By now, the words “negative oil prices” have stolen a bit of protagonism from COVID-19 as people all over the world turned their attention to the crude market. And if you are Venezuelan, you had time to panic and grieve about the possible end of our main source of income as a nation.
On Monday, a barrel of the US benchmark crude (WTI, West Texas Intermediate) was traded at $-40 per barrel —something I never thought I would see. By early March, a buyer had to pay $40 to get one barrel but, at the prices seen on Monday, that buyer would get the same barrel plus $40.
Does this mean that oil is now worthless?
Short answer: no. At least not right now and not for everybody.
The price volatility we saw in the last two days was a financial anomaly following a series of unfortunate events. In short, the price movements only affected a relatively small group of investors in financial contracts that were about to expire and which would have caused such investors to receive physical volumes of crude oil at a moment when storage options are running low and very expensive. Desperate to get out of a very messy situation, those investors decided to dump the contracts and pay someone else to get out of the problem, leading to the now-famous negative prices. Most of the media reports prices for these types of contracts as if they are the price of oil. In reality, no oil barrel was traded at negative prices.
By early March, a buyer had to pay $40 to get one barrel but, at the prices seen on Monday, that buyer would get the same barrel plus $40.
Back in Venezuela, the news of “negative oil prices” spread quickly. Besides all the dread caused by COVID-19, the quarantine, and the scarcity of gasoline, the basis for the Venezuelan economy —our very own raison d’etre— was now worthless.
While no oil barrel, as far as I’m aware, has been traded at a negative price, persistently low prices will always disproportionately hurt countries like Venezuela. Oil is the largest source of foreign revenues for the country and our economic fortunes are irremediably linked to oil prices. Just this year, the price for Venezuela’s main crude oil, Merey, fell from about $56 in January to around $16 in March. With estimated exports of 800 thousand barrels per day by the end of March, Venezuela now receives just about $12 million each day. At the heyday of Venezuela’s oil bonanza, when CADIVI was still a thing regular folks could dream of, the country would receive around $200 million each day.
But at the same time, the impact of low oil prices over Venezuela is now a bit more complicated. And while for the US, negative prices are the result of financial shenanigans, for Venezuela they may be a very real possibility.
First, Venezuela’s effective oil prices now depend less on international benchmarks since our exports are not traded in open markets. Few companies are willing to assume the risk of being sanctioned by the US for trading Venezuelan oil and demand a reward through price discounts. PDVSA introduced significant discounts in 2019 and recent reports indicate that the company is reducing prices for Venezuelan crude oil for as much as $23 per barrel, over already falling prices. With few buyers for Venezuela’s oil and a world awash in cheap oil, the effective price of Venezuelan oil now depends more on the negotiating skills by PDVSA’s traders than on international price benchmarks.
Lower international prices will also reduce the interest and participation of international oil companies in the country. PDVSA is the oil industry’s main player, with overwhelming control across almost every activity. But private partners still play a significant role in sustaining operations. Up to 2018, oil fields with investments from international companies produced about half of all Venezuelan oil. Furthermore, while PDVSA controlled production fell by about 1.6 million barrels per day between 2007 and 2018, production with international companies slightly increased during the same period by about 70 thousand barrels per day. As international prices fall, we will see more international oil companies reevaluating their investment and operation plans looking for opportunities to cut costs and save cash. Venezuela will almost surely be on the cutting board.
Beyond the effective price for Venezuelan oil, perhaps the most important challenge is to actually sell its oil. As more markets for Venezuelan oil are closed, PDVSA needs to find new ways to maintain its exports. Rosneft provided a very valuable service to Venezuela in this area, taking the role of an intermediary to move Venezuelan oil out of the country. After all, Rosneft is one of the largest oil companies in the world with the capacity to trade oil across the globe, access to refineries that can process Venezuela’s heavy crude, and technical and financial resources to support operations on the ground. We now know that a new state-owned Russian company will take Rosneft’s participation in Venezuela, but we still don’t know what role this new company will play or what resources it can assign to the country.
Lower international prices will also reduce the interest and participation of international oil companies in the country.
Without Rosneft’s logistical support, Venezuelan exports have fallen, and inventories are rising quickly. Building inventories is one of the strategies that many oil producers use to withstand low price periods: store oil and wait for a recovery in prices. But Venezuela has already very limited storage options available and oil inventories are approaching the levels that caused curtails during 2019. There’s little evidence that PDVSA has managed to build additional storage capacity and there are even fewer options to acquire international additional storage since most international oil producers are racing to secure capacity.
PDVSA now faces a very difficult decision. It can move to shut down production as tanks fill, which is very expensive in terms of the future costs to restart output as well as the risk of permanently losing reserves. Or it can keep its course, making every effort to clear its inventories or by offering even larger discounts to maintain production. With prices already low, is PDVSA willing to offer some of its oil for free? Could it somehow pay buyers to take away some of its inventories?
Suddenly, negative oil prices are a very real possibility for Venezuela.
Perhaps, as Quico suggests, we need to think long and hard about which role oil will play for our future economy.
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