OPEC keeps fingers crossed as post-Chavez era looms

10 March 2013
Many major oil producers and OPEC leaders may not have been enamored by Hugo Chavez's charm, but his presence served a useful purpose: under his leadership, Venezuela mismanaged its matchless oil reserves and crude production fell.

With him gone, major producers now face yet another competitor in an already crowded market.

Venezuela sits on the world's largest proven oil reserves of 296.5 billion barrels, but under Chavez, production had declined from a peak of 3.5 million barrels in 2000 per day to around 2.4 million bpd at the end of 2012, and Venezuela had slid from one of OPEC's major producers, to its sixth largest, according to OPEC data.

But Chavez was a key Iran ally and keen to balance Saudi Arabia's dominance in the group, often pushing for production cuts to keep crude prices high.

Chavez also had a mixed record in the Middle East.

While his tirades against Israel and the United States were popular among Arab citizens, he befriended Libya's Muammar Gaddafi, Syria's Bashar Al Assad and Iran's Mahmoud Ahmadinejad, which forced many Arab leaders to distance themselves from the socialist leader.

But his continued support of Gaddafi and Assad, even as they committed atrocities against their own people, saw his popularity among Arabs diminish.

He may be a divisive figure in the global political circles, but at home he was revered by his country's poorest.

Chavez came to power when oil was at USD 10 per barrel and died when it was USD 110. During this time he spent on laudable projects such as basic healthcare and education for the poor, but kept weakening his cash cow - the state-owned Petroleos de Venezuela, the oil company tasked with managing the country's hydrocarbon riches.

Instead of strengthening his one pillar of economic strength and raising production, Chavez used oil revenues on his social projects and subsidies, which were becoming difficult to sustain even when he was alive.

While his successful attempt to lift Venezuelans out of poverty is commendable, in the process the country became rife with corruption, killings, high inflation and shortage of basic food items. Political and social freedoms were victims in Chavez's government and he ruled more like an autocrat rather than an elected official.

Effect on oil prices

So damaging was his impact on the country's great natural resources, that crude prices didn't move an inch on news of his death.

"The death of the Venezuelan President, Hugo Chávez, is unlikely to have a significant impact on global oil markets in the short term, although this impact could yet be in either direction," said Tom Pugh, commodities economist at Capital Economics.

"Over the longer term, changes in policy towards the energy sector might eventually allow Venezuela's oil production to return to the much higher levels seen in the late 1990s. However, any such recovery would take many years."

Major crude producers like Saudi Arabia will be watching developments in Venezuela closely and looking at clues as to how Chavez's heir apparent Nicholas Maduro will be dealing with foreign oil companies.

"In 2002, nearly half of PdVSA's employees walked off the job in protest against the rule of President Chavez, largely bringing the company's operations to a halt," said the US Department of Energy.

"In the wake of the strike, PdVSA fired 18,000 workers and overhauled the internal organization in order to solidify government control. In 2006, Chavez implemented the nationalization of oil exploration and production in Venezuela, mandating a renegotiation of a 60% minimum PdVSA share in projects. Sixteen firms, including Chevron and Shell, complied with new agreements, while Total and Eni were forcibly taken over."

The Financial Times recently wrote that Maduro should "hug" major oil operators as it needs their money to maintain mature oil fields.

PdVSA needs USD 3 billion just to maintain its current production levels, but major oil operators will be quick to return to the country given Venezuela's natural riches.


The heir apparent

"While in the short term the political scenario will remain largely unchanged, with vice president Maduro widely expected to win the snap election, internal disputes within the ruling party could emerge in the medium to long term, increasing the long-term risk of political instability," notes risk consultants Maplecroft, adding that in the short term Venezuela's negative investor climate is likely to remain unchanged.

"This will be the case regardless of the outcome of the elections, as Maduro will seek to show the electorate that he embodies continuity and the preservation of Chavez's legacy. Furthermore, a potential opposition winner would lack the political capital to unwind some of Chavez's most controversial policies in the short term."

Maduro is unlikely to move away from resource nationalism and oil companies will continue to face a "markedly unfavorable regulatory regime".

"Maplecroft's Expropriation Risk Index 2013 considers Venezuela an 'extreme-risk' economy, scoring 2.28/10 (where lower scores indicate higher risk). The country ranks 16th out of 197 nations (where first is worst), located between Iran (15th) and Angola (17th)."

However, signs of warming relations with Washington may signal a rise in Venezuela crude to US refineries on the Gulf Coast, which were historically built for heavy Caracas blend, when the two countries enjoyed better relations.

"Oil is critical to the country's earnings (more than 95% of export earnings), so there could be the potential (longer-term on political change) for a change in approach to foreign investment in the sector," said Nathan Piper, an RBC analyst.

Threatening Saudi's oil dominance

Saudi Arabia would be dismayed by the proceedings. It is already facing competition from a resurgent Iraq and the United States shale revolution, and more Venezuelan crude could displace its own rising exports to the Gulf Coast.

Saudi Aramco is conscious of the moderation in demand and oversupply.

"Forecast growth has moderated, not only as a result of economic stagnation but also through welcome and increasing gains in energy efficiency," chairman Khalid Al Falih told energy executives at a conference in Houston on March 4. "Changing demographics and lifestyles, environmental pressures, and energy policies have played a role, too.

"So, while we believe long-term demand will be robust enough to provide us with the confidence to invest, it will not rise to the point where it creates market imbalances, and stretches the industry beyond its means."

Abdalla S. El-Badri, OPEC Secretary General, puts the new wave of production in perspective: "At OPEC we do not envisage a price collapse, but it is important we understand some of the potential effects of falling prices," he told a Chatham House audience earlier in the year. "Of course, OPEC Member Countries will receive less revenue."

While the new leader of Venezuela remains anti-American and it may take a while before the government's policy on crude oil production is revealed, economic reality may force its hand.

"Severe shortage of hard currency may force the new government to focus more resources on increasing oil revenues, which account for over 90% of foreign income," said Pugh.

"The current high level of global oil prices has reduced the pressure for reform. But if oil prices fall below USD 100 per barrel for a sustained period over the coming years, as we think likely, then there is a high chance of a balance of payments crisis and even a possible debt default. At the very least, the Venezuelan government would have to try harder to maintain revenues by raising production."

And that should make other major producers quack in their boots.

© 2013


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