Friday, May 20, 2005

May 20/05 - On the Revolution's Oil Strategy: The Oil & Prosperity equation re-examined

PMBComment: ever since he beat off efforts to recall him, many have predicted that Hugo Chavez will get into trouble only if, and when, oil prices fall from their lofty levels. My response has always been: "Hugo Chavez will get into trouble no matter what, because that is his preferred state of being, and because our oil & prosperity equation is somewhat more complex than: x ≥ y = 25,000,000 flourishing citizens, where x = price per barrel and y, an unknown variable".

Current developments have proven that facts are more powerful than the wishful thoughts of those who still believe that we are dealing with a rational and secure leader just because he: 1) won, or stole, a few elections, and 2) has a asphyxiating stranglehold on the core institutions of our society.

Over the last few months, numerous reports have appeared in the mainstream and specialized media about the state of affairs of Venezuela's once mighty Petróleos de Venezuela and its once envied US affiliate CITGO. This Op-Ed in today's WSJ mocks the Government's response to this grave crisis. The Chávez government has chosen to accuse the "traitorous opposition", "the CIA" and those it recklessly fired after the 2002-2003 national strike for problems that are solely the responsibility of those "revolutionaries" who have been calling (missing?) the shots for the past six years in the country, and particularly in its oil ministry and PdVSA.

If credit is due for "19,000,000 interventions (sic) by Cuban doctors", and "2,000,000 people alphabetized in just 18 months (sic)", they – Chávez & Co. - should also be prepared to accept responsibility for destroying 70 to 90 billion dollars in value in PdVSA over six years in which oil prices have rocketed.

While it is difficult, if not impossible, to value PdVSA today (due among others to the fact that it has not prepared or presented financial statements since 2002), it is clear that you would have to compare any value presented today with the 100 to 150 billion dollars range that resulted from the 1997 valuations commissioned to Morgan Stanley and Goldman Sachs by the Board Of PdVSA. Had Venezuela followed the path of; the UK, Spain, France, Italy, Brazil and China, and floated a small percentage of PdVSA non-voting shares in the local and global equity markets, we would have had an objective indicator of the rate at which value was being destroyed (just as we saw in the Yukos meltdown) and might have even avoided the triumph of criminal whim and neglect over rational professionalism.

Finally, Chávez and Co. seem to understand that they have to get ready for the day in which their "bought" popular support can no longer be "purchased" nor kept placidly in the barrios. Fear of popular discontent in the event oil prices head downwards, or PdVSA simple putters out, might be the reason behind Hugo Chavez's current and risky military maneuvers. If hoodwinked people take to the street, he will need a more loyal, more unswerving, clash force, and that means he has to replace – as soon as feasible - the current command structure in the military (groomed under NATO Military Doctrine) with militia officers better "equipped" psychologically to defend the revolution (trained in and out of Cuba using Cuban, North Vietnamese and North Korean tactics).

If all above is indeed correct, the abrupt end of the oil boom might not spell the end of Chavez, but it will likely put an end to peace and democracy as we came to know it in Venezuela . PMB

Wall Street Journal


Oil Wells Refuse to Obey Chávez Commands


May 20, 2005

"We have a little problem," Venezuelan President Hugo Chávez reportedly told Venezuelans on May 3, "and we are fixing it."

The "problem" is the drop in output by the Venezuelan state-owned oil company known as PdVSA. The Chávez fixes, thus far, have entailed sending military troops to the oil-rich west of Venezuela to investigate "management errors" and allegations of sabotage, while in Caracas the government is threatening foreign oil companies with contract cancellations and tax hikes.

For most chavistas this may suggest that the whole stink about Venezuela 's oil industry's underperformance is about to be resolved. Yet it is likely that the magnitude of the drop in petroleum output is a lot bigger than what Chávez has described. It is equally probable that a military invasion of PdVSA and property confiscations in the private sector won't fix it. Statist economic policies have a sorry productivity record and in this case that record is highly unlikely to be improved.

The big trouble is that Chávez has put Venezuela on a centrally planned economic path not much different from the failed experiments of the 20th century. Indeed, last year he declared that Venezuela was preparing for "the great leap," a seeming reference to Maoist China's 1950s agricultural policies that spread famine. Maybe his books about Chairman Mao never mentioned that disaster.

