Oil Markets Appear to be Taking a Longer View on Venezuela, for Now ...

Three weeks ago (January 23), Juan Guaidó, the newly elected leader of Venezuela’s National Assembly boldly invoked Article 233 of the country’s Constitution and assumed Venezuela’s presidency on an interim basis, pending new elections. Aided by massive public demonstrations and international support from both regional and global powers—including the United States, the European Union, and a cadre of Latin American neighbors—Guaidó has been able to unify previously fragmented opposition to reigning president Nicolás Maduro and raise hopes for a transition in Venezuelan governance. Buoyed by the imposition of sanctions from the United States, including on oil and PDVSA, a state-owned oil company, and the expectation of an influx of humanitarian relief, the confrontation and simultaneous existence of two presidents has set in motion a combination of economic and geopolitical events with far-reaching consequence.

On the heels of the imposition of Iran sanctions and announced cutbacks by the Organization of Petroleum Exporting Countries (OPEC) and their non-OPEC counterparts, a combination of supply challenges in Nigeria, Libya, and Canada, and infrastructure and refiner requirements in the United States, the impending loss of heavy, sour Venezuelan crude has raised alarms of potential price spikes and fuel shortages as refiners and marketers scramble for alternative crude feedstocks.

Tempering the concern is a backdrop of (currently) adequate global oil inventories, the prospect of weakened demand tied both to U.S.-China trade and broader economic concerns, the approach of seasonal refinery maintenance (when crude oil demand declines) and an influx of new supply from the United States and elsewhere. Complicating factors include Russian and Chinese support for the Maduro regime, and the inclination and ability of countries like Saudi Arabia, Canada, Mexico, Colombia, Iraq, Ecuador and others to supply replacement barrels to Gulf Coast refiners on a timely basis when turnaround seasons end.

As of this morning, oil markets continue to focus at the macro level on the dual notions of adequate supply and softening demand with sentiment also pointing to a stronger U.S. dollar. As a consequence, at least for now, markets appear calmed by the expectation that an unavoidable transition is currently in motion and that the loss of Venezuelan barrels can be “managed.” Oil prices for WTI and Brent remain substantially below (i.e., on the order of $20/barrel) levels of last fall. And while this sentiment may be fleeting and somewhat optimistic, the underlying rationale can be tied to a number of factors.

In the case of Venezuela, analysts’ sentiment appears to be coalescing around a limited set of scenarios for what happens next in Caracas. They can be briefly categorized under the headers of:

  1. a military coup or negotiated succession that removes and replaces President Maduro;
  2. the establishment of a “transitional” government, pending new elections;
  3. a failed coup with Maduro reasserting dictatorial control – at least for a while longer; and
  4. some sort of foreign intervention (low probability barring a catastrophic move by Maduro to use strong military force to curb demonstrations or physically disrupt humanitarian aid).

For guidelines as to which of the four is most likely to occur, and in what timeframe, key factors to watch include events and actions around the delivery of humanitarian assistance, notable defections of Maduro loyalists among the military and key supporters and the departure of key Cuban and Russian operatives. Guaidó has already floated offers of amnesty to certain military supporters, and the success of aid distribution within the country would require some level of complicity of state and local operatives. He has also aggressively moved to “appoint” a cadre of new leaders and national intermediaries, including representatives to the Organization of American States (OAS), the U.S. and foreign governments as well as new leadership within PDVSA.

In the interim, the U.S. government has been explicit in its desire to deny the “illegitimate” Maduro government of needed revenues, promote the legitimacy of the Guaidó government and support that effort by providing Guaidó access to real financial and bankable assets and resources to change the dynamics on the ground, thereby hastening Maduro’s departure. Toward that end, aggressive mechanisms have been put in place to preserve and protect national assets to be made available to the “legitimate” Guaidó administration prior to a change of regime.

