Tuesday, August 22nd, 2006
Caracas and Washington: Though Politically Divorced, the Economic Union Goes on, Despite Worries Over Oil Shortages

As the ideological battle between Washington and Caracas continues, policy makers are worried that Venezuelan President Hugo Chávez might limit oil exports to the U.S., either by intention or by production shortages
While the Government Accountability Office reports a decrease in Venezuelan oil production, substantial exports continue to flow to the U.S.
The reliance on oil shipments for both nations ensures that an economic marriage will continue

Washington’s incendiary response to Venezuela’s candidacy for the Latin American UN Security Council seat is indicative of its standard combative riposte to any serious challenge against the neo-liberal global economic order. However, no matter how sharp the Bush administration’s ideologically-driven criticisms of Venezuelan President Hugo Chávez appear to be, the security of its energy supplies clearly remains among Washington’s most important concerns. As the world’s fifth largest oil exporter and the fourth largest foreign oil supplier to the U.S. –
Venezuelan exports to the U.S. account for 15 percent of all U.S. oil imports – Venezuela serves as a top ranking economic partner. Recent rumors that Venezuela’s national oil company, Petróleos de Venezuela S.A. (PDVSA), cannot meet existing production quotas, along with fears of politically-inspired curtailments of shipments to the U.S, have increased speculations that the relationship between the two countries may be under severe economic stress. Examination of the economic realities of U.S.-Venezuelan relations establishes that as long as Venezuela feeds the U.S. with its contracted amount of black gold, this marriage of convenience will continue.

Strange Bedfellows

The Bolivarian Republic of Venezuela, an unrelenting force against U.S. regional hegemony, has a seemingly immutable economic link with the United States, no matter how troubling the political ties seem to be. Caracas possesses approximately 6.5 percent of global oil reserves and is currently exporting 68 percent of its production to its northern oil-guzzling neighbor . The majority of Venezuelan oil heading for the U.S. goes to refineries abroad that are capable of processing the sour and heavy feedstock . PDVSA owns five such refineries located in the U.S that are specifically built to convert Venezuelan heavy crude into a usable form. Considering the level of specialized Venezuelan investment that is required, the South American country would be hard pressed to cut off economic ties with the U.S., even if it wanted to.

While this economic bondage will have to remain for the foreseeable future, Chávez has taken steps to, over the long run, untie the Venezuelan economy from such a heavy dependence on the United States and diversify its potential oil markets. Venezuela has looked in particular to fast-developing China, whose enormous potential level of consumption could make it a more preferable option than the U.S. China, however, is still years away from possessing the refineries capable of processing Venezuela’s “sour” oil, requiring that Venezuela remains tied to U.S. markets if for no other reason than because that is where the refineries are located, as well as by the high cost of shipping such fuel to China as oppose to the U.S.

Oil Flows North: Dollars Flow South

The Bush administration’s relations with Caracas rapidly deteriorated after the U.S.-endorsed coup attempt against Chávez in April of 2002. Although the State Department ultimately was unable to assist the middle-class opposition in its attempt to handicap the leader, the desire to restrain Chávez has certainly not waned among U.S. policymakers . Washington’s failure to move past its ideologically-charged “Cold War” gutter diplomacy has distorted the direction of its ties abroad, arguably having a baleful impact on Washington’s full range of Latin American initiatives . The ramifications of this reality have been evident in the impressive amount of support for Venezuela’s bid for one of the non-permanent seats on the UN Security Council. But the increasingly volatile confrontation, at least until this point, has not at all interfered with the U.S. purchase of Venezuelan oil. According to the Senate Foreign Relations Committee, the continuation of exports of Venezuelan crude to the U.S. has not been interrupted by the exchange of hostile language between the two countries. Regardless of this increasingly splenetic ideological clash, the U.S. reliance on Venezuela’s status as its fourth largest petroleum supplier will be a factor that will continue magnetizing their relationship. While the ‘pink tide’ of left leaning South American nations may be of genuine concern to the U.S. State Department, Washington and Caracas will be pressured to maintain their ties as long as substantive alternate arrangements cannot be made in a timely and convincing fashion, and at least on comparable terms.

Threat to the Relationship: Rumors of Downturn in Venezuelan Oil Production?

According to Washington’s Government Accountability Office (GAO), Venezuelan oil production is in decline. This has greatly increased oil security fears. The question is whether Venezuela’s future oil output and investment levels will adequately maintain Venezuela’s present level of production, let alone allow for its expansion. While PDVSA, reports production of 3.3 million BD, rival data emanating from the Energy Information Administration (EIA) shows that Venezuelan exports have in fact fallen from 3.1 million BD in 2001 to 2.6 million BD in 2005 . Accordingly, exports to the U.S. have also marginally declined.

In the findings released by the EIA, the amount of barrels exported to the U.S. during 2006 is down 220,000 BD compared with the same period in 2005 . However, PDVSA and the Venezuelan government have denied that any production difficulties exist, or that a calculated curtailment of exports to the United States is in the works. In response to the apparent decline, PDVSA maintains that it is a result of the “market dynamic,” ambiguously suggesting that some exogenous market factors are affecting the nation’s production . According to the Financial Times, PDVSA-owned Citgo Petroleum Corp. has decided to discontinue their distribution of gasoline to 1,900 independently owned U.S. stations. This has added to speculation that there may be serious problems with the current Venezuelan oil supply chain. In any case, the current rumors regarding shortfalls in production levels could prove detrimental not only for current distribution channels but also on attracting new levies of direct foreign investment in the country. Luis Giusti, the former CEO of PDVSA, in appearing as a witness before the Senate Committee on Foreign Relations, noted that the Venezuelan government has ambitious expansion schemes for the state-run oil company, but none of these plans, however, have been executed . This further exemplifies Venezuela’s denial-mode response to any perceived problems with its oil industry.

