Amy Myers Jaffe

In early 2003, when debate was surfacing in the United States whether to invade Iraq, a Council on Foreign Relations working group drafted a monograph outlining the problems that such a policy would face. As I explained at the time as part of that effort, Iraq’s oil industry was in tatters and it would take years, not months, to restore it. It was clear prior to the 2003 war that Iraq’s oil could neither pay for the war, nor be nearly enough to fund its reconstruction.

Given the news that the United States has recognized the speaker of the democratically elected National Assembly Juan Guaido as interim President of Venezuela in defiance of ruling strongman Nicolas Maduro, the question about how long it would take Venezuela to restore its oil production under a new government is likely to arise. Like Iraq, Venezuela will need massive amounts of money to rebuild deteriorated national infrastructure. Also like Iraq, Venezuela’s oil industry has suffered serious damage, and the damage could arguably be harder to restore than in Iraq. The invasion of Iraq took place in 2003. Iraq’s oil production is now gaining ground, but that positive trajectory took almost a decade to establish, as seen in figure 1.

 It might seem relevant to note that Iraq faced a destructive war in 2003, followed by years of civil war and more recently, a battle to expunge ISIS and therefore its oil installations took a military beating that won’t be analogous in Venezuela. That is certainly true. But the fact is that there has been tremendous violence on the ground in Venezuela with multiple armed groups looting and raiding the country’s key infrastructure, and the oil sector has been targeted across the country. The violence has caused many of the international oil companies previously operating in the country to withdraw. One challenge that will face any new government, were one to be able to emerge, is that there are multiple renegade armed groups operating inside Venezuela, including Cuban mercenaries and others deeply entrenched in drug trafficking. This has made and will continue to make guarding Venezuela’s oil industry a major challenge.

Further complicating any oil sector transition, the Venezuelan military has virtually taken over as the gate keeper on the operation of the oil industry. The employment ranks of state firm PDVSA is said to now total as many as one hundred and sixty thousand people, up from its normal ranks of forty thousand in the years prior to the election of Hugo Chavez. Organizations like the Military Corporation for Mining, Petroleum and Gas Industries (Camimpeg) created in 2016 actively intercept the flow of income from the oil sector. Camimpeg’s soldiers have been working to suppress strikes by oil workers unions at oil fields around Lake Maracaibo, and Petroleum Intelligence Weekly is reporting that soldiers often siphon off barrels and engage in illegal smuggling for payments for stolen oil being included at Venezuela’s ports in larger shipments to Russia and China.

Last week Guaido bravely told a public rally that “We will not permit the continued use of public funds by a gang of thieves so they can continue stealing,” but acknowledged that gaining control of Venezuela’s offshore assets like Citgo Petroleum in the United States would take time. In fact, Guaido’s opposition government will need time to develop the leadership and capable administrative staffing that it would require to run an industry as technically complex as oil and gas.

The condition of Venezuela’s oil industry is dire. Of its four refineries, only one is running. Fires, explosions, looting and mis-operation has shuttered most of Venezuela’s refining capacity. Refining throughput is estimated at just under three hundred and fifty thousand barrels per day (b/d), mainly from the large Amuay Bay facilities, compared to its prior operational capacity of 1.5 million b/d. The Cardon, El Palito and Puerto La Cruz facilities face equipment failures and manpower shortages. PDVSA has also abandoned the Isla refinery on the Dutch Island of Curacao, which it had operated under a lease. The refining problems have led to gasoline and diesel shortages across Venezuela.

Venezuela has experienced a sharp oil production decline over the past two years, dropping from 2.2 million b/d in early 2017 to about 1.1 million b/d currently, as is seen in figure 2. The declines result from chronic technical mismanagement and underinvestment in the sector over a decade or more and massive arrears to suppliers such as international drilling companies and equipment suppliers who have slowed activity in Venezuela over the past year or so to limit unpaid bills. Other more recent problems are also taking their toll, including shortages of basic equipment, logistical problems on export loading ports, corruption, and labor unrest, worker desertions, and mass resignations. Historically, Venezuela’s conventional fields near Lake Maracaibo have required constant intervention because their natural decline rate is among the highest in the world at 25 percent. Venezuela’s heavy oil extraction operations are labor and equipment intensive and requires cash purchases of diluent on the international market. Estimates are that it would take an injection of over $20 billion of new investment to reverse the current downward path on production. Given this cost, the extent of existing damage, and the deterioration of PDVSA’s workforce, a reversal of Venezuela’s oil industry woes might prove more difficult even than war-torn Iraq.

