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The U.S. - Venezuela energy showdown

By Gustavo Coronel

17.03.06 | I. The developing global energy crisis has at least three main aspects that should be considered: one is psychological, the second is geological and the third is technological.

The psychological component.

This is probably the most important in the very short term and the one that could lead to widespread conflict, including war. It has to do with the interruptions in the normal supply-demand relationship between producers and consumers. The rupture of an Alaskan oil pipeline, the kidnapping of oil workers in Nigeria, the strike of Ecuadorian petroleum staff in Ecuador, the bombing of a refinery in Iraq, some of the ranting of Venezuelan president Chavez, any of these events send ripples of alarm throughout the industrial world and can play havoc with stock exchanges all over the world. A major disruption of oil supplies, either due to a natural disaster or to a political decision in a major producing country, could create chaos in the market.

The geological component.

This is a component over which we have little control. The answer to how much petroleum exists in the planet was already given by nature way back in geologic times. Although estimates might vary among geologists there seems to be reasonable agreement that we are near the midpoint in the utilization of our total petroleum resources. In addition, there is little doubt that the second half of the hydrocarbons existing in nature will be more costly to extract and, if demand is not drastically curtailed, it will take much less time to be drained than the first half. The time that these resources will last, at the current rate of utilization, is of the order of 50-70 years.

The technological component.

Technology will have the last word on the speed at which alternative sources of energy become commercially feasible. Some of these alternative sources, such as nuclear, wind, solar and ethanol, are already in different stages of commercial use. Others such as hydrogen are in a stage of large-scale experimentation. Technology, however, is intimately related to economics and politics. Until the numbers are right for investors or political leaders are convinced that strong policy decisions should be taken, the replacement of petroleum and gas by other forms of energy will not take place in force. Political and economic inertia will promote the delay in the use of alternative fuels, while environmental considerations will tend to accelerate this use.

II. The increasing political and economic split between the U.S and Venezuela.

Ever since commercial oil was discovered in Venezuela, in the 1920’s, a stable commercial relationship has existed between the two countries. Venezuela became the U.S. oil supplier of choice. Even after nationalization of the Venezuelan oil industry took place, 30 years ago, our country maintained a leading position as a supplier of oil to the U.S. Many of the long-term supply contracts with U.S. customers have existed since day one of nationalization and remain in force today. This condition of Venezuela as a stable supplier of the U.S. has been one of the cornerstones of the political and economic relations between the two countries.

Today, after seven years of an increasingly authoritarian political regime led by Hugo Chavez, in which he has promoted a socialist revolution and aligned himself with extreme political ideologies in Cuba and Iran, among other countries, the Venezuelan government is threatening to cut oil supplies to the U.S. At any time in recent history such a threat would have been a dangerous one but, at this particular time, when global oil supplies have tightened considerably and U.S. dependency on oil imports is greater than ever, the utterances of Hugo Chavez are being taken by the U.S. as a real threat to their national security and are already triggering important defensive measures from the U.S. government. One of these measures has been the request made by Senator Richard Lugar, to the U.S. Government Accounting Office, to conduct a study of the potential impact of such an action by the Venezuelan government.

Can Hugo Chavez afford to cut oil supplies to the U.S.?

What can Hugo Chavez really do? Can he afford to follow through in his threats? I think it is fair to say that there is a difference between what Chavez can afford to do as a responsible president of the country and what he might be prepared to do as a political leader with messianic pretensions. In the philosophy of Hugo Chavez what is good for the revolution is good for the country, even if it does not look that way for Venezuelans. If he believes he can damage the U.S. and survive politically in good form, he could well do it.

What are the numbers?

The numbers on Venezuelan oil production and exports are not reliable. The last ones we have on an “official” basis are those for 2003, as presented by PDVSA to the Security Exchange Commission and published in the official book of the Ministry of Energy and Petroleum “Petroleo y otros datos estadisticos”. We will use these figures which illustrate reasonably well the overall situation.

