How could Venezuela, the country with the largest oil resources in the planet — which received the largest commodity windfall in Latin America’s history and had the highest income per-capita in the region — end up with the worst economic depression, hyperinflation, and humanitarian crisis in the region’s documented history? One key aspect of this debacle is the steady destruction of the oil industry on which the country’s has been heavily dependent, accounting for more than 90 percent of its exports.
Venezuela has so much oil that it will most likely only extract a small fraction of it before it potentially becomes obsolete. The country could be producing 6 million barrels per day (bpd), more than seven times what it produces now, if it had taken advantage of the high oil prices in 2003-2014 and executed the investments that had been planned. Instead, Venezuela was one of the few oil exporters in which production declined during the price boom and the only one in which production collapsed after the price fall.
Hugo Chávez took power in early 1999, when the oil price was at a historical minimum, but starting in 2003 he benefited from a massive oil price windfall. In total, under his government, Venezuela received the equivalent of more than one trillion dollars in oil revenue. More than 20 percent of this revenue was wasted in massive energy subsidies, which are generally inefficient and disproportionately benefit those better-off. In addition, he more than quadrupled the external debt to around $150 billion. In the middle of the oil price boom, the country experienced a consumption boom and ran massive fiscal deficits. In the short term, this resulted in a significant reduction in poverty and boosted the president’s popularity. But economic growth was the lowest in South America.
Chávez not only benefitted from the oil price boom, he was helped by the oil opening done by the previous administration, which attracted large private investments, adding more than 1 million bpd of privately operated production. Thus, it is the more shocking that, by the end of 2018, before oil sanctions were imposed by the US, Venezuela produced barely 1.2 million bpd, close to a third of the 1998 production and equivalent to what the country was producing in the 1940s. How could such steep collapse happen in such an advantageous environment?
The story starts with the destruction of PDVSA, Venezuela’s national oil company. In 2003 after a protracted oil strike, Chavez fired close to twenty thousand PDVSA’s employees, including the vast majority of its managers, engineers, and geologists. In the next few years, the company was politicized and became a patronage machine of the ruling political party and a de-facto development ministry. As a result, PDVSA started experiencing severe financial problems, years before the collapse in oil prices in 2014. Widespread corruption inflated costs and reduced efficiency. The government obtained large loans from China and Russia, to be repaid with oil, committing its future exports. In addition, starting in 2005, Chávez forcefully renegotiated contracts and partially expropriated private oil ventures. As a result, no relevant new oil projects were developed since.
The fall in oil prices in 2014 was the final blow, which led to a steep collapse in investment. Debt default and financial sanctions closed the financial markets to PDVSA. During the last two years, widespread equipment theft, militarization, and worker desertion have compounded the problems. Creditors and claimants from expropriations have sieged the company, looking to get paid. The goose that laid the golden eggs was left to die.
How to rebuild Venezuela’s economy? The country needs a massive stabilization and rescue package from the IMF and the international community, estimated in more than $90 billion. At this point, such support is required to ease the severe foreign currency restrictions, jumpstart the economy, abate the hyperinflation, and mitigate the humanitarian crisis. Venezuela’s massive debt has to be restructured and the perverse controls on the economy lifted. Security has to be improved and property rights and the rule of law reestablished. Energy subsidies have to be removed and instead citizens should receive direct compensatory cash transfers.
The oil industry can recover. It would require attracting massive foreign oil investment by establishing a credible institutional framework centered on an independent regulatory agency. There are several examples in the region that provide guidance including Brazil, Colombia, and Mexico, which successfully implemented reforms to lure investors while obtaining a competitive government-take on profits. PDVSA would have to be resized, restructured, depoliticized, and refocused on its core business. It would only have a limited capacity to invest given its current level of production and debts; as a result, most investment would have to be done by international companies. Crucial for the framework is also social consensus, to assure that it does not sow the seeds for a future wave of resource nationalism, as it occurred with previous oil openings. It should ensure that the government share of profits increases with windfalls produced by high prices or large discoveries.
Oil investments, and the fiscal revenues that they generate, would help to give the broader economy a significant boost. However, if the country is to be economically successful and democratically viable, it would require learning from past mistakes and developing its significant potential in other economic sectors. Petro-populism has proven disastrous. Oil wealth is not going to be enough. During the last price boom, crude exports generated around US$2000 per capita, much less than in Venezuela’s prosperous past and not nearly enough to support a thriving economy in the future. In addition, one needs to take into account that global de-carbonization policies will likely reduce the life horizon of hydrocarbons.
The widespread success of members of the Venezuelan diaspora provides evidence that Venezuelans can thrive around the world if provided with freedom and incentives, instead of obstacles and controls. The talents, capital and networks of the diaspora could be instrumental in recovering the oil sector, but also in unleashing the country’s potential in oil equipment and services, engineering and construction, tourism, logistics, and manufacturing.
Again, this is not unprecedented. In countries like Chile and Peru, traumatic shared experiences, like hyperinflation, have generated societal consensus towards having macroeconomic prudency, allowing markets to function, developing effective social policies, and limiting distortionary state intervention. That consensus seems to be developing in Venezuela. Moreover, this time around, most oil exporting countries managed the oil boom and bust cycle decisively better. Venezuela can and must do it too or it will continue to be the victim of commodity cycles and the poster child of the resource curse.
This post originally appeared in the Forbes blog on June 12, 2019.
