After both Brent and WTI rose above their respective 50DMAs on Friday, capping 2017’s best weekly rally for oil, the rising tide is accelerating as the latest CFTC COT data confirmed, when net specs boosted bullish Nymex WTI crude oil bets by 27K net-long positions to 423K, the highest in two months, as producers continued to cover short hedges, sending their net position to the most bullish since the summer of 2015.
Meanwhile, oil started the Sunday session jumping out of the gate, with WTI rising above $50 for the first time since May in early Asian trading, following the usual non-material weekend chatter and “noise” out of OPEC (which to exactly nobody’s surprise “can’t stop pumping“), however what has attracted traders’ attention, is a WSJ report that following last week’s latest round of sanctions, and after today’s vote to overhaul Venezuela’s constitution further entrenching Maduro’s unpopular regime, US government officials are considering announcing sanctions against Venezuela’s oil industry as early as Monday, although as the WSJ notes, a full-blown “embargo against Venezuelan crude oil imports into the U.S. is off the table for now.”
In its latest escalation, last Wednesday the U.S. government levied additional sanctions on 13 high-ranking Venezuelan officials for alleged corruption, human-rights violations and undermining democracy in the South American country. On Friday Mike Pence vowed “strong and swift economic actions” if the vote goes ahead.
While Maduro’s government has responded defiantly, “dismissing sanctions and warnings from Washington”, with Maduro insisting the government would notch a triumph in Sunday’s vote, the potential collapse in oil trade between Venezuela could crippled the country even more, while sending the price of oil sharply higher.
In fact, in a note from last week posted here, Barclays Warren Russell explains just what will happen should Trump expand Venezuela’s sanctions to impact its oil sector: “a sharper and longer disruption (eg, exceeding three months) could raise oil prices at least $5-7/b and flatten the curve structure despite an assumed return of some OPEC supply, a more robust US shale response, and weaker demand. It may be just the opportunity OPEC needs to exit its current strategy. US producer hedging activity would pick up if WTI moves to $50-55, limiting price upside potential.”
Furthermore, among the downstream consequences, is that refining margins should deteriorate if Venezuelan crude oil supply is curtailed. US refiners will be negatively affected by any sanctions related to trade constraints. On the other hand, China and India could benefit if Venezuelan oil is offered at a discount to comparable grades, Barclays suggests.
Finally, looking at Venezuela from a longer-term perspective, this is how Barclays estimates the local investment climate:
It is too early to assess the investment appetite in Venezuela in a post-Maduro environment. Though Venezuela’s assets are large, they are not short-cycle. Companies with deep connections to the country are likely to maintain a presence, but wait for the political landscape to stabilize before making incremental investments. Either way, it looks like Venezuela’s production trend is down over the near term.
Of course, the higher the price of oil goes, the more profitable shale will be, the more oil it will produce and so on, in the diabolic feedback loop that will assure oil does not go too far above $50 for the foreseeable future, as Goldman explained efficiently in just three bullet points last Thursday:
- Oil prices have rebounded over the past month on large inventory draws, a declining US rig count and strong demand data, suggesting that the rebalancing is accelerating.
- We remain, however, cautiously optimistic on prices from the current level with the recent improvements in fundamentals needing to be sustained for oil prices to rally meaningfully further.
- In fact, too large a price recovery now would only increase the downside risks to our year-end $55/bbl WTI price forecast given the fast velocity of shale’s supply response.
At which point it’s back to square one. For now, however, the bulls get to enjoy the next few days until the momentum reverses once again.
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For those who are eager for more reasons to buy oil, there are more details in the full Barclays excerpt below and posted here first last week:
Looming risk of sanctions against Venezuela
The Trump administration is considering a wide variety of sanctions against the Venezuelan regime, which could range from sanctions on several senior government officials to targeting PDVSA’s ability to transact in US dollars, according to Reuters. This would not be the first time the Trump administration has taken action against Venezuela. The US already imposed sanctions on Venezuela’s vice president (February 2017), eight members of the Supreme Court (May 2017), and other military and government officials. The most recent Supreme Court sanctions were in response to the court’s decision to disband the democratically elected congress. The administration’s recent discussion of potential new sanctions would aim to keep elections “free and fair” and prevent President Maduro from being able to establish a dictatorship, which could occur as early as July 30.
