PDVSA: The hydro-carbon curse, a mutation of Dutch disease, and the house that Chavez built.

6 November 2014

As at Thursday,06 November 2014

Petroleos de Venezuela (PDVSA) is the Venezuelan state owned integrated petroleum company. It undertakes activities in oil and gas exploration, production, refining, distribution and exportation and the owner of CITGO a major fuel retailer in the USA.Since PDVSA was founded on the 1st January 1976 – when the Venezuelan oil industry was nationalised – PDVSA has dominated the oil industry of Venezuela. As a nation Venezuela is currently the world’s fifth largest exporter of oil and its proven hydro-carbon reserves are the largest in the world. If managed well, it can meet all its obligations with a great future.

The Chavez Years

When Hugo Chavez took office in February 1999 he began a long process of integrating PDVSA into his “Bolivarian-Socialist” economic vision for Venezuela. Chavez used funds from PDVSA spending lavishly on his constituents, creating the basis for large and popular electoral support, and effectively depriving PDVSA of the funds it needed for re-investment and maintenance. For the poor he spent heavily on social services, a health service staffed by Cuban doctors, an education system that offered free degrees from newly constructed universities, and new homes. To the rich he granted government contracts, and perhaps of greater importance, access to foreign exchange.PDVSA was redefined within Chavez’s concept of “Bolivarian Socialism” and ordered to diversify into areas outside of its core competencies. These areas included food importation and house building. Key positions within PDVSA were replaced by people sympathetic to the Chavez vision. Many of the quality staff that remained, over time, became disillusioned and left resulting in a significant “brain drain” of talent from the company. These factors have all combined to result in a fall in output with PDVSA now producing roughly 500,000 barrels of oil per day less than it did 15 years ago.

In comparative terms – not such a pretty picture

In the last 15 years Venezuela has received income from oil and gas of approximately US$1.5 trillion, and has produced close to 15 billion barrels of oil. Currently the country has liquid reserves to cover two months of imports and no oil stabilisation fund compared to Trinidad & Tobago’s 1 year cover and healthy Heritage and Stabilization Fund. In the same 15 year period the national debt of Venezuela has increased by a factor of seven.
Compare this as well to Norway who have produced 20 billion barrels of oil since 1971 when it commenced exploration activities in the North Sea. Norway has a stable and diversified economy, and has an oil stabilisation fund of close to US$720 billion that can act as a buffer against short term shocks caused by falling oil prices.
Dutch Disease 

Did Venezuela Suffer from Dutch Disease?

Dutch disease in its purest form, occurs when a country that is excessively dependant on income generated from commodity exports, experiences a significant and sustained income windfall from its commodity exports.The inflow of foreign currency derived from the imports, raises the demand for local currency, resulting in an uncompetitive exchange rate. The impact on the exchange rate, if not addressed, can significantly derail the country’s’ other non-commodity exports making them uncompetitive and in addition, can stimulate a significant increase in imports making it hard for domestic producers to compete with imports.Dutch disease is so named because this is exactly what happened to the Netherlands in the 1970’s as a result of the windfalls arising from the exploration of North Sea gas. The Dutch over time recovered from the disease but other countries such as Nigeria have never recovered. There is certainly evidence to suggest that Venezuela has suffered from a form of “Dutch Disease”. Whilst it is true to say that the export of oil and gas has dominated the Venezuelan economy (and at the same time exports of virtually everything else have more or less collapsed), and imports have flooded into Venezuelan markets, this is only part of the story.

Lack of accountability

Oil income that should flow into the Venezuelan central bank has in large part been diverted from PDVSA into a development bank often referred to as “BANDES”. The development banks trading activities are controlled by the President, the Minister of Finance, the Minister of Planning, and the President of PDVSA.BANDES has utilised these funds for partisan purposes including the funding of presidential campaigns in other countries such as Bolivia, Argentina, Ecuador and Nicaragua. Billions have also been utilised to support the activities of Petrocaribe, and specifically to support the Castro regime in Cuba.Billions have been spent, all with very little thought to any concept of accountability. Venezuela has certainly suffered from a form of “Dutch disease”, but it has also been coupled with an infection of the country’s politics.

The Mistakes Made

  • Building and maintaining a business like PDVSA requires continued re-investment. Diverting cash resources from the company to fund social and political agendas has starved PDVSA of the resources it needs to create growth. When oil prices are high the problem is less evident, but when they tumble as they have done over the last six months, the problem becomes acute because the only short term solution is to produce more oil (something PDVSA appears not in a position to achieve).
  • Filling senior positions in PDVSA with politically sympathetic appointees created significant problems. First it bloated the company with additional staff many of whom were not competent to perform the tasks required. Second it demoralised the skilled staff many of whom left to work in Canada and Colombia.
  • Diversification of PDVSA into non-core areas such as food importation and house building distracted the company from pursuing its core objectives of increasing production.
  • While the oil wealth of Venezuela belongs to all Venezuelans rich or poor, ultimately the biggest sin of the Chavez years may simply be to attempt to re-distribute wealth under various schemes or political agendas before the wealth had actually been created and without any regard to whether the income stream could, in less favourable conditions, be sustained into the future.  Admittedly though this historically occurs in many revolutions where those newly in power seek to correct historic wrongs inclusive of poverty and lack of opportunities amongst the masses.

Conclusions – The House that Chavez Built

Supporting the state apparatus and complying with the Bolivarian-Socialist vision for Venezuela has become a huge financial burden and drain on the resources of PDVSA. Falling oil prices have led to an urgent need to increase production just to maintain the huge financial demands the government places on PDVSA.PDVSA has been unable to increase production because of a sustained lack of re-investment and basic maintenance of its production and refining facilities. Perhaps the saddest postscript is simply this. Venezuela’s oil and gas resources are not its only riches. Venezuela has competent professionals and entrepreneurs, where have they gone? Vast forests cover much of Venezuela, yet many of its people live in run down shanty towns.Bountiful rivers criss-cross its terrain than can facilitate transport of its industrial and agricultural production, and granting the country an almost unparalleled hydro-power potential, yet the capital city suffers blackouts on a consistent and regular basis. Venezuela is a staggeringly beautiful country yet its potential to diversify and create a revenue stream from tourism has never been explored, and with a spiralling crime rate it possibly never will.

Perhaps of greatest concern Venezuela’s climate makes the cultivation of crops a relatively easy process, yet much of its food is now imported and many of its citizens rely on government hand-outs of food to survive.
This is the house that Chavez built…
If his predecessors had built a better house, there would have been no need for the Chavez architecture. Hopefully the design specifications for the house of the future to be built by Venezuelans for Venezuelans will be a mansion with rooms for all.

Firstline has over the years monitored and traded positions in PDVSA and Venezuelan bonds. Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers a number of unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@firstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.


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