Hugo Chávez and the Future of Venezuelan Oil (II): The Looting of PdVSA and the Threat to its Production Levels (ARI)

Hugo Chávez and the Future of Venezuelan Oil (II): The Looting of PdVSA and the Threat to its Production Levels (ARI)


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.


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.

This second part of the analysis concentrates on Chávez’s use of PdVSA to promote his social, political and geopolitical aims and the implications of this (ab)use for the future of the Venezuelan oil sector.

‘Chávez still talks about “sowing the petroleum” with strategic investments to guarantee future economic security. All Venezuelan presidents have promised to “sow the petroleum” since Arturo Uslar Pietri, a conservative writer and politician, coined the phrase in 1936. Despite its revolutionary rhetoric and its curtailment of democratic institutions, the “Bolivarian Revolution” seems merely to be continuing the history of colossal waste of oil revenues, disorganization and failed investments that have impoverished the Venezuelan people in recent decades’.

Norman Gall, Executive Director of the Fernand Braudel Institute for the Global Economy.

Oil and Democracy in Venezuela, September 2006.

‘The resurgence and the reaffirmation of nationalism centred around non-renewable resources is manifested in different ways in the main producing countries. A fundamental change in market conditions has renewed its latent potential. Extraordinary yields in the last few years and the embarrassing liquidity of oil companies has justified, and made feasible, significant increases in royalties and taxes. The desire to retake control of their resources has led many governments to increase their stakes in oil extraction projects and, in some cases, to renationalise the industry. The strength of the original owners of resources grows as they become increasingly aware of the enormous production challenges represented by mature oil assets. The increase in the costs of relevant marginal producers gives economic support to the demands and actions of the producers. Producer countries should be cautious in order to effectively manage the change in circumstances and uphold any attainable advantages. Greed and a lack of political responsibility might damage their interests in the long term. In turn, oil companies and consumer countries have to recognise the vulnerability of the dominance they have exercised so far, show some flexibility and offer constructive alternatives. It is rather ingenuous to respond with emphatic allusions to contractual inviolability. However, I should recognise my own pessimism in relation to the behaviour of the parties involved to negotiate and reach a new understanding. The flow of news is not promising’.

Adrián Lajous, ex CEO of PEMEX and current Chairman of the Oxford Institute for Energy Studies.

‘La oferta petrolera y la seguridad de suministro: una perspectiva latinoamericana’, in the seminar War and Peace in the 21st Century: The Geopolitics of Energy, Barcelona, 20/I/2007.


The New Threat: Falling Investment and Production Levels

Chávez’s government maintains that Venezuela has regained the maximum production levels achieved prior to the great oil strike of 2002-03 –around 3mbd– but other independent estimates place the current level at closer to 2.5 mbd. The International Agency for Energy (IAE) estimates that Venezuelan production fell by 27% from a recent high of 3.3 mbd in 1997 to 2.4 mbd in July 2006, while the London-based Centre for Global Energy Studies (CGES) London estimated Venezuelan production in August of 2006 at approximately 2.5 mbd. Other independent estimates emphasise the fact that PdVSA’s production (now estimated at 1.4 mbd) continues to fall, with the slightly higher production from international companies offsetting PdVSA’s losses (the IOCs in Venezuela are currently producing approximately 1.1 mbd). The principal unknown variable is whether private IOCs will continue to invest in new Venezuelan production in a corporate environment that is increasingly characterised by relative legal arbitrariness and insecurity.

