Tuesday, February 01, 2005

The Other "Bad Boy"
President Hugo Chavez seems determined to chart a course for Venezuela that brings it increasingly into opposition to the US and our friends in Latin America. He is even finding common cause with Iran, to which I devoted the last couple of postings. Several US oil companies with interests in Venezuela are experiencing contractual difficulties, leading to speculation that Mr. Chavez intends to strengthen energy ties with China and other markets at the expense of the country's historically close ties to the US market. How realistic is this?

Although President Chavez's Bolivarian Revolutionary politics may motivate him to move in this direction, energy economics will make this a costly and difficult proposition. Venezuelan oil is typically much heavier and more viscous than oil from the Middle East, West Africa, or other major exporting regions. This makes it more difficult to extract, requiring large, capital-intensive facilities similar to those involved in extracting Canadian oilsands. Following the crippling 2002-3 strike by employees of the state oil company, PDVSA, a growing share of Venezuela's production has come from these internationally-financed joint venture facilities.

The poor quality of Venezuela's oil also makes it more expensive and less attractive to refine, yielding less gasoline and high-quality diesel per barrel than that of its competitors, without significant prior investment in upgrading facilities. The last time I looked, few refineries in China were set up to run Venezuelan crude oil profitably.

The largest concentration of refineries configured to run Venezuelan crude is in the US Gulf Coast. In fact, a large portion of the Venezuelan crude sent to this country goes to supply PDVSA's subsidiary, Citgo, which has one of the largest service station chains in the US. Diverting exports away from the US would cost Venezuela several times: in lower netbacks on crude sales due to higher freight costs to more distant markets, in larger discounts versus competing oil grades, and in reduced profitability at its US subsidiary, which would have to line up other supplies.

Rather than expecting a move by Mr. Chavez to nationalize US investments or cut off crude supplies to us, I continue to believe that the largest element of political risk involved for US investors in Venezuela's oil industry lies in the prospect that our own government would take action to precipitate a crisis with Venezuela, in response to Mr. Chavez's growing activism in Latin America. Only companies with broad and deep portfolios should be taking on these risks today.

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