Outreach to oil producers, service companies, and refiners suggests that even as the Trump administration seeks to deny additional oil-related funds from reaching Maduro’s coffers, there is broad recognition that the presence of a functioning oil sector is pivotal to any successful reconstruction of the Venezuelan economy, post-transition. In that regard, the Trump administration has been measured in its application of sanctions even if Secretary Mnuchin’s assurance of no price impact is fundamentally flawed and not without challenges. The role that PDVSA, as currently constituted, will play in that resurgence, however, may be complicated by allegations of widespread corruption and its past complicity with drug smuggling and money laundering operations.

Somewhat ironically, the crisis in Venezuela has presented the Trump administration with the opportunity to pull off a rare “trifecta!” On public/global image grounds, with the stroke of a pen, the president has been able to take a principled stand and action against a much-maligned foreign leader, who has through greed and incompetence destroyed Venezuela’s economy and triggered a humanitarian crisis. It has reasserted U.S. leadership in the hemisphere, even as the OAS and the Lima Group were more proactive in pressing the case against Maduro for months and allowed the United States to find a commonality of purpose with the European Union, which opposed the U.S sanctions on Iran. At the same time, it has drawn a stark distinction between proponents of change in Venezuela and those nations (notably, Iran, China, Russia, Cuba, Syria, and Turkey) that have chosen to support Maduro.

In addition, recent U.S. actions have put Chinese and Russian investments in Venezuela on particularly shaky ground as oil-for-debt arrangements coupled with contracts that bypassed the National Assembly are likely to receive renewed scrutiny. The combination of the facts that the new Venezuelan government will need a functioning oil industry and that funds from the International Monetary Fund (IMF) will need to be approved by international partners suggest, at least in some cases, the potential for constructive cooperation down the road and ultimately may provide an opportunity for China, for example, to “reposition” and support Guaidó rather than continue to dig in behind Maduro. The case for Russia, reportedly preparing shipments of diluent to aid PDVSA, may be less convincing. The imposition of effective sanctions on Venezuela also sends a signal on determination vis a vis Iran, increases calls for regional cooperation and potentially compliments the wall narrative by appearing to help Latin American neighbors enhance stability and improve economics to retain their populations at home—all, so far, for the cost of $20 million in humanitarian aid.

In terms of domestic politics, the administration’s hard-line efforts with Maduro seem to have garnered bipartisan support with Senators Rubio (R-FL) and Menendez (D-NJ) among the most vocal of supporters. A rare feat indeed!

On oil/energy issues, the targeted use of sanctions and license authority allows U.S. companies to continue to work in Venezuela. And while the actions convey the “optics” of continued imports with monies redirected to Guaidó, as a practical matter most, if not all, Venezuelan oil shipments to the United States have effectively ended with Reuters reporting more than 20 tankers loaded with Venezuelan oil still anchored off the Texas and Louisiana coasts. In addition, U.S. actions are likely to pressure Saudi Arabia to choose between opportunistically increasing exports to the U.S. Gulf Coast or pulling back to draw down U.S. stocks to support prices, while also allowing the administration to simultaneously continue to promote domestic energy production, the Keystone oil pipeline, cooperation with Mexico and still retain the option of releasing oil from the Strategic Petroleum Reserve (SPR) to increase government revenue and keep oil prices lower.

All that said, the implementation and management of next steps are not without gaps and significant challenges, including higher oil prices. Gulf Coast refiners are likely to be increasingly short of the heavier grade crudes and scrambling for alternative supplies, especially later this spring as maintenance season ends. Infrastructure and logistical constraints will continue to be issues, prices for heavier grades will undoubtedly increase causing refiner margins to come under pressure, and global spare capacity is limited. The administration appears to be counting on a swift resolution to the crisis in Venezuela as the protracted loss of substantial heavy oil volumes could also complicate the next round of sanctions and waivers on Iranian oil. Add to that Venezuela’s assumption of OPEC’s presidency, planned changes in maritime fuel standards and resurgent calls for climate action, and 2019 has all the earmarks of another year of high volatility.

Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Frank A. Verrastro
Senior Adviser (Non-resident), Energy Security and Climate Change Program