Apr 7, 2014 | 10:59 GMT

4 mins read

Venezuela: Producing Oil Amid Political Unrest

Venezuela: Politics Cloud the Chances of an Energy Sector Revival

Editor's Note: The following is the first installment of a three-part series assessing the endemic risks of Venezuela's energy sector. Part 2 will examine the country's infrastructure vulnerabilities. Part 3 will examine its prospects for a turnaround.

Concerns abound as to whether Venezuela's recent political unrest will eventually disrupt the flow of oil exports. Certainly the concerns are justified; interruptions affect U.S. Gulf coast refineries as well as Caribbean, European, Indian and Chinese consumers, and they deny the Venezuelan economy a source of much needed revenue. Such was the case in 2002, when oil workers went on strike amid even fiercer unrest.

But a lot has changed in the past 12 years. State oil company Petroleos de Venezuela, or PDVSA, is much more firmly under government control. And Venezuela's energy infrastructure is sequestered from the cities in which the protests have taken place. The biggest threat to Venezuelan oil production is not the protest movement but the continued degradation of the energy sector. 

The current political situation differs greatly from the situation in 2002. Twelve years ago, PDVSA leaders joined a general nationwide strike by locking out workers for more than 50 days. During that time, oil production fell from 3 million barrels per day to 150,000 per day. U.S. monthly imports of Venezuelan crude fell from nearly 50 million barrels in November 2002 to 13 million in January 2003, and Venezuela was forced to import millions of barrels of refined products to offset the damage of oil shortages. The strike devastated the country's oil industry and national economy, but ultimately it raised the global price of oil only slightly — producers and refiners were able to compensate for the deficit. U.S. refineries, for example, were able to draw from oil stockpiles, and several months after exports resumed, the markets stabilized.

After the strike, the government of former President Hugo Chavez fired nearly 18,000 workers, or about 40 percent of PDVSA's workforce, many of whom were trained engineers, accountants and managers, for their actual or alleged involvement in planning the strike. PDVSA has never fully recovered from losing so many experienced personnel. But it has since been made responsible for financing several social causes, which have drained its resources and reduced investment in exploration, production and maintenance. Combined with subsequent energy nationalizations, these factors have prevented PDVSA from producing at pre-2002 levels.

Accepting the Consequences

Since foreign oil company holdings were nationalized in 2007, only a few countries — mostly China and Russia — have been willing to invest in Venezuela's energy sector. However, investors have become more willing lately, with companies striking $10.4 billion worth of financial deals over the past year. These include Chevron, Gazprom, China National Petroleum Corp., Italy's ENI and Spain's Repsol. Venezuela is borrowing money from these foreign partners on the condition that it will then be reinvested in joint projects between those companies and PDVSA. The official goal of this round of financing has been to add more than 200,000 barrels per day over the next several years.

But given the challenges facing the energy sector, not to mention declining output of older fields, added production may only compensate for declines elsewhere, assuming the goals are reached.

Notably, rising costs are also affecting companies that operate in Venezuela. One of the main reasons operating there is so expensive is currency distortion. This includes inflation, which reached 56 percent in 2013, and the growing disparity between the official rate of 6.3 bolivares to the dollar and the black market rate, which has risen to more than 90 bolivares per dollar. The effect of inflation can be seen clearly in the recent agreement between the government and the Federation of Venezuelan Oil Workers on Feb. 5, when the government agreed to a 90 percent salary increase for the two-year contract.

The difference between the black market and official exchange rates also affects oil companies significantly. Though oil companies have been granted a more favorable exchange rate of 11.3 bolivares to the dollar, the service providers they work with are frequently forced to use the black market rate. With the recent implementation of the SICAD II currency exchange system, the black market rate seems to have stabilized around 66 bolivares to the dollar, still well above official rates. The difference between the official rate and the black market rate creates additional costs, bogging down PDVSA and its partners. Meanwhile, shortages of other goods, including cement and steel, have hurt the energy sector by creating delays in production.

The government's challenges are manifold, but ultimately Caracas needs money. Not only do the economic conditions discourage investment, but political unrest has raised doubts about the government's ability to manage the delicate domestic situation. With such low oil production and export rates, there are fewer dollars in Venezuela's domestic market to finance imports, which will only perpetuate ongoing shortages of basic goods and drive further unrest.

At the same time, Caracas seems locked into maintaining enormous subsidy regimes, most notably on gasoline, and while price hikes have been discussed in recent months, so far no action has been taken. The low price of gasoline has encouraged high consumption, which is compounded by all the fuel that is smuggled to Colombia. What fuel is consumed at home cannot be sold by PDVSA abroad, so foreign currency reserves will continue to dwindle — they fell by nearly $10 billion in 2013 alone. Right now, PDVSA has no choice but to absorb these costs until the government is ready to accept the political consequences of raising prices on consumers.

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