Monday, February 11, 2008

Barrel Rattling

The chance that Venezuelan President Chavez will follow through on his threat to cut off oil exports to the US, in retaliation for a freeze on Venezuelan financial assets secured by ExxonMobil, seems minimal. As today's Wall Street Journal notes, he probably gains more through the impact of the threat on oil markets than he could from its actual execution. Still, Mr. Chavez has earned his reputation for being mercurial and unpredictable. With high energy prices already contributing to the weakness of the US economy, how much damage could such an oil cut-off inflict?

As of November, US crude oil imports from Venezuela in 2007 were averaging 1.1 million barrels per day, or about 11% of all our oil imports, with most of it coming into the US Gulf Coast, followed by the East Coast and an occasional cargo to the West Coast. By contrast, that volume amounts to roughly half of Venezuela's total oil exports, corresponding to roughly 20% of the country's GDP at current exchange rates. While the global crude oil market would surely readjust to compensate for a Venezuelan oil embargo against the US, the financial consequences of the temporary chaos following such a move could be proportionally worse for the perpetrator than the victim.

At the same time, we shouldn't underestimate the fallout in domestic energy markets, and for the economy as a whole. Even in a globalized market for crude oil, it would take a while to work around such a significant shift. US refiners would have to scramble to purchase cargoes of oil from more distant suppliers, driving up the cost of shipping and bidding up the price of the nearest substitute grades of oil. Coming at a time when the output from West Africa has been reduced by problems in Nigeria, it could take a couple of months to arrange suitable alternatives. In the interim, commercial crude oil inventories, which have recently recovered to more comfortable levels, would fall dramatically, unless bolstered by releases from the Strategic Petroleum Reserve.

Nor would refiners be the only ones affected. Although oil futures seem to be pricing in some small probability of such an outcome, the actual event would drive prices up by a lot more than a dollar or two. A $10 per barrel spike, about the least I can imagine for such a disruption, would quickly translate into another $0.25/gallon or so at the retail level, pushing us close to a record high for gasoline. That would pinch the average household's budget to the tune of another $20/month, further squeezing a variety of merchants or adding to credit-card debt.

Mitigating against that eventuality is the reality of what such a cut-off would mean for Venezuela. Citgo, the US refining and marketing subsidiary of PdVSA, the Venezuelan state oil company, controls about 5% of US refining capacity. Its facilities would presumably be hit as hard as any others by an embargo. Meanwhile, just as US refiners would drive up the price of non-Venezuelan oil in their search for substitutes, PdVSA would have to discount its oil twice, to keep it flowing. That's because the cost of shipping it to Europe or Asia would be much higher than for the short voyage from Maracaibo to Houston, and because few refineries elsewhere are configured to extract maximum value from the heavy sour crudes that make up much of Venezuela's output.

While I'm skeptical that President Chavez's remarks about suspending exports to the US mean much outside the context of his ongoing dispute with ExxonMobil over the nationalization of their assets in his country, stranger things have happened. Given the general antipathy of his government for ours, I continue to believe that we would be wise to plan for this outcome occurring sooner or later, and wean ourselves from a supplier so bent on creating the perception of unreliability. A gradual divorce would hurt both countries a lot less than a sudden breach.

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