The crisis in Venezuela is intensifying.

Growth has collapsed, inflation is running at one million percent, more than three million people have fled amid shortages of basic food and medicine.

Dozens of people have been killed in protests on the streets of Caracas, according to the United Nations.

At one time it appeared that Nicolás Maduro, long criticized for his human rights record and mishandling of the economy, could be consolidating his hold on power. But that suddenly seems more fragile.

Opposition parties and most Western democracies have declared his May 2018 “re-election” invalid and questioned the legitimacy of his attempt at a new term.

The U.S. and more than 20 countries have now recognized opposition leader Juan Guaidó as interim president.

Ratcheting up the pressure, the U.S. announced on January 28 that it would impose sanctions on state-owned oil company PDVSA, effectively cutting off the $11 billion worth of crude flowing from the South American country to the U.S. every year.

Maduro, however, continues to cling to power, maintaining the support of the military.

Below, the J.P. Morgan Research team examines what’s next in the political drama and assesses the impact of the crisis on the economy, oil production and different asset classes.

Sanctions Could Be the “Game-Changer”

For a country not at war, the economic outlook for Venezuela could not be much worse. The government has not produced fiscal data in years but real GDP is estimated to be about half of its 2014 level; hyperinflation is ravaging people’s wages and savings; and it has defaulted on $63 billion of sovereign debt.

Renewed U.S. pressure and the rise of a credible alternative leader, however, could be the game-changer, bringing about political and economic reform.

Oil production has already greatly diminished. The continued impact of sanctions could choke cashflow from the regime and force pragmatic members of the government or armed forces to swap sides. The International Monetary Fund appears to be on standby with a recovery and stabilization plan if order returns.

The risk, however, is that strong U.S. action prompts those around Maduro to close ranks. The already dire economic outlook and migration crisis could worsen, and Maduro—should he weather the storm, supported by China, Turkey, Iran and Russia—could point to an “external aggressor” as his scapegoat.

Facing a 40% Loss in Oil Revenues

Venezuela’s oil reserves are the largest in the world. 40% of its overall crude exports are to the U.S. so sanctions on the state-owned oil company PDVSA will really hit cash flow to the economy.

To plug the gap, Venezuela needs new buyers for at least 500,000 barrels of crude per day. It’s likely to source them from Asia or Europe. However, with the increased transportation costs, they will demand significant discounts. International insurance companies could also refuse to take the risk associated with Venezuelan barrels, restricting exports still further. This is an additional supply-side risk likely to tighten oil markets more than is currently priced in.

While Venezuelan oil prices come down, production costs are set to rise. A lot of new oil from Venezuela is very heavy and needs to be upgraded (i.e. turned into lighter synthetic crude) or diluted before exporting it. But the U.S. has now imposed a ban on the shipment of diluents or thinning agents to the South American nation. And the country’s upgrading facilities have been in decline for decades owing to a lack of investment and ongoing maintenance.

To maintain production levels, Venezuela will need to find about 100,000 barrels of diluent per day. With cash flow issues exacerbated by the new sanctions, it could struggle to finance the diluents and keep its existing upgraders in operation.

Oil production is expected to fall by at least 200,000 b/d immediately. What happens to the remaining 300,000 b/d will depend on how heavily Venezuela is willing to discount.

J.P. Morgan maintains its bullish view on oil in the near term because of the supply-side tightness.

The Debt Crisis and Venezuela’s “Alter-Ego”

A question mark hangs over Venezuela’s ability to service its considerable debts—both to bondholders and to companies whose assets were unlawfully seized during the rule of former president Hugo Chavez.

Venezuela has outstanding debts of approximately $25.5 billion in PDVSA bonds and $36.1 billion in Republic bonds. In addition, it needs to settle claims from firms like mining company Crystallex, which last year convinced U.S. courts that PDVSA is Venezuela’s “alter-ego,” and as such can be pursued by the country’s creditors.

Many of those creditors have their eyes on the oil firm’s U.S. subsidiary Citgo. However, the introduction of sanctions blocking of all PDVSA’s assets means that such claims are, for the time being, likely to be placed on hold.

A key consideration for any new political administration will be to balance honoring the demands of creditors with the need for investment to revive oil production and ultimately reestablish access to the debt markets.

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The Government of Venezuela (including the Central Bank of Venezuela) is targeted by US sanctions which prohibit dealing in new debt or equity issued by it, or any entity owned or controlled by it, after the effective date of the sanctions program (together “Sanctioned Securities”). Additionally, Petroleos de Venezuela SA (“PdVSA”) has been designated as an OFAC Specially Designated National, and US persons are generally prohibited from any activity with PdVSA; various licenses, however, may impact the permissibility. Nothing in this report is intended to be read and construed as relating to, encouraging or otherwise approving or promoting investment or dealing in such Sanctioned Securities. Clients should be aware of their own obligations and those of JPMorgan Chase & Co, its affiliates and/or subsidiaries under applicable US sanctions when making investment decisions.