The loss of a major part of PdVSA’s technical capacity, due to the strike and the governmental response to it has resulted in the abandonment of many marginal wells and an interruption of the efforts –previously mentioned as an essential component of the apertura– to increase the recovery rate of wells, many of which had been damaged by the extreme speed with which PdVSA tried to increase production after the strike, without previously having made sufficient investments. A large number of the wells in Venezuela are already mature and require considerable maintenance (most have a rate of decline of some 25% annually). Those in the western part of the country, which have been producing for eight decades, are in noticeable decline: more than 90% require gas or water injections to maintain the necessary pressure for production. Currently, there are 21,000 PdVSA wells closed for lack of maintenance and repairs, while only 14,000 continue to produce. The lack of technical capacity, together with an insufficient level of investment by PdVSA, may have resulted in a permanent loss of some 400,000 bd of production capacity. This could easily explain the discrepancy of more or less 0.5 mbd between the Venezuelan government’s official production figures and other independent estimates. At these levels, PdVSA is facing a dilemma between growing costs due to the maturity of its assets and the need to invest much more than in the past to increase recovery rates — and this in a period in which the state is demanding an ever higher proportion of oil revenues.

Even the modest current levels of production are in danger due to PdVSA’s politicisation and its almost exclusive use as a source of financing for Chávez’s priority policies, both domestic and international. Without new increases in the level of investment, production will probably fall by 20% per year. Just to maintain current production levels, at least US$2 billion in new investments are required annually, and that will only be sufficient if carried out efficiently and effectively (some estimates suggest a required figure of over US$3 billion per year). To actually increase its production level, Venezuela must spend US$4 billion annually on new investments. Although PdVSA has announced its intention to invest some US$26 billion in exploration and development between 2004 and 2008, the state company on its own is failing to meet its investment targets, mainly due to the pressure on its revenue stream exerted by the government to finance its growing social expenditures. Some independent sources indicate that PdVSA is currently injecting more money into social programs than into its own investments.

Nevertheless, PdVSA’s current management already has its own ‘oil sowing plan’, a rearticulation (based on different principles) of the previous aperture, with the aim of increasing production to 5.8 mbd in 2012, propelled by new investments of US$56 billion (or nearly US$6 billion annually). This amount, in any case, is significantly less than what was necessary to achieve a less significant increase in production capacity during the 1990s when conditions for private interests were much more favourable than presently. But the most doubtful aspect of these targets is the fact that they are based on the assumption that more than 30% of all new investments in the sector will come from private international companies (IOCs) still operating in Venezuela. The government’s expectations are –at the very least– suspect since the perception of legal investment security continues to deteriorate.

These same private companies –which since the ‘opening’ have invested approximately US$26 billion– have almost completely halted their new investment plans after the recent changes to the Hydrocarbons Law announced by Rafael Ramírez, Minister of Energy and Oil (and Chairman of PdVSA) in March 2006. These legislative modifications have forced the IOCs to accept the revocation of their previous contracts and to instead participate in mixed companies (joint ventures) as minority partners of the Venezuelan Oil Corporation (VOC), a PdVSA subsidiary, in all conventional oil activities. In most cases, the state company will have a 60% stake, while foreign companies are not allowed to book the reserves held by such mixed companies, a legal restriction which severely limits the business attraction of such joint ventures. In the wake of Chávez’s election victory in December 2006, the President announced, as an extension of the new Hydrocarbons Law, the nationalisation of the gas sector, on the one hand, and that the state will also demand majority stakes in the strategic associations that exploit the super-heavy oils from the Orinoco Belt, on the other. Furthermore, a new increase in taxes on the production of hydrocarbons (up to 50%) and state royalties (up to 33%) have worsened the investment environment even further, taking the state’s share of oil and gas revenues up to over 80%. In the final analysis, the Venezuelan government will now take all key decisions in the sector as a whole with respect to production levels, operating plans, export projects and annual budgets.

