Venezuela displacing Iraq as chief oil market worry

The prospect of regime change in Venezuela has become a bigger factor in oil markets than that of regime change in Iraq.

The main reason for that difference, which has helped New York next-month crude futures prices to over $33/bbl Jan. 3, is that the Venezuelan oil supply disruption has already occurred. And markets are already feeling the effects.

The most notable effect in the US has been the scramble for supply to offset the loss of about 1.4 million b/d of crude and about 300,000 b/d of refined products from Venezuela. That is being reflected in a US oil stocks picture already squeezed to historically unhealthy levels. For the week ended Dec. 27, the US Department of Energy reported that US crude oil stocks fell by 9.1 million bbl to 278.3 million bbl and that US oil imports plunged by 1.514 million b/d to 7.631 million b/d.

This situation prompted calls from some US refiners to the Bush administration to begin drawing down crude from the Strategic Petroleum Reserve. That is unlikely to happen unless a total Venezuelan outage persists to the point where it coincides with an allied attack on Iraq.

Ramping back up

Just as with Iraq, there are misconceptions about Venezuela's capability to ramp production back up once things settle down again.

Before the strikes began in November, Venezuela was producing close to its capacity at 2.95 million b/d, up from 2.5 million b/d last April, during the aborted coup attempt against President Hugo Chávez. The embattled president had abandoned his adherence to Venezuela's Organization of Petroleum Exporting Countries quota shortly after that revolving-door noncoup; before November, output had steadily risen back up to almost 3 million b/d to help quell local discontent.

While Venezuelan production ramped back up, the country's OPEC quota compliance plummeted to less than 50% from the precoup level of 100%.

Yet this raised no alarms within OPEC, as it coincided with the Saudi-led, de factor policy of allowing quotabreaking to offset the loss of Iraqi supplies in the spring and summer.

Now that the Venezuelan strike has removed such a large volume of crude from markets at a time when seasonal demand is high and another supply threat looms on the horizon, it has some in OPEC speculating on the possibility of ratcheting up group output again to fill the supply gap.

A mechanism already exists to implement this increase: OPEC's agreement to boost output in 500,000 b/d increments should the OPEC basket of crudes remain above $28/bbl (roughly $30/bbl for New York Mercantile Exchange crude futures) for more than 20 trading days. A similar mechanism exists for the downside, but in practice OPEC has been quicker to act on the downside than on the upside.

Scenarios

The circumstance most likely to lead to OPEC taking this step in the absence of simultaneous Iraqi and Venezuelan outages—and it could be accomplished with a series of phone calls and faxes rather than a full ministerial meeting—would be a prolonged strike with worsening bloodshed or even a sustained civil war in Venezuela.

Yet those prospects seem unlikely as well. The Venezuelan military has long been the key stabilizing influence in that country's politics. While there is a sharp division within the military as well, it is more likely that the Venezuelan military factions will resolve their differences than will the strikers and Chávez supporters. Recognizing Chávez's growing untenability will likely push more of the military leadership into solidarity with the strikers, and the degree to which this situation can be resolved with a minimum of further bloodshed will depend on how fanatic the Chávez loyalists in the military are.

Either way, a resolution is likely to come sooner rather than later. The betting here is that Chávez will be forced to cede power to an interim junta comprised of both military factions that will call for early elections. Venezuelan oil exports will quickly return to normal—perhaps just in time for the first attacks on Iraq later this winter.

And OPEC concern over a rapid rise in Venezuelan production thereafter must be tempered by the loss of about 400,000 b/d in capacity since Chávez's assumption of power spawned a disinvestment trend. The heavy oil megaprojects' projected doubling of volume in the years ahead will be needed to offset a natural decline that is pegged at 9%/year and that is unlikely to reverse for several years even after spending revives.

(Online Jan. 6; author's e-mail: bobw@ogjonline.com)

OGJ Hotline Market Pulse
Latest Prices as of Jan. 6, 2003

OPEC basket price data were unavailable for the period shown; the New Year's holiday also affected London and New York price data.

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NOTE: Because of holidays, lack of data availability, or rescheduling of chart publication, prices shown may not always reflect the immediate preceding 5 days.

*Futures price, next month delivery. #Spot price. @New contract

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