Geopolitics have been at the forefront of investors’ attention in the new year. The most consequential development has most likely been the sea change underway in Venezuela’s oil sector, with potentially far-reaching and unforeseen ramifications for the U.S. oil industry and, within that, for the value of the WTI/Brent arbitrage. As the United States has effectively become the sole protector and manager of the Latin American OPEC member’s oil production and exports, the prevailing belief is that refiners along the U.S. Gulf Coast will receive a steadily increasing volume of heavy-grade crude oil from Venezuela, the very type these refiners were built to process decades ago.

The potential impact is massive and would deal a significant blow to Canadian oil exporters. Venezuela, which prides itself on having the world’s largest oil reserves – accounting for 17% of the global total, or roughly 303 billion barrels – has been unable to fulfil this potential over the past 20 – 25 years due to severe mismanagement and corruption. As a result, Canadian oil exporters, as illustrated in the chart above, were able to fill the gap and supply U.S. refiners with the highly sought-after heavy and sour grades.

With ongoing changes south of the U.S. border, Canadian exporters may now be forced to compete for the coveted U.S. market. As a knock-on effect, this intensifying rivalry would free up lighter domestic U.S. grades to find homes overseas. Right on cue, the market was quick to price in such a possibility in the first half of January, as the WTI/Brent arbitrage weakened spectacularly by more than $1/bbl within the space of a week.

That said, the relative weakness in WTI is unlikely to be set in stone, as the revival of Venezuela’s oil sector will be a Herculean task. First, the breakeven cost of Venezuelan oil projects is close to $80/bbl. U.S. oil companies invited to participate in exploration and production may find that capital can be deployed more efficiently elsewhere. Second, the lack of a robust legal framework, elevated arbitration risk and a shortage of skilled labour represent further obstacles to meaningfully increasing production and, by extension, exports to the U.S. Third, while the leadership may have changed in Venezuela, the regime has not; consequently, internal sabotage of planned oil projects cannot be ruled out.

Admittedly, there is much to ponder, and numerous questions remain unanswered. Yet, it will be imperative to closely monitor the weekly EIA statistics on Venezuelan oil exports to the U.S. There is a good chance that current optimism surrounding rising volumes arriving at the U.S. Gulf Coast will prove misplaced. And should Venezuelan oil exports to the U.S. disappoint, WTI may soon emerge as a screaming buy relative to Brent.