Who in their right mind would loan someone money to a business if they knew the money was going to be spent on the equivalent of whiskey and handguns and not on growing their business or raise their ability to generate income? Notwithstanding our own politicians who promote moral hazard practices at every turn by guaranteeing lending for all sorts of things where there is no chance of repayment, the answer is "No One". In real life, you would only loan people like this money if they had something you couldn't really buy outright, but could sucker them into providing it as collateral.

So lets talk about Venezuela and its very special relationship with China.

Venezuela is a blessed country. Just ask China, who now has a stranglehold on at least 1/3rd of its crude oil deliverability from now until forever. Unlike western powers, China likes to transact its business State to State, bringing in its State-owned and private companies to directly benefit from its statecraft.

The chart above shows the "official" Venezuelan Crude Oil production numbers in barrels of oil per day, and its consumption in same. Its internal consumption is essentially given away via heavily subsidized fuel, and the rate of that take is steadily increasing, reaching a reported 752,000 barrels per day in 2015. Venezuela's crude oil production, touted by Venezuela in 2011 to reach 5 million barrels per day by 2015, is languishing officially around 2.7 million barrels today. Right. Unofficially, the flat line production reported is very unlikely to be true. It is very difficult to maintain exactly the same daily production number for 4+ years by completing a downward trend of wells? It's annual completions to rig rate has dropped from around 8:1 at the beginning of the decade to 3:1 or less today. Venezuela loses roughly 5% of its producing well inventory every year, and has gone from replacing those wells plus adding 1-2% (a 6-7% gross add annually) in new producing wells at the beginning of the decade to losing net wells (a 3-4% gross add annually) in the last 3 years, even though it has nearly doubled its rig count!

Why is that? Let's just ask Helmerich & Payne, who have told analysts it has "had trouble collecting on it's invoices in Venezuela combined with currency exchange issues", while also having its 11 rigs in the country "forcibly acquired" by the State. That seems a credible scenario for upping rig count, since stealing them certainly keeps them "in country" and not paying your bills brings your well costs down impressively. Efficiency suffers without good crews, though, and until Venezuela perfects the use of forced, free labor throughout its workforce, the road it is taking isn't ripe for efficiency improvements.

China has figured out some novel methods to avoid those pesky invoice collection issues and currency exchange issues by loaning Venezuela over $50 billion dollars to date, at a rate of LIBOR + 338 basis points, which, if dollar denominated, translates to between 3.38 to 4.24 annualized interest payment, depending if it is fixed to overnight LIBOR up to 12 month LIBOR. This debt is secured by 300,000 barrels at market price at day and point of delivery. At today's price, at Brent benchmark, which represents the most wildly optimistic VERY top end of what a heavy crude mix would likely sell for in the open market, Venezuela is retiring that principal at a rate ranging from $3 to $3.5 billion per year. More likely, it is closer to $2 billion per year at real market prices.

China has stepped in and announced an additional $5 billion dollar loan package in April and another $5 billion just yesterday. The first was for "infrastructure investment" (or "whiskey") and the latest to "help invest in crude oil deliverability" (or "handguns"). While Venezuela's ability to generate cash from its hydrocarbon resources has been crippled by the combination of lower crude prices, increasing internal use, and by a likely real production decline much more pronounced than the flat, nearly exact daily rates reported over the last 3 years, China looks very much the winner in this zero sum game. While President Nicolas Maduro has followed his predecessor's tactic of destroying capital as his principle weapon in a quixotic fight against western "imperialism", China is securing an ever-increasing share of Venezuela's crude through the structure of its loans. The loans aren't unrestricted cash, but focused on paying Chinese companies to provide consumer goods, energy infrastructure, and more to their workers paradise brethren. According to some estimates, over 50,000 Chinese citizens now live in Venezuela and, according to some, control the valves to a substantive amount of Venezuelan production. Somewhat ironically, the Chinese bosses have a reputation of being cruel and demanding task masters to the now "empowered" Venezuelan worker.

So, With a quick salute to the North, The Peoples Republic of China says "thanks for the object lesson, H&P. We will take it from here...".

The lower the price of oil goes, the more "free" oil China is able to get its hands on. Like a 4 year Ivy League graduate with a degree in "...ist" Studies, Venezuela will never be in a position to pay back its loans. Watch for China to increase it's take from the other 300,000 barrels per day it buys in open market, and for it to continue to buy forward with more loans to Maduro to prop up his government. The worst case for China would be regime change and the increased likelihood of consequential default. If I were Maduro, I would borrow from the Donald Trump/Aubrey McClendon book of finance. Borrow enough, you own the bank. President Maduro can save a bit of money by buying several round trip tickets to Beijing in advance every three months for more "State Visits" where he can walk out with whiskey and handgun money. China will quickly learn the cost of being a resource Imperialist!

Welcome to the club! We in the West left it empty for you.