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Venezuela's Oil-Based Economy

Authors: Cesar J. Alvarez, and Stephanie Hanson
Updated: February 9, 2009

Introduction

Venezuela's proven oil reserves are among the top ten in the world. Oil generates about 80 percent of the country’s total export revenue, contributes about half of the central government’s income, and is responsible for about one-third of the country’s gross domestic product (GDP). Increases in world oil prices in recent years have allowed Venezuelan President Hugo Chavez to expand social program spending, bolster commercial ties with other countries, and boost his own international profile. Though Chavez has threatened to stop exporting Venezuelan oil and refined petroleum products to the United States, its biggest oil-trading partner, experts say a significant short-term shift in oil relations between Venezuela and the United States is unlikely. The medium-term outlook for state oil company PDVSA is questionable, however, and analysts draw links between PDVSA's profitability and the political stability of the country. Analysts say the recent global financial crisis and sudden drop in oil prices are adding to the oil company's financial turmoil.

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Venezuela's Economy under Chavez

Hugo Chavez took office in 1999. Since then, Venezuela’s economy has remained squarely centered on oil production. In 2006, Chavez announced a nationalization of oil fields managed by foreign companies, which resulted in an increase of the government’s shares in these projects from 40 percent to 60 percent. Government officials argue, however, that economic growth efforts are not solely focused on oil. Venezuela’s ambassador to the United States, Bernardo Alvarez Herrera, wrote in a 2006 Foreign Affairs essay that the non-oil sector, which includes mining, manufacturing, and agriculture, grew 10.6 percent in 2005, “indicating an important diversification of the country's economy.” Yet even if the country is working to diversify,“oil still predominates,” says Miguel Tinker-Salas, a professor of Latin American history at Pomona College.

In 2002, the Venezuelan economy experienced a significant downturn following a failed military coup to overthrow Chavez and a two-month strike by the state-run oil company PDVSA. The response to the strike—the dismissal of more than seventeen thousand PDVSA employees—resulted in a rapid drop in GDP between 2002 and 2003. In subsequent years, rising international oil prices helped the economy to recover. In 2007, the International Monetary Fund (IMF) estimates, economic growth was 8.4 percent.

Opinion is divided over the effect of Chavez's policies on Venezuela's economy. Some economists say the tremendous rise in social spending under Chavez has greatly reduced poverty and pushed unemployment below 10 percent, its lowest level in more than a decade. According to a February 2008 report from the Washington-based Center for Economic and Policy Research, not only has unemployment dropped, formal employment has increased significantly (PDF) since Chavez took office. But other economists express concerns about the country's high inflation levels. The IMF has forecast inflation of 25.7 percent in 2008 and 31.0 percent in 2009—among the highest rates for any country in the world—and according to news reports, the country is already experiencing food shortages of goods such as sugar and milk. Francisco Rodriguez, former chief economist of the Venezuelan National Assembly, writes in a 2008 Foreign Affairs article that income inequality has increased during Chavez's tenure, and further, Chavez's social programs have not had a significant impact on infant mortality rate or literacy rates among Venezuelans.

PDVSA

PDVSA (Petróleos de Venezuela, S.A.), Venezuela’s state-owned petroleum company, oversees the exploration, production, refinement, and export of oil as well as the exploration and production of natural gas. It is the world's third-largest oil company, behind Saudi Aramco and ExxonMobil. According to Tinker-Salas, after the nationalization of Venezuala’s oil in 1976, PDVSA was very much like a “state within a state.” It “insulated itself from the government” and functioned largely as its own entity with control of the nation’s wealth. In 1980, PDVSA acquired CITGO, a U.S.-based refinery, and it is now one of the world's largest refiners.

Under Chavez, however, the company's mandate has drastically expanded. In 2002, Chavez redefined PDVSA’s role to include the government’s social priorities. PDVSA must now spend at least 10 percent of its annual investment budget on social programs. This money is funneled through the National Development Fund, or Fonden, an investment fund set up in 2005 that is not included in the government's budget. Peter Hakim, president of the Inter-American Dialogue, a Washington-based center for policy analysis, says that Chavez’s gradual takeover of PDVSA has given him an enormous bankroll to pursue his political and economic ambitions.

