Venezuela’s Maduro regime might have entered the end-game with its largely fake “election” for a constituent assembly, where voters were allowed (if not coerced) to choose candidates pre-selected by the regime to rewrite the country’s constitution. It is assumed that assembly will emasculate all branches of government except the executive office, ushering in a Cuban-style one-party rule if not an outright dictatorship. The opposition continues its increasingly violent demonstration, to the point that some are predicting a civil war.
There are a number of possible political outcomes, including Maduro being ousted by his party’s senior members, a military coup or simply an agreement with the opposition for new, independently monitored elections, but for this column, the issue is the turmoil’s potential impact on the oil market, including the possibility of a cessation of oil production and/or sanctions against imports of Venezuelan oil by the United States. The latter looks increasingly likely, and the former apparently so, although judging the politics of the Venezuelan street is difficult from a small town in the Berkshires. Oil workers receive benefits that most Venezuelans do not but appear increasingly disgruntled with the regime and its failings.
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The most important lesson from the history of economic sanctions is that single-nation embargoes are rarely successful, especially given that petroleum is fungible. It is very true that the price for Venezuelan oil in the U.S. market is better than it would be in other markets because a number of American refineries are designed to run optimally on heavy crudes, like the ones Venezuela produces. On the other hand, Venezuela represents only a small portion of the U.S.’s imports of heavy crudes (figure below). The leverage is on the side of the U.S., although some American refiners will suffer losses because of less-than-optimal crude slates or higher prices for replacement heavy crude. Still, there is unlikely to be any significant oil price impact.
One consideration is a cutoff of U.S. exports to Venezuela (yes, we export oil to a country with the second-largest oil reserves), products that the country lacks, especially light oil, which it uses to dilute its very heavy oil. Much of this goes to a Venezuelan-owned refinery in the Caribbean rather than Venezuela itself, and certainly cutting it off would be inconvenient, but the surge in light oil from U.S. shale fields in the past few years has ensured that there should be little trouble replacing it with another source, even if Curacao winds up as part of the U.S. embargo.
The market impact of a complete cessation of Venezuelan production would be pretty marginal as well, given that there is at least 250 million barrels of oil inventory overhang in the OECD, and Venezuela supplies little more than 1 mb/d to markets (the rest is consumed domestically). While the Saudis could offset lost Venezuelan production, especially since their spare capacity is usually heavy crude that substitutes well for Venezuelan crude, they would probably not step in as they did in early 2003, when both Venezuela and Iraq saw disruptions of their industry. Instead, a Venezuelan shutdown would become a de facto part of the market rebalancing efforts that many producers are attempting. Only if a cessation is long or prices shoot up too high are the Saudis likely to act.
Without question, should the U.S. ban imports of Venezuelan crude, the country would receive a financial hit, with the price it receives discounted by $3-5/barrel, in part because of higher shipping costs to reach more distant markets. Of course, oil revenues are down 75% in the past five years given lower oil prices and slumping production, worsened by the fact that increasing amounts of oil is being used to pay old debts, as the Chavez regime not only ate its seed corn, but mortgaged future seed corn.
Sanctions on Venezuela would thus have a small but noticeable impact on the country’s finances, but could be the straw that breaks the camel’s back. As the nation struggles to meet debt payments this year, the loss of even a few hundred million dollars could be crucial, although default seems inevitable at this point.
Could default worsen the situation in Venezuela? Probably not. An earlier president, Rafael Caldera, employed a number of leftist economic policies that Hugo Chavez later emulated, but unlike his successor, Caldera learned from their failure and reversed them, instead of blaming foreign enemies. It seems unlikely Maduro would do the same, but a default could trigger a regime change and possibly even his replacement with leftist colleagues who would see more rational policies adopted. The next government will hopefully be more democratic, reverse many of the disastrous economic policies and be more competent. (Okay, it couldn’t be less competent.) But it will take months to undo the immediate damage to the oil sector, and years to recover earlier levels of production.