Commentary: Is Venezuela turmoil good for oil sector?

This blog was written by Dr. David R. Mares, Baker Institute Scholar for Latin American Energy Studies, James A. Baker III Institute for Public Policy.

News reports indicate that Hugo Chávez remains hidden away in a hospital in Cuba. Venezuelan Vice President Nicolás Maduro has made public statements that Chávez is recuperating. But, in the face of a innumerable claims put out by the government that later proved false, rumors abound about the Venezuelan President’s health: some even speculate Chávez is either already dead, in a coma or dying. The ruling party (“Chavistas”) have bought some legal time by having the National Assembly and Supreme Court rule that, since he had been re-elected in October, Chávez maintains continuity as President and can take the oath of office for his new term at a future date when his health permits. That is giving the acting government under the direction of Maduro time to prepare for life without Chávez.

Political instability is virtually guaranteed for Venezuela, should confirmation emerge of Chávez’ death or definitive public disclosure of permanent incapacitation. Elections will have to be called within 30 days of the declaration that President Chávez cannot assume office in his new term, and in the interim, under official rules, the National Assembly president and a rival of Maduro within Chavismo, Diosdado Cabello, will assume the presidency. Maduro is friendly to the increasingly pragmatic Cuba of Raúl Castro and the US State Department has already sent out peace feelers to him. Cabello is a hard line nationalist, close to the military and reportedly less friendly towards both Cuba and the US. As Chávez’ designated successor, Maduro has the upper hand, but Cabello will certainly apply as much pressure as he can behind the scenes and on the streets to keep Maduro from consolidating control over the Bolivarian Revolution and repeating Chávez’ succession of electoral victories. Maduro will try to respond by demonstrating that he is a worthy heir to Chávez – which means continuing to subsidize social welfare programs associated with Chávez.

Chavez’ passing is not necessarily good news for the future success for opposition parties. Henrique Capriles Radonsky ran a moderate campaign in last October’s presidential elections, promising to make Chávez’ reforms more sustainable and transparent. Many on the right wing of the united opposition were unhappy by these themes but remained quiescent in hopes of defeating the popular Chávez. Moving forward, chances are the political diversity within the opposition will express itself, with multiple factions attempting to demonstrate before the new elections that they represent the will of the Venezuelan people opposed to the Bolivarian Revolution. Were the opposition to win the new election, the right wing would likely seek to create the conditions to disband the Chavista-dominated Legislature and hold new legislative elections as well; were Maduro to win, the right wing would fear that the chance to derail Chavismo was slipping away and act forcefully in the streets to contest Maduro and the Legislature’s efforts to consolidate ‘Chavismo without Chávez.”

Though the streets and the halls of the Legislature will be tumultuous, the future of the oil sector might be open to positive change. Chávez extracted high rents from both the national oil company (NOC) PDVSA and foreign oil companies far beyond what prudent review of contracts in the face of booming oil prices would have counselled. Investment in the sector fell even as the government announced memorandums, agreements and contracts heralding an investment boom. The result is clear. Production in the oil-rich Orinoco Belt (faja) has stagnated. The refining industry is in need of repair. The economic impact of these decisions was temporarily buffered by high oil prices (peaking close to $150 barrel and remaining around $100 since). It also helped that China provided over $40 billion in non-transparent ‘development loans.’ These factors allowed Chávez to spend profligately to provide social welfare to a previously abandoned poor, promote his Bolivarian Revolution and win multiple elections.

But the pattern of financial bonanzas may be ending. The Venezuelan economy grew 5.5% last year, largely stimulated by public expenditure, which grew by 6.7% in real terms. But it also suffered Latin America’s highest inflation (officially 20%, with agricultural prices up 35% and the basic food basket up 28.5%), food shortages, and port and transportation bottlenecks to service the increased imports of food and oil products given declining domestic capacity to meet demand in both sectors. Although the government is forecasting 6% growth in 2013, foreign analysts predict it can be as low as 2.5% and unlikely to exceed 4%; a devaluation is expected though unlikely to be undertaken until Chávez’ situation is clarified.

While the economy is showing its vulnerabilities, the supply of elixir used in the past is appearing problematic; even ruling party members worry that oil-generated revenues have reached their peak. Many international analysts are expecting falling oil prices in the face of the shale revolution in oil and gas and sluggish global economic growth. It would take a major crisis in the Middle East to push prices back to the levels that would bail Caracas out temporarily. The Chinese are concerned about Venezuela’s future and unlikely to provide a new government, even a Chavista one, with the loosely monitored tens of billions of dollars in loans that they did to Chavez’. The Chinese government will most likely focus on reducing their exposure in Venezuela. PDVSA debt has to be near its peak – the NOC’s bank debt rose $11 million in 2012 and now totals $32.5 billion. The company will need to pay $20 billion of that debt, plus interest, in the next five years. The NOC has total liabilities (including payments for pension, contractors, suppliers, etc) of $63 billion, almost double its situation in 2010. Although investors have been willing to purchase PDVSA debt with the expectation that the government will not permit it to default, as the government’s revenues become seriously constrained in addressing domestic political, economic and social demands the willingness of a government to meet its debt obligations will increasingly be called into question.

A Venezuelan government of any stripe is going to need more money to compensate its allies, who will worry that they are losing in the unstable political and economic environment. The one option politicians will have for increasing revenue is to increase production of oil and their virtually untapped large reserves of conventional gas (at 193 tcf they are the 8th largest in the world).

Chávez wielded a big stick because of his popularity at home and rising oil prices, and he used that power to significantly alter contracts and the distribution of profits. But even he could not decree increased production by either foreign companies or his NOC. PDVSA had a rig sink offshore, has experienced multiple refinery fires and has invested significantly more in social programs than in exploration and production. Under Chávez’, the NOC’s payroll has more than doubled to 115,000, employees despite a decline in its production of over 10%. Foreign investment will be needed in any strategy to increase production in the short term and rebuild PDVSA in the medium term.

The level of Venezuelan hydrocarbon reserves will continue to entice. Chávez’ retreat from the scene makes any successor heavily dependent on significantly increased hydrocarbon production and thus it is reasonable to expect that incentives to foreign investment in the oil and gas sector will be improving significantly sometime soon.