The Trump administration is likely to proceed cautiously and incrementally with any sanctions. In contrast to the energy-related sanctions imposed on Russia and Iran, the more entrenched connections between US companies and consumers and the Venezuelan oil industry lead us to believe that the US administration will take a cautious approach.
Venezuela produces around 2.2 mb/d of oil and NGLs, which represents roughly 2% of the global petroleum market. Its Orinoco heavy oil plays a critical role as a feedstock for complex refineries around the world, particularly along the US Gulf Coast. Close to half of its 1.8 mb/d of oil exports go to OECD countries, with Asia consuming most of the remainder. Venezuela is the third largest exporter of oil to the US (?750 kb/d), behind Canada (3.2 mb/d) and Saudi Arabia (1.1 mb/d).
As a guide to potential outcomes, we examine US sanctions on Iran and Russia and their impact on the oil market. We find that the sanctions on Russia have not had a noticeable effect on its production or the oil market, while sanctions against Iran lowered its production and exports and supported oil prices. For more on sanctions on Russia and Iran, see the Appendix of this report.
We see several important differences between the situation in Venezuela and those in Iran and Russia.
- Unlike Russia and Iran, Venezuela is at significant risk of political and economic collapse. Low oil prices have greatly reduced the government’s ability to pay its outstanding debts while funding imports of basic goods. As a result, President Maduro has taken decisions that have resulted in a deteriorating quality of life for Venezuelans in recent years. Amid the current instability, even limited sanctions are likely to have an outsized effect on the oil market.
- A collapse in Venezuela could turn it into a regional crisis. More than 1.5mn Venezuelans have already fled the country because of the current crisis, this number could increase exponentially, affecting neighboring countries, particularly Colombia. The international community will need to support the region in a refugee crisis. In the case of Colombia, the situation could have additional implications because there are nearly 2mn Colombian and Colombian descendants living in Venezuela. Those people would likely be the first to cross the border and the Colombian government cannot deny them their rights as Colombian citizens. This could become significant fiscal burden for the Colombian government.
Venezuela needs to import oil and refined products to produce oil. Roughly 50% of Venezuelan production is heavy oil, which is typically blended with diluent for transportation purposes. Without access to diluent imports from the US and elsewhere, certain Orinoco projects may be at risk of being shut-in. A trade embargo, sanctions that affect PDVSA, or a sovereign default could be catalysts for heavy oil shut-ins in the Orinoco. We estimated earlier this year that a default could take around 300 kb/d of heavy oil production offline (Commodities special report: The black swans of 2017, January 2017).
- The current state of Venezuela’s refinery sector necessitates fuel imports, which have been met in part by imports from the US. Plagued by underinvestment, Venezuela’s refineries have been running well below nameplate capacity, with Bloomberg recently reporting that the Puerto La Cruz refinery is running at 15% utilization. Restricting fuel shipments to Venezuela would result in increased dependency on the PDVSA’s dilapidated plants and imports from other origins to prevent the country coming to a standstill.
- Venezuela’s oil sector is much more intricately connected to the North American energy system, due to CITGO’s presence in the US and the dependence of other US refineries on Venezuelan feedstock. This interdependency with the US and the lesser connection with other OECD countries, mean Venezuela’s position in the international energy system is quite different to that of Russia or Iran.
If the US does impose further sanctions on Venezuela, it would likely take into account these differences. The use and timing of various sanctions will likely depend on how much the conflict escalates in the coming days and whether other factors (such as the potential for default on sovereign debt payments due in October and November), might be a catalyst for political change in the near future. In our view, if the Trump administration decides to issue sanctions, it would proceed conservatively and become increasingly restrictive only if its goals are not being achieved. One of the stated goals of the Trump administration is for Venezuela to hold “free and fair elections,” according to the White House press statement on July 17, 2017. Before implementing more aggressive sanctions, the administration is likely to seek multilateral support from other nations.
