Tuesday, February 11, 2025

INCENTIVES, TARIFFS, AND SANCTIONS: A COMPLEX EQUATION TO SOLVE

 El Taladro Azul  Published  Originally in Spanish in  LA GRAN ALDEA

M. Juan Szabo and Luis A. Pacheco 


 

Less than a month after being sworn in as U.S. president, the world continues trying to decipher President Trump's ultimate intentions beyond the turmoil caused by executive orders. For example, finding coherence between his energy domination policy and incentives to increase hydrocarbon production is complex, particularly in the U.S. The handling of economic sanctions also appears contradictory, and using tariffs as a negotiating element to amend trade imbalances goes against his objective of lowering living costs. The oil market, somewhat bewildered, has reacted with lower prices, interpreting that the sum of announced measures could ultimately erode oil demand. A possible trade war between the U.S. and China has become the main topic of conversation in the markets and their biggest concern.

 

Oil markets briefly rose after the Trump administration issued its first set of sanctions against Iran on Thursday, a sign of the volatility generated. The sanctions targeted what the administration said was an illegal international network facilitating the shipping of millions of barrels of crude to China. The upward momentum didn't last long, and prices resumed downward. They erased gains they had achieved during the first days of 2025 and headed for another week of losses.

 

Geopolitics

 

Announcements from the new U.S. administration have replaced conflicts in oil-producing nations as the most relevant variable for the market. A few days ago, the United States imposed tariffs on imports from Canada, Mexico, and China; in the case of the first two, this represents a violation of the Agreement between Mexico, the United States, and Canada (USMCA), negotiated in 2018. However, the tariffs' implementation was suspended for one month for Canada and Mexico, who showed a willingness to reinforce their borders to control immigration and drug trafficking, especially fentanyl.

 

For its part, China responded to the 10% surcharges on its exports to the U.S. by imposing tariffs of 10 to 15% on imports from the U.S., the first salvo of a possible trade war. Investors are also looking for potential trade measures from Washington aimed at Europe.

 

Moving away from the trade area, President Trump signed an executive order imposing sanctions on the International Criminal Court (ICC) for its investigations into Israel, a close U.S. ally.

 

Neither the U.S. nor Israel are members of or recognize the ICC, which has issued an arrest warrant against Israeli Prime Minister Benjamin Netanyahu and his former Defense Minister for alleged war crimes during the military response in Gaza following Hamas's attack on Israel in October 2023. "The ICC has no jurisdiction over the United States or Israel," states the order, adding that the court had set a "dangerous precedent" with its actions against both countries.

 

Human rights activists said that sanctioning judicial officials would have a chilling effect and would be contrary to U.S. interests in other conflict zones where the court is investigating, a close example being the investigations into Nicolás Maduro's regime.

 

In the Middle East, President Trump's unexpected announcement proposing that the U.S. take control of the Gaza Strip and that its population be relocated to neighboring countries enraged the Arab world. The unexpected proposal surprised U.S. allies and other world powers and even bewildered members of his party. The reaction in Israel was markedly different, seeing it as a vindication of their actions.

 

The idea of forcibly relocating nearly two million Palestinians, previously relegated to the margins of the country's political discourse, has found fertile ground among an Israeli public traumatized by Hamas's attacks of October 7, 2023, seeking ways to feel secure again, however implausible they may seem. Israeli politicians across the political spectrum enthusiastically embraced the idea. Newspaper columns praised its audacity. The country's Defense Minister ordered the military to make plans for its eventual implementation.

 

The ceasefire continues, and Hamas announced five new hostages to be released. On Saturday morning, Hamas released three Israeli hostages in Gaza, and Israel released 183 Palestinian prisoners. Since January 19, 21 hostages and 566 prisoners have been released. The first stage of the agreement includes the release of 33 hostages in exchange for 1,900 prisoners and Hamas fighters; subsequent stages will release the remaining hostages and the bodies of those who did not survive. There remain 76 hostages, of whom 42 are alive.

 

Regarding the conflict between Ukraine and Russia, which has been ongoing for 1,080 days, Donald Trump stated this Friday that he would "probably" meet with his Ukrainian counterpart, Volodymyr Zelenskyy, next week. He also repeated his intention to speak with Russian President Vladimir Putin. The Kremlin indicated that neither a meeting nor a call with President Trump was scheduled.

 

In an interview with Reuters, Zelenskyy spoke about rare earth deposits and other strategic minerals in Ukraine, intending to include this topic in negotiations with Trump to end the war. The U.S. President mentioned Monday that he wanted Ukraine to supply rare earths and other minerals to the U.S. in exchange for financial support for its war effort.

 

Ahead of negotiations, Ukrainian forces launched a new series of assaults in the Kursk region in southern Russia on Thursday, advancing up to five kilometers behind Russian lines southeast of Sudzha. The strategy of annexing more territory is to value the incursion when negotiating the war's end.

 

With a different objective, Ukraine successfully attacked another oil refinery in the Russian city of Kstovo, about 800 kilometers from the front lines in eastern Ukraine. According to Ukrainian media, four drones hit a Lukoil facility, and the installation suffered significant damage.

