On December 28, 2017 the Venezuelan government announced that it would launch a new oil-backed cryptocurrency, the “petro” within “days.” Apparently, the Venezuelan government, inspired by the success of cryptocurrencies like Bitcoin, Litecoin, Ethereum, Dash, Ripple and others, has concluded that minting its own electronic money will provide an easy way out of it’s self-inflicted economic crisis.
Some background is in order to fully appreciate Venezeula’s cryptocurrency move.
New U.S. Sanctions
As recently as September 2017, the Venezuelan state oil company, Petróleos de Venezuela (PDVSA), announced it would no longer accept payment for its oil exports in dollars and instead accept euros as a replacement. That move was seen as having two motivations. First, to avoid U.S. sanctions and second, to attract customers who prefer to pay in a currency other than the dollar, such as India and China.
According to the BP Statistical Review of World Energy 2017, China and India are the world’s second and third largest importers of oil, respectively, behind the United States. The ability to pay for oil imports in local currency would be highly attractive to these developing nations who would otherwise have to raise dollars to make payment.
Venezuela’s dollar replacement scheme followed the August 2017 Trump Administration’s executive order to impose stringent new financial sanctions on the Venezuelan government aimed at upping the pressure on that nation’s quasi-dictatorship. The executive order bars U.S. financial institutions from dealing in new stocks or bonds issued by the Venezuelan government or PDVSA, the parent company of Citgo.
This was a significant move, because according to OPEC oil accounts for 95% of Venezuela’s export revenues and the petroleum business accounts for 25% of that nation’s total economy. Mismanagement of the oil and gas sector combined with slumping crude prices has sent Venezuela’s economy into free fall. Rampant corruption, including indictments of high-level Venezuelan government officials for drug trafficking, has not exactly engendered trust with the market.
Ignore the Decline Curve at your Own Peril
Apparently, Venezuela’s former president Hugo Chavez and his hand-picked replacement, Nicolas Maduro, never understood that the most valuable day of an oil well is its first day. Once a well begins to produce, the decline curve takes effect and more wells need to be drilled to offset falling production from older wells. The leftist Venezuelan government has used the petroleum sector to subsidize consumer prices and fund massive social programs, but it has taken what many socialists originally believed was a good idea to an illogical extreme. Socialist policies have drained PDVSA of the precious capital it needs to reinvest to maintain production and cash flow.
Consequently, Venezuela is dependent on outside investment to maintain and grow its oil business even though it has the world’s largest reserves of crude oil estimated at 300.9 billion barrels, even more than Saudi Arabia. Recent developments in the South American nation have caused even European oil companies pause for concern and are questioning their commitments to the Venezuelan industry. As a result, Venezuelan oil production has fallen to 2.4 million barrels per day (MMBopd) in 2016, down 33% from 3.3 MMBopd in 2006.
Threat to the Dollar
The plan to create a new cryptocurrency backed by 5.3 billion barrels of oil reserves must sound appealing to the Venezuelan government and its ersatz dictator Nicolas Maduro. It appears to be an easy way to skirt U.S. sanctions and delay the inevitable collapse of the socialist economy. It is not lost on outsiders, however, that Venezuela’s most recent gambit is one of desperation.
In our view, the petro cryptocurrency gambit is a desperate move by the Venezuelan government to capitalize on the modern version of the tulip bulb craze. Others having more legitimacy have tried to create an alternative to the U.S. petrodollar in the past and none have succeeded. The Venezuelan government simply lacks the trust and transparency required to pull this one off.
We are wary of U.S. authorities allowing the petro, an ostensible but unlikely threat to the dollar’s primacy in oil markets, to even get off the ground. As a fiat currency, the value of the dollar is a function of supply and demand. The world’s huge and growing thirst for crude oil ensures that there is always ample demand for the dollar and U.S. markets are considered the most transparent, liquid and reliable of all. If a rival currency were to supplant the dollar as global petrocurrency, it would have serious negative long-term effects for the U.S. economy. Consequently, we would anticipate that even if the servers light up and the petro makes its debut, we anticipate U.S. treasury and foreign policy officials will move expeditiously to strong-arm allies to avoid the new cryptocurrency.
Bitcoin and other cryptocurrencies give corporate CFOs and government officials anxiety because of their extreme volatility and potential for fraud. Combine the lack of transparency and trust of the Venezuelan government with the ordinary cryptocurrency jitters, and we find it unlikely that oil buyers will readily adopt the petro.
As a practical matter, however, Venezuela’s cryptocurrency gambit has real implications for oil markets:
- We anticipate that the Maduro government will continue draining PDVSA of the funds and resources it needs to reinvest back into the oil sector, accelerating the production decline. Venezuela’s production will likely continue to fall by perhaps another 300,000 barrels of oil per day (Bopd) in 2018.
- Declining production from Venezuela provides some space for other OPEC members to fill and potentially makes it easier for the cartel to meet its production limits, currently OPEC is restricting production 1.8 million Bopd below full capacity.
- Potential customers like India and China value reliability of supply, not just access to oil. Even if they choose to pay in Venezuela’s cryptocurrency, it is unlikely they will be making large commitments to a potentially unreliable supplier, making it difficult for the petro to gain traction as an accepted medium of exchange.
- The Trump Administration’s new financial sanctions will accelerate change in Venezuela and force the government to adopt more transparency and restore democratic rule…or they won’t. If the Maduro regime digs in its heels, then Venezuela stands to descend further into poverty resulting from extreme socialist policies and economic isolation.
- Importantly, it is unlikely that the nation with the largest oil reserves will be a meaningful player in the global markets for some time. For the Venezuelan people, that means an acceleration of the economic death spiral, representing a threat to regional social and political stability.
Perhaps the biggest barrier to bringing the petro to market is the market itself. Investors have recently begun to sell off cryptocurrencies, as regulators in China, South Korea begin tightening oversight on traders. Perhaps the Bitcoin bubble has finally burst.
It has been nearly two weeks since Venezuela’s announcement that the petro would launch “within days,” and there has been only silence. You didn’t really think governments were going to let high-tech upstarts appropriate the economic sovereignty of the world’s largest economies, did you?