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Venezuela girds for further deterioration of its oil industry

Houston/London — Venezuela's already freefalling crude production may have a way further totumble.

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Current oil output is around 1.4 million b/d, and the oil ministry's "worstcase scenario" projects a further 200,000 b/d decline by December to 1.2million b/d, a ministry source told S&P Global Platts on condition ofanonymity.

That would be a precipitous halving of output in two years.

"The downside risk is large," the source said, adding that he does not see anyshort-term solution to Venezuela's woes, which include labor unrest,hyperinflation, failing equipment, crushing debt and a brain drain among stateoil company PDVSA's management ranks following a purge overseen by oilminister Manuel Quevedo.

The International Monetary Fund has pegged Venezuelan inflation this year at astaggering 13,865%, with GDP forecast to contract by 15% from 2017.

Crude oil exports -- the country's main source of revenue -- have plunged,exacerbating a cash crunch that makes it difficult for PDVSA to supportproduction of the vast Orinoco reserves that a decade ago were projected tounderpin the country's oil resurgence.

Those reserves consist of extra heavy crude that require injection of lightercrude or naphtha to extract. But declining output from Venezuela'sconventional fields and an inability to consistently afford imported diluentprevent PDVSA from boosting Orinoco production.

"Venezuela would not be able to increase production even if they wanted to,"said Tamas Varga, an analyst with brokerage PVM Oil Associates. "Only Godknows how low oil production will fall."

Making matters worse, what exports Venezuela is able to sell have to be pricedat a $5-$7/b discount, due to water contamination of as much as 9% thatrefineries must pay to have removed as PDVSA no longer has the capability todo so, according to an official at a crude processing company in Venezuela whoasked not to be identified.

PDVSA has seen 25,000 employees -- almost 20% of its workforce, ranging fromengineers to lawyers to oil rig roughnecks -- walk off the job over securityand safety concerns and low pay, according to Ivan Freites, a union head andfierce government critic.

'A lack of everything'

Venezuela's oil ministry has not responded to several requests for comment inrecent weeks.

Quevedo, a brigadier general in Venezuela's national guard with no oilindustry experience, was installed in November as oil minister and head ofPDVSA with an audacious directive from President Nicolas Maduro to add 1million b/d of production in a year's time.

With no signs of progress, Quevedo last month was granted broad powers in apresidential decree to renegotiate contracts with joint venture partners,including Total, Statoil, Chevron, Rosneft and CNPC, and reorganize operationswithin PDVSA.

The partners appear unimpressed.

Total CEO Patrick Pouyanne indicated last week that the Petrocedeno heavy oilproject, which was producing 70,000 b/d out of a capacity of 120,000 b/d,could be shuttered for safety reasons. The project is a joint venture withStatoil and PDVSA.

"Our production is declining because there is a lack of machines, there is alack of crude, there is a lack of everything," Pouyanne said on an earningscall with investors.

Eni's chief financial officer, Massimo Mondazzi, also said last week theItalian major, which has a stake in the giant offshore Perla gas field,expects to recover just 20% of what it is due from PDVSA in 2018 and 2019,although operations continue. Eni's outstanding receivables from Perla aresome $650 million and rising, he added.

Chevron, meanwhile, is reeling from the arrests of two of its employees at itsPetropiar joint venture with PDVSA in mid-April that have yet to be fullyexplained.

Even Venezuela's key allies Russia and China, who soak up the bulk of PDVSA'soil exports under cash-for-crude loans, seem loathe to offer furtherlifelines.

China reportedly did not renew a two-year grace period that expired last weekon payments toward about $19 billion it is owed, and analysts say Russia maybe running out of patience after having restructured a $3 billion loan lastNovember, although state-owned Rosneft has said its separate loans toVenezuela are being repaid on schedule.

Election objection

Looming over Venezuela are the prospects of additional US sanctions targetingPDVSA, which the Trump administration has threatened over ongoing corruptionand Maduro's crackdown on political dissent.

The US has already imposed sanctions that hamper Venezuela's ability torefinance debt and fund new projects. Further measures could include bans onUS exports of oil and diluent to Venezuela or restrictions on internationalsales of Venezuelan crude, White House sources have told Platts.

Analysts expect Venezuela's May 20 presidential election, for which Maduro hasessentially cleared the field to ascertain victory, to be a potential catalystfor any new sanctions.

A Maduro win "would remove almost any prospect for the economic reformsrequired to reverse production declines, and could create even more pressureon PDVSA by triggering US oil sector sanctions," Platts Analytics said in arecent note.

--Mery Mogolion,

--Herman Wang,