Yet Chavez has also moved to expand PDVSA’s role in Venezuela’s oil ventures. In the 1990s, Venezuela opened its oil industry to limited private investment and allowed foreign companies to manage specific oil fields. Such “strategic associations” made up roughly 23 percent of total oil production as of 2006. In April 2006, Chavez announced the government would take a majority stake in such projects, increasing its share from 40 percent to 60 percent. Though this partial nationalization is expected to burden PDVSA with investment costs in the billions, in 2007 the president created seven new subsidiaries of PDVSA, including services, agriculture, shipbuilding, construction and industry. The head of PDVSA, Rafael Ramirez, told the New Yorker in June 2008 that Chavez plans to use the oil company to transform Venezuela from an "oil sultanate to a productive society within a socialist framework."

The financial crisis and oil price drop has had some impact on the oil company. In particular, PDVSA lost a $5 billion line of credit in October 2008. In early 2009, Chavez signaled the government would be open to more foreign investment in its oil resources, but analysts say there is little trust (Bloomberg) contracts would be honored over the long term. "Chávez is celebrating the demise of capitalism as this international crisis unfolds," Pedro Mario Burelli, a former board member of PDVSA, told the International Herald Tribune. "But the irony is that capitalism actually fed his system in times of plenty."

Spending the Oil Money

It is difficult to determine how Venezuela has been spending its oil windfall, given the lack of government transparency (the country ranks 162 out of 179 countries ranked on Transparency International's corruption index). However, from the few official figures the government has released and its stated pledges of aid to foreign countries, it is possible to glean a picture of billions of dollars dispersed on activities not directly related to PDVSA's core business. Analysts express frustration that these reports lack detail, and efforts by news organization to obtain further information from government agencies have been rebuffed (NYT).

PDVSA has transferred billions of dollars to Fonden, the off-budget investment fund many experts say is financing Chavez's social projects. According to International Oil Daily, an energy trade publication, PDVSA spent $14.4 billion on social programs in 2007 (as compared to $6.9 billion in 2005). These programs include projects such as medical clinics providing free health care, discounted food and household goods centers in poor neighborhoods, indigenous land-titling, job creation programs outside of the oil business, and university and education programs.

Increased oil revenues have also given Chavez the ability to extend assistance programs outside Venezuela’s borders. For example, he provides oil at a preferential price to many countries in the Caribbean through the Petrocaribe initiative. In 2009, a Venezuela-backed home heating program to low-income households in the United States was briefly halted, a sign that low oil prices may be forcing Chavez to reconsider (TIME) some of his social programs. In August 2007, the Associated Press calculated that Chavez had promised $8.8 billion in aid, financing, and energy funding to Latin America and the Caribbean between January and August 2007, a figure far higher than the $1.6 billion of U.S. assistance for the entire year. Though it is impossible to determine how much of that funding was actually dispersed, the difference in aid is striking. Chavez is also suspected of funneling money to the FARC, a Colombian guerrilla group, as well as providing funds to Argentine President Cristina Kirchner’s election campaign in 2007—though he denies both charges.

Military expenditures are also funded by the government's flush coffers. Between 2004 and 2006, Venezuela spent roughly $4.3 billion on weapons, according to a January 2007 Defense Intelligence Agency report. As part of deals signed with Russia in 2006, Venezuela purchased 100,000 Kalashnikov rifles, twenty-four Sukhoi-30 fighter planes, and fifty-three Russian helicopters. In March 2008, it hired Belarus to build an air defense system.

Critics of Chavez think he should be pouring money into infrastructure to ensure a sustainable oil industry rather than allocating so much for social and foreign policy initiatives. According to the Wall Street Journal, PDVSA “spent just $60 million on exploration in 2004, compared with $174 million in 2001.” But Vicente Frepes-Cibils, the lead economist for Venezuela at the World Bank, says “investment is increasing” and Venezuela has an accumulation of reserves including outside funds ranging from $10 billion to $15 billion that it is planning to use for oil infrastructure.

PDVSA's Production Levels and Fiscal Health

PDVSA has not filed financial statements with the U.S. Securities and Exchange Commission since 2004. As a result, its production levels and overall fiscal health are subject to debate among economists and industry analysts. A report (PDF) by the International Energy Agency examining Venezuela's extra-heavy crude oil production put PDVSA’s 2005 production rate at 3.2 million barrels per day but showed a decreased rate of 2.55 million in September 2006. Currently, OPEC, the U.S. government, and the International Energy Agency agree that Venezuelan oil production amounts to roughly 2.4 million barrels per day. The Venezuelan government, however, says PDVSA's production is about 3.3 million barrels per day.

