Orinoco Woes. JUNE 26, 2017 Profiting from the PDVSA Crisis

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1 JUNE 26, 2017 Profiting from the PDVSA Crisis Orinoco Woes With all the media attention fixed on the unfolding crisis in the Persian Gulf it is easy to forget that the real OPEC basket case lies on the other side of the world. Venezuela. The government and its financial policies have descended into the realm of what we used to call a failed state. This is a nation unable to provide security, food, employment, or even beer. The effective value of the bolivar has cascaded with prices set several times daily in the streets (where the genuine barometer of what it costs to live is really measured). Meanwhile, the crime rate has skyrocketed, riots are epidemic, and government bonds have collapsed to well below junk status. All of this against the backdrop of having the largest crude oil reserves in the world (even greater than those booked by Saudi Arabia). Unfortunately, most of this is heavy oil found in the Orinoco River belt. It is costly to extract and to refine. And that puts the national oil company Petróleos de Venezuela, S.A. in the center of one genuine mess. PDVSA has seen its crude extraction volume plummet to 27 year lows, now projected to decline below 1.9 million barrels day. That s a more than 40% drop from 1998, just prior to the late President Hugo Chávez s disastrous populist revolution. Ultimately, the socioeconomic moves created such a domestic market crisis that PDVSA was forced by Chávez to use hard currency proceeds from oil sales to purchase foodstuffs and staple goods abroad for a dysfunctional economy at home. Nicolas Maduro, the current president, has experienced a rapid rise in opposition, leading to a multimonth wave of violent (and deadly) protests. These he blames on a US led attempt to unseat the government, reflecting the refrain often used by his predecessor when things didn t work out. Well, PDVSA is now on the ropes. Over the past two days, reports have emerged that Portugal and Spain are investigating an alleged massive PDVSA fraud involving some $6 billion in company funds. According to the reports, misappropriated cash flows ended up in global accounts controlled from Spain by members of the Venezuelan Ministry of Energy. The conduits were a series of banks including Espirito Santo in Portugal and several branches of the Banco Madrid. The latter bank s outlet in the

2 ALL ABOUT THAT (QATARI) GAS 2 postage stamp (and tax haven) Pyrenees enclave of Andorra seems to have been a principal link. Combine that with the threat made by Washington earlier this month of unspecified sanctions against PDVSA (to punish the government for its crackdown on political opposition) and the situation is worsening. And that has led to several avenues for profit off of the malaise. Imports Despite Record Reserves First, despite having a surfeit of crude oil, PDVSA refineries are unable to process it. The country has, at least on paper, a daily refinery capacity of 1.3 million barrels. Yet the network requires significant maintenance and a larger volume of light oil not produced by the country. The Cardon refinery's catalytic cracker (essential for the breakdown of heavier oils) resumed operations only last week after a prolonged period of reduced activity. But PDVSA's largest refinery, Amuay, and the smaller Puerto la Cruz refinery continue to work at only partial levels. This has led to PDVSA attempting to buy as much as 6.32 million barrels of fuel in one of its largest offers on the open market in recent years, according to documents seen by Reuters last Thursday. Gasoline and other product shortfalls in the country have provided additional fuel for the unrest rolling across Venezuela. 17 fuel cargoes of gasoline blend stock, ultra low sulfur diesel (ULSD), catalytic naphtha, vacuum gasoil (VGO) and components for motor gasoline are expected to be received from July through December, according to the report based on tender documents. Reuters added that earlier this month PDVSA awarded a group of firms, including Russia's Lukoil, previous tenders to buy 600,000 barrels of VGO and 300,000 barrels of gasoline blend stock RON 95 for July delivery. And now in its latest move, PDVSA is seeking 600,000 barrels of gasoline blend stock RON 91 and 95, up to 900,000 barrels of ULSD and 600,000 barrels of catalytic naphtha for delivery July 1 20 at any of its ports. It is also seeking up to seven 500,000 barrel cargoes of VGO and 720,000 barrels of MTBE (Methyl Tert Butyl Ether) from July through December. Some cargoes are to be paid 35 days after discharge. For others, PDVSA will attempt swaps under crude oil offsets. As of the end of last week, about 18 tankers carrying crude and fuels for PDVSA were

