M. Juan Szabo[1] y Luis A. Pacheco[2]
THUNDERCLOUDS ON THE HORIZON
The oil market experienced one of its worst weeks in a long time. Oil prices fell sharply midweek, and although they rallied towards Friday, they were highly volatile. Both the Brent and WTI crude oil prices fell 11% before recovering almost half of the loss at the close of markets.
The bearish sentiment in the markets, which we have been warning about since last week, has been driven by pervasive fears of recession, renewed fears of contagion from the US banking crisis, as well as relatively low numbers in the manufacturing sector in China, which do not match the recovery shown in its services sector and its exports.
In connection with the US banking crisis, PacWest (NASDAQ: PACW) was the latest bank to falter - its shares falling 50% - joining Silicon Valley Bank, Signature Bank and First Republic as troubled assets. Additionally, Toronto-Dominion Bank (TSE: TD) and First Horizon (NYSE: FHN) have agreed to suspend their agreed merger deal, pushing First Horizon shares lower.
Announcements from the Energy Information Administration (EIA), indicating another drop in US crude inventories, the continued suspension of the flow of Kurdish oil through Turkey, the surprise drop in the US unemployment rate, and Iranian bravado in stopping a second tanker near the Strait of Hormuz, failed to offset the macroeconomic pessimism affecting the price of a barrel.
The rebound in the price of oil at the end of the week was undoubtedly due in large part to major oil companies posting solid first-quarter earnings, despite lower oil prices. This time, it was impressive earnings in the refining and petrochemical sector that underpinned the results achieved in the oil and gas production sector. It is not clear whether these profit levels can be sustained in the second quarter if prices remain depressed. We believe that the pessimism reflected in oil prices is not supported by demand-supply fundamentals.
Market fundamentals have been in the background for some time, muted by the threat of recession, but appear to have reared their heads again after OPEC+ officials confirmed that their June 4 policy meeting will be a face-to-face event in Vienna, the first in some time. The oil cartel meeting could clarify the realities of the market and show who is in control.
In any case, the cuts previously announced by OPEC+ will take effect as of this month, and although is certain that the volumes to be cut are much more modest than those announced, some will materialize. For example, the United Arab Emirates (UAE) have informed their customers that they will reduce deliveries for May by 5%, certainly a stabilizing sign for the market.
Russia is expected to increase its oil exports from its eastern ports this month, draining its inventories, to meet Asian demand for cheap oil, and to help its dwindling cash flow at a time when the war in Ukraine is requiring more funds.
The weaker international prices indicate that Russian oil is trading below $60 per barrel, the price ceiling imposed by Western countries, making it more attractive to Asian buyers, as they have fewer problems with transportation, banks, and compliance.
The announcement of the 25-basis point rise in interest rates in the US can also be considered a stabilizing aspect, with indications that the current rate hike cycle could stop. Europe matched the Federal Reserve (FED) with a rise of 25 basis points, taking the rate to 3.25%.
The great intermediary between the negative perception of the market and the fundamentals, somewhat more optimistic, corresponds to OPEC+, whose impact in this case will really be somewhat muted; it will probably be Saudi Arabia that determines the future behavior of the global organization.
OPEC+ faces a difficult decision, since the interpretation that the market can give to its decisions can be unintended. If they decide to further cut production, to recover prices, it could be interpreted as that they indeed believe that a destruction of demand is inevitable, or that they act only according to prices, regardless of impact on the economy.
A Solomonic solution may be to maintain production targets, officially, and let the inevitable declines in production capacity in some of its members, such as Russia, Mexico, Nigeria and others, bolster prices on the supply side.
The US appears to have lost its energy compass, and its strategies for the oil and gas sector are adrift. Without clear signals from the Administration, the companies continue to prefer giving returns to their shareholders rather than investing in drilling in domestic basins. This week there is a reduction in the number of rigs drilling (-8), mostly in the most attractive Shale Oil Basins. Also, the decision of if and when to replenish its strategic oil inventories continues to paralyze the Administration.
