A Post-Chávez Energy Sector: Resisting The Temptation Of Optimism
BMI View: With a post-Hugo Chávez future seeming increasingly imminent, it is tempting for markets and industry players alike to imagine a brighter future for the Venezuela ' ' s energy sector . Indeed, the country ' ' s unparalleled below-ground potential has disappointed in recent years due to economic mismanagement, underinvestment, and the unsustainable social policies which have drained state-owned PdVSA of critical resources. As such, market optimism has prevailed in recent weeks, signalling that investors view a Venezuela without President Chávez positively . However, it would be wise to keep brace for a period of energy sector instability in immediate aftermath of any transition in leadership .
The Venezuelan energy sector has undeniable below-ground potential and strong long-term growth prospects. However, the sector currently faces massive structural challenges, each of which we have been highlighting for some time. Over the long-term, reform is necessary in each of these areas in order for the sector to meet its potential. These include:
An unsustainable domestic fuel pricing regime amid insufficient domestic refining capacity, which leaves the country increasingly dependent on imported refined products. Indeed, it has recently been estimated that for every 10 barrels (bbl) of crude oil sold to the US, it must import two bbl of refined fuels, at higher prices, contributing to a massive increase in the country's import costs.
Exacerbating these fuel import dynamics are unsustainable domestic subsidies, which grant Venezuelans access to the cheapest fuel in the world. Despite the cost of these subsidies, the government has continued to view these low prices as critical to maintaining popular support - and they are unlikely to be removed in the short-term.
The August 2012 explosion at the Amuay refinery highlighted the effects of years of underinvestment and mismanagement at state-owned Petr ó leos de Venezuela S.A. (PdVSA)'s operations. Additionally, the government has spent years diverting oil sector revenues towards an ambitious social agenda, and the practice of favouring Cha vistas (those loyal to Chávez) over competent technocrats - appointing them to key leadership positions within the company - has been a key factor in the decline in the country's oil production.
The endurance of unsustainable political arrangements, most notably the alliance between Venezuela and several Caribbean states known as Petrocaribe, has highlighted the government's continued favouring of politics over sound economic policies. Indeed, Petrocaribe allows these countries to purchase Venezuelan crude at massive discounts in exchange for their political support.
Furthermore, through a series of bilateral deals, Beijing has agreed to lend a total of US$36bn to Venezuela, the bulk of which is to be paid through an oil-for-loans scheme. However, rather than using these loansto boost the country's long-term production growth, much of the money has been spent financing Chávez's social agenda. Importantly, Venezuela may end up sending half of its total net exports to China by the middle of the decade in order to replay these loans, despite no benefit having materialised within the sector itself.
On the back of all of these interrelated and negative dynamics, the market seems to be tempted to consider a post-Chávez Venezuela in an optimistic light. Indeed, Venezuela ' s five -year credit default swap (CDS) spread has compressed over 160 basis points since the beginning of November 2012 . Additionally, several international oil companies (IOCs) have publicly expressed interest in re-entering Venezuela if and when the country ' s political situation and business environment begin to change .
|Market Optimism In Anticipation Of A Post-Chávez Venezuela|
|Venezuela - Sovereign US$ 5-Year Credit Default Swap, bps|
However, it is the view of both our Country Risk and Oil & Gas teams that in the immediate aftermath of Chávez stepping down, there would be a period of policy continuity on the part of his political party, the PSUV, in order to maintain political stability - and dominance over the country's institutions. This would occur largely on the back of a desire to maintain strong popular support, which Chávez has built throughout his 14 years in power, as well as to avoid political fragmentation. Consequently, both those investors and industry players that are betting on reform in some of these aforementioned critical areas of the energy sector could be sorely disappointed.
Beyond the government's immediate response (to hold on to Chávez's legacy), there are already visible signs of potential cracks in the PSUV party ( see 'Political Instability To Heighten After Chávez,' January 9 2013). As such, we cannot rule out a more extensive political crisis, with the potential for military intervention in the near term. While we do see scope for change to policy in the long term, particularly as any new government will be confronted with the increasingly unsustainable state of affairs in the energy sector, it is our view that this will only come after a painful and likely destabilizing political process.