Due to the current high price of oil, and the fact that Venezuela at least offers the real possibility –although ever less attractive– of participating in one of the few domestic national hydrocarbons sectors that continue to offer the possibility of access to major reserves, the 22 foreign companies working in the Venezuelan sector still have sufficient incentives to remain, despite the recent deterioration in the legal investment environment. Proof of this is that only ExxonMobil has decided to abandon the scene. But it is very doubtful that the private sector will to continue to invest in Venezuela at the same rate as during the last 10 years. The most likely outcome is that at least a large part, if not all, of the investor effort necessary to simply maintain current production –not to mention the possibility of significant increases– will fall on the shoulders of PdVSA, the same state company that just a short while ago lost nearly all its skilled technical human resources and that remains a financial hostage to Hugo Chávez’s political aims. In such a context, expecting the minimum US$4 billion in new investments each year necessary to increase the level of Venezuelan production seems excessively optimistic; not even the US$2 billion annually necessary to maintain current levels seems guaranteed.

In short the current situation is characterised by a precarious Venezuelan oil sector highly vulnerable to any further negative shocks to the legal framework and the investment climate and reference crude (WTI and Brent) prices of just over US$60 a barrel. If prices were to resume their decline of the autumn of 2006 and early 2007, as some analysts (although not the author) continue to predict, and if OPEC is incapable of designing and carrying out a new and credible plan to reduce and effectively enforce new quotas, it is very possible that Venezuelan production will fall below 2 mbd.

Chávez’s Geopolitical Aims

While the Venezuelan oil industry is in danger of decline and its physical and human infrastructure on the verge of collapse, Chávez is proposing major investments in international projects, frequently by means of Venezuelan subsidies to other countries (such as subsidized sales of oil to Cuba (almost 100,000 barrels a day), Jamaica (more than 20,000 bd) other Caribbean countries (a further 72,000 bd through the San José and Petrocaribe agreements), and subsidized gasoline to consumers in certain regions of the US where CITGO, the downstream subsidiary of PdVSA with distributions networks in the US, continues to operate). But beyond these cooperation and subsidy projects, one of Chávez’s ‘petro-policies’ with the most media exposure is his plan to divert to China and East Asia much of Venezuela’s oil exports currently destined to the US market.

China vs. the US

Venezuela currently exports nearly 1.5 mbd of its production (60% of the total) to the US. This export flow accounts for between 10% and 15% of all US oil imports, making Venezuela one of its most important suppliers. In fact, Venezuela has always been a strategic supplier for the US, given its closeness to the ports and refineries of the Gulf of Mexico and the East coast (Venezuelan crude takes only five days to reach the US, compared with the four to five weeks it takes for crude to arrive from the Middle East). Most of these American imports are managed by CITGO, the PdVSA subsidiary that owns five refineries (and stakes in three more) in the US, all specialised in processing the heavy and high-sulphur content crude from Venezuela.

However, on a recent world tour to several pariah states and other key nations in the international energy arena (for example, Iran and Russia), Chávez made his fourth official visit to China after which he revealed more details about his long-term strategy (reflected partially in the 18 new agreements he signed with China) to divert oil exports to China that are currently destined to the US. Venezuelan exports to China currently stand at less than 75,000 bd but the aim is to increase them to more than 1 mbd over the next five years.

Nevertheless, for this objective to be reached, several doubts will have to be dispersed. First, the relatively heavy crude that constitutes most of Venezuela’s exports needs to be processed by specialised refineries such as those owned by CITGO in the US. All the refinery capacity that China has installed on its Pacific coast is designed to receive light sweet crude from the Persian Gulf. For China to be able to import 1 mbd of Venezuelan heavy and high-sulphur crude, it will have to invest several billion dollars in new specialised heavy oil refineries. Yet it is far from clear that this will occur, at least not in the short run.

Similarly, Venezuela itself will have to make significant investments in a new pipeline (that will probably have to pass through neighbouring Colombia, with which relations are sometimes tense) just to transport its crude to the Pacific coast of Central America, where it will then begin its journey by tanker to Asia. The alternative options would be to send the oil by tanker through the Panama Canal (which, given the recent increases in traffic volumes, will not be feasible until the Canal itself experiencing a significant expansion of its capacity over the coming years) or around the tip of South America (which would substantially increase the cost of transport). Currently, transport costs for Venezuelan oil to China stand at around US$12 a barrel, compared with only US$2.5 per barrel to transport crude to US refineries. It is not clear which party would bear the burden of this higher cost: China or Venezuela? The fact that Venezuela has just ordered 18 oil tankers from Chinese manufacturers suggests that PdVSA will deliver the crude itself directly to Chinese refineries, thereby absorbing an additional cost of approximately US$10 a barrel.

