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Tuesday, September 26 2017 @ 02:05 PM AST

Scotiabank: PetroCaribe has more noose than lifeline



PetroCaribe has "more noose than lifeline" Scotiabank has said in a special report released Thursday (September 4). Authored by Rory Johnston of Scotiabank Economics at world headquarters in Scotia Plaza, Toronto, the report looks at what would happen if PetroCaribe were to unwind as forecast by analysts.

In the report entitled, "PetroCaribe: More Noose Than Lifeline," the bank said: "There are political and fundamental factors affecting the longevity of PetroCaribe, and both are trending toward an eventual dissolution of the energy union. When, how, or even if the PetroCaribe agreement will collapse is clouded by uncertainty but the outsized impact of such a scenario necessitates concern."

The PetroCaribe energy accord was created in June 2005 to provide preferentially financed Venezuelan petroleum to Central American and Caribbean member states. Today there are 13 active PetroCaribe members. Currently importing petroleum through PetroCaribe, according to PDVSA annual reports, are Antigua & Barbuda, Belize, Dominica, Dominican Republic, El Salvador, Grenada, Guyana, Haiti, Jamaica, Nicaragua, St Kitts & Nevis, St Vincent & the Grenadines, and Suriname.

Nine years after its foundation, the agreement has "fostered a fiscal dependence on Venezuela amongst members and perpetuated petroleum consumption patterns that are unsustainable in the current era of high oil prices," Scotiabank said.

Conditions governing PetroCaribe include quotas that are " subject to assessment and adjustment," according to the signed agreement, which also caters for "any other circumstance that will oblige the government of Venezuela to change the assigned quotas." Members also agreed that PetroCaribe will be "exclusively enforced by the public entities supported by the government of Venezuela."

As for rescindment, the agreement says it can "be modified or denounced when the interest of the government of Venezuela so requires, …notified in writing and through diplomatic channels, 30 days in advance."

Scotiabank said: "Should the agreement collapse, unsubsidized market prices would amplify public sector and current account deficits in member countries. Meanwhile, rapidly reducing the consumption of petroleum-based fuels would adversely impact the fragile economies of participating states. The future of PetroCaribe is far from certain but it is essential to understand how it works in order to best assess and manage discontinuity risks. In particular, it is crucial to ascertain which participants are most vulnerable to its unwinding — see Figure 2 (attached) for an overview of member vulnerability."

US$40 per barrel oil
PetroCaribe employs a progressive financing system to provide relief from the volatility of global energy prices to energy importing nations in Central America and the Caribbean. Under the agreement the percentage of payment deferred rises with the price of oil, keeping the up-front cost of petroleum around US$40 per barrel, less than half the going market rate. It was felt that softening oil price swings and allowing the full cost to be amortized over 25 years (at very low interest rates of 1-2 per cent) would facilitate a better sense of future expectations, enabling more effective public planning and budget management for member countries.

"With rates so generous and maturities so long, however, it is more useful to think of PetroCaribe as a subsidy rather than simply a loan; 25 years is a very long time for countries that are facing acute financial distress today," Scotiabank said.

PetroCaribe’s generous subsidies benefit recipients in the short term, yet the illusion of affordability has preserved uneconomical energy practices such as petroleum-fueled
electricity generation, the bank said. Most PetroCaribe members depend on outdated fuel oil generators to provide the majority of their electricity, a practice that non-subsidized states have long since dropped — creating a juxtaposition of member and non-member electricity generation, the bank said.

These subsidies have distorted price signals that would have exerted downward pressure on petroleum demand as prices rose, eliminating the impetus for timely substitution to less-expensive feedstock such as liquefied natural gas, coal, or non-hydro renewables.

Petroleum supplied through PetroCaribe has more than doubled since its inception and as of 2013 accounted for 34 per cent of members’ total consumption, Scotiabank said. "Substituting physical supply would not be difficult if Venezuela chose to turn off the tap, but the value of PetroCaribe is its preferential financing and members would be hard-pressed to find similar terms in the open market," Scotiabank said.

