Venezuelan Oil – The Unfulfilled Promise

Background
Winston Churchill once said that: "Russia is a riddle wrapped in a mystery inside an enigma". One is reminded of these words when approaching the subject of Venezuela's oil strategy in the last few years.
Venezuelan politics, and by implication its economy, have always been a product and a hostage to oil and the capriciousness of the oil price. A founder member of OPEC, and throughout history a very vocal, and at times vociferous advocate for the rights of the sovereign state against the international oil companies, Venezuela is today the archetype of an oil producing and exporting country that does not seem to be able to leverage its resource base into sustainable development for its population.
Ever since the nationalization of its oil industry in 1975, in the wake of the then oil price bonanza, Venezuela's oil strategy has struggled to find a consistent direction between two seemingly contradictory objectives. On the one hand to maximize the rent per barrel either through increasing fiscal pressures or embracing OPEC's strategy of production quotas to raise prices, and on the other, to increase production in the hope of fostering growth in the non-oil economy.
At the risk of oversimplification, one may argue that this as yet unresolved dichotomy lies at the heart of the strategic seesaw with which one can characterize Venezuelan oil strategy in the last fifteen years.
-->In 1970 Venezuela reached a production peak of almost 3.8 million B/D, out of proven reserves of the order of 14.000 million barrels. By 1988, production levels had fallen to almost 1.5 million B/D and reserves had risen almost 59.000 million barrels. During the same period Saudi Arabia, had increased its production from 3.8 million B/D to 5.1 million B/D (going trough a peak of almost 10 million B/D in 1988), and increasing its booked reserves from 141.000 million barrels to 255.000 million barrels. [1]
Today Venezuela claims booked reserves of the order of 80.000 million barrels, and has announced that it expects to book an additional 50.000 million barrels in the next 18 months. However, its level of production still hovers between 2.5 and 3.1 million B/D, depending on whose numbers one chooses to believe, but still quite far from the potential its resource base should allow.
Does Venezuela have long term oil strategy?
When the present administration came to power in 1999, the Venezuelan oil industry differed significantly from the modest beginnings after nationalization in 1975. The production levels were still around 3.1 million B/D and reserves in books had risen to a staggering 77.000 million barrels. PDVSA, the state owned company, had evolved from a Venezuelan based E&P focused outfit, into a world class corporation with significance presence in the downstream of its primary markets in the USA and Northern Europe, and with plans to penetrate the Latin-American and Asian markets.
Furthermore, as a consequence of a change in its investment strategy, Venezuela had managed to attract back foreign investment through the structuring of a various upstream business opportunities, the so called 'Apertura Petrolera' (opening of the oil industry). This strategy was inscribed into the wider vision of leveraging the ample resource base and the market opportunities identified in Asia and South America, into an aggressive growth plan of the production and refining capacities, in and out of Venezuela
-->The inertia and robustness of those plans, in particular the huge investment that the IOC's were still making in the late 90's, guided the oil strategy of the incoming government during the initial years, despite the fact that the collapse of the oil price in 1997, and the promises of the then presidential candidate, called for a sudden change of direction.
Since then, and despite a nominal adhesion to an aggressive expansion plan ('Siembra Petrolera', circa 2006), very similar to what previous administrations had pursued, one can safely surmised that the real strategic intent of the administration is the maximization of the oil rent and therefore the fiscal revenues for the central government. As we will discuss below, this has been somewhat at the expense of economic efficiency and long term sustainability.
This strategy of rent seeking can be characterized under three headings:

a. Production quotas to maintain high oil prices

b. Increase political control over the oil industry

c. To use oil and oil revenue as political weapon (nationally and internationally)

-->OPEC Quotas
OPEC quotas have always been difficult and economically painful to implement for the Venezuelan oil industry. This is a consequence of the low productivity and relative high cost of production of its reservoirs, and in particular, the result of the complex mesh of relations between the oil industry and the rest of the economy (gas for manufacturing and electricity generation, social impact in communities, marketing strategies, downstream integration, operational downturns, etc.)
From 1999 onwards, and at great cost to the efficiency of the industry, the Venezuelan government has embraced wholeheartedly OPEC's strategy, at least nominally, and has been rewarded with an increase in oil prices, that the administration attributes to itself and its action.
Without getting involved in the discussion of whether or not OPEC's discipline is the main reason behind the historical level of prices or not, the end result of the strategy is that Venezuela, because of the constraints briefly mentioned above, always ends with the short end of the stick. In 1998 OPEC's production was 27.37 million B/D, of which Venezuela contributed 3.12 million B/D. By 2005, OPEC's production had increased to 30.67 million B/D, of which Venezuela still remained at 3.12 million B/D (At the time of publication, and apparent slip by the OPEC bureaucracy let the world know that Venezuela's production quota is now 2.4 million barrels per day, which has put under an uncomfortable light five years of official Venezuelan production figures). One is reminded of Orwell's Animal Farm: "All animals are equal, but some animals are more equals than others".

