Industry Trend Analysis - Stronger Military Role Will Deepen Production Declines - FEB 2018

BMI View: Th e shakeup at PdVSA will expand the role of the military within the upstream to cement its support for the regime. A lack of skilled workers will exacerbate development challenges, informing our production downgrade for 2018.

The ongoing political and economic crisis in Venezuela is having an increasingly negative effect on the country's vital upstream sector. The lifeblood of the ruling PSUV party, chronic underinvestment, rampant mismanagement and weak profitability has resulted in the lowest crude production levels in nearly three decades, averaging 1.86mn b/d in October versus a peak of 3.3mn b/d in 1997.

Limited revenue generation and an overwhelming debt burden have made it nearly impossible for state-owned PdVSA to repay its service providers, increasing pressure on the government to seek alternatives. This exacerbated production declines over 2017 with Schlumberger, Weatherford, Baker Hughes and Halliburton winding down operations in the prized heavy oil Orinoco Belt ( see ' Unpaid Service Providers Will Accelerate Upstream Woes ' , November 10).

Sinking To New Lows
Venezuela - Active Oil Directed Rigs
Source: Baker Hughes

In the wake of a selective default on November 13, the administration of President Nicolas Maduro has enacted a widespread shake up at PdVSA, arresting upwards of 65 former executives including former energy ministers Eulogio Del Pino and Nelson Martinez. This is in an apparent attempt to distance itself from the prolonged deterioration of the sector while consolidating the president's power via the military.

The announcement by the new head of PdVSA, Major General Manuel Quevedo, that Maduro would be personally reviewing all oil service contracts and executive positions from December 4, underscores the importance of the military to the regime as its primary source of domestic support. We expect members of the military will comprise an increasing number of prominent roles at PdVSA over the coming months as Maduro seeks to cement its backing for his administration.

Moreover, state-owned Camimpeg - the military-run oilfield services firm formed in March 2016 - will likely take on a more active role in the upstream as private companies exit the market. We caution that this will exacerbate production declines over the coming months given Camimpeg's lack of requisite scale and skill to make up the difference.

Faster Declines Ahead
Venezuela - Monthly Crude Output, 000b/d
Nov 17- Dec 18 = BMI forecast. Source: OPEC secondary source data, BMI

In addition, we maintain that PdVSA's investment into the sector will be restricted as the government prepares for forthcoming debt repayments. The country owes nearly USD9.0bn in debt across both sovereign and PdVSA bonds in 2018, compared to just under USD5.0bn in 2017. Limited inflows due to prolonged oil price weakness and continued oil-for-loan exports to China and Russia will leave minimal funds for reinvestment. This will cap development upstream as PdVSA's remaining counterparts limit their involvement in the market ( see ' Upstream Partners Won't Come To PdVSA's Rescue ', July 17).

More Debt Coming Due
Venezuela - Bond Repayment Schedule, USDmn
Source: Bloomberg

We have therefore downgraded our 2018 crude production forecast to an average rate of 1.68mn b/d down from 1.77mn b/d previously. This implies declines will accelerate from 2017 levels, from an estimated 11.1% y-o-y decline to 12.6% y-o-y in 2018 due to Maduro's strengthening grip on power.