Oil Sanctions and Venezuela

Facts:

• In anticipation of last week’s National Constituent Assembly Election—an effort designed to consolidate power in the government of President Nicolás Maduro, upend the democratically elected National Assembly, and rewrite the Venezuelan constitution—the U.S. Treasury Department imposed financial sanctions on 13 individuals connected to the Venezuelan government.
• The July 31 election was largely boycotted by the opposition, and recent reports indicate substantial irregularities in the voter tabulation. The United States, Mexico, and the European Union do not recognize the reported results, while Russia and Cuba staunchly maintain their support for the Maduro government. In response, the U.S. Treasury Department has directly imposed financial sanctions on President Maduro, and the U.S. State Department has promised further “strong and swift actions” if the government proceeds with efforts to redraft the Constitution.
• President Maduro has responded to the sanctions by stating that the election was a “vote for the revolution” and added that “sanctions from the (U.S.) empire doesn’t scare me.” Russia has shown its support for Maduro by urging the international community to restrain and “abandon their destructive plans” to pressure Venezuela.
• Additional sanctions under consideration by the United States reportedly include further designations on individuals, bans on U.S. oil exports to Venezuela, prohibition of crude oil imports from Venezuela, and bans on U.S. dollar-denominated transactions with Venezuelan entities.
• Petroleum trade between the two countries is significant, with the United States importing about a third of Venezuela’s crude oil production. These sales represent the lion’s share of Venezuela’s export revenues. Some 95 percent of the 720 thousand barrels per day (kb/d) imported to the United States so far in 2017 has gone to U.S. Gulf Coast refiners, which are configured to run heavier grade crudes. Refined oil product trade also exists between the two countries, and U.S. light oil exports and light product are used as a diluent for transporting Venezuela’s heavy oil.
• Citgo, a subsidiary of PDVSA, Venezuela’s national petroleum company, is one of the largest recipients of Venezuelan crude oil in the United States and accounts for roughly 4 percent of U.S. refining capacity. Complicating matters, the Russian oil major, Rosneft, currently holds a 49.9 percent collateral stake in Citgo, although they are reportedly looking to transfer that ownership for equity in Venezuela’s upstream sector and fuel oil transactions.

Opinion:

Deteriorating economic conditions and moves by the Maduro administration to attain a greater level of government control have led to social unrest and government crackdowns that have increasingly threatened the stability of the country. Food and medicine are in short supply, and a decided lack of revenues has put the nation on the brink of default. And while relations between the United States and Venezuela have deteriorated over time, oil trade (being beneficial to both parties) has continued. That said, President Maduro’s latest power grab is viewed by the Trump administration as a threat to democracy sufficient to warrant a substantive response.

Among the list of options the Trump administration is currently considering are a series of energy-related sanctions to be levied against Venezuela and the Maduro government. In order of increasing severity, these options include restricting U.S. light oil and gasoline exports, banning the sale of certain oil-related equipment to Venezuela, preventing the importation of Venezuelan crudes (from which the Caracas government derives a significant portion of its operating revenues), and prohibiting the use of U.S. dollars to pay for oil transactions. Although the operational specifics of each of these options remains unclear, such actions would have an adverse impact on Venezuela, U.S. Gulf Coast refiners, and to a lesser extent, U.S. consumers.

In the short term, mainly due to quality considerations, the loss of 700+ kb/d of Venezuelan crude supply to the United States would be difficult (and likely costlier) to replace. The United States could authorize a sale of oil from the Strategic Petroleum Reserve (SPR) coincident with the implementation of oil import sanctions (to provide some limited market relief and reduce price volatility), but distribution would likely take weeks as bids and transport logistics are worked out. Alternatively, refiners could look to the global market for replacement crudes of similar or comparable quality (e.g., Canadian, Mexican, or Middle East oils), which would require longer shipping times and presumably equivalent or higher costs, assuming they were available. Increased utilization of U.S. light oils could offset some of the loss, but they are not a comparable substitute for the heavier grade crudes given the configurations and economics of the U.S. Gulf of Mexico refineries. The likely impacts on Gulf Coast refiners would be reduced runs or loss of some higher margin product yields and consequently less attractive economics—all of which are currently contributing to stable domestic product prices and higher product export and trade benefits.

If the United States imposes oil sanctions unilaterally, it could increase the chances of Venezuelan default; however, the unilateral nature of the action may simply result in a market readjustment, with Venezuelan crude exports being rerouted to Asia (so the lasting impact in economic terms could be confined to more costly tanker transportation rates). Prohibiting dollar-denominated transactions with respect to Venezuela would adversely impact U.S. companies with contractual obligations in Venezuela and any companies using U.S. dollars for transactions.

Further, the imposition of unilateral sanctions by the United States is likely to carry political/geopolitical consequences also. Though such action would be aimed at targeting the Maduro regime, it also provides an entrenched government in Caracas with an external enemy (the United States) to blame for the economic devastation that is likely to continue to befall the Venezuelan people. Unilateral U.S. actions, which are seen by Europe and others as negatively impacting their own energy security but not ours, could undermine Western alignment on the use of sanctions and weaken the utility of sanctions as a policy tool in the long run.

Energy, economic, and foreign policy initiatives often carry far-reaching and unintended consequences. And while taking action to restrain intolerable acts by international bad actors is both warranted and often popular with a domestic audience, sustained support is sometimes difficult. A thoughtful examination of the web of potential outcomes that could result from even well-intended actions should be the prerequisite to deciding to take such action.