Theme: The recent oil price boom has generated unprecedented revenue for the Venezuelan government. However, it is far from clear that Hugo Chávez’s oil policy will ultimately benefit the broad masses of Venezuelans, to say nothing of the billons of energy consumers around the world.

Summary: President Hugo Chávez has taken advantage of the surge in ‘petrodollars’ to finance his aggressive social spending and to subsidise many of his geopolitical ambitions in the international arena. But his growing interventionism in the Venezuelan energy sector now endangers the continued flow of sufficient investment necessary simply to maintain current levels of oil production, while his attempts to divert oil exports, traditionally aimed at the US, to growing Asian markets will generate no tangible geopolitical impacts beyond a superficial and merely symbolic media effect. Nor is it clear that Chávez’s social expenditure will be capable, in the end, of laying the basis for sustainable economic development.

The first section of this analysis focuses on the evolution of the Venezuelan oil sector before Chávez’s arrival to power and his onslaught on the management of the state oil company, Petróleos de Venezuela (PdVSA).

Analysis 

‘I believe that (Hugo) Chávez is good for Venezuela. He is the President who has shown the most concern for the poor in the last 30 years’.

Luiz Inácio ‘Lula’ da Silva, President of Brazil

El País, 3/XI/2006

‘I believe that the President of Venezuela is really destroying his own country, economically, politically…’

Condoleezza Rice, US Secretary of State

Washington Times, 8/II/2007

Chávez and his Oil
Although the most common reaction to Hugo Chávez is to demonise the Venezuelan President, many (and not only on the left) might be inclined to think like Lula – that despite everything, Chávez’s impact has been better for the country than that of any other national leader to have governed this long abused country in at least a generation, if not longer.

One thing is clear: before Chávez, no Venezuelan leader had proved capable of improving the average standard of living since the first major oil boom. Although it is true that real per capita GDP is no higher today than in 1998 (when Chávez became President), it is also true that real per capita income had languished well below the maximums reached in the 1970s all through the subsequent two decades. Nevertheless, after suffering a noticeable decline as a direct result of the oil strike of 2002-03, real GDP per capita has returned to its previous levels. Furthermore, since the initial election of Chávez in 1998, the income levels of the poorest has increased by 43% while the country’s intermediate income-earning segment has experienced an average increase of nearly 20%.

This phenomenon has been due not only to the favourable --at least for Chávez-- evolution of oil prices, but also to Chávez’s policy – in start contrast to his predecesors – de dedicate a large part of the oil revenues to finance social programmes via the so-called ‘missions’. However, what remains unknown is, first, whether this oil revenue will be sustained in the future and, secondly, and even more importantly, whether petrodollars will ultimately have –given Chávez’s peculiar way of spending, governing and conducting foreign policy– a positive and lasting impact on the millions of Venezuelans currently mired in poverty.

During the first Chávez mandate (1998-2006) oil prices rose from a low of some US$10 per barrel to their historical high of more than US$78. Since Venezuelan oil is a relatively heavy variety (and high in sulphur content), it is generally sold at a discount of several dollars a barrel to the major reference crudes (WTI and Brent). In 1998, when WTI and Brent were trading at between US$10 and US$12 a barrel, the price of Venezuelan crude was only US$7.20. Nevertheless, Venezuelan oil has followed the main reference crudes along their recent upward slopes. In 2005, when Chávez consolidated his power over the major public institutions of the country, the price of Venezuelan crude exceeded US$50 and in 2006 reached nearly US$70 for some months.

