How To Deal With Venezuela Without Shocking Oil Markets

The Trump administration has, for now, opted against hitting Venezuela’s oil sector with the harshest possible sanctions despite disavowing the re-election of President Nicolas Maduro as a “sham.” The White House did issue new financial sanctions on Caracas and state oil producer Petroleos de Venezuela (PDVSA) this week, but pulled up short of a full-scale embargo on U.S. refineries importing Venezuelan crude or banning U.S. companies from selling Venezuela the light petroleum diluent the crumbling country needs to make its heavy oil usable for refining. Consider these the nuclear options of Venezuela sanctions.

The decision to hold off on such nuclear options is prudent given the current state of global oil markets. Oil prices have surged recently to multi-year highs of around $80 a barrel, mainly on the back of supply fears related to renewed sanctions on Iran. The last thing the market needs now is more headlines about sanctions wiping out yet another OPEC member’s production.

Besides, Maduro has been doing an excellent job of running Venezuela’s oil sector into the ground on his own. It’s also clear that previous rounds of sanctions are starting to have an impact on Caracas. Venezuela’s creditors have lost patience and commenced legal actions to ensure repayment of debts. Trump did not go nuclear because he didn’t have to. Barring a sudden extra-constitutional regime change, Venezuela’s political and economic crisis will likely continue. The result will inevitably be a further decline in the nation’s oil production, which brings in nearly all of its foreign currency.

The political impact of rising oil prices is not lost on President Trump. Since his inauguration, domestic gasoline prices have increased 54 cents a gallon – the average American household is paying nearly $300 more a year to fill the family SUV. The average retail gasoline price has risen from $2.33 to $2.87 a gallon over that span, a 23% increase. With the peak summer driving season about to kick off this weekend and mid-term elections looming in November, the political stakes are high for rising prices to eat into the president’s tax cut bump.

While the decision on Iran had a May 12^th deadline, the president has more flexibility in dealing with Venezuela. Trump also has the biggest arrow still in his quiver should he need it in the future, though this does not offer much of a lifeline to Caracas. Maduro’s mismanagement of PDVSA is epic. Venezuela stands out for the world’s steepest production decline since 2015, a drop of nearly 40% or 800,000 barrels a day to 1.4 million barrels a day. Moreover, existing U.S. sanctions are having a significant impact on the country and its PDVSA cash cow. Although sanctions do not specifically target the oil sector, counter parties are increasingly wary of doing business with PDVSA as the sanctions regime has intensified.

American refiners have dramatically reduced imports of Venezuelan oil, which dropped to a 15-year low of 409,000 barrels a day in February from over 700,000 barrels a day in early 2017. Some refiners have stopped buying any crude at all from Venezuela, and the U.S. oil industry appears ready for a full embargo of Venezuelan oil. Even if it never comes to pass, refiners can see the further collapse of Venezuelan oil production, and finding alternative supplies at this point is smart business. While American shale is the answer for some, many domestic refineries are configured to process Venezuela’s heavy, sour grade of crude oil. Unfortunately for Maduro, such crude can also be procured from Canada, West Africa and the Middle East.

There are reasons to believe Venezuela’s collapse will soon accelerate even without President Trump using the nuclear option. While Venezuela and PDVSA have technically been in default since November, their bondholders and creditors have until recently been patient about debt repayment schedules. The recent move by ConocoPhillips to seize PDVSA assets in the Caribbean as compensation for the $2 billion of upstream holdings that Venezuela nationalized in 2007 could not only deal a blow to the state oil company’s exports, but also set off a wave of legal claims from numerous creditors seeking payment before PDVSA’s cash flow dries up. ConocoPhillips is going all out in its attempts to seize Venezuelan oil tankers, even as Caracas does its best to redirect them.

The Trump administration should support such legal claims against Caracas. Steadily and quietly bleeding the Maduro regime dry is the preferred political solution. Previous rounds of sanctions have done their work to soften up Caracas, and this week’s move to ban U.S. purchases of debt or accounts receivable issued by Venezuela or PDVSA should tighten the noose. Trump’s sanctions this week limit Venezuela’s ability to liquidate state-owned assets or finance itself using PDVSA’s U.S.-based refining subsidiary, Citgo. Venezuela will be lucky if its output doesn't drop below 1 million barrels a day by the end of the year.

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