Managing the downturn in production will require great technical expertise. If pointed in the right direction by Chávez and his advisors, PDVSA has the capability to overcome Venezuela’s potential oil production shortage. New funding and wider political support for the industry however, are imperative. As GAO analysis reveals, there is a “high correlation between Venezuelan oil production and net investments in Venezuela.” According to the UN Commission for Latin America and the Caribbean, if a decline in direct foreign investment continues in a similar fashion – from $2.6 billion in 2003 to $1.1 billion in 2004 – Caracas will become increasingly reliant on domestic investment in order to prop up the industry . If the output capacity continues to diminish, as oil experts predict, Chávez will have to decide whether he should curb domestic spending or restrain his otherwise ambitious foreign assistance plans. The implications deriving from the former will most likely affect Chávez’s national popularity, while the realization of the latter will inevitably impair the country’s mounting influence within the region.

Restraining Foreign Investment

As president, Chávez has asserted greater governmental control over the country’s oil reserves by limiting foreign investment. This was done by increasing the royalty rates paid by foreign oil companies from 16.33 percent to 30 percent, establishing a new extraction tax, and raising income taxes on foreign companies while instituting new provisions requiring joint ownership structures with majority shares assigned to PDVSA . Although a popular move among Chávez’s constituents, evidence exists that some foreign companies have consequently diverted their oil investments and have reduced their production in Venezuela.

Foreign Investment: A Necessary Evil?

Despite Chávez’s ambitions to obtain greater influence over Venezuela’s petroleum sector, foreign investment is essential for spurring its efficiency, maintenance and expansion. Moreover, U.S. investment in Venezuela has not waned significantly and the connection between the presence of U.S. companies and Venezuela’s economic success should not be underestimated. Recent developments in the Orinoco Belt, located in the eastern region of Venezuela where the oil has traditionally been scorned as having little commercial value, have caught the attention of various U.S oil firms and several foreign entities that possess the refineries capable of processing it. Oil companies are now desperate “for new sources as global reserves of traditional light crude taper off.” Despite Chávez’s aggressive attempts to obtain more oil revenues from both public and private companies via increased taxes and higher royalties, there are few indications that this will definitively stave off foreign investment. Foreign oil companies are accustomed to operating in hostile fiscal environments such as Russia, Nigeria and Ecuador making ventures in Venezuela a typical investment paradigm. Generally, the soaring costs of operating in a country highly sensitive to foreign companies are dwarfed by the potential short-term windfall profits . Considering this, the mutual economic gain in oil relations between the U.S. and Venezuela will most likely prevail over any dramatic political petro-posturing.

The Curse of Lofty Oil Prices

In spite of the aforementioned production problems, elevated oil prices have enabled the Bolivarian Republic to maintain its major presence within the hemisphere. Chávez has used his petrodollars to expand the nation’s infrastructure and dramatically increase social spending. Contrary to Secretary of State Condoleezza Rice’s meretricious condemnation of the socialist regime, this money has gone to significant social policy initiatives, “which spent more than $3.7 billion last year on social and agricultural programs, housing and other projects – about a third of PDVSA’s earnings.” These programs have cemented a high approval rating for Chávez and have all but ensured him victory in the upcoming December presidential election. With such popularity, the people of Venezuela expect him to keep his word and continue funneling a suitable percentage of the country’s petro-dollars directly into his social programs.

Nevertheless, the Venezuelan leader’s over-reliance on the soaring price of oil should be considered somewhat risky. Economies that exclusively depend on one commodity and make little effort to undertake economic diversification often experience, a corruption, instability and slowing down long term growth. Chávez would do well not to fall into this predictable trap. He would be better served using the windfall profits to build on the nation’s existing, if barely adequate, infrastructure, reform the oil industry and reinvest in PDVSA, improving efficiency and sustaining long-term upward curves in production. This will allow both Caracas to protect the nation from market vulnerability and secure the U.S. as a long term trading partner.

The Marriage Will Continue, Despite Threats of Divorce

Although some neo-conservatives within the Bush administration icily hint that the decline in Venezuelan exports to the U.S. represents a political move to injure the U.S. economically, in fact, the economic impact, regardless of its motive, is relatively small. Though the growing level of Venezuela’s state control over the industry is of concern to Washington, U.S. companies and refineries understand that Chávez is reasonably pragmatic and will not soon turn away from the indispensable services that foreign hands provide for the Venezuelan economy and its oil output. Despite the grossly exaggerated perceptions of Chávez’s global ambitions by U.S. officials, the strategic limiting of production or placing an embargo on oil supplies to U.S. refineries, categorically will not happen for a number of reasons; the most important being the damage it most certainly would do to Venezuela’s oil sector and the nation.

While the relationship remains convenient, Venezuela will continue to feed the U.S.’ vast demand for oil. As such, the issue of production should not be an immediate concern for the U.S. Congress, particularly for Senator Richard Luger, Chairman of the Senate Foreign Relations Committee, who commissioned the GAO study of Venezuelan oil production. Nonetheless, if the current confrontational relationship further deteriorates, the issue could become a critical political factor between the two nations. For now, however, the dual reliance on oil ensures that the marriage of convenience will continue, and that the future of this odd couple is as much in Washington’s hands as it is in Caracas’.

This analysis was prepared by COHA Research Associate Alastair Sussock