This steep upward movement in the price of oil explains to a large extent, if not completely, Chávez’s political successes and his capacity to remain in power with the electoral support of a comfortable majority. It is also responsible for the recent surge –permanent or not– of the income and consumption levels of the poorest Venezuelans and for the high rates of GDP growth since 2003. After the steep recession in 2002-03, brought on by the collapse of oil production provoked by the strike, the Venezuelan economy registered growth of 18% in 2004 and over 9% in 2005 (with nearly 8% estimated for 2006), stimulated by the boom in oil prices and sustained by the related jump in public spending (now nearly 30% of GDP, compared with an average of roughly 20% during the oil sector opening of the 1990s). Still, there are a number of lingering doubts –and not only among die-hard critics and ideological enemies– about the efficiency and efficacy of the social expenditure Chávez continues to undertake, particularly its capacity to generate sustainable development actually capable of progressively eliminating poverty. There is also widespread scepticism, even among socialists and social democrats, with respect to his renewed energy nationalism, particularly in the wake of its most recent outbreaks since Chávez’s re-election in December 2006.

Although Chávez’s policies are usually accompanied by a rhetoric –and even an authenticity– quite alien to that of the other national leaders to have preceded him, there exists the real possibility –something that his sympathisers should take seriously– that they ultimately end up merely perpetuating the deep-rooted Venezuelan tradition of corruption, waste and degradation, with the only real distinction of having channelled more petrodollars into the hands of the least privileged classes, but without the slightest guarantee of generating a positive and lasting legacy. Too many of Chávez’s critics, both hostile and sympathetic, merely repeat a simple analysis that has now become a cliché: that Chavez can only survive politically if oil prices continue to rise, or at least remain high. Yet a more significant and sustainable reduction in poverty –a political requirement for Chávez, at least in the long-term– will depend not only on oil prices but also on –as a minimum-- the maintenance of at least current levels of production, levels now under threat by the lack of investment during recent years and the chaos currently undermining the potential of the Venezuelan oil sector.

On the other hand, critics also highlight the uneasy implications for US energy security –due to its dependence on Venezuelan oil– or the geopolitical risks to the West of Chávez’s aggressive foreign policy, in particular his plans to divert oil exports tos China in order to punish the US and establish stronger strategic links between Asia and Latin America. But the true strategic risk that Chávez represents for the world has less to do with the more media-driven and superficial aspects of his foreign policy and much more with the technical and business implications for the Venezuelan oil sector stemming from its increasingly aggressive energy nationalism. The danger is not that Chávez ever actually try to cut off the flow of oil to the US; the real problem for the world (a world that will require an increase of nearly 50% in global oil production between now and 2030) is that  Chávez’s continuing state interventionism –which diverts ever more revenue, both private and public, from the energy sector to his own political purposes– will end up undermining the investment in oil and endangering future production levels.

Finally, however, there is at least one aspect of Chávez’s rhetoric that is exactly the same as that of nearly all of Venezuelan presidents going back nearly a century. Chávez too speaks of ‘sowing the oil’ (or more precisely, of ‘sowing the oil revenues’), although the debate over what is really being sown is still open for discussion. With his international ambitions and his committed geopolitical battles, Chávez risks neglecting many national economic demands (for improvements in decaying physical infrastructure and the health system, for example), not to mention the jump in increasingly violent crime and corruption, and the nagging sense that the macroeconomy is progressively slipping out of control (inflation is still moving towards levels of 20% annually and the bolivar continues to show signs of weakness despite enormous oil revenues). This impression of chaos threatens the future vitality of the oil industry, currently the political system’s only support and the only hope for stemming a rise in already widespread poverty.

The ‘Boom’ and ‘Bust’ Cycle: Yet Again?
Chávez presents Venezuela as one of the most powerful ‘petro-states’ on the planet. With nearly 80 billion barrels of conventional oil (albeit a relatively heavy variety with an API between 15º and 30º), it has nearly 7% of the world’s conventional reserves (the world’s sixth-largest) and a ratio of reserves to annual production (the ‘r/p ratio’) of 72.6 years (the world’s third highest). Furthermore, together with Canada, Venezuela has one of the largest stocks of so-called ‘unconventional oil’. Beneath the soils of the Orinoco Belt lie another 270 billion barrels of super-heavy crude (with an API between 8º and 10º). Under the appropriate circumstances (that is to say, sufficiently high prices –at least above US$ 40 a barrel– and a significant quantity of investment), this super-heavy crude could be commercially exploited, transforming Venezuela into the world’s major oil power. Chávez’s government is currently attempting to classify a large part of this super-heavy crude as official ‘proven’ reserves. It has announced that, by November 2007, Venezuela’s proven reserves will have doubled to 171 billion barrels (the second-largest in the world after Saudi Arabia, or the third largest if unconventional Canadian oil is counted), and that by October 2008 they will have tripled to 360 billion barrels, turning its proven reserves into the world’s largest (Canada has done something similar, announcing an increase in its official reserves from less than 5 billion barrels to 180 billion, as a result of  the incorporation in to official reserve accounting of the ‘oil sands’ of Alberta).