Political Control
Ever since nationalization, the political actors in Venezuela characterized PDVSA (the state owned oil company), as too independent and difficult to control.
--> The expression "a state within a state" was freely used by all sides of the political spectrum. After the crisis of 2002/3 which resulted in the firing of more that 20,000 employees (including almost all the management) and the resulting reorganization of the industry, PDVSA has now lost all its independence to pursue its own industrial strategy. The most telling sign of this loss of independence is that the minister of energy and petroleum is now, at the same time, the representative of the shareholder and the chief executive of the corporation. This in itself is not much different than the structure utilized by other NIOC's in OPEC countries, but for a constitutional republic such as Venezuela, it represents a significant loss of the orthodox mechanisms of balance and control.
The most significant part of the new political control is the so called 'new nationalization' of the oil industry, carried out since 2005. This is basically the renegotiation of all the contracts that PDVSA entered into during the 1990's with private oil companies, both national and international.
A complete treatment of this subject is beyond our scope. Suffice to say that the increase of the oil price well above the expectations of the industry when all this contracts were signed, highlighted asymmetries in the rent distribution that were politically difficult to sustain for any government.
The government has taken advantage of this very rational argument as an opportunity to extract political capital out of the situation, by colouring the whole exercise with the politically popular palette of nationalism, The net result of this exercise, which still has not ended, has been the reluctant acceptance of the private companies of the terms imposed by the government, as price to pay for remaining in what is still one of the world's most promising oil provinces, but at the expense of an uncertain investment climate and reduced production share.
-->One has to admit that the gap between the discourse and the implementation can be very confusing at times. The migration of the 32 Operating Contracts into Mixed Capital Companies, where the private operators now have equity rights over oil, is called "Recuperation of Sovereignty". The reduction of the equity share of the private companies in the four Strategic Alliances that exploit the Orinoco Belt, from 60% to 40%, is called "Nationalization".
The fact of the matter is that the rent distribution has been redrawn in light of the new market realities, and that the private companies, although significantly weakened, still remain an important factor in the Venezuelan Oil industry. Indeed, one may argue that without their continuous presence, the Venezuelan oil sector will be in even greater dire straits.
It may be, after all, that the rumours about the death of the "Apertura Petrolera" have been greatly exaggerated. At the time of writing this essay, some IOC's have decide to abandon Venezuela altogether, after what they qualify as severe breaches of their contractual rights by the Venezuelan government.
Oil as a Geopolitical Weapon
The Venezuelan governments are no strangers to using oil to further its geopolitical objectives in the region. The present administration, however, has taken this to a new level, both internally and internationally. Although most its initiatives are still mostly announcements, and one can not be sure of their sustainability in time, its undoubted that the promises of the supply of gas, oil, oil products at reduced prices or with generous financing terms, not to mention direct assignment of hard cash, have attracted a lot of sympathy from governments in and out of the region.
The fact that most of those promises, in particular those associated to the financing of ambitious infrastructure projects such as refineries in south and central America, a gas pipeline to be built through the Amazon rain forest, the gas pipeline to Colombia, and a myriad of other projects are unlikely to be fulfilled, does not stop the strategy from being geopolitically effective, much to the chagrin of the traditional powers in the region: USA, Mexico and Brazil.
-->From the recipients' perspective, it would be a political suicide to refuse the offers from a country that has such a huge resource base of fossil fuels, in a continent that has a net deficit of energy, at a time of high prices. However, this strategy has one major Achilles'' heel: it depends on Venezuela being able to tap its resource base into long term sustainable production streams.
What of the future?
The easiest answer to the question of what lies ahead, at least in the short run, is one of continuity. Why change a winning game? However, there are some important caveats to keep in mind when one tries to look beyond the next OPEC meeting or the next headline by the Venezuelan president:

a. Will Venezuela continue to bite its tail in regards to its production capacity strategy? Will it continue to sacrifice its market share for a sustained per barrel rent?

b. With an ever growing demand for barrels for the Venezuelan internal market, will it continue the subsidies? Is Venezuela going down the route of Iran and become a gasoline importer?

c. Why is Venezuela intent in booking more reserves, however fragile, if it has no intention of going beyond the OPEC restraints?

-->

d. When the time comes to develop the technically challenging Orinoco Belt, or its offshore gas reservoirs, will it call back the IOC's, or will it keep faith with its new allies the Iranian, Russians, Chinese and Argentineans? Can these new actors deliver?

e. At a time of a huge world demand for technical and physical resources in the energy sector, have the Venezuelans priced them out of the market?

f. Either way, what is the answer to the old age question of whether the state should invest in the oil and gas industry that keeps the country afloat, or invest in what is after all the state's real health, education and infrastructure?

When 2007 is safely archived into the annals of history, the present administration will have put to rest all the alleged warts that they have assigned to previous oil policies. Still, the administration will have to find the answers to that old question: how to transform the country's generous resource base into sustainable benefit for their citizens? And in the process help quench the thirst for energy of their partners in trade.
For that they will have to find new ways of looking at the relationships between resources and wealth, control and participation, mistrust and alliances. This question has always been a Sisyphean riddle for this oil blessed/cursed country.
-->It is a great and difficult challenge for any country, but in particular to one so entangled in ideological dogmatism and with the pressures of a very poor and impatient population. If one is to judge by present evidence, Venezuela is heading for a Gordian knot, for which they have no Alexander in sight.

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[1] All figures from The OPEC Annual Statistical Bulletin, 2005

Published in The Oxford Energy Forum, Issue 70, August 2007, Oxford Energy Research Institute