Oil: The real influencer in the Venezuela intervention

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The capture and arrest of Venezuelan President Nicolás Maduro on January 3 will have broad geopolitical and global market implications, potentially for years to come. While the situation remains fluid and there are many unknowns, risk markets are viewing the events as positive, with Venezuelan bonds and equities both up as of this writing, as are equities in many Latin American and developed markets. Developed market bond yields are down on the expectation of lower inflation, giving the US Federal Reserve (Fed) room to ease rates further this year and maintain supportive conditions for risk taking. Oil prices are up due to near-term supply risks but also possibly because positioning was already short. Gold prices are up as well.

Informed by the many discussions I have had with investors across the firm, I think the short-term positive reaction is supported by the overarching expectation that Venezuela will eventually be able to produce much more oil than its current one million barrels per day. The country’s oil reserves amount to around 300 billion barrels or 20% of global reserves, so there is plenty of upside. After more than a decade of neglect and mismanagement by the Venezuelan leadership, US President Donald Trump is focused on revitalizing this industry, increasing production, and transitioning the Maduro government to one with US-aligned interests.

Against this backdrop, I’m tracking four potential sources of uncertainty:

Time and money — Restoring production will take time, money, and a regulatory framework. Estimates suggest it will take US$80 billion – US$100 billion to restore facilities. I will be watching for signs of investment.
Political instability — Free elections are not being contemplated at this point, despite María Corina Machado and her opposition party having popular support. I am watching for strikes, violence, and other forms of unrest.
Degree of compliance — Hardline Maduro supporters are still leading the military and intelligence. Will interim President Delcy Rodriguez be able to comply with US demands if the minister of defense and intelligence chief are committed to regime survival? I am watching for changes inside the regime.
Broader conflict — At this early stage, it is unclear under what conditions the US administration might stage another military action. There are also broader geopolitical questions: If spheres of influence are becoming more hardened, will the US back away from Ukraine or Taiwan? Could we see an escalation of US-Iran tensions, given Iran’s close ties to Venezuela and US concerns about its nuclear, missile, and drone programs? (This could be another reason oil prices moved higher in response to the US raid.) On the other hand, since China and Canada will be hurt by moves to redirect Venezuela’s oil to the US, President Trump may have a stronger hand in trade negotiations.

Investment implications

Notwithstanding these risks, in the short term, I see several positive investment implications:

For risk — Expectations of more oil supply and lower prices will likely put a cap on overall inflation (though it may not have a material effect on service prices). Lower inflation will support further Fed easing, which is a powerful risk-on signal and will contribute to liquidity in the financial system.
For US oil refiners — With lower prices for heavy crude, refiners can buy it at a discount and sell refined products priced off global benchmarks, boosting margins. In contrast, I see a negative impact for US oil producers given the prospect of lower oil prices.
For emerging markets — I see opportunities in select debt and equity markets. Latin America, in particular, could benefit from closer political and trade ties to the US.
For precious metals — Increased geopolitical volatility and fragmentation of the global order will likely support precious metal prices. Miners could also get a lift as energy is their largest cost.
For long-dated government bonds — Along with relatively steep yield curves around the developed world, lower inflation expectations and potential Fed easing would benefit bonds.