A detail that for now seems of little relevance in terms of its effect on the current oil market, but may be significant going forward, as it occurs in a country with an emergent presence on the list of emerging oil producers, is the decision of the Supreme Court of Guyana ruling that ExxonMobil ( NYSE:XON) breached its environmental permit by failing to provide adequate oil spill insurance for its first oil project off the US coast. Additionally, the court indicated that the company must provide insurance issued by a reputable company, covering possible damages from incidents that include spills, before June 10, or the environmental permit of the Liza 1 project will be suspended.
ExxonMobil, the court says, "engaged in a course of action permitted only by the omissions of a derelict, flexible and compliant Environmental Protection Agency," the ruling said. However, the country's government has rejected the High Court's decision and plans to appeal the decision. In any case, this could be the beginning of the typical tension between the operating company and the host state.
Venezuela
Political-economic aspects
In neighboring Trinidad, there is a debate about whether it is the opportune moment to negotiate with the Venezuelan authorities the agreement for the transnational production of natural gas from Campo Dragón. Given all the accusations of corruption surrounding PDVSA, the Trinidadian government seems to favor waiting until things get back on track.
Another announcement, somewhat unexpected, was published via the Twitter account of the Minister of Petroleum, Pedro Rafael Tellechea (also president of PDVSA). He announced the signing of licenses to allow the export of gas liquids produced in the Cardón IV Gas License, by Repsol (BME: REP) and ENI (BIT: ENI). The details of the license are not known, but it refers to the liquids, owned by PDVSA and the companies that make up the contract, which today are mixed and delivered to the Cardón refinery for processing; a procedure that has contributed to increasing the accounts receivable of Repsol and ENI.
The new agreement may be aimed at reducing PDVSA's outstanding debt with its partners, as well as the sporadic shipments of crude oil sent to Europe. On the other hand, it could also represent a mechanism to finance investments to increase the production capacity of the Perla field ( Cardón IV), a marginal investment, since the existing infrastructure can be used to add additional drainage points.
In other news, PDVSA appears to have informed Chevron that it did not have the necessary funds to dredge the Lake Maracaibo Canal, so Chevron will have to continue shipping incomplete cargoes of Boscán crude from the Bajo Grande terminal; the only optimization that remains is to complete the cargoes of the tankers in Aruba, before continuing the trip to the coast of the Gulf of Mexico, a process that they have already carried out a couple of times.
CITGO and creditors
The first week of May has been very busy around the situation surrounding CITGO Petroleum Corp. (CITGO), because of the multiple lawsuits that threaten its continuity as a PDVSA asset.
But first, some background. As is well known, CITGO, a refinery complex in the US and PDVSA's only remaining important asset abroad, has become the preferred target of PDVSA’s and Venezuelan Republic’s creditors. The collection of part of the liabilities (it is estimated that the total debt is 140 billion US dollars), resulting from financial indebtedness, as well as lawsuits from those whose assets were expropriated during the time of the Hugo Chávez presidency, have continued to advance in different courts with protracted success.
This week's news relates to the lawsuit by Crystallex International Corporation (Crystallex) against the Venezuelan state in the jurisdiction of the US state of Delaware.
Crystallex initiated proceedings before the International Center for Settlement of Investment Disputes (ICSID), on the occasion of what it described as the expropriation of its investments in Venezuela by the government of Hugo Chávez. In April 2016, the Arbitral Tribunal declared the claim admissible and ordered the Venezuelan State to pay 1,202 million United States dollars, an amount that must be adjusted for interest and net of payments already made during the Republic.
