students every Friday.