 

Regarding the Russian advances in eastern Ukraine, the city of Pokrovsk (Donetsk) is currently under siege by Russian troops. Pokrovsk serves as the primary supply center for Ukrainian forces and troops operating on the front lines in the region, making it a key target for Russian forces. Given the likelihood of continued attacks on the city, Ukrainian officials and police have been working to persuade the last remaining residents to evacuate.

 

Syria, which is surrounded by conflicts involving Iran, Turkey, Israel, and Saudi Arabia, is striving to normalize following the fall of Bashar al-Assad. Ahmed al-Sharaa has been appointed interim president and is working to gather international support for reconstruction. Turkish President Erdoğan met with Ahmed al-Sharaa in Ankara to discuss Syria's economic recovery and stability.

 

With the new powers installed in Syria, Russia has conducted multiple flights to an air base in the Libyan desert. Moscow appears to be seeking an alternative stopover for its growing military involvement in Africa and a way to maintain its military presence in the Mediterranean. For almost a decade, the Jmeimim Air Base and Tartus Naval Base on the Syrian coast have served these purposes.

 

Libya, a conflict-ravaged nation in North Africa, is currently central to Russian efforts to project its power in the Mediterranean. Flight tracking data indicates that these flights are conducted from Moscow and Jmeimim to al-Khadim, a base near Benghazi in eastern Libya, using giant Antonov An-124 and Ilyushin II-76 transport aircraft.

 

Geopolitical relations are increasingly interdependent, especially in hydrocarbons. The distinction between traditional fundamentals and geopolitical catalysts is blurring, highlighting the growing importance of energy in countries' actions and alliances. The U.S., China, Russia, and Iran directly or indirectly influence all conflicts and their impacts on the oil market.

 

Fundamentals

 

Although early, the "Drill Baby Drill" policy in the U.S. has generated more noise than real investment intentions. It will need incentives such as royalty reductions on federal and offshore lands and tax reductions for corporations to be effective. Without these incentives, companies will probably maintain their investment balanced with decline, sustaining production at around 13.2 million barrels per day.

 

This week, there has been a significant rise in commercial crude inventories in the U.S. The Energy Information Administration (EIA) reported an increase of 8.7 million barrels. This substantial rebound was mainly due to a decrease in refinery processing levels and a rise in crude imports, which accounted for an addition of 6.1 million barrels. In distillate inventories, a decline of 5.5 million barrels was noted; half of this reduction can be attributed to the lower levels of refinery operations. According to Baker Hughes, drilling activity rose by 4 units, with two in natural gas basins.

 

The United States imposed additional sanctions on Iranian crude exports, temporarily increasing prices. However, this rebound quickly reversed, as it was considered unlikely that the sanctions would immediately impact Iranian exports to China. Analysts also indicated that any successful U.S. policy to reduce Tehran's oil revenues to zero would require support from the broader OPEC group, which is not guaranteed.

 

Trump has also urged OPEC to add more barrels to the market to cool energy prices. OPEC downplayed Trump's request, and according to some reports, they have expressed that it is they and not Washington who set the price of oil. The OPEC+ Joint Ministerial Monitoring Committee (JMMC), chaired by Saudi Arabia and Russia, decided this Monday to maintain its plan to increase crude supply starting in April gradually.

 

Iran's president, Masoud Pezeshkian, urged OPEC members to unite against possible U.S. sanctions after President Trump said he would seek to reduce Tehran's oil exports to zero. Pezeshkian made the request during a meeting with OPEC Secretary General Haitham Al Ghais. Iranian crude oil exports currently amount to about 1.5 million barrels per day, most of which go to China.

 

In South America, Argentina continued increasing its production, mainly from the Vaca Muerta basin. It surpassed Colombia's production in January, reaching 765,500 barrels per day.

 

Canadian pipeline operator Trans Mountain is considering short and long-term expansion projects that could add three hundred thousand barrels per day of transportation capacity to the company's system. The pipeline, which can currently transport up to 890,000 bpd of crude from Alberta to Canada's Pacific coast for export, has been in the spotlight since Trump brought additional tariffs.

 

Global production has not materially increased this year despite Brazil increasing production in two of its Floating Production Storage and Offloading units (FPSO). According to the EIA, global production in 2024 was slightly higher (500 Mbpd) than in 2023.

 

Price Dynamics

 

While President Trump's "Drill Baby Drill" policy has primarily been sidestepped by oil executives gathered in Houston this week, Trump enthusiastically insists on more excellent U.S. production, adding another bearish note to market sentiment, reflected in a drop of almost 2% compared to last week. At market close on Friday, February 7, 2025, Brent and WTI marker crudes traded at $74.66/bbl and $71/bbl, respectively.

 

VENEZUELA

 

A Tale of Two Diplomats

 

The best description of relations between the Venezuelan regime and the White House is that they are confusing. The regime, however, boasts publicly that the visit of special envoy Richard Grenell and less publicized contacts indicate that a kind of agreement was reached: accepting U.S. conditions to receive Venezuelan deportees and the release of American prisoners in exchange for maintaining oil licenses and perhaps eliminating sanctions in general.

