DiliTimes

Two weeks ago, the global power centers were left reeling by the geopolitical earthquake of ex-Venezuelan President Nicolás Maduro’s capture. For decades, the so-called “Venezuelan problem” was slow-burning dynamite due to sanctions and diplomatic stalemates. With the US military presence in Caracas and the capture of Nicolas Maduro, the global energy map is now set on fire by this dynamite.

The US intervention bypassed traditional diplomatic channels as special forces entered Caracas, and by the time the sun rose, a “new era” was declared by headlines of the Western Hemisphere.

Profound confusion followed rather than celebration, as Brussels, UN and various Latin American capitals were questioning the legality of this capture. Was law enforcement based on long-standing narcotrafficking indictments or a blatant violation of sovereignty?

US forces secured key nodes of the state oil giant, Petróleos de Venezuela, S.A. (PDVSA), and the global community remained confused as to who was in charge due to interim authorities being hastily organized in coordination with Washington, and so, the largest proven oil reserves effectively fell under US “energy dominance.”

Why did prices fall, then?

Major oil-producing nations being invaded by the military would have had triple-digit-level soars in crude oil prices in any other decade, yet, in a complete paradox, WTI crude dropped to around $57 per barrel in the days after the takeover. Looking at economic theory, this paradox can be explained by the Theory of Rational Expectations and the Efficient Market Hypothesis.

Under the Efficient Market Hypothesis, all available information is immediately incorporated into the current price by the market; therefore, after the “political risk” of the Maduro regime was removed, markets priced the certainty of future supply, even if this supply is years ahead. Investors did not perceive the situation as a war but as a decade-long bottleneck.

Hotelling’s rule states that non-renewable resources’ prices, minus extraction cost, eventually rise over time at the rate of interest to ensure efficient extraction and maximization of resource owner profits. In essence, it refers to the optimal path for depleting a final resource, where scarcity value increases over time and so do returns, directing owners to wait because they could earn more, with the resources’ “in-situ value” growing like an interest-bearing asset. Venezuela’s oil was blocked by sanctions, and this had created artificial scarcity; therefore, this intervention supposedly “unlocked” these reserves, lowering the scarcity rent. Other global producers, fearing a future flood of Venezuelan crude, may have increased output to capture market share before prices bottom out, giving birth to a phenomenon similar to the “Green Paradox,” defined by German economist Hans-Werner Sinn in his controversial book with the same name. Record-breaking production from the US Permian Basin and surging output from Guyana, Brazil and Canada have created a massive buffer, as market analysts expect a 2 million barrels per day (mbd) surplus for the year, with Venezuela’s resources merely adding to the bearish sentiment, further accentuating the aforementioned effects.

Beijing, which relied on Venezuela as a key strategic partner, is now facing a catastrophic loss, introducing two critical economic tensions:

1. Venezuela used a clandestine network of tankers to bypass sanctions and sell oil to China illegally, with US intervention forcing this trade into light. Cournot competition explains how the sudden unification of this “dark supply” with the global market led to the discovery of the real price, revealing that global supply was actually higher than previous estimates.
2. China has extended over $60 billion in loans-for-oil deals to Caracas. The interim government of Venezuela may invoke the legal-economic theory of odious debt, saying that such loans sustained a dictatorship instead of going towards the people. If this debt is declared unenforceable, China will face a credit shock and most likely will prompt reciprocal retaliation by potentially restricting rare earth mineral supply chains critical to the US tech sector.

This regime change does not result in instant oil, as the physical state of PDVSA is the result of infrastructure rot. Mismanagement over the years left the Orinoco Belt’s “upgraders” nonfunctional and pipeline networks looted for scrap. A 3-5 year process of restoration is expected to reach the 3 million barrels per day (mbd) production level, along with $100-200 billion in capital. While Chevron and other companies are poised to lead this, the operational landscape they are supposed to work with is basically non-existent. The current low price of the market is a bet on the long-term efficiency of Western capital over the short-term reality of a broken industry.

Conclusions

Washington has fundamentally shifted the global cost curve of oil through acquiring Venezuela, showcasing a demonstration of force and confidence in betting on their long-term energy dominance over short-term geopolitical stability. However, a trade-off as such needs navigating a standoff with the Chinese counterparts and the multi-year slog of rebuilding a nation. Oil has been secured by the gun barrel, but long-term restructuring of global energy markets has only just begun.

Cover image: Renan Braz