The Clock Is Ticking On Venezuelan Oil Production

| About: The United (USO)

Summary

The Guri hydroelectric dam, which provides a majority of Venezuelan power, is near critical shortage levels due to drought.

Venezuelan power production is near a tipping point.

With a power crisis, an economic crisis, and a political crisis hitting the country concurrently, the chances of wide-scale production outages have become a near certainty.

The clock is ticking, it is only matter of when Venezuelan oil production will meet a steep decline.

Venezuela has the largest proven oil (NYSEARCA:USO) reserves on the planet. The country sits on nearly 300 billion barrels of proven reserves. However, as a country mired in corruption and mismanagement, it is not surprising that Venezuela is nearing collapse as low oil prices persist.

As I have pointed out before, more than 60% of Venezuelan power production is sourced from hydro. Technical difficulties for the nation's heavy oil fields also mean that a lack of investment, technical expertise, and civil unrest will handcuff production.

Source: EIA

Drought At Crisis Levels

Droughts have been impacting water levels for the last three years, with water levels continuing to plummet, the government has had to resort to ever more extreme measures.

"For three years, according to the Ministry of Electricity, Venezuela's rainfall has measured 50 percent to 65 percent lower than normal. Drought conditions, according to the country's meteorologists, are the worst they've been in at least 40 years." - Circle Of Blue

The Guri hydroelectric plant is at the center of the water crisis, and as the majority power provider for the country, it is at the heart of its economic crisis. Venezuelan authorities elected to cut the working week to two days as the plants operating has had to shut down turbines at the dam due to reduced water levels.

As the problem persists, the economy continues to weaken, and the country ebbs closer to becoming a full-blown humanitarian crisis. There is little doubt that should sufficient rain not fall to saturate the land and welcome flowing water; the Guri dam will be shut down in the coming months. With the majority of its baseload power offline, Venezuela would struggle to maintain order - forget raise production quotas as recently touted by officials.

Impact

Public servants and independent sources have pegged the estimated loss of production at 200 thousand bpd; Bringing the total production rate to 1.9 million BPD. The real figure will likely surpass 0.5 million BPD, and could be even higher as the countries economics deteriorate. With little confidence from the international community, PDVSA and Venezuela have both struggled to gain financing. It certainly doesn't help that domestic gasoline prices in Venezuela are the lowest in the world, zapping any profits that would be made for the countries coffers.

Since the government is subsidizing domestic consumption through low prices, it costs the government roughly $US 15-25 billion in foregone revenue each year.

The Bolivar

For Venezuela to stem the tide of falling production, they would need to purchase goods produced in the U.S., Asia, and Europe. None of those countries are willing to accept Bolivars and companies can not get their hands on U.S. funds. So begins the death spiral. Bolivars have become nearly worthless - in February of this year; the black market exchange rate surged by 1000 Bolivar/USD, 100 times the official exchange rate. This means that any plans to rebuff the oil industry with new equipment are tedious at best. It is unlikely that Venezuela will be able to work on any technical issues of decline. The sustainability of power generation of the country is even more tedious. As the country falls into chaos, instability increases and the chance of a major event wiping out vast pools of production.

Wrap-Up

It is only a matter of time before Venezuela production drops significantly. The drop is going to come harder and faster than many predict. However, the outcome for oil markets is less clear. As the market has absorbed record production outages around the world, it will likely do the same with Venezuelan production. The foregone production will be ceded to Saudi Arabia and Iran, increasing the value of high margin heavy oil. The oversupply of light tight oil will continue to persist and maintain an oil price band below $60.

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