Venezuela's state energy company (PDVSA) recently projected that oil production will continue to stay at 23-year lows for 2017. We believe Venezuela's oil production will actually continue falling in the new year given credit constraints. Let's explore the reasons.
OPEC/Non-member OPEC Agreement
The recent OPEC and non-member OPEC decision to cut oil production by 1.8M barrels per day (bpd) for six months portends higher oil prices as inventories begin to draw down. Oil prices consequently have risen to $53/barrel (WTI) from the lows, and bears have begun claiming that as prices "stabilize", OPEC and non-member OPEC producers will cheat and begin to overproduce again. In conjunction with the shale industry, the two sources of increased production will essentially negate the effectiveness of any oil cuts.
We've held the thesis that the ramp-up in production will in fact be muted at today's prices. Simply put, sub-$60 oil continues to be unsustainable. Any increase in production by shale, or better-off OPEC/non-OPEC members will essentially be stealing market share from the more expensive producers, whether private or national oil companies, as those indebted and poorer producers struggle to raise capital to similarly increase production.
Case in point: on Friday, January 13, PDVSA's latest report for 2017 sees production at 2.5M bpd, essentially a flat production profile from 2011. Venezuela relies almost exclusively on its oil production to fund the government's socialist programs, and the fall in oil prices has brought upon the country an unprecedented wave of inflation and hardship. This report was significant for a few reasons.
First, it's difficult to believe that Venezuela can produce anywhere close to 2.5M bpd in 2017. In OPEC's latest Monthly Oil Market Report (December 2016), secondary sources reported that Venezuela produced 2M bpd in October and November 2016. Venezuela itself self-reported oil production of 2.3M bpd. Consequently, even if we relied on the suspect self-reported figures (one made in anticipation of the OPEC negotiations in Vienna) it would mean that Venezuela would be increasing oil production by 10% to achieve the 2.5M bpd figure in PDVSA's report.
We think this is highly unlikely. The more likely scenario is that Venezuela's oil production has declined to 2M bpd (as per secondary sources), and will now decline further because of credit issues.
This is because in the same report, PDVSA noted that shipments to China under their "oil-for-loans" program are slated to increase to 550K in 2017, after declining from 627K in 2015 to 355K in 2016. We believe the increase is likely related to China's recent $5B loan to Venezuela, one trumpeted by President Nicolás Maduro on September 1. China has already invested over $56B in loans to Venezuela since 2007, and about $20B is outstanding. Coupled with the $5B of additional loans, Venezuela's capacity to borrow is stretched. China likely granted Venezuela a reprieve in 2016, but as oil prices rise, China wants its money, in the form of oil.
Ponder this for a minute: close to 200K bpd of additional oil (i.e., 10% of Venezuela's oil production) will now be unavailable for sale. Production that could have been sold on the open market for badly needed cash will now be siphoned to repay debt. This will have a profound affect on the government's coffers, and further limit its ability to increase capital expenditures to maintain or increase oil production.
So if Venezuela's own national oil company reports that production won't grow in 2017, and if 10% of total oil production will now be transferred to its major creditor, is Venezuela much better off today than a few months ago? We think not. Sure oil prices have recently increased by 10% from early December, but Venezuela will likely see little of it in this new year. At this stage, Venezuela's best hope is to have oil prices increase much more than the "lost production". This likely explains President Maduro's recent comments about introducing a new proposal to increase oil prices, only a few weeks after a historic Vienna agreement.
So for oil bears, note that the OPEC and non-OPEC agreement accelerates rebalancing, but it doesn't usher in a new era of cheaper oil. It still costs the world much more than $55/barrel to produce what's needed, and anything less points to higher oil prices in the long-run. Just ask Venezuela.
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