Venezuela Sliding Into Oblivion

Jim Brown
 
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With the situation in Venezuela getting worse as each day passes I am going to layout the reasons why their oil production is not going to bail them out of their current problem.

Christopher Helman, a Forbes writer, had an excellent article last week. Why Venezuela Is Doomed To Collapse

I am going to paraphrase his article here but anyone with time on their hands should spend ten minutes and read the original article. Helman lays out the fiscal problems facing Venezuela from an oil perspective.

Chavez and now his successor Maduro have made paying off consumers and benefactors to stay in office a real science. The trouble is you can only do it for so long and then you run out of money. Chavez started the problem by nationalizing every major business so he could seize their capital and their future revenue in order to buy votes and keep himself in office. The problem with that scenario is that once you seize their operating capital and any future income for yourself the business fails because it can't buy inventory, pay employees or invest in new technology. By seizing all the income from the major businesses in Venezuela he killed the geese laying the golden eggs.

In order to keep citizens happy Chavez set the price of gasoline at roughly the equivalent of 5 cents a gallon. That is great for citizens but bad for the country since the gasoline costs a lot more than 5 cents. That is based on the "official" exchange rate of 6 Bolivars to the dollar. With inflation at 56% and rising the black market is now about 88 bolivars to the dollar making gasoline about 1 cent per gallon.

The country consumes about 800,000 bpd of gasoline and diesel. That equates to about 290 million barrels per year. Venezuela refines the majority of the gasoline used at a cost of about $1.50 per gallon but they can't make enough because they lack capacity. They are forced to buy the shortfall on the open market at $2.50 per gallon.

This means Venezuela can't sell that 290 million barrels of oil for the current $100 per barrel to generate money to run the country. That oil is lost revenue. By subsidizing fuel the country is missing out on about $50 billion a year in revenue. The last time Chavez tried to raise fuel prices the country rioted. Helman points out that once you give people a government benefit it becomes a right in their mind and it can't be taken back. It becomes permanent and that is a $50 billion a year right.

Venezuela claims it produces about 2.5 mbpd of oil. Analysts believe it is a lot lower since the state owned oil company PDVSA has not had any capital to drill new wells and upgrade facilities for years. Chavez took it to provide subsidies for citizens so he could stay in office.

In theory after subtracting the 800,000 bpd used for fuel that would leave 1.7 mbpd available for sale into the global market. However, PDVSA and Venezuela has borrowed heavily from China to the tune of about $50 billion. To repay this China receives about 300,000 bpd of oil. That reduces the available oil for sale.

Chavez had tried to make friends in South America by giving/selling oil to other countries at redced prices and on credit. That has been as high as 200,000 bpd and that further reduces income. Helman claims the Dominican Republic has been repaying their debt in black beans.

After subtracting all the items listed above and some I did not mention the country is left with about 1.3 mbpd of production to sell. That assumes they are actually producing those claimed volumes and many analysts believe depletion, infrastructure breakdown and lack of investment has reduced that volume even further. The U.S. imports about 1.0 mbpd from Venezuela in exchange for real dollars and that is the only thing supporting Venezuela at present. If the U.S. was to suddenly halt imports from Venezuela the country would collapse in a matter of weeks.

Venezuelan oil is heavy and high in sulfur and is not desirable in global refining circles unless it can be bought at a steep discount. That means the U.S. could end the dictatorship in Venezuela at any time but because of the cost to the people of Venezuela we have not done it.

More than 90% of the country's revenue comes from oil sales and the majority of that to the USA.

Food stores have closed because they can't afford to buy things like flour, eggs, bread, etc, in dollars at the real inflated cost and then sell them at the government mandated price that is 90% less. Maduro sent troops to seize some stores and force the inventory to be sold at government mandated prices. Obviously once it was sold there was no more because the owners did not have enough money to buy new inventory even if they wanted to. You can't sell a TV at 5 cents on the dollar and then go buy more TVs.

Venezuela is in a death spiral. They can't raise prices to the point where vendors can purchase goods and sell them for a profit so there are no goods. Maduro can't stop the various subsidies because they have existed for so long they are now a "right" of the people. Oil production will continue to fall and that will continue to reduce operating revenue for the government. Currency reserves are plunging because no outside vendor/country wants to export into Venezuela in return for Bolivars. They want dollars or euros and those are in increasingly short supply.

The lights are dimming in Venezuela both figuratively and literally since nationalized utility companies have no funds to repair failing equipment. The country is failing and it could happen at any time. However, we know from experience that dictators can remain in office for a long time after their viability has expired simply because they control the police and military. Eventually those agencies will revolt when they are no longer paid. The citizens of Venezuela are facing a huge reset event where prices revert to normal once the government changes and it may be a long and painful process.

Venezuela is thought to have the largest oil reserves in the world but they are also the least developed because of the damage done by Chavez and now Maduro. If the government were to change the major oil companies would be eager to come back and begin production again but only if they could be assured of a stable government and no further nationalism. Most have already seen their prior efforts seized by the Chavez government and they will demand reparations in whatever new contracts they sign.

I would not plan on any vacations to Venezuela in the near future. It is not going to be a friendly place to visit.

Market

The markets struggled last week and closed with mixed results. We have about an equal chance of posting new gains next week as we do retreating to lower levels. The market has been very resilient considering the bad economics but that may not continue much longer. Eventually they will get the message and react accordingly.

Until the S&P moves over 1,850 on strong volume we are still in danger of a market decline.

Jim Brown

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