 

There is no conclusive evidence that this agreement is anything more than an aspiration of the regime. However, the lack of an official denial from the United States and various media reports has discouraged many Venezuelans. Many anticipated that the outcomes of the July 28 elections last year would garner more explicit international recognition and support, particularly from the new U.S. administration.

 

An article in the Miami Herald has received particular attention. It associates talks between the White House and the Maduro regime with oil businessman Harry Sargeant III, supposedly a friend of Trump and a major Republican party donor, and his interest in Venezuelan oil without sanctions. Although somewhat speculative, it is said that Sargeant and his company would be incorporated into the mixed company PetroCedeño, whose last private partner, Jindal of India, abandoned the project.

 

We also cannot overlook the influence of oil lobbying led by Mike Wirth, Chevron's president, who claims to have informed the White House about the negative geopolitical consequences that would stem from his company's departure from Venezuela. He argues that this decision would enable China and Russia to expand their regional influence. Wirth seems to be unaware that, in the meantime, Sinopec, China's most prominent national oil company, was finalizing an agreement to transfer its assets in the Gulf of Paria to an investment fund managed by Chevron's former president in Venezuela.

 

We must not forget the comments of recently elected Senator Bernie Moreno, who, in an interview with Caracol News in early January, declared: "They had an election, people say it wasn't fair, but at the end of the day, U.S. interests are to stop drug trafficking, to take back all illegal Venezuelans who are in this country, and to do business with the United States, to stop doing business with Russia and China." At the time, not much importance was given to the Colombian-American senator's comment, contrary to then-nominated Secretary of State Marco Rubio's position and inconsistent with the official U.S. position regarding the elections and recognition of Edmundo González as president-elect.

 

During his recent tour of several Central American and Caribbean countries, Marco Rubio continued his criticism of the Venezuelan regime. Still, he was careful to describe Grenell's recent trip to Caracas and the negotiation outcomes as nothing more than a victory for Trump and a defeat for Maduro. The White House must soon clarify which way the diplomatic balance will tilt.

 

On the other hand, the elections called by the National Electoral Council (CNE) for April this year, where governors, the national legislature, and local offices are elected, have become the most significant component of the regime's strategy to, once again, divide the opposition that unitedly won the 2024 presidential elections. Zulia state governor Manuel Rosales and former governor Henrique Capriles, who exemplify the division within the opposition, have already urged participation in elections that González Urrutia and María Corina Machado reject.

 

The mechanisms for controlling the exchange rate have been inadequate. The BCV has permitted its continuous decline. This week, the official rate closed at 60.52 Bs/$, while the parallel rate was at 72.11 Bs/$, creating a gap of 19.2%. Without a significant change in circumstances, this will likely lead to increasing triple-digit inflation, despite control efforts, and would shrink the economy's size.

 

The current economic situation, highly compromised by the lack of oil activity and awaiting definition, could change if the pragmatic negotiation scenario between Maduro and Trump described above is confirmed.

 

The cancellation of the TPS extension, which protects approximately 600,000 Venezuelan immigrants in the U.S., is a source of concern among them. The Department of Homeland Security (DHS) claims that "Venezuela no longer meets the conditions that led to the designation in 2023," citing significant improvements in the country's economy, public health, and crime rates following consultations with several departments, including the State Department.

 

Although we haven't seen a thorough analysis of this issue, the return of large numbers of immigrants to Venezuela will have an immediate social, economic, and political impact, exacerbating an already challenging situation despite what the Trump administration claims.

 

We await the coming weeks to determine whether we move towards "license cancellation" or maintain the "status quo," which would result in diametrically different conditions for regime financing.

 

Oil Operations

 

Natural gas and gas liquids shortages in the form of cylinders have been the most relevant news of the week; collaterally, the deterioration of these cylinders' integrity has caused two explosions during the last few days.

 

In January, 390 Mbpd of crude oil was placed in the international market under a combination of production and marketing authorized by OFAC licenses.

 

The average sale price, net of debt payment, associated with exports under the OFAC license was $53.1/bbl, while the weighted official price of all exported barrels was $37.2/bbl. This latter price results from weighing barrels that do not generate income, such as debt payments and barrels to Cuba.

 

Crude production during the last week averaged 861 Mbpd, geographically distributed as follows:

 

- West:                                    210 (Chevron 95)

- East:                                      131

- Orinoco Belt:                 520 (Chevron 119)

- TOTAL:                                  861 (Chevron 214)

 

However, it should be noted that, due to the low availability of light crude to blend the crude to Merey 16 segregation, the marketed volumes have been dispatched with slightly modified specifications, and part of the upgraded Hamaca crude was used as diluent.

 

Refinery runs averaged 215 Mbpd of crude and intermediate products, with a gasoline yield of 77 Mbpd and a diesel yield of 73 Mbpd.

 

While it is still too early to determine export levels for February, we estimate that Merey 16 will be lower than last month because some of the inventories at the Jose terminal were utilized to fulfill exports to China.

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  El Taladro Azul    Published  Originally in Spanish in    LA GRAN ALDEA M. Juan Szabo   and Luis A. Pacheco     In last week's article...