Venezuela: The Failed Petro-State, Or Not Just Yet?

Upon his rise to power in 1999 as the 62nd President of Venezuela, Hugo Chaves went on a spree of welfare reforms, admirable by intention whilst poor in implementation. Venezuela houses the world’s largest oil endowment at 300 billion barrels in reserves, higher than other well-positioned oil producers like Saudi Arabia, Canada, Iran and Iraq (Atlas, 2018). In order to finance his new ambitious Bolivarian revolution, Mr. Chaves sought to assert control over the country’s national oil company, Petróleos de Venezuela, S.A. (PDVSA). Founded in 1976, this institution has historically been seen as the country’s workhorse and cash cow simultaneously. Since the nationalization of the oil industry in Venezuela, PDVSA led a leap of modernization where thousands of well-qualified staff accessed world-class training and implemented cutting-edge technology for the standards of that period, all while enjoying heightened levels of income and a comfortable lifestyle in one of the most professional oil firms in the world. Indeed, PDVSA was the envy of the whole of South America. PDVSA’s reach extended abroad, especially north in the United States, where it owned a number of refining assets. An intelligent move, seen then, as heavy Venezuelan crude is mixed with lighter US condensates and greatly consumed as gasoline on American highways (Energy Information Administration, 2018).

PDVSA Fortunes Turn

In 2003, PDVSA went on a major strike. Seen as a perfect opportunity to extend his political reach over the company, Chavez, in retaliation, fired hundreds of experienced executives and technical mid-staff. Then, he commenced on a quick journey of renegotiating joint ventures with foreign major oil companies as well as operational contracts (Monaldi, 2018). This trend did not limit itself to the oil industry but, in stages, extended to manufacturing, retail, and other industries. Joint ventures were forcefully nationalized leading to an exit by major oil and gas players like ConocoPhillips and Exxon Mobil. With them, much-needed technology, expertise, and capital left the country’s oil fields. However, the impact was not immediately felt as post-2000s brought higher oil prices that cushioned Mr. Chavez’s mammoth welfare state. People in Caracas and other Venezuelan cities saw a decline in poverty, literacy, income inequality and an unprecedented increase in access to food, housing, healthcare, and education. Yet, these improvements were not just temporary in nature but came on account of the oil industry that fueled them. No important oil expansion projects were executed, and PDVSA became the, de facto, social and development ministry. Infested by loyalists with short-term vision, the government went into a debt extravaganza to finance all the ‘Bolivarian missions’, a name given to the different social programs then, where it placed the country’s oil assets as collateral for debt sourced from international banks and investors.

Economic Woes

By 2014, the oil price crashed as more US shale oil was pumped. With its high breakeven prices, many oil fields in Venezuela seized to become financially feasible to export. Unable to bring in necessary technology or invest in declining fields during the boom time, Venezuela, an oil-dependent nation, began a pathway to economic ruin. Average Venezuelan oil basket price plummeted from a high of $100 per barrel in 2010-2011 to $35 in 2016. Even at that point, Caracas was incapable of sorting its priorities; out of the 1.9 million barrels per day of oil and condensate (natural gas liquids) produced, 400 thousand barrels went into the heavily subsidized local products market, 500 thousand barrels were used to repay loans to creditors, another 50 thousand were supplied with a hefty discount to other Caribbean nations, mainly Cuba, leaving a mere 800 thousand barrels per day for export (Monaldi, 2018).

Today, Venezuelan crude has become problematic. Washington placed sanctions on Caracas in 2017, not directly targeting oil exports or imports. Yet, as the main market for Venezuela is the United States, due to the aforementioned synergies, market share has been shrinking significantly. Buyers started to look into alternatives as PDVSA could not secure lines of credit from established banking institutions. Even exporting to farther markets in Asia is becoming troublesome for the company’s margins adding transportation and discount constraints. On the macroeconomic level, it is a miracle that the country still functions on a basic level at least. As oil production flattered, Inflation, increasing since Mr. Chavez’s economic experimentations, has become hyper-inflation. From 17% in 2006, it hit the 1000% mark in 2016 (Economics, 2018a). By 2017, inflation became 2400% and the International Monetary Fund estimates it to hit the 13,000% mark by the end of this year (Biller, 2018).

