Monday, March 13, 2006

A slow tanker to China 

Over the past year there has been talk of Venezuela attempting to sell more of its oil to China. While this may have seemed to be idle talk or hollow threats aimed at the United States it now seems that there is an actual plan to shift Venezuelan oil sales to China.

The first indicator was the news recently that Venezuela plans to purchase 40 new oil tankers from Brazil with options for another 46 ships later on. Some of the tankers will be among the largest in the world capable of carrying 2 million barrels of oil each. The purchase of these ships will cost billions of dollars. That kind of money would not be spent unless a serious need for it was seen for it. And what is the potential need? Shifting a significant portion of Venezuela’s oil sales from the United States to China. As the journey around South America and across the Pacific to China is many times the distance across the Caribbean to the United States Venezuela would need many more tankers to keep up the flow of oil. So signing contracts to purchase those tankers indicates the shift to China is more than just talk.

Today we received yet more confirmation of that this is moving beyond the talking stage when PDVSA’s head of Commercialization, Asdrubal Chavez, told Panorama newspaper that Venezuela would almost double oil sales to China this year from 160,000 barrels daily to about 300,000 barrels. He further indicated that if Venezuela is successful in securing a pipeline across either Panama or Colombia to shorten the trip to China oil shipments to China would increase significantly. Clearly this is a plan that is now being executed.

What are the repercussions of this shift in oil sales? Probably not what most people think. First, as oil is a fungible commodity both China and the United States will still get the oil they need, neither will be left high and dry. If the U.S. gets less oil from Venezuela it will simply purchase the oil other exporters were selling to China but is now displaced by Venezuelan oil. So from the point of view of oil consumers not much of anything would change.

For Venezuela however there would be significant changes. First and foremost shipping costs would increase due to the increased distance the oil would have to be shipped. I don’t have firm figures on how much but the estimates I’ve seen are around $1 per barrel. Because oil is a fungible commodity this cost isn’t borne by the consumer, it is borne by the seller, in this case Venezuela. The reason for this is that the end product of this oil that Chinese consumer would buy, say gasoline, has to be priced the same as all gasoline in that market. Chinese consumers aren’t going to pay more for Venezuelan gasoline than they would for gasoline from Saudi Arabia or anywhere else. So for that end product price to be the same in spite of Venezuelan gasoline having higher shipping costs the Venezuelans themselves have to eat the higher shipping cost.

How much would that cost Venezuela? It depends on how oil much it sends to China. At the current rate of 160,000 barrels per day it would be:

160,000 barrels x $1/barrel x 365 days = $58.4 million.

That $58.4 million is how much money Venezuela is losing yearly by selling the current 160,000 barrels of oil to China. If they double their oil sales to China this year that loss will double to $116 million. Obviously in the context of the $48 billion worth of oil Venezuela sold last year these losses are not that significant, but they are real and they can add up. For example, say Venezuela were to shift all the approximate 1.5 million barrels it sells daily to the U.S. to China. The additional shipping costs for that would come to:

1,500,000 barrels x $1 x 365 days = $547 million dollars.

Clearly depending on how far this switch to China goes the cost to Venezuela can start to become significant.

So is it completely off the wall for Venezuela to do this? Not necessarily. There are a couple reasons why Venezuela might see this as a necessary step. First, while oil is fungible interchanging oil sellers and buyers isn’t necessarily pain free in the short term. Different oils have different refining requirements and so not all potential buyers can use all potential types of oil for sale. This could result in market imbalances and leave Venezuela’s hard to refine oil on the outside looking in at least for the short term (it wouldn’t literally go unsold, it would just have to be sold at a lower price). The potential for this type of problem may push Venezuela to want to diversify its sales so as to not have all its eggs in one basket.

The second reason is diversifying away from the U.S. market will make it easier do something the Venezuelan government has wanted to do for some time – sell its U.S. subsidiary, Citgo. With refining profit margins currently very high in the United States Venezuela could probably get a very good price for Citgo. I have heard up to $12 billion although with profits running about $500 million per year they would probably get between $8 and $10 billion. Still that would be a very good chunk of change that could be used to invest in Venezuela or pay down debt.

However, the fact that Venezuela would be losing hundreds of millions of dollars in additional shipping costs makes it unlikely that the motivation for moving away from oil sales to the U.S. and divesting itself of Citgo is financial. Rather it is likely that the true motive is removing its exposure to actions being taken against it by the U.S. government. As things stand now there is a kind of economic Mutually Assured Destruction between Venezuela and the United States. Both have so many assets and commercial ties to each other that no matter how heated the rhetoric neither side can afford to really do anything. If the U.S. were to move against Citgo for example Venezuela could retaliate against U.S. oil companies operating in Venezuela. Conversely, Venezuela has to be very careful not to cross any U.S. multinational operating in Venezuela as it has a multi billion dollar investment (Citgo) at risk in the U.S. If Venezuelan authorities were to seize a U.S. pharmaceutical plant in Venezuela the U.S. could very easily retaliate.

However, if Venezuela divests itself of Citgo and no longer sells much of its oil to the United States it really has no exposure to economic attacks by the United States, short of things like quarantines which are an act of war. The Venezuelan would then have a free hand to act as it pleased against even U.S. interests within Venezuela without little fear of U.S. retaliation.

So what then is the significance of the recent indications that Venezuela will indeed begin shifting its oil sales to China? Given that it is clearly at some level an economic loss for Venezuela what it really represents is a hedge against significant deterioration in the relations between the U.S. and Venezuela. Clearly the Venezuelan government thinks there is a good chance things are going to get quite bad between the two countries and that it must take this expensive precaution to protect itself and ensure itself freedom of action.


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