First of all, Venezuela exported an average of 1,648,000 barrels per day of crude oil and 502,000 barrels per day of products in 2003. Of the crude oil exported 62% was “heavy” oil, defined as having API gravity of 30 degrees or less. In fact, about 40% of the total exported, about 650,000 barrels per day, was oil of 20 degrees API or less, requiring specialized refineries to process. This is important since refineries for this kind of oil are not common on a worldwide basis. Of this total of crude oil and products exported by Venezuela, about 1,200,000 barrels per day of crude oil (including the volumes going to the refinery in the Virgin Islands) and about 260,000 barrels per day of products went to the U.S. and Canada. This is almost 70% of the total crude oil and 52% of the total products exported by Venezuela.

Venezuelan exports of crude oil to other destinations included about 88,000 barrels per day to Europe, 65,000 barrels per day to South America and some 300,000 barrels per day to the Caribbean and Central America. Exports of products to other destinations included 100,000 barrels per day to the Caribbean and Central America and some 140,000 barrels per day to South America. In 2003 the volumes of hydrocarbons exported to Asia were negligible and remain very small today.

These figures evidence a very strong dependence of Venezuela on the U.S. as a major client. Indeed, the economic lifeline of Venezuela runs directly from the U.S. The volumes exported to the Caribbean and Central America are mostly tied up to easy paying terms and some, like the 100,000 barrels per day going to Cuba nowadays, are practically free of charge since Chavez is not collecting the money from Castro. The subsidies to the other Caribbean countries and the give away to some South American countries are not economically rewarding to the country. In other words, Venezuela gets paid mostly from the U.S., to a lesser extent from Europe and, even less so, from Latin America.

Of the crude oil and products exported to the U.S. about one third are committed to third parties that have been clients of PDVSA for 20 or more years and about half of the oil sent to PDVSA’s affiliates are heavy, of lower quality. It would be difficult for Chavez to suspend the deliveries to third parties without risking strong international isolation and it would be very difficult for him to place the heavy oils in any other country in the short or even medium term. This would leave Venezuela with roughly 600,000 barrels per day of oil that theoretically could find a market in other countries in the short to medium term (say,six months). The question is: where?

The oil Venezuela could reasonably try to place elsewhere is of some 600,000 barrels per day.

Where could Venezuela place these volumes in the short or medium term? The only countries where these volumes would probably find a home are China and India. But the limiting factor in those countries would be of refinery capacities and configurations, not to mention transport costs. Both these countries have little or no spare refining capacity and cannot easily handle heavier oils. Furthermore, the limited availability of large tankers and increased transport costs would be a factor against the imports of Venezuelan oil, as compared to oil from the Middle East or Indonesia. These large costs explain the negligible exports of Venezuelan oil to Asia in the past. Any increase of this trade, therefore, would be fundamentally dictated by political considerations and could result in huge losses for Venezuela and huge costs for the clients. Due to this combination of factors Venezuela simply cannot divert the volumes marketed to the U.S. in the time framework and in the quantities that the country would require to keep economically stable.

The impact of a supply interruption on the two countries.

1. In the U.S.

The immediate impact on the U.S. would be psychological. The stock markets would suffer greatly and the country would have to go through a painful period of readjustment. This period can be made shorter depending on the measures taken by the government. The government of the U.S should know by now what alternative sources of supply are available, how much can the other producing countries contribute to compensate for the absence of Venezuelan oil. It seems probable that much of the shortage can be compensated rather quickly, within the first three months of the disruption. The U.S. has about 540 million barrels of oil in strategic reserves and this volume is enough to compensate a total lack of alternative supplies for about one year, although this certainly would not be necessary.

2. In Venezuela.

The immediate impact on Venezuela could be political, probably triggering popular protests in a large scale. Venezuelans generally do not agree with the policy of confrontation with the U.S. promoted by Hugo Chavez and would probably consider this action too much to digest. Protests could take the form of a general strike and this could lead to military intervention. A second type of impact would be economic and could become apparent within the first three months of the disruption, as Venezuelan international reserves start being drained. Although these reserves are significant, in the order of $28 billion, they are already under pressure from a Chavez government that is somehow managing to spend more than it earns from current oil income. The pressures on the economic stability of the government could become very great within a short time.

The combination of increased popular protest and economic instability could result in a significant weakening of Chavez’s grasp on power and his fall from power within the year.

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