Oil traders and companies factor in a Chvez premium

January 30, 2005

From todays Financial Times, I post the whole article because in three days you have to have a subscription


Oil traders and companies factor in a Chvez premium By Andy Webb-Vidal

Oil futures traders in
London and New York have come up with a catchy term to describe an additional source of uncertainty when it comes to judging potential volatility in supplies: the Chvez premium.


 


There is as yet no established formula that serves to precisely calculate how many dollars should be added to the price of a barrel of oil because of Venezuela‘s President Hugo Chvez, from whom the term derives.


 


However, one thing is clear: political uncertainty stemming from Mr Chvez and his policies is becoming not only a factor in the oil markets, but it also has implications for Venezuela‘s sovereign bond holders and for oil multinationals.


 


As the world’s fifth largest oil exporter, for decades Venezuela had been seen as a secure source of oil, particularly to the US. Tens of billions of dollars have been invested to extract oil from the South American country.


 


However, Mr Chvez is uncomfortable with Washington, which he sees as the centre of an imperialist “empire” bent on dominating the rest of the world, and intent on overthrowing him and his self-styled “revolution” for the poor.


 


Mr Chvez’s repeated threats to “cut off” oil supplies to the US used to be dismissed by analysts as mere rhetoric.


 


It is becoming clear that Mr Chvez means business, inasmuch as he is planning to ship the oil he controls to anywhere but the US.


 


“He’s trying to align his business movements with his political aspirations to have closer relations with non-US countries,” says Rob Cordray, analyst at PFC Energy, a consultancy based in Washington. During a visit to Beijing in December, Mr Chvez offered to send oil to China.


 


Mr Chvez has wasted no time in fulfilling his pledge. Since the start of this year, Venezuela has sold two 3m-barrel cargoes of crude oil to China.


 


Some observers point out that because Venezuelan crude is heavy, it will be unusable in Chinese refineries. Also, because China is far more distant than the US, a strategy of diverting oil to China is an exercise that has to be paid for by one of the parties, and is economically unsustainable.


 


Venezuela‘s dependence on US refining capabilities and the lack of access to the Pacific will limit Chvez’s ability to diversify Venezuela‘s export market in the near future,” says Patrick Esteruelas, a Latin America analyst at Eurasia Group, a consultancy based in New York.


 


While that may be true, people familiar with the recent shipments say the oil is being sold at a heavy discount, in theory allowing China to be able to resell the oil at a small profit.


 


The re-sale of Venezuela crude oil to third parties was previously forbidden by Petroleos de Venezuela (PDVSA), the state-owned oil company.


 


“The reason for the dispatch of these cargos is 100 per cent political,” said a trader familiar with the deals.


 


Venezuela is also planning to ship oil to Asia via a pipeline across Panama.


 


While the diversion of oil exports to China for political reasons is at an early stage, analysts say that its expansion will damage Venezuela‘s credit rating because it will receive less income, especially if oil prices decline. The issue of Venezuela’s creditworthiness was called in to question two weeks ago when Standard & Poor’s, the ratings agency, dropped the country’s debt rating to “selective default” after the country missed a $35m payment due in October.


 


Richard Francis, analyst at Standard & Poor’s, said: “It was more for technical issues, we don’t believe that the ability or willingness of the government is really in question, at least at this point.”


 


Venezuelan officials said the payment was missed because of an “error”, but other observers are concerned.


 


“The selective default reflects the state of disarray the public administration is in,” said an investment banker dealing in Latin American debt.


 


PDVSA has become far more poorly managed since a strike two years ago that led to the summary dismissal of 18,000 experienced employees.


 


Today, rather than the seat of a $100bn oil company, PDVSA’s headquarters is the hub of a chaotic social welfare agency, with distressed mothers breast-feeding babies in a foyer scattered with “revolutionary” pamphlets.


 


Indeed, such is the lack of control at PDVSA, which has to maintain a $2bn-plus revolving “social fund” under orders from Mr Chvez, that no one knows the state of its financial health.


 


“How can anyone assess a company that has not presented its financial statements since 2002?” asks Pedro Burelli, a former director of PDVSA.


 


Foreign executives who deal with PDVSA also allege irregularities such as the issue of parallel contracts that allow for personal fortunes to be made by “mafia-like” factions inside the company.


 


Today, PDVSA sells most of its oil-derived products on a spot basis or via contracts of no more than 12 months’ duration. Some crude is also sold “spot” for immediate delivery.


However, there is another related issue that is complicating Venezuela‘s capacity to continue pumping oil.


 


Because of declining output at PDVSA, due to the diversion of money away from essential investment, poor management and alleged corruption, a greater share of Venezuela‘s oil supply is coming from private companies.


 


Yet the investment conditions for foreign oil companies is deteriorating fast rather than becoming easier.


 


In recent weeks Mr Chvez has ordered a unilateral overhaul of dozens of oil contracts in an effort to raise tax revenue.


 


Alarm bells are ringing in Houston. Harvest Natural Resources, a US company, has seen its shares collapse in the past two weeks after it was told by Venezuela to suspend exploration in its main project.


 


At least one investment bank downgraded its outlook for ConocoPhillips after its plan to develop its promising Corocoro oil field was stopped by the government.


 


Venezuela, which currently produces about 2.6m barrels per day, predicts it will increase daily oil output to 5m barrels by 2009.


 


In practice, say experts, Venezuela is every day shipping less oil to world markets, in effect bolstering the “Chvez premium”.

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