How Oil Prices in the Short Term and Long Term Can Differ with Venezuela’s Turmoil

The government shutdown has overshadowed major news developments in other parts of the world. What may be Venezuela’s biggest news this century occurred this week, and it’s difficult to find more than a line item on it.

End of a dictatorship?

The short version of this is that the last elected dictator (Chavez) of 14 years died in 2013 and his successor, Maduro, who was never “legally” elected, took over.  Venezuela had been in a tailspin when Chavez was in power and it became exponentially worse under Maduro.  Continual declining oil exports, inflation over 1 million percent, and food shortages (imagine having to wait for your day of the week to buy a particular good, then have it be sold out by the time your group in line can enter the store) are just a small example of the problems Venezuelans have faced.

Venezuela Inflation Rate Chart

Fast forward to this week.  Juan Guaido, the elected leader of the National Assembly stated that the presidential election last year wasn’t valid and was unrecognized by many nations, so technically – Venezuela did not have an official president. He clarified that it’s the job of the National Assembly to appoint an acting president, and as the elected leader of Venezuela’s National Assembly, Mr. Guaido swore himself into the Presidency role on Wednesday. Hundreds of thousands of Venezuelans came to the streets in support of Guaido (see video) and hope of a new future.

The United States, along with a growing list of other countries including Colombia, Canada, Brazil, and Chile were quick to accept this new President.  Not so much for Russia, China, Cuba and Turkey (Venezuela has deep debts to China and Russia).  Maduro has not accepted the change, and now the power struggle begins. Maduro has a stronghold with the violent military and the situation could provide more bloodshed if this take-over is actually real, not just another attempted coup.  We can only be optimistic for the people of Venezuela that the transition will actually occur, and with minimal violence.  President Trump, Vice President Pence and Secretary of State Pompeo have all issued statements supporting Venezuela.

How could this affect oil prices now and in the future?

I view these developments as potentially short term bullish and long term bearish for oil prices. Headlines can move the markets and we are just starting to see the news. As I write this, oil has advanced over 1% today.  Current headlines include sanctions talk from the U.S, and how further disruptions to the oil supply can affect prices. However, in the big picture, when the bottom line is taken into consideration, I don’t think the higher prices from the Venezuela story can last long (other bullish factors like cold weather and Q1 seasonality will still be there though), as Venezuela has become a declining player when it comes to oil production, only producing 1.1m bpd.  The U.S. alone has increased production enough to offset Venezuela’s production decline. (In comparison, the  U.S production is near 12m bpd).

I see a longer-term bearish story for oil prices.  There is a possibility that if the new President stays, sanctions get removed, and Venezuela is able to successfully increase production. As of 2017, Venezuela had the largest proven oil reserves, which could increase supply for long time.

Countries With The Largest Proven Oil Reserves

https://www.worldatlas.com/articles/the-world-s-largest-oil-reserves-by-country.html

That being said, improvements won’t happen overnight. It will take time to return the equipment to operating condition, have experienced oil companies return to the country, (a few years back, Venezuela “Nationalized” oil production companies and areas, and forced foreign companies out) and obtain the brain power and experienced workers to operate the production flow and distribution. Capital Economics stated it well by saying: “The oil sector has simply been starved of the capital goods needed to undergo routine maintenance and everyday operations.”

In summary, this could be Venezuela’s chance to turn the page. It will need the proceeds from oil production to re-stabilize the country. The underinvestment in its oil infrastructure could delay production increases, however, the country has the oil reserves to make an impact on overall long-term supply.

Disclosure: Mrs. Rios, Portfolio Manager on the Catalyst Hedged Commodity Strategy Fund, expresses bias in favor of Venezuela, as this is her husband’s birthplace and familial home.