By Felix Fallon
In 2001, Venezuela was the richest country in South America, as stated by the World Economic Forum. The country’s economic position in the region was closely tied to its oil reserves, which – to this day – are the largest known reserves in the world. Under the reign of former President Hugo Chavez, the Venezuelan oil industry provided the capital to fuel large-scale socialist reforms. Now, five years after Chavez’s death, the economy and energy sector have collapsed, and the country is in a state of penury.
Production from the state-run Petróleos de Venezuela, S.A. (PDVSA) has drastically fallen. As a member of the Organization of Petroleum Exporting Countries (OPEC), Venezuela’s downturn in production affected the outcome of the production cut deal carried by OPEC and other major oil-producing countries out of the cartel, as Venezuela was not able to meet its agreed output. Brent crude reached $80 a barrel in May, leading OPEC to increase production from July to account for Venezuela and other under-producing nations on pressure from the US and other countries to balance soaring oil prices.
Oil Economy and Downfall
Crude oil comprises roughly 95% of total Venezuelan exports. However, more than half of what is produced does not garner profit; it is sold at a loss to the domestic market or used to repay government loans to Russia, China, and others. These loans constitute a total of $80 billion in debt, on top of which, the country also owes about $60 billion in outstanding bonds issued by the government and the PDVSA, as stated by Reuters last June. However, US sanctions on Venezuela prevent the country from restructuring its debt, as it could be seen as illegal financing by Washington.
As the country’s debt has been mounting, Venezuelan oil production has been accelerating downward over the last five years; from 2.39 million barrels per day (b/d) produced in 2013 to its lowest point of 1.92 million b/d in 2017, a 19.7% decrease, according to an OPEC assessment of secondary sources – primary PDVSA figures show a drop of 25.8% from 2.79 million b/d to 2.07 million b/d over the same time-span.
The local oil industry collapse and high foreign debt obligations have led to a severe economic downturn over the last two years. Venezuela’s foreign exchange reserves have fallen from $16 billion in 2015 to $11 billion at the end of 2017. As more than 90% of the country’s hard currency is obtained through exports, the government in 2013 – in an attempt to offset low oil prices and combat an already growing inflation rate (45.4% in August 2013), – increased the printing of 100 bolivar notes by 79%. Since then, inflation has risen steeply, so steeply in fact, that predictions of inflation rates have consistently fallen short of reality.
In May 2017, while inflation was 700%, the International Monetary Fund (IMF) predicted it would reach 2000% by 2018. In January 2018, inflation was over 4000%. In April 2018, the IMF forecasted inflation of just under 13,000% for 2018 year-end. By May 30, inflation breached 25,000%, and as of June, inflation was over 43,000%.
In July, the IMF predicted that Venezuela’s inflation will accelerate to 1 million percent by the end of 2018 as the government continues to print money to cover the growing budget hole, Bloomberg reported.
The economic collapse has resulted in a humanitarian crisis. Large swathes of the Venezuelan population have limited access to food and medicine, imports of food and other necessities were cut by 30% in 2017 to meet $10 billion in debt payments.
The average Venezuelan lost 11 kilograms in 2017 due to food shortages, according to a March Gibson Dunn Report. On top of which, an over dependence on the country’s oil resources means that no other industry is strong enough to subsidize the PDVSA’s current lack of productivity.
Reasons for the Current Situation
Between 1999 and 2015, the Venezuelan government earned nearly $900 billion from petroleum exports, with about half earned between 2007 and 2012 as oil reached its peak of $133 a barrel in July 2008. Under Chavez’s presidency, the nationalization of the PDVSA allowed him to use oil profits to give food subsidies, and increase education enrolment and access to healthcare for the largely poor population. Chavez used the oil money to restructure the country under his socialist revolution. Under Chavez, Venezuela’s GNP doubled.
Yet, Chavez’s tenure as president was not without trouble. In December 2002, members of the PDVSA went on strike, as the Coordinadora Democratica (an umbrella group of Venezuelan political parties and organizations opposed to Chavez) called for a general civic strike in an attempt to force a presidential election, with the stoppage of the oil industry intended to have the greatest effect. The strike led oil production to fall from 3.1 million b/d to 100,000 b/d – the minimum production level needed to maintain pressure in the pumps. The decline in production during the strike meant that Venezuela – a country with crude reserves of roughly 300 billion barrels – had to import oil from Brazil to keep up with domestic needs. Venezuela lost approximately $20 million ($13.5 million direct and $6.5 million indirect) as a result of the lack of production during the strike. As a disciplinary measure after the strike, 18,000 out of 40,000 PDVSA workers were let go, including specialists and staff in managerial positions. ExxonMobil and ConocoPhillips withdrew from the country as a result.
Some of the PDVSA’s problems are due to ideology; as the company is a wing of the government, supporting the government is a requirement of employment. With the socialist regime remaining ideologically divisive, the PDVSA’s recruitment policy has continued to lose the company many more specialist and technically skilled workers.
The 2014 oil price crash was a major contributing factor to the current state of the PDVSA and Venezuela’s broader economic woes. Successor to Chavez, Nicolas Maduro, appointed in April 2013, was poorly equipped to handle the oil crash. Chavez’s government had not used the country’s vast oil profit to increase exchange reserves or sovereign wealth funds that would mitigate fluctuations in oil prices.