To collect the amount owed, Crystallex International Corporation applied to the District Court in Delaware for the seizure of PDVSA's property in the US, specifically, the shares of PDV Holding, Inc. (shareholder latest from CITGO in the US), arguing alter ego issues that breached the corporate veil. On August 9, 2018, the Court agreed on the admissibility of this measure, which, although against the Republic, affected the assets of PDVSA. It is worth remembering that by decision of the Venezuelan government of the time, the Republic did not participate in that trial, although PDVSA did have representation.
In the period of the so-called interim government, 2019-2022, its legal representation filed new allegations and several appeals before the courts, with the aim of reversing the decision and at worse gaining time to ensure that these debts were negotiated in a new political context in Venezuela. Unfortunately, it was not possible to reverse the court's decision, and the new political context never materialized.
Thus, the Delaware court, presided over by Judge Leonard Stark, continued with the protocol that is applied in these cases and appointed a Special Master to be responsible for organizing and executing the sale/auction of the shares of PDV Holding, owned by PDVSA, and thereby cover the debts with Crystallex. However, this process has also been semi-paralyzed until now due to the protection that the American executive provides to Venezuelan assets in the US under the umbrella of the economic sanctions' regime.
It is at this point in the story that this week's events enter. The Special Master, after intense lobbying before the Department of Justice (DOJ), managed to obtain a letter from that office (dated April 7, 2023, but made public a few days ago in writing submitted to the court) where the DOJ affirms that the US Government will not oppose the advancement of the prefatory process for the sale/auction, and that OFAC will not act against the actors that could participate in said process, that without the need to modify the sanctions regime and without prejudice to their opinion that licenses are needed.
The DOJ also wrote that, although an OFAC license was required to execute any provision of those "blocked assets", and that it is still premature to consider granting it, the US government would look favorably at the eventuality of the sale of assets or of negotiation between the parties, after analyzing all the facts. This is not good news for Venezuela, as it seems to herald a weakening of the robust protection that CITGO had been exercising to date in this case in Delaware.
It is worth noting that the Delaware court has earlier also received a license from OFAC that would allow the judge to add ConocoPhillips and other creditors who have legitimate claims, as beneficiaries of a potential sale of PDV Holdings shares.
In parallel, Judge Stark had recently decided in favor of other creditors and against the Republic, using the "alter ego" criteria. In this context, better news was known at the end of the week: the superior court of the State of Delaware decided to suspend the effectiveness of this last decision, while it decides on the appeal presented by PDVSA ad hoc: it is only a temporary respite.
The week had begun with the OFAC's publication of General License 42 (GL 42), which, although it does not directly impact any of the lawsuits in progress in the short term, could be interpreted as a change in its position regarding the protection of Venezuelan assets. On the one hand, the license authorizes the 2015 National Assembly and the persons or ad hoc boards designated by it to be the legitimate representatives for the eventual negotiation of debt agreements, etc. This license, read together with the DOJ letter, sends a clear message from the US administration that it is in their interest to see progress in negotiations with Venezuela's creditors – it remains to be seen if it is also a sign of a dismantling of the regime of asset protection.
In any case, this makes it urgent, if that were necessary, for the National Assembly 2015 to take the necessary political decisions to avoid a disorderly liquidation of Venezuelan assets abroad.
Operational Activities
Regarding the operational part of the oil activities in Venezuela, production is relatively stable at 702 Mbpd, of which 110 Mbpd corresponds to the mixed companies operated by Chevron: 47 Mbpd come from the Boscán Field, 54 Mbpd from PetroPiar and 9 Mbpd from PetroIndependencia. No material changes are projected in these production levels, as long as the conditions of the OFAC License (GL41) do not include express authorization to invest, that is, to drill wells. Currently, everything indicates that the license will be extended under the same current conditions.
In the national refineries, 190 Mbpd of crude oil and intermediate products are being processed, almost entirely in Paraguaná in western Venezuela. The performance in terms of diesel and gasoline is 63 Mbpd and 40 Mbpd respectively. Gasoline distributed in the domestic market appears to be contaminated with water and sediment, in addition to not meeting the minimum octane number required for most vehicles.
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