Although Venezuela might have very large reserves, this does not necessarily translate into high production levels. Currently, the country is producing between 2.5 million and 3 million barrels a day (mbd). The Venezuelan government continues to claim that production levels have recovered since the 2002-03 strike to more than 3 mbd. Other independent sources (such as the CGES in London and the International Energy Agency in Paris) estimate instead a current production level of not more than 2.5 mbd, some 700,000 daily barrels below Venezuela’s official quota (3.23 mbd) within the OPEC cartel.

Venezuelan Production and Exports
The fact that Venezuela might be producing significantly below its OPEC output quota during a lengthy period of high prices is somewhat worrying, as it suggests that for one reason or another, the Venezuelan oil industry, led by state-owed PdVSA, is unable to increase its production. Many observers claim that production is actually on the decline for technical reasons --or at best at a standstill-- with only minimal increases (between 200,000 and 300,000 bd) feasible over the next few years, and even then only under optimal technological and investment conditions. For the time being, this difficulty has not yet clearly manifested itself, as revenues from oil exports have been increasing --despite these restrictions on Venezuelan crude supply-- given the phenomenal rise in oil prices. Although oil revenues fell from US$23.5 billion in 2000 to less than US$19 billion during the strike years (2002 and 2003), they rebounded strongly to US$26.2 billion in 2004 and US$38.4 billion in 2005, with more than US$45 billion estimated for 2006 and at least US$40 billion in 2007. If the price of WTI and Brent were ever to reach a sustained annual average US$75/barrel, Venezuela’s oil revenues could rise to more than US$50 billion.

Although it is difficult to identify the level of exports with precision (given the lack of transparency in official data), it is estimated that between 2 and 2.5 mbd are being exported (a total production of between 2.5 and 3 mbd, with internal consumption of 0.5 mbd), making Venezuela the world’s eighth-largest exporter of oil and the largest in the western hemisphere. These exports came to represent more than 60% of total exports between 1993 and 2003 but today they are equivalent to nearly 85% of total Venezuelan exports, nearly one-third of Venezuelan GDP and more than half of all state revenue –a quite high level of oil dependence, indeed, for any national economy. Chávez’s government is well financed at the moment, but if prices continue to fall off (from US$72 a barrel of Venezuelan crude in the summer of 2006 to more or less US$50 at the start of 2007), or if national production starts to decline due to lack of technical maintenance or sufficient investment –or both– the pressure on the oil sector, the economy and the government will be increasingly difficult to bear.

The Past: The First Two Cycles
How has Venezuela arrived at these crossroads, enjoying a level of oil revenues without historical precedent yet facing a looming threat of an erosion of these same revenues in the middle and long run? First, we should recall that Venezuela has not always been in this unusual if still precarious situation. During the 1960s, although oil prices were relatively low (less than US$2 a barrel in market terms, and less than US$12 in real terms measured in current dollars), the Venezuelan oil industry was booming. The country was one of the founders of OPEC, and during the second half of the 1960s became the world’s largest oil exporter. From 1965 to 1974, Venezuela produced an annual average of 3.5 mbd, and in 1970 production levels reached nearly 4 mbd. Although Venezuela had already partially nationalised the energy industry, the oil sector still enjoyed the presence of major international companies (the so-called oil majors) which operated under relatively attractive conditions. The result was an increasing level of investment and growing production levels.