The Venezuelan economy contracted by an estimated 35% between 2012 and 2017, and the Maduro government has been funneling much of the government’s profit into repaying debts out of fear of legal challenges from creditors. As the value of Venezuelan exports fell by 67% from $82.7 billion to $27 billion in the period from 2013 to 2016, the government has very little money to re-channel into domestic growth or the PDVSA.
Yet, the problems caused by mismanagement and oil instability have been exacerbated by US sanctions on Venezuela. In 2017, the US government imposed economic sanctions on the Bolivarian Republic that prevent the country from obtaining long term credit in the US and restrict dividends from CITGO Petroleum Corporation (a PDVSA-owned, US-based, refinery). In addition, targeted sanctions have been imposed on 40 Venezuelan individuals, including President Maduro and Vice President Tareck Zaidan El Aissami Maddah, under the Foreign Narcotics Kingpin Designation Act, which deemed them responsible for human rights violations, money laundering and other crimes. Both amounting in an economic, financial, and trade blockade against Venezuela.
The individual and economic sanctions further reduce any possibility of an upturn in the Venezuelan situation as the government cannot call on US financial firms to aid in restructuring its debt and US entities will have great difficulty in dealing with the PDVSA as some of its leadership are sanctioned parties, meaning options for external oil investment are slim.
A White House statement in August 2017 affirmed that the US government would not “stand by as Venezuela crumbles.” After imposing further sanctions on the country in May 2018, US president Donald Trump stated that the executive order would prevent Venezuela’s government from conducting “fire sales” of its asset, adding that “[this] money belongs to the Venezuelan people,” presumably referring to the Venezuelan government’s current policy of focusing cash flow on foreign debt.
OPEC & Global Ramifications of Collapse
On June 23, OPEC and non-OPEC countries agreed to raise production by roughly 1 million b/d, although no specific figures were released. The decision came 18 months after the OPEC agreement that enforced supply cuts of 1.8 million b/d.
The recent rise in oil prices is largely because of Venezuela’s inability to produce enough oil, not the OPEC production caps, according to Nick Butler, Chair of the Kings Policy Institute at Kings College London. Butler added that the only reason for prices not rising higher than they already are is the unexpected surge in the US shale industry.
Potential to Recover
There are limited options for Venezuela, one of which is privatization of the oil industry. Speaking to Venezuelanalysis, Carlos Mendoza Pottella, economist and oil expert at Venezuela’s Central Bank (BCV), stated that the privatization of the PDVSA as a whole potentially breaches Article 303 of Venezuela’s constitution, but would be legally possible through privately owned subsidiaries of the PDVSA. Privatization would take pressure off the limited financial resources of the Venezuelan government and potentially give needed financial leeway for the country to recover from the current crisis.
“When you have a plan that requires $60 billion in investment and your income is $5 billion per year, what are you implying? That you are looking for someone to come and invest. That is the logic of privatization,” he added. “So the conditions for privatization are here. The Venezuelan state seems incapable of managing oil production now. On the other hand, I would not say that the tendency toward privatization is planned. I think it is involuntary. I think it is the result of a perfect storm.”
However, the possibility of private companies taking over operations such as exploration, servicing, exploitation, distribution is marred by two problems. Firstly, the staunch ideology of the Venezuelan regime. “We are in a political context in which, when a critical voice emerges, then that person is categorized as opposition, as the enemy” Pottella stated. “There is no capacity to reflect scientifically from above, and those with critical perspectives within do not want to get involved in the game, as it may have negative political consequences,” he added. Secondly, the US sanctions are designed to dissuade any external cooperation and investment in Venezuela.
Pottella provided another potential option to aid recovery: changing the oil production strategy. “For the last decade and a half, or even longer, the focus of oil exploration and exploitation has been the Orinoco Belt (located in the eastern part of Venezuela),” the crude from which makes up the majority of Venezuela’s provable reserves, but is made up of unconventional fields containing a heavy grade; expensive and difficult to pump and refine. “A cost-benefit analysis indicates that we must shift our investment away from the Orinoco Belt and back to the conventional wells. That alone would help to stabilize production.”
“The exceptionally high oil prices 10 years ago led us to neglect our limited but real and important production capacity. We forgot that our conventional fields produce 30, 24, and 20 API oil that goes directly to the refinery, and that we should focus on stimulating that kind of light oil exploitation. The fields in the Maracaibo Lake and elsewhere [conventional wells with lighter oil] are indeed declining. Perhaps they will last for only another 50 years, but five decades of profitable production is very good.”
Following the June 23 OPEC meeting, Venezuelan oil minister Manuel Quevedo stated that the PDVSA will raise production to 1.9 million b/d before the end of the year – a 400,000 b/d increase bringing Venezuela near to the OPEC quota that it failed to fulfill last year.
The China Development Bank raised hopes of an increased production by pledging a $250 million to Venezuela, according to Finance Minister Simon Zerpa, with an additional $5 billion loan from China to finance the Venezuelan oil industry being discussed.
Yet, neither promises to OPEC, nor further loans, address the systemic problems afflicting the PDVSA; production reliant on high oil prices, an exodus of qualified workers, a lack of resources, a lack of equipment maintenance, and general poor management. Not to mention the worthlessness of the Venezuelan Bolivar severely hindering both the internal economy and any purchases of foreign goods. But most of all, US sanctions remain in place, sanctions that proliferate Venezuela’s internal problems and quash most prospects of changing the failing Venezuelan system.