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Nobody’s Covering the Other Oil Story in the Gulf

by | published May 19th, 2010

Over the weekend, I had the first of two meetings here in the Bahamas. And it occurred to me, as I sat with the three fellows sipping rum on my veranda, that I was witnessing a microcosm of the market fast approaching…

While much of the attention in my current part of the world remains fixed on BP (NYSE:BP), Transocean Ltd. (NYSE:RIG), Halliburton Co. (NYSE:HAL), and on the attempt to plug a gusher in the Gulf, I have been watching another development down here in the Caribbean this week.

It is going to impact crude oil and oil product movements throughout the hemisphere and, thereby, it will impact how one plays the relationship between crude oil and oil products from the U.S. Gulf Coast to South America. Even though, as you shall see in a moment, we arrive there by a rather unusual route.

My place in the Bahamas is outside Port Lucaya, a quaint postcard marina on the water near Freeport, roughly 100 miles east of Florida. Thanks to Bell Channel, which cuts directly to the sea, hundreds of big, private boats anchor here. It’s one of the reasons I bought a piece of this yacht club some 15 years ago.

These days, the cost of fuel is eating away at our mooring revenues, with fewer vessels spending time here than in the past. The tourist traffic is also uneven. As one of the owners, I must periodically review the books. But my investment was more about having a hideaway than a revenue flow.

This first meeting in my bungalow involved the regional fuel market. Now, that certainly affects our situation at the yacht club. But it has a far greater impact on Freeport, the largest deepwater port in the eastern Caribbean. The port is a primary location for major cargo moving between North and South America.

And it’s about to change the way oil companies (and investors) turn a profit…

A Microcosm of the New Oil Market

On my sunny veranda sat representatives from Freeport Oil, the largest retailer in the islands; Refidomsa, the dominant Dominican Republic refinery and a main supplier of oil products throughout the east end of the Gulf; and PDVSA, the Venezuelan state oil company.

I have close connections with all three. I served as a consultant to Freeport Oil when they first expanded operations and currently advise a refinery project in Ecuador designed to process PDVSA’s heavy oil (this marks the fifth meeting with the Venezuelans in less than a year). And the Refidomsa crude oil flow manager did his graduate degree with me.

Here’s the kicker.

Since 2005, PDVSA has been acquiring a greater control over the entire Caribbean fuel market. It does this through an oil alliance called Petrocaribe. Designed as a cooperative venture to provide discounted oil throughout the region, it was the brainchild of Venezuelan President Hugo Chavez and his Cuban chum Fidel Castro.

Not exactly our two favorite people…

The approach has been a success among the island nations, where access to fuel remains a primary concern. Nonetheless, the market is a bit nervous these days; prices are going up quicker here than in the States. On Friday, filling the car to drive to the other end of the island cost me $4.80 a gallon.

Cuba has little oil, which means PDVSA was certain to run Petrocaribe. The company’s refineries on Curacao provide some of the fuel for the basin, but PDVSA crude has far greater power.

That crude already dominates the processing sector in the Caribbean, providing raw material for main refineries on Trinidad and Tobago, Jamaica, and the Dominican Republic, as well as its own on Curacao. Smaller plants on another half dozen islands extend that influence. The stability of the region’s economies is now dependent on which way PDVSA moves.

And that brings us back to the meeting at my place. PDVSA requires that regional refineries be able to process heavier oil. More of them are now able to do so, and new projects, such as the one I advise in Ecuador, are emerging to increase the outlets.

That’s why I believe these three gentlemen enjoying my rum signify the start of something big for oil companies… and their shareholders.

Going Vertical – Where the Money Is

Freeport Oil is a prime example of a major end user whose entire network requires the distributor be able to locate sufficient supply at affordable prices. Its sources are refineries, primarily Refidomsa. The refinery stays in business by maintaining a sufficient margin on the crude oil processed. Its source is PDVSA.

For its part, PDVSA needs to sell its crude for the highest price but is hampered by the political objectives of Chavez – who is using Petrocaribe as much to send a political message to Washington as anything else.

When in doubt, “verticalize.” That is, move down the oil curve from crude oil extraction to processing facilities and retail sales – from upstream to downstream. That is what PDVSA is doing – it is acquiring positions in other refineries. It already owns a major retailer in privately held CITGO, one of the top five providers in the U.S. and a major network in the region. Controlling a greater percentage of regional refining is the essential linchpin in PDVSA’s overall Petrocaribe strategy.

Those refinery acquisitions have everybody concerned down here. Just ask Freeport Oil. They have relied on Refidomsa for years. About a week ago, PDVSA acquired 49% of the Dominican refinery. In return, PDVSA has guaranteed crude deliveries. A similar move is underway in Jamaica.

The main target remains the largest facilities on Trinidad and Tobago. These currently have access to contracts from BP and others. They are also rapidly becoming the last line of policy options for the U.S. government in its attempt to deflect the influence of Petrocaribe.

Now here’s how to make some money from all this.

Invest in the Companies Saving PDVSA’s Crude Flows

You cannot gain direct access to CITGO, because it does not trade. The move emerges in two other places.

First, the U.S. has been increasing its imports of oil products quicker than crude oil. More of the gasoline in the American market is actually refined abroad, and the Gulf of Mexico remains the primary import location. Put simply, as PDVSA increases its holdings in Caribbean refining, it increases its direct control over exports to the U.S.

Second, as I noted in February (“Hugo Chavez Now Has No Choice But to Make You Money“), Chavez’s destructive economic policies have required Venezuela to open up new heavy oil development in the vast Orinoco belt to Western majors. At stake is almost 600 billion barrels.

That means we have access to the companies who will be saving PDVSA’s ability to maintain crude flows to refineries. Thus far, Chavez has allowed back in Chevron Corp. (NYSE:CVX), the Spanish-Argentinean major Repsol (NYSE:REP), French Total (NYSE:TOT), Italian ENI (NYSE:E), along with the new National Oil Consortium set up by Russian majors LUKOIL Co. (OTC:LUKOF), Rosneft (LSE:ROSN.UK), the Russian/British TNK-BP (OTC:TNKBF), Gazprom (OTC:GZPFY), and Surgutneftegaz (OTC:SGTZY).

Venezuela is also moving closer to Chinese companies. PDVSA has agreements with CNOOC Ltd. (NYSE:CEO), national oil company CNPC (accessed via CNPC Hong Kong Ltd., OTC:CNPXF), and Sinopec (through Sinopec Shanghai Petrochemical Co. Ltd., NYSE:SHI).

This last company just happens to be building the refinery that I advise in Ecuador, which brings me to my next rounds of meetings here in the Bahamas. I will be sitting down with Sinopec reps later this week.

You’ll want to stay tuned… My next column is certain to shed new light on what the Chinese are doing in our hemisphere.

Kent

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