Figure1: Historical GDP & Employment Indicators. (Source: World Bank Data)

The economy has been in recession for a long time, as a result, unemployment rate, currently at 7.3%, is expected to further grow in 2018 (Economics, 2018b). The country’s GDP on the other hand, contracted by 13.2% according to Banco Central De Venezuela, the country’s main monitory institution. Figure 1 shows constant GDP change percentage as well as unemployment rate as a percentage of the labor force. The IMF sees this figure reaching 15% this year. When these numbers are translated into realities on the ground, Venezuela is seen to be going through a frightening social crisis. Figure 2 showcases IMF forecasts for a number of selected indicators. With prices bloating by 2400%, basic necessities, mostly imported since ousting foreign industrial companies and nationalizing – or seizing in practical terms – their assets, are becoming almost impossible to provide. Shortages range from foodstuff, medicine to increasingly, gasoline and raw materials. Mr. Chavez’s heir, current President Nicolas Maduro, seems very ill-equipped to deal with the woes. His government has, against the advice of international organizations, banks, and creditors, maintained currency exchange controls and pricing caps as an attempt to restrain inflation. Yet, these measures have been evidently unsuccessful (Cawthorne & Rabouin, 2018).

IMF Forecasts for Venezuela
Figure 2: Forecasts for Selected Economic Indicators (Source: IMF 2017 World Economic Outlook Database), forecasts based on 2016 data.

Oil Sector Struggles

But how has the combination of brain-drain, mismanagement, and politicization left Venezuela’s crown-jewel industry? From the current 1.8 million barrels per day (mbpd), the first quarter of 2018 saw oil production further declining into 1.35 mbpd with an analysis, circulated by Barclays, seeing the year ending at 1.45 mbpd, 700 tbpd lower than 2017 (Cunningham, 2018). Although the country’s humanitarian crisis had worsened, repayments of major loans were not stopped for the last couple of years, mainly in fear of creditors attempting to forcefully grab foreign assets via arbitration. The government may have started to default on some of its loans already while expressing intention to restructure them, but thus far, PDVSA has not yet, officially, defaulted on its $1.7 billion debt, but this might be looming (Butler, 2018). Few months into 2018, the company has slowed repayments to some of its creditors. Unable to reach settlements so far with foreign creditors, especially those weary of Washington’s sanctions, the country’s credit rating bottomed to C on Moody’s credit rating scale (Mathis, 2018). Effectively prohibiting Venezuela from issuing new bonds and turning those already with bondholders worthless. Cash-strapped, Caracas is in waiting mode towards catastrophe as PDVSA cannot afford to finance operational expenditures towards maintaining fields and refineries. Mr. Maudoro installed a military general with no prior experience of the ins and outs of the oil and gas sector, as the new head of PDVSA. His team’s mission is quite straightforward; to come up with a miracle of restoring lost production and fighting corruption (Monaldi, 2018). The latter was, as many perceive, utilized as the underpinning for yet another politicalized purge of the last three CEOs of PDVSA and sixty other executives. Barclay’s report has been quoted to forecast a further decline of 15% in Venezuelan production in 2018, an equivalent of 250 tbpd in 2018. Figure 3 shows Venezuelan historical crude oil production as compiled by the EIA while Figure 4 shows declining rig count. To the rest of OPEC, this seems to be working out well for the production cuts implemented to restore stability in the market (Wingfield, Dodge, & Sam, 2018).

Venezuela Oil Production
Figure 3: Declining Venezuelan Oil Production. (Source: EIA)

 

Figure 4: Decreasing Venezuelan Rig Count. (Source: EIA)

Any hope?