The United States had previously banned U.S. entities from trading in new Venezuelan government debt beyond the thirty days customary for letters of credit for oil trade. U.S. entities were similarly banned from trading in existing debt held by the Venezuelan government as well as trading in new debt instruments with maturity beyond ninety days. Citgo, as a U.S. entity, was forbidden to make financial distributions back to Venezuela. Last week, U.S. National Security Advisor John Bolton reiterated the Trump administration goal to disconnect “the illegitimate Maduro regime from the sources of its revenue.” With the U.S. recognition of Guiado as interim President of Venezuela, one option will be to establish a special purpose bank account for the opposition government in the United States, to include revenues that involve payments by American firms involved in business dealings in Venezuela. U.S. refiner Valero has been a major importer of Venezuelan crude, and Chevron Corporation has ongoing oil field operations in the country. The U.S. Department of State has already served notice to the U.S. Federal Reserve to recognize Guaido as the primary agent for access to Venezuelan financial assets in U.S. banks.  The practicalities of implementation remain to be seen.

There is speculation that Venezuela will stop shipping any oil to the U.S. including to Citgo to avoid transfer of any funds to the Guaido-led interim government. That means in effect the current U.S. actions have already in effect embargoed imported Venezuelan crude to Citgo and other U.S. buyers. In a sign that Maduro regime is already taking a different approach, state PDVSA issued a tender early last week for the open market sale of four million barrels of Venezuelan crude oil slated for delivery in late January and into February. Black market sales of oil and refined products either by truck or otherwise have been a staple of declining oil regimes over the last few decades, and could possibly sustain Maduro with some cash even if his regime has difficulty maintaining official government exports.

The situation with Citgo Petroleum is also a sticky problem with the Trump Administration. The wholly Venezuelan owned U.S. refiner also imports crude oil from Venezuela and purchases Canadian and other crude oil for its three refineries. Citgo is among the largest U.S. branded gasoline marketer in the United States. Citgo’s refineries produce roughly 4 percent of U.S. refined petroleum products. At its peak, Citgo supplied close to 9 percent of annual sales of U.S. retail gasoline. The firm is a major supplier to the Chicago area.

Prior to the recent political events, investors who hold Venezuela’s unpaid bonds in Citgo had been organizing and were expected to push for a restructuring. Canadian miner Crystallex won a legal judgement against Venezuela last year that would have facilitated it to seize and sell Citgo as compensation for Venezuela’s 2007 nationalization of a gold mine. Venezuela still has $1.5 billion in settlement payments to make to ConocoPhillips as part of its 2007 nationalization of the American oil company’s assets in Venezuela’s oil sector. It is unclear how the unraveling of Citgo’s financial structure would proceed under a new Venezuelan government. Guaido has specifically announced plans to create a new board for Citgo but has been mum on how it might restructure the liens against the company’s assets and revenues. In 2016, Caracas used a 50.1 percent stake in Citgo as collateral for new bonds. Russian state oil firm Rosneft also has a $1.5 billion lien on the other 49.9 percent share of Citgo. Additionally, Venezuela remains highly indebted to China, which extended over $60 billion in aid during the rule of Hugo Chavez. To date, Venezuela has been repaying this latter debt slowly over time in the form of oil shipments.

Geopolitically, the oil situation in Venezuela presents a difficult and complex challenge for U.S. diplomatic and treasury officials. On the one hand, the United States is helped by the fact that the Organization of American States (OAS) issued a resolution declaring Nicolas Maduro’s January 10 reelection “illegimate.” The United States has been leaning on allies and the United Nations to address the humanitarian emergency that has been created by the exodus of several million Venezuelans to neighboring countries. But China and Russia, which have invested heavily in the Maduro regime, are likely to push back on efforts to topple it, arguing at the U.N. Security Council that wider intervention is interfering with sovereign internal affairs. Both countries are heavily embedded in the Venezuelan oil sector.

Given the complexities of how Venezuela has tried to insulate itself over the years from U.S. pressure using friendly oil investors as leverage, it will be tricky for the Trump administration to proceed to back a Guaido presidency without creating a disruption in Venezuelan oil production and exports as an unintended result. Presumably, a new government would be in a position to receive some debt forgiveness combined with a broad restructuring of its government debt. In doing so, the demands of Russia and China will have to be factored in to ensure a lasting resolution of Venezuela’s indebtedness. The obvious importance of Citgo inside the U.S. refining system and as a key preserved asset for Venezuela should give pause to all parties about the relative stakes of failing to find a creative diplomatic solution to the current stand-off. Implementation of a political transition on the ground inside Venezuela, given the multitude of rogue military gangs operating within the country, may still make geopolitical deal-making just the tip of an iceberg for restoring stability to either the country and to its oil industry.

Source; Council on Foreign Relations