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How Venezuela's Loss Is Turning into Shell and BP's Gain

Nilanjan Choudhury
In mid-July 2019, Tullow Oil (TUWOY) is likely to drill the second well in the Orinduik oil and gas field at 650 meters of water depth.

Apart from oil prices climbing to their multi-month highs, there is another reason to be excited about energy majors Royal Dutch Shell plc RDS.A and BP plc BP: the loss of oil exports from Venezuela. Let's jump into the details to find out how.

The Decimation of Venezuela's Oil Industry

Years of mismanagement and alleged government corruption resulted in the destruction of Venezuela’s energy industry. With the country tethering on the verge of political and economic collapse, oil output has dwindled by more than 50% since 2016. Venezuela currently churns out around 1.1 million barrels per day, the least since the 1950s.

Restrictive financial sanctions imposed by the United States on the Maduro regime and periodic power blackouts throughout the country has further strangulated the Latin American nation’s struggling energy sector. In fact, analysts believe it's only a matter of time before the embattled OPEC producer – exempt from the cartel’s output cut pledge – sees its daily crude production plunge below 1 million barrels.

Trump Administration’s Sanctions Disrupts Exports

Expectedly, the ongoing production disruptions have led to a plunge in Venezuela’s oil exports to multi-decade lows. Further, as part of the U.S. sanctions on the government in Caracas, American companies have been restricted to conduct business with Venezuela's state-run oil firm PDVSA. This has affected the purchases of crude oil from Venezuela and the sales of refined products to the crisis-stricken country.

Til recently, PDVSA exported roughly 500,000 barrels per day of crude to the American shores, while buying refined products (like diluents) to blend the Venezuelan oil, which is of the ‘heavy crude’ variety. However, since Washington's freeze on PDVSA’s export proceeds, Venezuelan oil supplies to U.S. have steadily declined – falling to zero during the week ended March 15. To put this in context, U.S. imported around 514 million barrels per day of crude from Venezuela in 2018.      

Disruptive for U.S. Refiners

The loss of Venezuela’s heavy grade oil has put the U.S. refiners in a fix.  

Despite the U.S. being one of the largest producers of oil globally, a number of domestic refiners – especially those located along the Gulf Coast’s vast refining sector and in the Midwest – prefer to import crude from countries like Mexico, Canada and Venezuela. This is because most of the refining units in the region were constructed or modified about a decade ago i.e. prior to the shale revolution.

At the time, these facilities were configured to process the heavy/sour grades of oil coming from outside suppliers. In fact, it was then thought that the U.S. would need substantial quantities of such crude from other nations to meet the demand and consequently, many refineries in these regions upgraded their units to run heavy crude.

On the other hand, around 95% of the domestically produced oil from shale plays in recent years are of the ‘light sweet’ variety – not the one the Gulf Coast and Midwest refineries are set up for. As such, these facilities still prefer to import the heavier crude from outside rather than use the locally available type from formations like the Permian and Bakken.

Of the total oil imports of United States, nearly two-thirds are heavy crude type and Venezuelan supplies constituted about 10% of that.

How Are the Refiners Substituting Venezuelan Crude?

The downstream operators seemed to have settled on the Mars crude for now. Mostly scooped up from the offshore Gulf of Mexico fields, this variety (produced chiefly by integrated majors Shell and BP) has seen its demand take off lately.

Named after the Mars development – a joint venture between Shell and BP situated around 130 miles from the coast of New Orleans – it is a type of U.S. heavy oil that is currently being used by the refiners as a replacement of the Venezuelan imports. With top refiners like Valero Energy Corp. VLO and Marathon Petroleum Corp. MPC buying more of Mars, price of the grade recently touched five-year highs. Shell’s trading division has also been busy selling Southern Green Canyon, a grade close to Mars, to another downstream player Phillips 66 PSX.

What Next?

With the Venezuelan turmoil unlikely to be resolved anytime soon amid the power tussle between U.S.-backed opposition leader Juan Guaido and President Nicolas Maduro, a near-term reversal of the export embargo looks bleak. Meanwhile, other heavy oil supplying countries to Gulf Coast refineries – Mexico and Canada – are also plagued by certain issues like production decline and pipeline bottlenecks. Therefore, U.S. refiners are currently left with no option but to depend on Gulf of Mexico crude grades like Mars, thereby benefiting dominant players like Shell and BP. Both the companies currently carry Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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Phillips 66 (PSX) : Free Stock Analysis Report
 
Marathon Petroleum Corporation (MPC) : Free Stock Analysis Report
 
Valero Energy Corporation (VLO) : Free Stock Analysis Report
 
BP p.l.c. (BP) : Free Stock Analysis Report
 
Royal Dutch Shell PLC (RDS.A) : Free Stock Analysis Report
 
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