The EU recently expressed a willingness to impose sanctions on Venezuela as well. We believe sanctions could turn out to be a double-edged sword. Multilateral sanctions implemented after having exhausted negotiations are most likely to be successful. Nonetheless, history shows that sanctions alone are not enough to trigger political change, eg, Cuba, North Korea, and Syria. This finally depends on the level of internal pressure, which in Venezuela seems high.
Sanctions against individuals
Additional US-imposed sanctions against government officials may be the next step. Such sanctions are likely to cause some inconvenience but probably would have only a limited impact on Venezuela’s oil industry, in our view.
Sanctions on Venezuela’s energy sector
Sanctions could take several forms, ranging from sanctions similar to those imposed on Russia to more disruptive ones that could completely halt existing operations.
- Sanctions that prohibit or limit investment in new exploration and production activity would not likely have an immediate direct impact on Venezuelan production. Many of the companies with equity stakes in Venezuela’s new greenfield developments are headquartered in non-OECD countries. Furthermore, due to the current upstream investment environment and the increasing political risk within Venezuela, we believe upstream spending on greenfield projects is limited, with many projects shelved for future reconsideration.
- Sanctions prohibiting businesses from operating in Venezuela would be much more disruptive to Venezuela’s current contribution to the oil market. A policy that would limit US producer and service company operations and further investment in Venezuela, would require PDVSA and other international companies to step in to maintain operations. This scenario is likely to exacerbate Venezuela’s declining production profile.
Sanctions against PDVSA
The US could take an even more drastic approach by issuing direct sanctions against PDVSA. In an extreme scenario, if the NOC is banned from banking activity in the US and from trading with US entities, the impact would likely be swift and very damaging to Venezuelan oil production. Directly targeting PDVSA will also likely lead to a sovereign debt default in 2017. This action would affect Venezuela’s petroleum imports and exports.
- PDVSA would have to find new destinations for nearly half of its oil exports, assuming production does not collapse. Currently, Venezuela ships more than 700 kb/d of oil to the US and nearly 100 kb/d to the EU. China and India would likely be alternative destinations for some of this crude.
- PDVSA would also need to find a new source for some of its diluent needs. Algerian and Nigerian crude and condensates were previously used for diluent purposes and could substitute for shipments of US crude and products used in the transport of heavy oil. PDVSA could ask it JV partners to import diluent, but the capacity to do this would depend on the extent of sanctions and other countries’ participation. Even if possible, this could also increase the production cost of these fields to levels that are not financially viable, which could ultimately result in shut-ins.
We believe the US would implement such measures only as a last resort. In addition, the US would likely seek multilateral support from other nations before taking this route. Such an action is likely to be severely disruptive to Venezuela as well as the oil market and its participants.
Sanctions against PDVSA would likely also mean that US producers and service companies conducting business in Venezuela would have to cease operations, which would have an outsized effect on oil production compared to the effect of the US-imposed sanctions on Russia. Compared with Russia, Venezuela is much more reliant on foreign oilfield service companies for oil extraction.
Discussions of broader sanctions likely limits Venezuela’s access to capital
Regardless of whether new sanctions are imposed, discussion of broader sanctions could limit the Venezuelan government’s ability to raise financing and to make debt payments coming due in October and November. Moreover, it could change the government’s willingness to pay. If the current government wants to remain in control and not negotiate, it may be unwilling to use the few assets left to service its debt. As mentioned above, default alone would have a significant impact on oil production and the domestic economy.
The US could sell oil from the SPR to steady the market
We believe the US would consider the sale of oil from the strategic petroleum reserve (SPR) in order to smooth any price volatility that may result from a disruption to supply from Venezuela. The previous US administration was willing to tap the SPR to steady markets after the Libyan supply disruption, and we believe the current administration would consider this option as well. The US did not sell oil from the SPR during the 2002-03 Venezuelan supply disruption and prices rose by more than 40% during that period, although other factors also contributed. We doubt a disruption will result in a 40% price increase in the event of a supply disruption, but we think prices will rise nonetheless. For this reason, we think the US government would consider using the SPR as a backstop.
At present, we believe the price response to a disruption would be more muted than previous disruptions due to the apparent increased willingness of the US to use its SPR, the fact that OPEC could raise quotas, and US producers would begin to respond to sustained higher prices.