3 ALL ABOUT THAT (QATARI) GAS 3 waiting by Venezuelan ports to be paid to authorize discharge, according to Reuters vessel tracking data. In both of these situations 35 day payments and offsets PDVSA is looking at hefty premiums from market prices or exchange provisions. A group of middlemen are negotiating extortion rates to keep PDVSA s commercial distribution system afloat. Terminal Ill Will Second, there is a similar development afoot in Caribbean Basin terminal access. PDVSA is moving millions of barrels of oil from a Bahamas storage facility after terminating a contract with the owner, U.S. Buckeye Partners LP. The parties had tried to resolve payment delays and other frequent problems that stalled some shipments, sources are saying. But in another indication of how its deteriorating finances have strained business relationships, PDVSA moved its oil to the Statia terminal on the nearby island of St. Eustatius. That facility is operated by U.S. NuStar Energy LP. The Buckeye contract covered storage for as much as 6 million barrels of crude and fuel oil. The contract was due to expire in December, but PDVSA decided to end the lease in advance and seek some $10 million in overpayments, according to a PDVSA source. None of the three entities PDVSA, Buckeye, or NuStar are responding to journalist requests for details. But this much is well known to those in the Western Hemisphere storage sector. Buckeye (whose terminal facilities had actually been owned by PDVSA until 2008) had intermittently suspended PDVSA from moving its stored oil out of the terminal the Caribbean's largest over monthly payment delays. That part of the story is confirmed by information from Thomson Reuters Trade Flows data. PDVSA is now paying more for less. The Statia accord is believed to cover only 5 million barrels of storage at a rate higher than the 6 million barrel agreement with Buckeye. In late August, PDVSA renewed a 2014 contract with NuStar to secure its presence at Statia for three more years starting in March. The state run company is now paying some $2.3 million per month to lease space excluding extra charges, according to a document seen by Reuters. In addition, trading sources have told me there is a provision in the contract to allow NuStar to confiscate in kind for failure to pay. These traders have indicated provisions are already being drawn up

4 ALL ABOUT THAT (QATARI) GAS 4 to sell the oil at a profit from the terminal should PDVSA default. Goldman Sacks Third, major investment houses are coming under scrutiny for some highly discounted bond transactions. Opposition members in the Venezuelan National Assembly late last week petitioned US officials to investigate a $2.9 billion bond deal involving Goldman Sachs Group and Nomura Securities, saying the transaction fleeced the country for the benefit of political elites. Letters addressed to the US Securities and Exchange Commission, the Financial Crimes Enforcement Network and Financial Industry Regulatory Authority, requested a probe. Since revealed last month, Maduro opponents have charged that Wall Street banks were providing funding to the government by purchasing national assets at fire sale prices. According to the letter, Goldman Sachs paid just 31 cents on the dollar for PDVSA bonds with a face value of $2.8 billion that had been held by Venezuela s central bank. The price was more than 10 cents less than what similar notes were trading for at that time. Following the sale, PDVSA bonds experienced a rise in price. In a detailed account of the transaction carried out in late May, National Assembly president Julio Borges said: It is our understanding that there is enough evidence of wrongdoing for the US government to start an investigation against Goldman Sachs and Nomura under the Foreign Corrupt Practices Act. Borges said the assembly had obtained documents that show Venezuela s central bank board approved selling the bonds originally issued by PDVSA. They were first bought by Commonwealth Bank and Trust (Dominica), which then listed them for sale using Dinosaur Merchant Bank (London) and Midclear SAL (Lebanon) as intermediaries. However, Borges says in the letter that, according to numerous sources, the ultimate beneficiary owners of all three institutions are Venezuelan citizens with a history of carrying out corrupt business with the Venezuelan government and its officials. The letter doesn t provide the names of the citizens. Borges said Nomura also bought $100 million of the same bond at the same discount. In the two days after the purchase by Goldman, Venezuela s international reserves increased by only about $750 million

5 ALL ABOUT THAT (QATARI) GAS 5 which Borges said implies a substantial, above market fee paid to the broker. The money paid by Nomura is also unaccounted for, he said. In total, there s a $150 million discrepancy between the $899 million sale price and Venezuela s international reserve growth for the relevant period. The pricing and spread paid by each institution to Dinosaur suggest price fixing and above market commissions, he said. All this has led us to believe that acts of corruption may have been committed under our legislation. Many opponents of Maduro s have described this PDVSA paper as hunger bonds. It is increasingly looking like the expanding crisis at PDVSA is making some people a nice profit. Unfortunately, none of that seems to be trickling down to the streets where Venezuelans increasingly riot for food.

6 ALL ABOUT THAT (QATARI) GAS 6 About the Author Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment. He serves as an advisor to the highest levels of 27 countries, including the U.S., Russian, Kazakh, Chinese, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He s served as a consultant to private companies, financial institutions and law firms in 29 countries, and has appeared more than 2,300 times as a featured radio and television commentator. He appears regularly on ABC, BBC, Bloomberg TV, CBS, CNBC, CNN, NBC, Russian RTV, and the Fox Business Network. A prolific writer and lecturer, his six books, more than 2,700 professional and market publications, and over 650 private/public sector presentations and workshops have appeared in 47 countries.