Either way, there are new signs that all isn’t rosy at PDVSA. In 2008, Venezuela's energy ministry released unaudited results documenting a 35 percent fall in profits by PDVSA the previous year. A few months later, audited figures were released that indicated profits increased 15 percent in 2007. The International Energy Agency, however, shows a $7.9 billion loss in 2007. Oil prices, which were extraordinarily high through much of 2008, helped mask some of the company's financial woes. Since they began to drop dramatically PDVSA has struggled to keep up with its financial obligations, especially once it lost a $5 billion line of credit (CNBC) with the Royal Bank of Scotland in October 2008. The company had about $7.9 billion in unsettled accounts (Latin Business Chronicle) between January and September 2008, up from $5.7 billion during all of 2007, but analysts say so far the company is unlikely to default on its creditors. However, the company may need to make serious cutbacks or possibly even sell assets, analysts say.

Venezuela has an estimated 78 billion barrels of proven conventional crude oil reserves and an additional estimated 235 billion barrels of unconventional extra-heavy crude oil in the Orinoco Belt region located southeast of Caracas. If development in the region can turn this extra-heavy tar-like oil into a more marketable commodity, Venezuela’s total reserves could rival those of Saudi Arabia, reports the New York Times. Oxford Analytica notes, however, that PDVSA will struggle to develop its heavy-oil reserves in a timely fashion given its lack of infrastructure investment and the ongoing oil nationalizations. Oil industry experts suggest that PDVSA needs to invest at least $3 billion annually into its existing fields just to maintain current production levels.

Regional Ventures

Venezuela is South America’s third-largest market and is actively pursuing further economic integration with other countries in the region. In July 2006 it became a member of the South American trade group Mercosur (Mercado Común del Sur), joining Brazil, Argentina, Uruguay, and Paraguay. Chavez has also spurred the creation of a regional development bank, known as Banco del Sur. Highlights of Venezuela's recent regional agreements include:

  • Argentina. Venezuela and Argentina have made agreements to create an investment bank for infrastructure development, as well as joint hydrocarbon exploration and development in both countries. Venezuela has also purchased $3.5 billion in bonds to help pay off Argentina’s debt.
  • Brazil. In May 2008, Petrobras and PDVSA signed an agreement to build an oil refinery in northeastern Brazil, which is anticipated to require $4.05 billion in investment. Petrobras will hold 60 percent of the refinery's shares. Crude oil will be supplied by both countries to refine a projected 200,000 barrels per day.
  • Colombia. In 2007, Venezuela and Colombia opened a natural gas pipeline that links northern Colombia’s La Guajira gas fields to the Paraguana refining complex in western Venezuela. Tensions between the two countries have heightened, however, since a March 2008 standoff in which Chavez sent troops to the Colombian border and temporarily severed diplomatic ties.
  • Bolivia. Venezuela and Bolivia signed agreements in January and May 2006 for Venezuela to supply preferentially priced diesel and invest $1.5 billion in the Bolivian oil and gas sector in exchange for Bolivian goods and services, according to Oxford Analytica.
  • Ecuador. In February 2008, Venezuela and Ecuador agreed to collaborate on an oil refinery in Ecuador estimated to cost $5.5 billion. Under agreements signed in May 2006, Venezuela is expected to refine up to 100,000 barrels of Ecuadorean crude oil per day at discount prices.
  • Cuba. Commerce between Venezuela and Cuba soared to $7 billion in 2007, according to the Cuban government (in 2006, trade was $1.7 billion). Venezuela is selling up to 100,000 barrels of oil per day to Cuba, discounted by as much as 40 percent. In exchange, thousands of Venezuelans have traveled to Cuba for medical treatment, and Cuban doctors help administer health care programs for low-income Venezuelans.
U.S.-Venezuela Oil Ties

Though Venezuela has repeatedly threatened to cut off its oil exports to the United States, analysts say the two countries are mutually dependent. Venezuela supplies about 1.5 million barrels of crude oil and refined petroleum products to the U.S. market every day, according to the EIA. Venezuelan oil comprises about 11 percent of U.S. crude oil imports, which amounts to 60 percent of Venezuela’s total exports. PDVSA also wholly owns five refineries in the United States and partly owns four refineries, either through partnerships with U.S. companies or through PDVSA’s U.S. subsidiary, CITGO. A U.S. Government Accountability Office (GAO) report (PDF) says Venezuela’s exports of crude oil and refined petroleum products to the United States have been relatively stable with the exception of the strike period.

The World Bank's Frepes-Cibils says “Venezuela will continue to be a key player in the U.S. market.” He argues that in the short term it will be very difficult for Venezuela to make a significant shift in supply from the United States. Nevertheless, Chavez has increasingly made efforts to diversify his oil clients in order to lessen the country’s dependence on the United States. The GAO report says the sudden loss of Venezuelan oil in the world market would raise world oil prices and slow the economic growth of the United States.

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