How a 'Venezuelan Spring' could push down oil prices
Matthew Partridge Feb 28, 2012
Political risk is being blamed for driving up oil prices. The looming threat of Iran, the constant risk of further money-printing by central banks, and concerns over unrest in Saudi Arabia are three that we’ve covered.
However, it’s worth pointing out one political risk that – in the longer run - could end up making crude oil cheaper. We’re talking about Venezuela.
It turns out that Venezuelan president Hugo Chavez is sicker than previously thought. This could force him to stand down – creating a power vacuum. And even if he continues in office, he could lose the election in October.
Chances are, any change in government could result in a major boost for oil production in Venezuela. It might even help to curb the power of both Iran and Saudi Arabia. Here’s why.
A tale of two economies
The experience of Brazil shows how developing countries can take advantage of a commodity boom. In the last decade, Brazil has paid down its debts, becoming a net creditor. It has also invested in roads and ports.
This has led to a virtuous circle of increased economic growth, rising living standards and increased foreign investment. Adjusted for prices, Brazil is now the ninth largest economy in the world. Towards the end of last year, credit rating agency Standard & Poor’s upgraded its debt.
Venezuela has done exactly the opposite. Since Chavez came to power in 1999, he has wasted oil revenue buying votes and supporting countries such as Syria and Cuba. His decision to take 300 private companies into public ownership - many without compensation - has scared investors away.
The oil industry has been hit hard by Chavez’s policies. Not only did he reverse plans to let the private sector have a greater role, he raised production taxes and fired a large number of oil workers for political reasons – starving the state oil company of talent.
The 'Chavez effect' on oil production is easy to demonstrate: in 1998, when the price of crude oil hit a low of under $11 a barrel, Venezuela produced 3,167,000 barrels of crude oil a day. Twelve years later, despite record prices, output was only 2,090,000 barrels a day – nearly a third lower.
Could Chavez step down?
Despite these economic failures, Chavez was re-elected in 2000 and 2006. He runs what some call a 'soft dictatorship'. Although the law allows free speech and free elections, these rights do not exist in practice.
Those who speak out against the regime may lose their jobs or have their firms taken over by the state. Critical papers and TV stations have been banned. Voters also face intimidation while the opposition has been heavily divided. This has made it hard to effectively challenge Chavez.
However, these things may be about to change. The opposition has finally united behind a single candidate, Henrique Capriles. Despite high levels of official pressure, huge numbers of people turned out to vote in the opposition primary.
More importantly, Chavez may not make it to the election. Last year doctors found that he had cancer. Earlier this month he returned to Cuba for more surgery. However, the follow up radiation treatment will make it hard for him to work full-time.
Ray Walser of the Heritage Institute tips henchmen Diosdado Cabello, Rangel Silva and Adan Chavez – Hugo’s brother - as possible replacements. But Andrew Cawthone of Reuters believes that “none of the figures around him has his charisma, political and rhetorical skills”. Overall, says Walser, “if Chavez dies, I think the chances are good for a reformist. Even if he does not I think we could see the Bolivarian movement self-destruct”.
Of course, even if Chavez dies or loses the election there is a chance that his cronies could still cling to power. In 2002, a popular uprising forced him out of office, only to see pro-Chavez forces remove his successor from power. Since then Chavez has put his supporters in key military positions. He has also devolved power to political militias, and worked with Russia, China and even Iran to arm himself to the teeth. A civil war could stop all output – increasing the price of crude.
It’s all about the long run
Even if Chavez goes in October, there will be little short-term impact on oil prices. When he leaves office, the state firm PDVSA is also likely to be sued over the seizure of assets in 2008 and 2009, delaying any investment. Foreign firms are likely to hold back until the political situation has calmed down.
However, the ability of a free Venezuela to lower oil prices in the long run is huge. The US Energy Information Agency (EIA) thinks that Venezuela has the second largest levels of proven reserves in the world. Oil cartel Opec even claims that it could have more crude oil than Saudi Arabia.
A committed private sector player could even find the huge amount of sea oil that is not currently viable. This would bring the total amount up to 513 billion barrels.
Clearly, this isn’t a story that will have an instant impact on investors. But in the long run, Venezuela could be a ‘game-changer’ for oil prices. We’ll be keeping a close eye on it and watching for potential opportunities.
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.