Takeaway: State-owned PDVSA on OFAC SDN list is defacto oil import ban to US. But most intern'l banks will avoid Venezuela making sanctions broader.

Trump Hits Maduro With Oil Sanctions to Turn Off Cash Machine - IMG 1558

President Trump issued an executive order Monday directing the Treasury Department to implement sanctions on Venezuela’s state-owned Petroleos de Venezuela S. A. (PDVSA) and a defacto ban on US imports of Venezuela crude.

The move is a major blow to the Maduro regime, which depends on the cash generated from oil sales to the US to keep the loyalty of the Venezuela military. The rest of Venezuela’s oil production is sent China and Russia in the form of debt payment on loans. 

The administration’s Venezuela policy is aimed at cutting off Maduro’s cash machine in order to separate him from the military support that is keeping him in power. A secondary goal of the plan, unveiled today, is to freeze Venezuela government assets or divert funds or revenue to the US–recognized President Juan Guiado, who also serves as President of the constitutionally-elected National Assembly.

If you followed our notes on Venezuela since the beginning of this year, you were not surprised by today’s development, as we had outlined the Administration’s intentions as early as January 11. To read our earlier, notes click on the links below.

01/11/19  Venezuela: Rising Oil Market Risk with Maduro Second term & Guyana Moves

01/14/19  Trump Admin Considers Tougher Action on Venezuela’s Maduro Raising Oil Market Risk

01/23/19  FLASH – Trump Administration Readies Venezuela Oil Sanctions

01/25/19  US Venezuela Plan: Turn Off Cash Machine to Separate Maduro from Military

There is some language about general licenses in the Treasury Department Office of Foreign Assets Control (OFAC) fact sheet on the PDVSA sanction.  But make no mistake, it is a defacto ban on Venezuela crude imports to the US. With the exception of oil already purchased and enroute to the US, the Treasury announcement bans any US persons or entities, directly or indirectly, from commercial transactions with PDVSA.  

The Treasury language also attempts to provide a wind-down period but requires that any payments by US entities during this period are to be sent to US-blocked accounts that prevents access to the Maduro regime and makes the funds available to the Guiado government.  For practical purposes, this is also a ban because it is unlikely that a Maduro PDVSA would engage in transactions where it does not receive funds.  Indeed, Maduro said Monday that he would find other buyers for the “Gringo” oil sales.

But that may prove to be difficult as well.  PDVSA was also placed on OFAC’s Specially Designated Nationals and Blocked-Persons List (SDN).  Most international banks will cease dealings with a person or entity on the SDN list out of concern for risk exposure.  Therefore, the sanctions are likely to have broader application than just US commercial transactions.

We certainly expect China and Russia to continue to receive oil in exchange for debt payments as long as Maduro is in charge. But we think other potential buyers will think twice about it.  India is the most mentioned replacement buyer for Venezuela crude displaced by US sanctions but it is really not a good solution for Maduro – as the crude will be highly discounted and margins cut due to greater transportation costs.

There is no question that US Gulf refiners will be taking an economic hit with sanctions on Venezuela crude. The refineries were built specifically to take the heavy crude and replacement supplies are hard to come by with a freeze on Canadian production and Saudi cuts announced in December. The medium-to-heavy crude market is already tight, and the Venezuela sanctions will create pressure on already rising oil prices.

Secretary Mnuchin tried to downplay the impacts to US refiners and potentially rising oil and gasoline prices by suggesting that surging US shale production creates a cushion for the US market.  But these Gulf coast refineries cannot process large amounts of the light oil produced by shale and will likely have to cut runs without adequate supplies of heavier crudes.  

A gasoline supply glut in the US may also blunt price spikes in the short term.

We expect Administration will soon announce measures to try to help mitigate the impact on the US market. Among the measures we think could be under consideration are targeted sales to affected refiners from the US strategic petroleum reserve (SPR) and appeals to Saudi Arabia for sales of heavier Saudi crude to US refiners.  Indeed, Secretary Mnuchin today referenced turning to "our friends in the Middle East" for help with oil supplies.  

Unrelated to the sanctions announcement, the Saudi energy minister earlier in the day said that Saudi production for the next several months will be even lower than the 10.2 million b/d allowed under the OPEC agreement and current Saudi production levels. However, we suspect the Saudis will be responsive to overtures from the Trump administration on helping to bridge the gap in heavier exports to US refining customers. 

The US sanctions on PDVSA also cut sales of US diluent to Venezuela that will also create an even greater shortage in gasoline supplies that already exists.

Lastly, we do not think potential US military action in Venezuela can be ruled out.  

We have discussed this possibility in past client notes that Trump considers military action to be a true option and has compared it to US military intervention in Panama to oust former President Manuel Noriega from power.

On Monday, Axios reported that Trump also once again raised the possibility of US military action in Venezuela in a recent meeting with Senator Lindsay Graham.  Graham told Axios that "Trump's really hawkish on Venezuela."  

Much is being made of a press photograph of NSC Advisor John Bolton’s note pad during Monday’s press conference in the White House briefing on Venezuela sanctions. The note said “5000 troops to Colombia.” See link for photograph of Bolton's notepad taken by Associated Press photographer Evan Vucci.

The Administration’s line is that “all options are on the table,” inferring that it includes military action. 

We do not think the Administration will further clarify Bolton’s note about such a troop deployment but it could be positioning for potential rescue missions of US citizens or to distribute humanitarian aid.  However, we also do not think you can discount the message being sent to Maduro and more importantly the Venezuela military leadership.  As our friends at Caracas Chronicles tweeted last week, “Venezuela's generals aren't dumb, they understand the prospect of a real military confrontation with the Americans would be a disaster.”

In addition, the Secretary of State Mike Pompeo last Friday appointed Elliott Abrams, former state department and NSC official in previous administrations, to be the new coordinator of US Venezuela policy. Abrams, while in the Reagan administration, had recommended military action in Panama. President Reagan rejected the recommendation but his successor President George H.W. Bush implemented Abrams plan. 

Stay tuned for much more US action on Venezuela in the coming days and weeks.