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Venezuela's political crisis remains in stalemate. Escalating
oil-sector sanctions imposed by the United States have contributed
to massive declines in crude oil production, but the collapse of
Venezuela's petroleum industry has not resulted in a political
shift. President Nicolás Maduro appears to maintain full control of
Venezuela's political, economic, and military apparatus nearly six
months after Juan Guaidó, the president of the
opposition-controlled National Assembly, announced that he was
assuming Venezuela's presidency on an interim basis by invoking the
constitution.
The IHS Markit Oil and Gas Risk scoring methodology captures
Venezuela's process of petro-state failure: Since 2014, the
country's overall score has fallen by almost half from an already
low base score - an unprecedented decline that underscores our view
that any eventual recovery will be prolonged.
Figure 1: Venezuela: Oil and Gas Risk rating,
2014-2019
Military opts to threaten - and incentivise - foreign
upstream investors
Venezuela's sustained state collapse has triggered erratic
behaviour on the part of the ruling military elite toward foreign
upstream investors. In 2018, Major General Manuel Quevedo, who
jointly heads PDVSA and the oil ministry, employed sticks and
carrots - namely international oil company (IOC) personnel
detentions and tax exemptions for foreign companies - in a largely
unsuccessful attempt to compel PDVSA's foreign partners to help
stabilise the country's oil output.
PDVSA also undertook a questionable audit of its foreign
partners last year under the guise of ensuring that the companies
were meeting their volumetric obligations and paying the
corresponding royalties. According to official PDVSA documents,
foreign partners that consistently do not comply with their
volumetric commitments should be replaced.
Quevedo's simultaneous use of aggression and incentives has
continued through 2019. In the wake of US sanctions, PDVSA
leadership has allegedly used opaque threats to compel partners to
confirm that they will remain in joint ventures with the NOC.
Meanwhile, PDVSA has reportedly negotiated favourable tax terms for
a production license that it directly awarded to Russia's Rosneft
in 2017 for the Patao and Mejillones offshore non-associated gas
fields. This agreement marks another element of Rosneft's
years-long contrarian strategy to extract concessions from
Venezuela while expanding its presence in the country's petroleum
sector amid worsening crisis conditions.
PDVSA also has reportedly offered to cut the royalty rate that
Chevron pays to the government for its 30% stake in the Petropiar
heavy crude upgrader project located in the Faja (Orinoco Oil
Belt). Waivers to existing US sanctions on Venezuelan operations
for Chevron and US-based service-sector companies Baker Hughes,
Schlumberger Limited, and Weatherford International are set to
expire on 27 July 2019. The looming deadline is likely driving the
offer of improved fiscal terms in exchange for Chevron's request
for a waiver extension.
Erratic approach to investors will intensify amid
accelerated oil production collapse
The official use of hostility and inducement toward foreign
E&P companies is expected to intensify amid a new phase of
collapsing oil production. IHS Markit forecasts sharp declines in
total crude oil production over the next 12 months, including key
projects with foreign partners. US sanctions will likely have a
material effect on curbing the supply of diluent used to dilute and
upgrade volumes of its heavy crude for export. Anticipated US
pressure on buyers of Venezuelan crude is expected to compound the
crunch on Venezuelan production, exports, and associated oil
revenues. As a result, Venezuela's crude oil production could fall
below 500,000 b/d next year.
Figure 2: Venezuela: Crude oil production outlook
We expect that PDVSA leadership will offer expanded fiscal and
contractual incentives - combined with the use of intermittent
hostility - to companies in exchange for increased upstream
investment. For companies taking a long view of the country,
ingratiating themselves to the current military-backed government
could enable them to expand their in-country foothold. However,
this approach carries legal risks, as a future government could
scrutinise investment agreements signed without the requisite
approval of the opposition-controlled National Assembly, as
specified by law.
E&P companies and service-sector providers that do not
engage in industry cooperation with the current government - either
of their own volition or due to international sanctions - will
confront risks to their in-country assets. Indeed, the military
leadership of Venezuela's hydrocarbon sector could invoke PDVSA's
stipulation of replacing foreign partners who fail to meet their
production requirements as justification to seize specific assets
in the name of a national emergency.
Importantly, the aforementioned agreement with Rosneft
reinforces the reality that even Venezuela's most strategic
geopolitical allies are not immune to these risks: The agreement
reportedly includes a clause stipulating that Rosneft be
compensated per fair market pricing in the event of an asset
expropriation.
From the perspective of the armed forces, taking control of
foreign upstream assets could give them a strategic bargaining chip
in any negotiations regarding a future power transfer. However, the
fact that Venezuela lacks the finances and personnel to invest in
boosting output from any seized upstream assets will represent a
check on the extent to which the armed forces take this
approach.
For foreign investors with confiscated assets, legal battles
aimed at securing compensation would most likely last years, with
diminished prospects of ever fully achieving recompense due to
Venezuela's limited financial resources and a lengthy queue of
aggrieved creditors.
