October 27, 2011
by Jaime Daremblum
Earlier this month, New York Times correspondent Simon Romero reported on a tectonic shift in the South American energy landscape. To sum up: Brazil is fast becoming a global oil powerhouse, while petroleum-rich Venezuela is seeing its influence decline. Call it the Chávez effect.
After all, there is no good reason that the Venezuelan oil industry should slowly be crumbling. But thanks to disastrous government policies, a country that once dominated the regional energy game is losing ground to its neighbors (not only Brazil, but also Colombia). "Hugo Chávez is putting on a clinic in Venezuela," energy expert Robert Rapier wrote last year. "The theme is 'How to Destroy a Domestic Oil Industry.'"
According to central-bank data, Venezuela's oil GDP dropped by 7.2 percent in 2009 and by 2.2 percent in 2010. During the latter year, its total oil production hit a seven-year low (in real terms). When we chart fluctuations in global oil prices between 2009 and 2010, these numbers don't make much sense. As the Venezuelan newspaper El Universal has noted, the average price of oil was more than 27 percent higher in 2010 ($72.60) than it was in 2009 ($57.01). Yet "the operational capability of Venezuela's oil industry was significantly affected by poor oil services (which were seized and nationalized in 2009), by poor maintenance of rigs and oil shipping facilities, and a higher number of plant shutdowns."
A dearth of adequate operational capability will prevent Venezuela from realizing its full oil potential. Over the summer, OPEC announced that the South American country now boasts more proven oil reserves than any other country, including Saudi Arabia. Of course, OPEC estimates are notoriously suspect, and the Chávez regime is not exactly known for being trustworthy. According to the oil cartel's Annual Statistical Bulletin, Venezuelan reserves increased by more than 40 percent (from 211.2 million barrels to 296.5 billion) between 2009 and 2010. It is reasonable to question the accuracy of these figures.
But even if they are perfectly sound, their significance should not be overblown. As Jorge Piñon, a former president of Amoco Oil Latin America, told the Miami Herald, extra-heavy crude oil (EHCO) accounts for roughly a third of total Venezuela reserves. That's a big problem for Caracas, because EHCO is relatively difficult (and thus relatively expensive) to extract, refine, and transport. "You can be sitting on the largest reserves in the world but if you do not have capital and technology to recover them … they are worthless," Piñon said.
Under Chávez, Venezuela has experienced a dramatic deterioration of its oil infrastructure, thanks to government mismanagement and a constant stream of anti-business policies that have scared away foreign companies. The country is also suffering from wild inflation: The Latin Business Chronicle estimates that it will finish 2011 with an annual inflation rate of 25.8 percent, the third-highest rate on earth (behind only Argentina and Belarus). And yet, the Chávez regime has embarked on a massive borrowing spree to fund even more profligate, inflationary spending. (On October 17, Fitch Ratings declared that "a significant macroeconomic shock could erode [Venezuela's] sovereign credit quality quickly.") For example, the country has signed around $32 billion worth of "loans for oil " deals with China. This past April, BCP Securities analyst Walter Molano estimated  that the China deals were causing Venezuela to lose "almost half of the oil revenue that was being generated to service its external debt obligations."
While Caracas hopes that major foreign energy firms will invest in its Orinoco Belt oil projects, those firms are justifiably worried about Venezuela's lousy infrastructure, its nonexistent rule of law, its political instability, and the windfall-profits tax that Chávez decreed six months ago. "There aren't positives signs regarding the conditions for investing," one oil executive recently told Reuters. No kidding. The World Economic Forum's 2011–12 Global Competitiveness Index ranks Venezuela dead last out of 142 countries for the quality of its institutions, dead last for the "business impact of rules on FDI," dead last for overall goods-market efficiency, and dead last for overall labor-market efficiency. The country also places a dismal 128th for the quality of its transport infrastructure. The World Bank's 2011 Ease of Doing Business Index ranks Venezuela several spots behind war-torn Iraq and Afghanistan.
To be sure, the Brazilian business climate is hardly ideal: It is plagued by high taxes, cumbersome regulations, rampant corruption, and poor infrastructure. Yet despite these weaknesses, Brazil has been implementing pragmatic economic policies for the best part of two decades, and today it is a far more attractive investment destination than Venezuela.
The existence of huge oil reserves under a country's soil or territorial waters is obviously a matter of luck — or, as former Brazilian president Lula da Silva once put it, "a gift from God." But how a nation utilizes its energy resources depends on political leadership. And whereas the Venezuelan state-run oil giant PDVSA has been ravaged by incompetent management, the partially state-owned Brazilian firm Petrobras has enjoyed stunning success.
In a 2008 article for The American, energy expert Robert Bryce explained that "Petrobras has become an elite global energy player by doing what most other national oil companies refuse to do, including selling shares of the company to the public." (Its public offering in September 2010 generated $70 billion, making it the biggest share issue of all time.) "And while many other big oil exporters, particularly within OPEC, either refuse to disclose their production data or publish fictitious numbers, Petrobras issues frequent press releases that discuss the latest developments within the company, including production trends, financial conditions, and new discoveries."
Speaking of new discoveries, Brazil's recent oil finds rank among the largest in modern history, and they have made foreign investors salivate (while also sparking domestic political fights). "Within the next 10 years," writes journalist Kenneth Rapoza, "the oil and gas industry around the world will invest an estimated $3 trillion exploring and drilling for oil. Of that, around a third will be invested in Brazil." According to Romero, its daily oil output could more than double by 2020 to reach over 5 million barrels. Such growth would effectively be like "adding another Kuwait to world oil production." Already one of the world's top ethanol producers, Brazil could eventually become the fourth-biggest oil producer (behind only the United States, Saudi Arabia, and Russia).
The fundamental lesson of Brazil's rise and Venezuela's decline is not terribly complicated: Democratic capitalism leads to economic progress, while Bolivarian socialism leads to economic ruin. Happily, as the Economist observed this past July, the pro-market Brazilian model "is now the fashionable formula in the region," and "the tide of Latin American history has turned against Mr. Chávez." Unfortunately for Venezuelans, they will be living with the consequences of Chavismo for many years.
Ambassador Jaime Daremblum is a Hudson Institute Senior Fellow and directs the Center for Latin American Studies.
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