What are the options available to Venezuela? Well, not many and definitely, not pretty either. On the macroeconomic level, Caracas needs to loosen its foreign exchange rate, lift pricing controls, remedy hyperinflation, and reach a quick, yet painful, debt restructuring settlement with bondholders. The latter group pose a long-term risk as Caracas’ debt and incurred interest swaps hands privately between investors for pennies on the dollar. Russia and China might look like Caracas’ allies, but both have been trying to lower their exposure to Venezuela. Even though they have been offering limited help, their intentions, especially Moscow’s state-owned giant Rosneft, have been to acquire more assets from the struggling Bolivarian state, both domestic and abroad. Focusing on the oil and gas sector, Venezuela needs to reform PDVSA, lighten its financial burdens, restore capable technocratic cadres, and rekindle foreign investor trust in this historic institution. Finally, the political regime needs to understand that Mr. Chavez’s policies, however popular and gracious, are unsustainable. The sweetening of Venezuelans’ welfare endowments has turned sour. With a protectionist administration at the White House, moving toward a pragmatic agenda is the best course, given Mr. Trump’s willingness to ignore democratic gains for narrow American economic benefit. Venezuela’s heavy crude may create an oil market shifting synergy when combined with booming light and sweet US shale oil. After all, this might be the missing part of the jigsaw of American oil dominance of international refining, at least technically not politically. Venezuela’s capacity to reapproach the US and attract investor appetite remains a big question.

References

Atlas, W. (2018). The World’s Largest Oil Reserves By Country – WorldAtlas.com. Retrieved April 3, 2018, from https://www.worldatlas.com/articles/the-world-s-largest-oil-reserves-by-country.html

Biller, D. (2018). IMF Projects Venezuela Inflation Will Soar to 13,000 Percent in 2018 – Bloomberg. Retrieved April 3, 2018, from https://www.bloomberg.com/news/articles/2018-01-25/imf-sees-venezuela-inflation-soaring-to-13-000-percent-in-2018

Butler, N. (2018). It is Venezuela’s crisis that is driving the oil price higher. Retrieved April 3, 2018, from https://www.ft.com/content/5815d0b8-2c7f-11e8-9b4b-bc4b9f08f381

Cawthorne, A., & Rabouin, D. (2018). Venezuela says debt refinancing under way, S&P calls selective default. Retrieved April 3, 2018, from https://www.reuters.com/article/us-venezuela-debt/venezuela-says-debt-refinancing-under-way-sp-calls-selective-default-idUSKBN1DE1QS

Cunningham, N. (2018). How Far Can Venezuela’s Oil Production Fall | OilPrice.com. Retrieved April 3, 2018, from https://oilprice.com/Energy/Crude-Oil/How-Far-Can-Venezuelas-Oil-Production-Fall.html

Economics, T. (2018a). Venezuela GDP Annual Growth Rate | 1998-2018 | Data | Chart | Calendar. Retrieved April 3, 2018, from https://tradingeconomics.com/venezuela/gdp-growth-annual

Economics, T. (2018b). Venezuela Unemployment Rate | 1999-2018 | Data | Chart | Calendar. Retrieved April 3, 2018, from https://tradingeconomics.com/venezuela/unemployment-rate

Energy Information Administration. (2018). Venezuela’s crude oil production is declining amid economic instability. Retrieved April 3, 2018, from https://www.eia.gov/petroleum/weekly/archive/2018/180328/includes/analysis_print.php

Mathis, W. (2018). Venezuela Credit Rating Bottoms Out With $1.7 Billion Overdue – Bloomberg. Retrieved April 3, 2018, from https://www.bloomberg.com/news/articles/2018-03-09/venezuela-credit-rating-bottoms-out-with-1-7-billion-overdue

Monaldi, F. (2018). The Death Spiral Of Venezuela’s Oil Sector And What Can Be Done About It. Retrieved April 3, 2018, from https://www.forbes.com/sites/thebakersinstitute/2018/01/24/the-death-spiral-of-venezuelas-oil-sector-what-if-anything-can-be-done-about-it/#61e78c5c7e60

Wingfield, B., Dodge, S., & Sam, C. (2018). OPEC Oil Cuts Deepen. Kazakhstan’s Ramping Up. Retrieved April 3, 2018, from https://www.bloomberg.com/graphics/2017-opec-production-targets/

Interested in energy, economics, and current affairs. I endeavor to learn and share my views with the world. I hold an MSc in Petroleum Economics & Management from IFP School, Paris.

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