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Venezuela, Oil and Chavez: a Tangled Tale

Matt Smith, Oilprice.com
Friday, 11 Jan 2013 | 3:55 PM ET
Hugo Chavez wins election.
Juan Barreto | AFP | Getty Images
Hugo Chavez wins election.

With the rapid deterioration of Venezuelan president Hugo Chavez's health, it seems pertinent to ask at why the country – and by extension Chavez – plays such an integral role in the global energy market.

A glance at a few statistics highlights the importance of the country's role. It is the largest oil exporter in the Western Hemisphere (and 10th largest in the world),and with 298 billion barrels, holds the world's largest proven oil reserves.

It also has the second largest natural gas reserves in the Western Hemisphere, second only to the United States. These rather salubrious details, however, mask a situation more worrisome than these numbers would have us believe.

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Venezuela is ultimately what is known as a 'petro-state'. Oil revenues account for 94 percent of export earnings, 50 percent of budget revenues, and 30 percent of GDP. But since 2001, overall oil production has fallen by roughly one-quarter,while since 1997; oil exports have dropped by almost 50 percent. It is no coincidence that these declines coincide with Hugo Chavez becoming President in 1998.

Venezuela nationalized its oil industry in 1976, creating the state-run company Petroleos de Venezuela (PDVSA). Upon taking office, Chavez immediately increased state control of the oil industry even more, in order to gain more control of itscoffers. As Daniel Yergin says in his book 'The Quest', PDVSA 'became the cash box of the state', which caused immediate tension between Chavez and PDVSA. It didn't take long for these tensions to escalate.

In 2002,nearly a half of PDVSA workers went on strike to pressure Chavez to call early elections. This virtually halted oil production for two months before the government gradually reestablished control over PDVSA. It then promptly fired 18,000 of its workers – approximately 40% of the workforce. The country's oil industry was then further hindered when the government, in an attempt to replace the fired employees, hired less skilled -- yet pro-Chavez – workers.

Despite his authoritarian tendencies, Chavez is still idolized by many in Venezuela for having greatly improved the standard of living for his people, giving them access to healthcare and education. Even these well-meaning initiatives,however, can be traced back to the mismanagement of the country's oil. Cuba provides Venezuela with personnel such as health workers (some 40,000 doctors)and teachers, but as a quid pro quo for heavily subsidized crude.

A similar scenario exists regarding domestic fuel subsidies. Fuel prices in Venezuela are the cheapest in the world at about 18 cents a gallon. All this does is pander to the Venezuelan people, but in a highly inefficient fashion. After all, these heavy subsidies mean domestic oil consumption has risen from 36 percent to 47 percent of the total energy mix in the last decade, which has created a scenario where Venezuela has less oil to sell into the global market due to higher domestic demand.

This means less government revenues. Yet due to the lack of investment in domestic refining capacity, for every ten barrels it sells to the U.S., it must now import two barrels of refined product at a higher price.

These counter intuitive actions are neither new nor isolated. A decade of under investment and mismanagement of Venezuelan oil resources has led to varying degrees of malfeasance: PDVSA only employs pro-Chavez workers, while international oil companies such as Exxon Mobil and Conoco Phillips have faced expropriation when they declined to give PDVSA majority control of their Venezuelan projects. This leaves PDVSA needing to invest $3 billion a year just to maintain production levels in existing fields.

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Unfortunately,this lack of under investment in the domestic oil industry manifested itself last August when an explosion at the Amuay refinery – the country's largest –caused 42 deaths. Amuay processes 645,000 barrels a day, and is part of a three-refinery complex which is billed as the world's second largest. This was the deadliest refinery blast in 15 years, and although an accident, led to suggestions of inadequate maintenance and safety checks; Venezuela's refineries executed only 19.3 percent of all planned shutdowns in 2011.

This brings us to the present, and the upcoming inauguration of Hugo Chavez's third term.Instead of being in his country, Chavez is in Cuba undergoing cancer treatment,a process he's been following for the past month. The strongman's health has reportedly deteriorated in the last week due to a respiratory infection.Unwilling to step down yet too sick to be sworn in for another term, the inauguration is to be postponed amid calls from opposition leaders that a delay would be unconstitutional.

Chavez's poor health and his absence from Venezuela leave his country facing an uncertain future. Although Chavez still has the support of his people, and likely the support of the Supreme Justice Tribunal who can swear him into office despite his absence, his death could throw the country into turmoil.Instability, a power struggle, and ultimately, an election would likely ensue.

Chavez may succeeded either by his current Vice President Nicolas Maduro, or the man he defeated at the polls in October, Henrique Capriles. Given the state of affairs under Chavez, however, it seems that either successor will have a very low bar to clear when it comes to managing Venezuela's domestic oil industry.

—This story originally appeared on Oilprice.com. Click here to read the original story.

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