How Venezuelan crude could shake things up for Canadian producers

With the Trump administration seizing Venezuelan oil tankers, demanding the “return” of oil and other assets and threatening war against the Maduro regime, the fate of the world’s largest proven reserves is once again in doubt.

As a result of U.S. sanctions, Venezuela has been all but frozen out of the international oil market, despite having more known oil than either Canada or Saudi Arabia.

If the oil were to start to flow again — as it did before the arrival of president Hugo Chavez and his successor, Nicolas Maduro — it could have profound effects on Canada.

That’s because Venezuelan and Canadian oil have been intimately linked for a quarter century, ever since Chavez came to power in Caracas.

“The bitumen in the Orinoco Belt is identical to the bitumen in Alberta. Identical,” said chemical engineer Lino Carrillo. He should know, having worked for 22 years at Venezuela’s state oil company, PDVSA, followed by years in Fort McMurray.

But Venezuela enjoys some advantages, thanks to climate and geography. Higher ground temperatures make its heavy crude more free-flowing, allowing it to be extracted rather than mined. Both its heavy crude deposits (concentrated near the Orinoco Delta) and its conventional oil (found mostly around the Maracaibo Basin) are much closer to tidewater than Canada’s oil sands.

The problems that plague Venezuela’s oil industry are mostly of its own making.

Carrillo was a senior manager in a PDVSA joint project with Total Oil when Chavez’s socialist government fired 23,000 personnel from PDVSA in 2003 following a strike — a loss of talent and expertise the state oil company never recovered from.

Venezuela’s loss was Canada’s gain. 

“Suncor Energy knew about the firing of all of us,” Carillo said. “So they looked for people that knew the Venezuelan oil industry, because there was a big boom in Alberta at that time.”

Carrillo was one of the first 25 Venezuelan engineers to move to Canada in 2004, where many managed projects and operations. “By the end of 2008, there were about 400 Venezuelan families working in the oil sands.”

Canadian oil replaces Venezuelan

Venezuelan crude had long been refined partly in the U.S., where many Gulf Coast and Midwestern refineries had retooled to handle the bitumen- and sulfur-heavy Orinoco crude. As Venezuela’s production began to shrink, Canadian oil began to fill the gap.

“Historically, Venezuela was one of the largest suppliers alongside Mexican Maya, another heavy crude grade, of these heavy sour barrels to U.S. Gulf Coast refineries,” said Rory Johnston, an oil market analyst who teaches at the University of Toronto and is the founder of market research firm Commodity Context. “Canada has actually been a relatively recent entrant to this U.S. Gulf Coast market.”

As Canadian production grew in the first decade of the century, Johnston said, Canada first satiated the closer Midwest refineries, then spilled over into the Gulf refineries and finally ended up producing so much oil that some of what it sent to the Gulf was being re-exported out of the U.S. entirely.

At that point, Canada became a victim of its own success, and was forced to accept steep price differentials (markdowns) by refineries that were clearly enjoying a buyer’s market.

Venezuelan oil disappeared from the scene entirely, and pipelines that once flowed north from the Gulf were reversed to bring Canadian oil south, a process that has continued almost to the present day.

Self-sabotage in Venezuela’s oil fields

Meanwhile in Venezuela, political firings and a brain drain of skilled engineers, combined with the incompetence and inefficiency of the Chavez and Maduro governments, had predictable effects on the industry, says Carrillo.

“The infrastructure is completely destroyed. I believe that, beginning in 2011-12, they stopped doing major maintenance.”

Low salaries drove away those professionals who still remained, and who could command higher pay elsewhere.

“That’s why we went to Saudi Arabia, Mexico, Brazil, Colombia, Canada, the U.S.,” said Carrillo. “We are all over the world, you know, most of us who worked in the oil industry, and the [Venezuelan] infrastructure is pretty much in shambles.”

Carrillo says the breakdown of Venezuela’s pipelines has led to oil being shipped long distances by trucks, which are themselves often in poor shape. Ports are also in lamentable condition.

Production has fallen from 3.4 million barrels per day to only about a million, and most of that is sold on the black market in China at knockdown prices, owing to U.S. sanctions. (About 15 per cent goes to the U.S. under a licensing agreement with the oil giant Chevron.)