Even if this were not the case, it does not appear that all this geopolitical juggling is necessarily worth the trouble. Even if Venezuela makes a success of diverting its sales from the US to China, this will not imply an excessive inconvenience for the US. Given that oil is a fungible product traded in a truly global market, any Venezuelan exports that shift to China will simply displace the Chinese need to import other flows of oil from the Middle East that now might be redirected to the US. Since, with the passage of time, and the exhaustion of oil reserves of light sweet crude in the Gulf region, a growing portion of the oil that leaves the Middle East is increasingly heavy, it will be easily possible to refine such heavier Middle Eastern crudes in any of the heavy oil refineries in the US. CITGO will have the option of (1) refining these new flows of Middle East oil for distribution in the US; (2) selling its refineries to third parties who would then proceed to refine and distribute these flows; or (3) simply abandon them, thus renouncing billions of dollars in commercial value. If the US ends up paying more for its gasoline in the short-term as a result –either due to increases in the cost of transport of crude or to the lack of a specialised refinery capacity– Venezuela will also end up paying more. Because energy costs are much less important for the US economy than for Venezuela, it does not seem a viable strategy to attempt to use oil exports as a geopolitical weapon against the US beyond the very short run time frame, or simply as pure propaganda.

Venezuelan Gas and the ‘Great Southern Pipeline’

If the political power to manipulate the oil market –beyond causing temporary changes in the market price– is typically less pronounced than what the general public assumes, political power in the gas sector is somewhat more tangible and significant, particularly when gas is transported by pipeline from a specific country of origin to another specific country of destination. In this respect, Chávez’s government is proposing a major regional energy integration project that would integrate all the net gas consumers and importers in the South Cone (including Brazil, Argentina and Uruguay — and indirectly Paraguay and Chile– and possibly also with its ally and fellow gas exporter, Bolivia) with Venezuela, the continent’s most powerful potential gas exporter of the future. This project, known as the ‘Great Southern Gas Pipeline’ would not only supply the South Cone with gas but would also substantially increase Venezuela’s political influence over the continent, particularly in the major nations which, simply by participating in the project, would for the first time depend increasingly on Venezuela for their essential gas supplies.

Nevertheless, this project will not be easy to bring to fruition. Indeed, most analysts believe that it will never be successfully concluded. It is likely to cost at least US$20 billion (or US$134 per barrel of oil equivalent), an amount so great that in order to be financed by the market it would have to offer the guarantee of a stable gas supply for a very long period of time. It would also have to cross more than 8.000 km of the continent, from the Caribbean coast of Venezuela to Buenos Aires, passing over thousands of rivers and piercing through the tropical Amazon Forest where the rainy season lasts approximately eight months. Since there are still not enough technical studies detailing the projects feasibility and potential environmental impacts, the project will no doubt be plagued, even in the best case scenario, with myriad construction difficulties and budget crises, not to mention the ongoing subsequent maintenance work. Furthermore, it is almost certain that the project will encounter an endless stream of ecological protests, particularly in Brazil. In the best case scenario –even if final costs are ultimately in line with the early provisional estimates– the gas would in any case be much more expensive than which Brazil and Argentina could continue to import through current channels from Bolivia (even after the ‘renegotiations’ recently ‘carried out’ by Evo Morales) or gas these same countries might import in the future in liquid LNG form (even after investing the huge sums necessary for LNG import infrastructures). But Chávez has already announced that Venezuela will sell the gas transported through this mythical pipeline at the subsidised price of US$1.00 per Mbtu, well below the price of US$4.00 dollars per Mbtu for Bolivian gas exports to Brazil, and the current price of more than US$5.00 for Bolivian gas exports to Argentina.