Closer to home, Chávez emulates Fidel Castro, who once commanded that a 10-million-ton sugar harvest spring from the soil. Fidel also promised to clone a prolific wonder-cow called "Ubre Blanca," so that Cuba would promptly rival Switzerland in cheese yields. Almost 50 years into the revolution, Cuba still isn't Switzerland and milk is a luxury. Venezuela is on the same trajectory.

Chávez has at least one thing right: Tight control of the country's political agenda requires tight control of the country's economy. In Venezuela , that means controlling PdVSA.

PdVSA was born in 1976. Until the Chávez government came to power in 1999, the company made some effort to be politically nonpartisan. Getting a job at PdVSA required business, engineering or technical know-how, not political connections.

That has changed. Not content with just the golden eggs, Chávez wanted the goose. As he began to consolidate his power, he began politicizing both the management and labor arms of the company. That prompted a 66-day strike by employees on Dec. 2, 2002 , which brought production levels as low as 150,000 barrels per day (b/d). When the strike ended on Feb. 4, 2003 , 18,000 workers were let go, taking the skills and knowledge necessary to run the company with them. PdVSA has never fully recovered.

Today Chávez claims that production is down by a mere 200,000 b/d for a daily output of 3.1 million barrels. Industry experts dispute this and this month critics grew more vocal.

On May 4, Alberto Ramos, an analyst for Goldman Sachs' Emerging Markets Economic Research, noted that since the strike local and international oil analysts have consistently put PdVSA production some 500,000 to 600,000 b/d below government claims. "Such level of production is also corroborated by production statistics published by OPEC and other international energy agencies."

Venezuela's El Nacional (a daily newspaper) Web site issued a similar report on May 15 -- according to a translation by BBC Monitoring Americas: "An extensive survey of oil industry engineers, geologists, geophysicists and experts indicates that corrective measures have not been taken and the decline in Venezuelan oil production is nearing 1,000,000 b/d. This drop, coupled with a shortfall of associated natural gas, creates an alarming situation with the foreseeable consequence of diminishing crude oil extraction."

In his report, Mr. Ramos also noted that "several oil analysts" attribute the company's inability to return to pre-strike levels of production to "corruption, mismanagement, inadequate investment levels, sloppy maintenance, and lack of qualified technical personnel."

Maintenance, management and qualified personnel can be traced to the strike and the layoffs. It is also possible that disgruntled employees are not toiling as they did when they felt they were measured by their work, not their politics. Yet human capital is but one factor of production. Investment is also scarce and likely to grow scarcer as Chávez puts the squeeze on foreign oil companies.

Since being named president of PdVSA, Chávez ally Rafael Ramirez has been working to expand the company's control of the entire industry. On May 6, the research firm Oxford Analytica reported the government is arm-twisting to force the conversion of 32 foreign company contracts into joint ventures that will give the government 51% ownership. The newsletter also said that the government wants -- as prescribed by Chávez -- to raise income taxes on foreign oil companies to 50% from 34%. On Tuesday, Reuters reported that Venezuelan tax authorities "held a second round of talks with seven foreign oil companies, including units of Chevron and Shell" on the matter. The government has also said it will no longer pay foreign oil firms in dollars.

Added to the drain on human and financial capital, are serious internal problems that this power grab is producing at PdVSA. Oxford Analytica writes that Mr. Ramirez fired 30 "Chavista managers" on corruption grounds soon after he took over his post -- although he did not present proof.

Oxford Analytica said that the move was "interpreted inside the Chavista movement as Ramirez settling old scores with high-ranking executives of the previous PDVSA administration." This has provoked an increase in job insecurity among chavistas who thought their politics gave them security. Analytica says that, "crossed accusations of corruption based on leaked internal documents have increased among different Chavista factions."

Mr. Ramos notes that "aggressive" policies toward the private sector and weak investment in PdVSA "raise serious risks of a further gradual decline in oil production," making Venezuela all the more vulnerable to a drop in world oil prices. It's quite possible that Chávez will have no more luck commanding oil out of the ground than Fidel had getting cows to give more milk. The "great leap" is looking more and more like a great flop.