But with the politicisation of the oil market and the intrusion of the state into the energy sector in most producer countries (PdVSA was nationalised in 1976) after the first oil price shock of 1973-74, coupled with the need to cut production in order to preserve price levels in the face of a slump in global demand and an increase in supply from non-OPEC countries, Venezuelan oil production went into decline for some ten years, reaching a low during the 1980s at a level (1.8 mbd) less than half its 1970 peak. In 1986, the unity of OPEC crumbled and oil prices experienced their first significant fall (from nearly US$30 to less than US$15) while Venezuelan real GDP per capita reached one of its lowest levels in a generation (only exceeded by the crisis of 2002-03, the years of the great oil strike). State oil revenues in the wake of the 1986 oil price crash would not have stood at more than US$3 billion, less than 10% of the current revenues (in nominal terms and less than 30% in real terms).

With the collapse of OPEC’s strategy of maintaining prices through restrictions on supply, Venezuela began to increase its oil production, taking advantage of the global recovery in demand to maximise its oil revenue. Production gradually rose but halfway through the 1990s Venezuela still produced less than 3 mbd. In harmony with the privatising spirit of the 1990s in Latin America, the Venezuelan energy sector experienced a rebirth, undertaking a limited liberalisation of the sector as part of a strategy to increase its production capacity over the coming 10 years. The so-called ‘oil opening’ (or apertura) implied a partial opening of the Venezuelan hydrocarbons industry to private investment, both domestic and foreign, with the aim of attracting the necessary investment to increase national oil production in 2005 to 5 mbd and eventually to 6 mbd in the following years.

The apertura had three central policies aimed at improving production capacity and offsetting PdVSA’s growing financial and technological weaknesses. The first was to reactivate efforts to increase the level of oil recovery at marginal wells from 20% to 40% of the total original oil in place, applying advanced techniques and better management. The second was to begin to develop the super heavy oil of the Orinoco Belt, legalising the formation of strategic associations between PdVSA and foreign companies to engage in its exploitation. The final component of the ‘Venezuelan opening’ was to allow for an increase in private sector exploration, beginning in 1996 with the tendering of operating licences to 75 companies from 17 different countries. Thirty-two service agreements (‘operational service agreements’ or OSAs) were also signed, by which 22 foreign companies produced oil for Venezuela, selling it to PDVSA at market prices. With these changes in Venezuela’s energy policy, PdVSA narrowly managed to escape the destiny of PEMEX, becoming a model of efficiency and competence (on par with Statoil of Norway and now Petrobras of Brazil) for other state oil companies around the world. By 1998 Venezuela was on the road to achieving its original apertura objectives: production had reached 3.5 mbd and seemed to be on the verge of surging past the historical maximums of 1970.

Chávez’s Resurgent Energy Nationalism
This impeccable reputation faded rapidly after Chávez’s election victory in 1998 and accompanying radicalization of PdVSA’s philosophy and behaviour. The state oil company was ‘renationalised’ (although it had never been privatized), with political criteria introduced into its management, including the appointment of political commissars within the company. Since Chávez’s arrival to power PdVSA has had six different CEOs, and in 2004 he appointed Rafael Rodríguez, the Minister of Energy, to also serve as its chairman. There have also been legislative changes that have damaged the oil sector’s investment climate and production volumes. The first was the introduction of the Hydrocarbons Law of 2001 that superseded both the previous Hydrocarbons Law of 1943 and the Nationalization Law of 1976. This new legislation made it compulsory for all future activities in the oil sector (except for the super heavy oil projects of the Orinoco Belt) to be carried out by mixed companies (or joint ventures) in which the state would hold stakes of more than 50% and all private investors remained minority partners. The new law also eliminated the OSAs, mentioned above, for any new activity. State royalties on oil production practically doubled, rising from the previous maximum of 16.6% up to 30%. Later, in 2006, a further change to the Hydrocarbons Law increased taxes and royalties even more and made it obligatory for PDVSA to have majority stakes in all sector activities, including projects for the development of super heavy oils (see the Part II of this analysis).