Pressure on local currencies
PetroCaribe financing is a material factor affecting the economies of participating states and would leave a sizable fiscal gap if discontinued, Scotiabank said. "While it is questionable whether or not these loans will ever be repaid, they still weigh on recipient economies, if only symbolically. Over US$11 billion in PetroCaribe debt had been accumulated by the end of 2013, equal to 16 per cent of gross debt and 8 per cent of the group's GDP (see Figure 6 attached)," the bank said.

The petroleum import costs deferred each year act as cheap long-term deficit financing and reached an annual average of US$2.3 billion between 2011 and 2013, equal to 9 per cent of the group’s public sector revenue, according to Scotiabank global economics team.

"Without this financing, most participating governments would be pushed into public sector deficits, if they are not there already. The deferral also has a significant impact on the external position of member countries, amounting to an average 7 per cent of member country exports and 13 per cent of foreign currency reserves. If the agreement collapsed, members would feel considerable pressure on their current accounts and further downward pressure on local currencies," the bank said.

Scotiabank said there are wide disparities between participant countries concerning their relative reliance on the PetroCaribe framework and some members have done better than others in diversifying their energy profiles. The Dominican Republic serves as "an excellent example of how diversification can lower reliance on the agreement," the bank said. When PetroCaribe was signed in 2005, oil accounted for over three-quarters of Dominican electricity feedstock. That figure decreased to one-half by 2013 as policymakers prioritized structural energy sector reform by building liquefied natural gas import terminals and increasing coal deliveries. Decoupling subsidized petroleum from core economic performance would benefit every member country in the long run and resources saved on current consumption could be used for these purposes, Scotiabank said.

PetroCaribe Unwinding?
The PetroCaribe agreement's continued existence should not be taken for granted and the deteriorating political, economic, and petroleum sector environment in Venezuela calls into question the longevity of the accord, the bank said.

The legacy of the Chavismo era is the steady weakening of political and economic institutions, the analysis said. Soaring crime rates, inflation of almost 60 per cent year on year, and an inability to import basic consumer goods have served as traction for the opposition, the bank said. "For many, it is hard to justify billion-dollar handouts when Venezuelan citizens are in need of assistance and opposition parties have already signaled their intent to dismantle the agreement should they come to power. It is difficult to forecast exactly when or if this public discontent will result in regime change, but the likelihood increases as the situation continues to deteriorate in Caracas. If PetroCaribe survives it will likely be due to the current government's deference to past Chávez policies and trouble for president Nicolás Maduro translates to trouble for PetroCaribe," the bank said.

Add to this that Petróleos de Venezuela S.A. (PDVSA), Venezuela’s national oil company, is run more like a government ministry than a typical oil company and petroleum proceeds are used to support general government finances rather than being reinvested in production infrastructure, Scotiabank said. "PDVSA is perceived to be governed by those loyal to the government and investment decisions are often made on the basis of political rather than technical gain," Scotiabank said.

It recalled that former President Hugo Chávez fired thousands of PDVSA employees — including roughly 80 per cent of the company’s research division — during political purges that occurred in 2003, draining the country of some of its top technical minds. Since then, the country has struggled to increase production despite sitting on the world’s largest deposits of crude oil. Venezuela was pumping over 3.5 million barrels of oil per day in the year before Chávez took office but current production stands at only 2.5 million barrels per day, almost 30 per cent lower.

Heavy financial demands placed on PDVSA by the government serve to exacerbate this operational strain by starving the company of its cash flow, the bank said. The most onerous of these burdens is the programme of deeply subsidized domestic petroleum prices. Venezuelans enjoy the cheapest gasoline in the world with an official posted price
of US$0.05 per gallon and a street price reaching as low as half a US cent due to the demand for foreign currency.

In addition, Scotiabank said, the government is diverting a growing share of production to pay back Chinese loans, on which the Venezuelan government is increasingly reliant due to falling export earnings. Less cash is flowing into PDVSA coffers as more production is diverted into these non-cashgenerating avenues, and this share is growing at the very time when domestic production infrastructure desperately needs heavy capital injections, Scotiabank said.

The report concluded that PetroCaribe members "have grown accustomed to the status quo" but it is important for both governments and global investors to consider the implications of a policy shift in Venezuela given current domestic trends. Mitigating the importance of the agreement would require an expensive reworking of national energy systems, but preventative action would cost far less in the long run than an unexpected and disorderly unwinding of PetroCaribe, Scotiabank said.