The skilled workers who remain in Venezuela, says Carrillo, aren’t able to fix the problems without massive outside investment. 

“They’re working under duress, being watched by the police, by the military people, who are forcing them to do things that are unsafe. That’s why they have so many accidents.”

Venezuelan oil would have easy access to Gulf refineries

The strong similarities between Venezuelan and Canadian crude, as well as the ease with which tankers could move the crude between Venezuelan ports and refineries on the U.S. Gulf Coast, suggest that if Venezuelan crude production ever came back — and sanctions went away — Orinoco heavy crude would likely be able to undercut Canadian crude at refineries in Texas and Louisiana.

“The most natural market for Venezuelan barrels are the refineries actually sitting along the U.S. Gulf Coast,” Johnston said. “They won’t need additional pipelines or anything else. Basically, you’ll just pull a tanker up, unload and then you’re competing directly with Canadian barrels.”

Getting the oil to the Midwest, where most Canadian oil is refined, would be harder, says Johnston.

“That would require [a] vaster kind of retooling of pipelines,” he said, to restore the south-north flows that were reversed many years ago.

Francisco Monaldi, a Venezuelan-born fellow in Latin American energy policy and director of the Baker Institute at Rice University in Houston, Texas, agrees that Venezuela would be in a strong position to replace Canada on the Gulf.

“Because the Keystone XL pipeline that was supposed to bring 800,000 barrels of oil [a day] from Canada to the Gulf was never built, just a fraction of Canadian oil actually reaches the Gulf,” he said. “So they have a thirst for heavy oil that is not going to be supplied by Canadian oil given the limitations of the infrastructure to get it down.”

He said “Venezuela would have a lot of capacity to increase production and find the market.”

Investment needed would be huge

But Monaldi says a lot of money would need to be invested in Venezuela, “particularly in reworking some of the wells, drilling new wells and also reducing the bottlenecks.”

The investments required to meet the demand for Venezuelan crude would likely dwarf the costs of transition in the U.S.

“For Venezuela to produce four million barrels a day in a decade, it will require north of $100 billion,” he said. “For that to happen, it would require mostly private investment and the conditions to attract that private investment, because the national oil company is bankrupt and the country itself has an external debt of more than $150 billion.”

All analysts agree that while Venezuela presents low geological risk, it is a very different story when it comes to political risk.

A history of coups, strikes, nationalizations, high rates of violent crime and the presence of armed groups all make Venezuela a challenging environment compared to Canada.

Trump’s threats and demands that Venezuela “return” oil ostensibly stolen from the U.S. only add to the uncertainty. One of the few points the Maduro government and the opposition agree on is that Venezuela’s oil belongs to Venezuelans, not to the U.S.

But with such a valuable resource under the ground, there would be huge incentives both for Venezuelans and for international partners to get the industry running again if the Maduro government were to fall.

In that scenario, Venezuela can count on another valuable resource: its people overseas.

“There is a massive Venezuelan diaspora of petroleum engineers, geologists, et cetera, all over the world, including in Canada, because of their expertise on heavy oil,” said Monaldi. “And that diaspora would have to be tapped if the oil industry will ever recover back in Venezuela, because very few remain in the country.”

One of those who says he’d be ready to help is Lino Carrillo.

“I will go back. I mean that. I have no doubt, even though my kids have married, and we have our grandkids here in Canada who are Canadians. So maybe they will not come back, but I will come back and help for two or three years.”

Another reason to build West

Johnston says the potential for a new competitor from the South should refocus Canadian attention on building infrastructure to carry Canadian oil to new markets, away from the U.S.

“This is yet more reason to say there are additional reasons, beyond those that are currently in front of us, to go West. And I think the most important factor here is that it just increases our optionality right now, because if it wasn’t for the TransMountain expansion, we really only have one way to go with our crude oil,” he said.

“When people talk about energy security, they’re typically talking about energy security of supply. But as Canada is a vast net exporter, what we’re really most interested in is energy security of demand. And the only real demand security you can get, much like the supply side, is variety.”