By Nick Cunningham
Oil has been struggling to break above $50 per barrel for months, but there are two reasons why prices could be heading north in the next few months: Venezuela and Iran.
Both countries are large oil producers, but both are vulnerable to supply outages, for very different reasons. But depending on what plays out in the next few weeks for them, oil prices could spike well above $50 per barrel, according to RBC Capital Markets.
The risk from Venezuela is more acute and more immediate. The Venezuelan economy has been broken for a long time now, leading to a sharp decline in oil production. Output is down by a fifth over the past two years, falling to 1.93 million barrels per day in July – as recently as 2015, Venezuela averaged 2.375 mb/d. Without any money to reinvest into its oil sector, Venezuela’s production will certainly continue to fall. The only question is how fast.
The pace of decline would pick up significantly if Venezuela defaulted on its debt. “They have $3.5 billion in national oil company debt coming due in October-November. If they default, that could be significant for Venezuela’s production outlook,” Helima Croft of RBC Capital Markets told CNBC. The problem for Venezuela is that their cash reserves are not much higher than those debt payments. October looms large.
If Venezuela defaults, the decline of its oil production could accelerate. Overseas assets could become a target of bondholders, which would deprive state-owned PDVSA of much needed cash. Venezuelan oil shipped abroad might even be in jeopardy.
Venezuela’s only hope at this point would be more assistance from Russia or China, two countries that have loaned large sums of money to the South American nation, a lot of which was given in exchange for oil cargoes. “The math simply does not work on PDVSA staying solvent” without help from China or Russia, Helima Croft told CNBC. However, she says that the patience of both countries is starting to wear thin.
One investor told the Wall Street Journal, that the Venezuelan government has prioritized debt payments above all precisely because it needs to keep Russia and China from cutting off lines of credit. A debt default might be the final straw for them.
“If he stops [servicing the debt]…oil production will stop. The government will fall,” Jan Dehn, head of research at Ashmore Group PLC, told the WSJ. His fund is buying up Venezuelan debt because he is wagering that a debt default would be such a nightmare for Venezuela that repayment is likely.
RBC Capital Markets is not as confident, mostly because there is simply not enough money to make things work out. If PDVSA prioritizes meeting its October debt payments, then it would have no money to pay salaries, which, could also lead to the collapse of the government or a decline in oil production, or both.
Citigroup mostly agrees, but thinks the government can hold on a few more months, pushing off a default until 2018.
Nevertheless, while the exact date of default is up for debate, most analysts see it as a likely outcome. That could push oil above $50, perhaps in the next two months or so, but sharp oil production declines would probably send prices much higher.
Meanwhile, the other country that could push up oil prices, according to RBC, is Iran. Not because Iran is as unstable as Venezuela – it obviously isn’t. But the threat would come from the U.S. government. The Trump administration is considering backing out of the 2015 nuclear accord, which would reignite tensions between the two countries. Ultimately, a renewal of U.S. sanctions could once again pose a threat to Iranian oil exports.
However, the threat here is more speculative than it is for Venezuela. The U.S., after deftly threading the needle among the varying interests of disparate countries, managed to bring the international community on board for the 2015 nuclear accord while also convincing Iran to sign on. If the new administration backed away from the deal only two years later, for dubious reasons, it would return to confrontation with Iran without many friends. Without the assistance of the rest of the world, U.S. sanctions would have much less bite. In short, it is unclear what this would mean for the oil markets.
Venezuela, then, presents a much more likely – and more imminent – upside risk to oil prices. Production declines are certain, but the pace of decline depends on what happens when billions of dollars of debt falls due in October.
By Nick Cunningham, Oilprice.com