The great irony of this situation lies in the fact that currently the gas industry in Venezuela is noticeably underdeveloped, especially compared to its elder cousin, the oil sector. The country currendly produces some 28.9 billion cubic metres (bcm), a mere 1% of global production, and behind Argentina’s 45.6 bcm and Trinidad and Tobago’s 29 bcm. Most importantly, Venezuela now consumes roughly the same amount domestically and will have to import gas from Colombia for the next seven years through the Transguajiro gas pipeline in order to supply the western region of the country where there is a relative lack of gas. There are plans to increase domestic gas production by another 22 bcm before 2012 and construct an east-west gas pipeline to eventually eliminate the need to import gas from Colombia, but it is not at all clear that the necessary investment will ultimately be made for this purpose. Thus a country which is currently not even a net gas exporter –and with no clear roadmap for becoming one—is proposing export infrastructure as if it were already one of the world’s active gas giants.

In theory at least, Venezuela could become Latin America’s gas giant. It has the largest gas reserves –152.3 trillion cubic feet (tcf), or 4.32 trillion cubic metres (tcm)– in all of Latin America, five times more than Bolivia (the second-largest in the region) and equivalent to some 2.3% of global reserves. This is nothing to sneeze at. Still, more than 90% of Venezuelan gas reserves are associated with oil deposits and 70% are used in the same deposits for pressure injection necessary to maintain production levels in aging oil fields, at least until they go into rapid decline. With the current shortage of gas in the country, oil production in mature wells is slipping fast due to a lack of sufficient gas for injection purposes, while the production of the super-heavy oils, which depends to a large extent on the use of gas in its extraction and processing, will also remain limited as a result. Nor is there sufficient gas to supply petrochemical plants. The basic problem is that there has never much money invested in exploration and production of gas unassociated from oil for strictly commercial purposes. If current offshore gas exploration (undertaken by Chevron and Statoil) is successful, Venezuela will eventually produce more gas, but in the best of cases such new production would only cover domestic consumption, at least for some time.

Chávez’s ever more aggressive energy nationalism is not helping either. As of the recent elections, it has even begun to make itself felt beyond oil sector and is now clouding the investment environment in the gas sector as well. Offshore gas projects until recently contemplated the export of liquefied natural gas to the US, not pipeline exports to the Southern Cone. Modifications to the Hydrocarbons Law this year have imposed the control of PdVSA on all export projects and all gas pipelines in the country. The question of how it will affect, along with the radical turnaround in the future destination of Venezuelan gas, the level of investment in gas exploration and production remains unclear. But it is unlikely that Venezuela will have sufficient amounts of gas available in time to make the ‘Great Southern Gas Pipeline’ an economically viable project. Venezuela might possibly be able to finance it alone but this financial burden would then be added to all the other voluntary costs that Chávez’s political projects are imposing on the fragile and unbalanced Venezuelan economy. But, as in the case of the diversion of exports from the US to China, the ‘Great Southern Gas Pipeline’ at least serves an important rhetorical and propaganda function.

Super-Heavy Oils

During the past few years, Venezuela has classified as new probable reserves some 270 billion barrels of super-heavy oil (with an API of less than 10º). These probable reserves form part of total possible reserves of some 700 billion barrels of super-heavy oil that is found in the subsoil of the grasslands north of the River Orinoco, in the so-called Orinoco Belt. It is very likely that, before 2008, PdVSA will declare some 240 billion barrels of these super-heavy oils as a new component of Venezuela’s official proven reserves, which, in addition to the current 80 billion barrels, will take the country’s total proven reserves to nearly 320 billion barrels. These would be the world’s largest official national proven reserves, topping both Saudi Arabia and Canada.

