Why Higher Oil Prices Won’t Save Venezuela
When oil prices started their collapse in 2014, plummeting from well above $100 a barrel to just over $29 by early 2016, the market drama sent shockwaves across the global economy, producing winners and losers. Oil importers benefited from sharply lower import costs, while producers’ economies, particularly those that rely on oil for the majority of their exports, went into crisis mode. The financial pressure persuaded many countries that had been overly dependent on oil to enact reforms that they had long known were necessary, but were also politically risky.
Now that crude prices are rising again, the political and economic pressures are easing on oil exporters as revenues, in most cases, begin to surge. But there is one glaring exception, one country that relies on oil exports for essentially all its export revenue and whose economy is continuing its downward spiral despite the sharp rise in oil prices: Venezuela.
The simplest way to gauge the impact of oil price fluctuations on the economy and the potential effect on policy is to look at an exporter’s fiscal break-even price. The break-even price is the minimum oil price level that will allow an exporter to meet government spending and produce a balanced budget. When crude prices fall below break-even, budget deficits start to balloon, eroding reserves and threatening economic stability. Depending on the availability of other exports and the size of reserves, large gaps between break-even and market prices can force a government to cut spending, raise taxes and borrow heavily. It can squeeze an economy well beyond the oil industry.
The most dramatic response to the drop in global oil prices came in Saudi Arabia, where an ambitious and daring crown prince, Mohammed bin Salman, launched revolutionary reforms with an eye toward, among other things, reducing the country’s overreliance on oil. While the success of many of his reform plans remains unclear, the crown prince’s efforts to lower Saudi Arabia’s break-even price has been little short of spectacular. Before prices fell, Saudi Arabia’s break-even price was $105.70 per barrel. The government has since slashed expenditures by about one-fifth, cutting subsidies and other expenses, and raising taxes. The break-even level now stands at $74.40, and a recent study by a Japanese bank predicts it will reach $55 a barrel by 2021, giving the kingdom ample room to finance Crown Prince Mohammed’s goal of diversifying the economy.
Other Gulf states have also moved to narrow the gap, introducing a value-added tax, lowering subsidy payments and promoting new industries. Now, with oil prices climbing, these petroleum producers are set to reap a sharp rise in revenues against a lowered level of national expenditures.
The contrast with Venezuela could not be starker. Despite the rise in prices, Venezuela, holder of the world’s largest known oil reserves, is seeing its oil income continue to plummet, along with the rest of its economy.
Venezuela’s cost of production, around $20 per barrel, is higher than that of Middle Eastern producers. But it is well below the current price of around $70 per barrel, which should be enough to dramatically improve Venezuela’s conditions.
Under normal circumstances, even if Venezuela had used the market turmoil to diversify away from oil, a jump of 150 percent in the average crude price over the past few years would have amounted to a surge in revenues to government coffers. But precisely the opposite is happening.
Oil still accounts for an estimated 98 percent of export earnings, but Venezuela’s oil operations are in a state of collapse. Output is falling and the many maladies afflicting Venezuela are bearing down on its oil industry, crippling its ability to save the state.
As Maduro’s regime becomes more desperate, it is mortgaging Venezuela’s most valuable asset, its oil reserves, to the benefit of Russia and China.
In a surreal moment last week, Gen. Manuel Salvador Quevedo, the president of the state-owned oil company, PDVSA, organized a Catholic mass to pray for increased production. That PDVSA is run by a general is just one sign of the way politics has invaded the oil industry, with President Nicolas Maduro appointing loyalists rather than oil experts to run such a crucial part of the economy.
Venezuela’s oil output stood at 3.5 million barrels per day in 1998, when Maduro’s predecessor, Hugo Chavez, came to power. Since then, incompetence, politicization, corruption and criminality have conspired to let facilities fall into disrepair, and to prevent experts and outsiders from righting the sinking ship of the national oil industry. Output has sunk to just 1.3 million barrels per day and is expected to fall below 1 million before long. Venezuela used to be one of the top suppliers to the United States, but now Colombia, with a much smaller oil industry, has surpassed it. The situation is so dismal that last month Venezuela informed customers it would not be able to fulfill its orders.
PDVSA is caught in a vicious cycle. Because it produces less, the government has less money, so it invests less on maintenance and exploration. The government does not release statistics, but the economy is in a deep depression, contracting sharply year after year. Government spending far beyond its means is triggering record-breaking hyperinflation. Last year, the government spent an estimated $160 billion and took in revenues of less than half of that, $78 billion. The International Monetary Fund projects a GDP contraction of 15 percent this year, with inflation near an astounding 14,000 percent.
PDVSA workers are leaving their jobs and the country in droves. By one count, 10,000 workers left in a single week in January, tired of holding other jobs to make ends meet because their salaries, in local currency, are worthless, while their jobs are increasingly dangerous due to work accidents from poor maintenance and relentless violence from common criminals.
Foreign investors might be a solution, but foreign oil companies, too, are struggling in Venezuela. Chevron evacuated its executives after authorities arrested two of its employees over a contract dispute. The workers say they had refused to sign a contract that was a pathway to extortion.
Foreign firms are reluctant to abandon their Venezuelan assets and take steep losses if they leave, but many are doing it anyway, writing off their investments and declaring that living conditions, corruption and continuous crime make it too difficult to stay. France’s Total has sharply cut back its operations in Venezuela, while Spain’s Repsol already wrote down $1 billion in Venezuelan assets. Halliburton wrote off all of its investments there, as did others.
With Western firms throwing in the towel, the field is open to Russia and China, with Moscow increasingly becoming Venezuela’s savior. China has stepped aside lately, fearing it might lose its investment after financing the regime in Caracas for years. But Russia’s Rosneft is moving in, offering financing in exchange for ownership.
As Maduro’s regime becomes more desperate, it is mortgaging Venezuela’s most valuable asset, its oil reserves, to the benefit of Russia and China. Rising oil prices may be helping other petroleum producers regain their prosperity. But in Venezuela, the problems are much more serious than market fluctuations, and they will endure long after crude prices stabilize.
Frida Ghitis is an independent commentator on world affairs and a World Politics Review contributing editor. Her WPR column appears every Thursday. Follow her on Twitter at @fridaghitis.