The bank said: "Dwindling Venezuelan petroleum production is being spread ever-thinner across a complicated web of regional alliances, oil-for-loan deals, and a domestic fuel subsidy program that costs the government tens of billions of dollars every year. As the government in Caracas moves to rationalize energy policies, many beneficiaries of Chavismo largess may lose that status."



SIDEBAR

How is Petrocaribe being used?

ANTIGUA & BARBUDA

• Food and utility subsidies to pensioners
• People’s Benefit Program
• Propane subsidies to Barbuda
• Vocational skills training
• Potential reactivation of WIOC refinery
• $695 million in fuel has been purchased under the agreement ~40% financed as at January 2014

BELIZE

• One of main drivers in net foreign assets position
• Foreign currency required to make bond payments (CB)
• Initial $20 million in capital for the establishment of the National Bank of Belize
• Infrastructure funding Belize Infrastructure Limited
• 1/3 of foreign exchange inflows came from Petrocaribe; US$59 million financing in Budget 2014/15

DOMINICA

• Free LPG gas for centenarians programme
• Construction of schools
• Beach maintenance and clean-up
• Housing projects
• Contributed more than $60,000 for Carnival 2014
• Installation of a coffee processing plant (2,000 tonnes per year)
• Dominica in 2013 fell behind on payments on the US $23.6 million
• Talk of West Indies Oil buy-out
• Offered bananas, coconuts and citrus in repayment

DOMINICAN REPUBLIC

• Electricity subsidies (General Fund + PetroCaribe)
• Funding of CDEEE deficit
• Funding for electricity distributors EDEs
• 17 per cent external financing from national budget is from PetroCaribe
• 25 per cent external debt with Venezuela
• Offered free zone goods in repayment

GRENADA

• Grenada Home Improvement Programme
• Sustainable Livelihoods Project
• LED Lighting Retrofitting
• Support for Education, Employment and Development
• Youth Upliftment Programme
• School Feeding Programme
• Free School Books Programme
• Road Improvement & Maintenance

GUYANA

• Special fund for PetroCaribe through GEA
• Special fund used to finance two GPL power plants and the Hope Canal
• Oil + Fertilizer received under the agreement
• Roughly 30 per cent of external debt reduced to US$198 million in 2013
• Venezuela is main destination for rice and paddy exports

HAITI

• 189 projects underway…
• 735 km of roads, airports, hospitals, schools, energy and water infrastructure, urban renewal, social housing units and food security programmes
• Food storage facility, public markets, reforestation, irrigation
• Sporting facilities, 8,000+ homes
• Delmas and Carrefour overpasses US$30 million; Ile-a-Vache and Jacmel US$20 million
• More than 90 per cent of investment budget comes from PetroCaribe
• Debt expected to reach US$1.6 billion this year; currently over US$1.3 billion
• Payment with Surtab tablets, seeks to pay with rice, beans, bananas (future)

JAMAICA

• Development Bank of Jamaica/PetroCaribe Energy Fund preferential financing for SMEs
• Land Administration and Management Programme: subsidies for 1,000 land titles
• Housing units, infrastructure, Wigton expansion, human resource development
• Debt outstanding US$2.4 billion (Reported: Q1 2014)
• Payments with clinker (cement)

ST KITTS

• Fuel storage and distribution facility
• LED retrofitting of 200,000 light bulbs in residential areas and public institutions

ST VINCENT & THE GRENADINES

• Urban re-development
• Jaden Sun fast ferry repairs and dutyfree fuel concession
• Fuel for International Airport Development Company
• VINLEC fuel acquisition
• Agriculture revolving credit facility

ST LUCIA

• Construction of three bridges
• Annual fuel bill US$110 million, around 8 per cent of GDP
• Began receiving oil under pact in 2013

SURINAME

• Agricultural processing facility (drying, storage and processing)
• Infrastructure to increase production in the citrus areas
• Suriname imported 1.1 million barrels under PetroCaribe in 2013, and 0.85 million in 2012

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