But given the very high cost of extracting, processing, transporting and refining super heavy Venezuelan oil, international oil prices would have to remain above US$40 a barrel for decades to justify the major investment necessary and to maintain significant production levels. The nearly 270 billion barrels (nearly a third of the possible total) that are considered recoverable with current technology could theoretically support a production level of some 10 mbd for 70 years. With advances in technology, the potential rate of recovery might be even higher. Therefore, this is another key aspect of the economic and political significance for Venezuela of today’s currently high international oil prices.

At present, there are four ventures (or ‘strategic associations’) that produce a mere 600,000 bd of super-heavy oil using advanced recovery techniques, the result of an investment of US$1 billion by PdVSA and other foreign companies (such as Conoco-Phillips, Chevron, Exxon-Mobil, Total and Statoil) in the 1990s. With all its other current challenges, PdVSA has not started to invest seriously in super-heavy crude from the Belt, but has contracted other major state companies (NOCs) from countries which Chávez considers strategic and possible geopolitical allies in the long-term to measure and confirm future increases in Venezuela’s official proven reserves from the Orinoco Belt. Such partner NOCs include Petrobras from Brasil, Petrosaur from Iran, ONOC from India, Gazprom from Russia, CNPC from China and Enarsa from Argentina, although none of them have had prior experience in super-heavy oils.


According to Chávez, Venezuela will soon be the world’s most powerful oil producer with the largest reserves, inflated by the inclusion of super-heavy oils. For this vision to become a reality, among other things a significant and durable increase in the long-term of levels of investment in the hydrocarbons sector will be necessary. It will also be necessary to count on the technical capacity of international private companies (IOCs) in this endeavor, as the brain drain from PdVSA as of 2002 and 2003 has left the state company with very little technical and scientific capacity (and most of what remains is committed to Chávez’s projects abroad, such as the help that PdVSA is providing to Bolivia in the gas sector).

For better or for worse, it appears that the behaviour of Chávez’s government –still spending in a wild, spree-like fashion– will not enable a significant increase in PdVSA’s investment levels. According to Norman Gall, PdVSA has transferred so much money to the Venezuelan government in the last few years that, despite today’s high prices, the state-owned company experienced a shortfall of some US$5.3 billion in its cash flow for 2006 (it is unsurprising therefore, that PdVSA plans to issue more than US$5bn in corporate bonds on the private market). Meanwhile, Chávez’s government recently announced plans to spend US$38 billion in July of 2006 alone (more than two-thirds of PdVSA’s revenues for the entire year) and more than twice its revenue during the first half of 2006.

According to sector sources, the fall in production in many mature areas and wells that have been shut-in due to lack of maintenance will force Venezuela to add 400,000 bd in new production capacity each year –and for many years– simply to stabilise its production at current levels. But PdVSA’s current budget envisages an expenditure on social programmes of US$8.2 billion, 67% more than its investments in exploration and production. Disturbingly, there has been no significant new discovery in the Venezuelan oil sector during the past several years.

Although Chávez is not the devil, described in apocalyptic terms by both US strategists and international oil sector executives, neither is he showing any signs of acting with the prudence and shrewdness mentioned by Adrián Lajous as being essential for producer countries to take advantage of the new context in the international oil market and the increased the influence with which this change provides them. Without a significant change in the direction of PdVSA and of the Venezuelan government’s oil policy, the prudent approach by an external observer would be to expect a drop –faster or slower– in the country’s production levels.

This possible result of the current developments in the sector will be far more serious for the world than any hypothetical diversion of Venezuelan oil to China or any hypothetical geopolitical imposition in Latin America by Chávez with his dreamed-for ‘Great Southern Gas Pipeline’. Further reductions in Venezuela’s oil production could significantly add to the instability of the global oil market, which has little idle capacity and a lack of sufficient investment to adequately increase global production to meet the demand projected for the future.