Due to Chávez’s politicisation of oil, for the first time in decades there were sufficient government funds available to try to mitigate the country’s social problems. However, the negative alterations in the corporate aspect of both PdVSA’s management and in the Venezuelan investment environment had a depressing effect on production capacity in the medium-term. Oil production fell by nearly 400,000 bd in just one year, from nearly 3.5 mbd in 1998 to little more than 3.1 mbd in 1999. Although a large part of this fall was due to a new attempt by OPEC to raise prices through production cuts, the number of exploratory drillings fell dramatically after 1998, suggesting that perhaps more was at play. While between 1996 and 1998 there were 109 rigs actively drilling, their numbers fell to 50 in 1999 and, after a slight and short-lived recovery to 70 in 2001, there were only 35 operating on the eve of the great strike in December 2002. Investment, both private and public, also dropped off, and the targets set for PdVSA and the Venezuelan oil sector were never met. This suggested, on the one hand, that private international companies (the so-called IOCs) were no longer so amenable to investing in exploration and production in an ever more nationalised sector with growing (and increasingly arbitrary) state intervention, and, on the other hand, that PdVSA itself, although more powerful in the local context (at least on paper) was ever more dysfunctional and incapable of maintaining its production levels in the medium-term.

The Great Oil Strike
If the situation surrounding Venezuela’s production capacity were not already sufficiently serious, Chávez’s attempt to impose his control threatened a mortal blow to the sector. The dismissal of seven top executives and the forced early retirement of another 12 provoked a brief initial strike in April 2002. Chávez responded by labelling such behavior as ‘sabotage’, bordering on ‘terrorism’. The violence caused by the strike, with 17 demonstrators killed and more than 100 injured, was one of the motivating factors behind the brief –and ultimately unsuccessful-- coup d’etat attempt later that same month. Once returned to power, Chávez’s political appointments to replace the displaced executives prompted strong, if only partial, resistance within the ranks of the company that eventually led to a second –and even more serious– strike in December 2002 and January 2003.

This second strike brought oil production, transport and refining to a near complete halt. The gas supply was also cut off, and with it, the production of super-heavy oil. Halfway through December, a new management team took over at PdVSA. A state of emergency was declared in the country and the army occupied the oil facilities. Despite the government’s efforts, production levels in January and February 2003 were barely 500,000 bd, nearly 2.5 mbd below their previous level. By April, Chávez had dismissed 18,000 PdVSA employees, more than half the original total, and divided the company into two geographical units (east and west). The second strike was a key event in the sector’s development. Given the dismissal of a large part of the staff of geologists, geophysicists and engineers, and the dismantling of its training and investigation centres, PdVSA lost a large part of its specialised human capital.

Chávez forbade other oil companies in Venezuela from contracting former PdVSA personnel, thereby creating a diaspora of Venezuelan oil technicians all over the world. This obliged the government to replace technical capacity and specialised knowledge in heavy and super-heavy oil with technicians from other state companies (so-called NOCs) from countries with which Chávez was seeking some type of strategic association (eg, Petrosaur from Iran, ONOC from India, Gazprom from Russia, CNPC from China and Enarsa from Argentina), although none of these NOCs has developed significant experience in the production of super-heavy oils.

Another result of the major drain in talent from PdVSA has been the rise in fires and accidents at refineries and other PdVSA complexes (nearly 20 in 2006 alone). For instance, the continent’s largest refinery, Paraguaná, had to halt its operations for six months due to a fire last July, obliging Venezuela, the area’s major energy power, to import gasoline as a result.

Conclusion: So far, Hugo Chávez’s government has managed to impose its control on the Venezuelan oil sector and survive the crises of 2002 and 2003. It has taken advantage of a significant increase in international oil prices to enjoy revenue levels that are unprecedented in Venezuelan history. In any case, the way in which Chávez is spending this revenue, his way of managing the energy sector and his peculiar style of foreign policy are potentially endangering the Venezuelan energy sector itself. Part II of this analysis will concentrate on this threat and its possible implications.