Venezuela's Bigger Problem
Actually, it's a problem for other countries as well: Chile comes to mind, for instance. The problem? Overdependence on commodity exports.
A lot of pixels get burned out in this place talking about internal stuff re Venezuela, and I've been guilty right along with everyone else around here. But whether Chavez was corrupt or Capriles deserves to be impeached for not attending to his duties as governor is for the people of Venezuela (or Capriles' province) to decide.
Some things, however, can be addressed objectively. One of these is that if the election of Maduro was reasonably clean, say, Obama should recognize it, regardless of being called a devil or any other name by Maduro.
Another of these is that Venezuela is entirely dependent on oil for its export earnings. As I said, it shares this overdependence on raw materials earnings with a lot of other countries. And to be crystal clear so this doesn't get involved in just the issue of Chavez, it predated his rule as a problem for Venezuela and there is no evidence that I can find that his opposition understands the problem either.
Which isn't surprising, as I don't think it's appreciated just how bad this is as a problem.
The reasons it's bad, and particularly so for Venezuela, are as follows:
1 - "The Resource Curse": this is a well-known drawback to economies like Venezuela. The basic idea here is pretty simple: dependence on a single commodity distorts both the politics and economics of a place, since everything revolves around the resource in question. Venezuela has this big time, as the major focus of the government's political and economic energy is PDVSA, and the distribution of its earnings. Who controls PDVSA controls Venezuela. This makes politics a zero-sum, binary game. This usually means you don't get republican government (see, for instance, Saudi Arabia or any of the other Middle Eastern states for the most part), but despite coup attempts by Chavez in '92 and his opponents at least twice during his rule, the republic has survived for decades. How long this will last is anyone's guess, but it's not at all a given that it will last. Too much revolves around the control of that one entity and the resource it controls. 94% too much.
2 - "The Resource Curse", Part Two: The above is the part of the resource curse that usually gets written about, but there's a second problem with it: the price of raw materials isn't set by small countries with economies that are entirely dependent on that resource. They get set by the buyers: the developed economies that take those raw materials and turn them into useful products. In the case of oil, the usefulness of oil is truly amazing: it's used as fuel in many different forms (gasoline, jet fuel, heating oil, kerosene), in asphalt, which itself is used for both road paving and roof shingles, in plastics, which are used everywhere now, in synthetic fibers for clothing, to make wax in all its various forms, to make fertilizer, to make cosmetics like mineral oil, baby oil, and petroleum jelly; the list goes on and on.
Most of these products are made in developed economies rather than in the resource-dependent countries from which the oil is extracted.
Raw materials prices don't generally rise as fast as inflation. At best, like gold, they rise at the same rate as the general price level. Oil is an exception: over the long term it tends to rise at a faster pace than inflation. This is probably due to its usefulness in all of those products I just listed above. Those products were developed over time, and as each one was developed, it increased the usefulness of oil, which would of course put upward pressure on its price.
But substitution can take place in any of those products. To take two examples: in electricity generation, I have pointed out in a thread in the Environment & Energy group that oil is now used far less than wind as a fuel source. In fibers, cotton made a comeback after having been threatened by synthetic fibers. That's just two examples; go down the list of products and you can pretty easily think up substitutes for oil based products in all of them.
As oil's price rises, those substitutes become more attractive. This is what happened in electricity generation, where the per btu price of oil is now so high in relation to natural gas that it has now become a trivial fuel source in that area as utilities have switched out of oil to natural gas (while at the same time increasing their use of wind energy as well).
In short: just because oil's price has risen faster than inflation in the past doesn't mean that will happen in the future. And the threat to oil isn't just its price: it's that it is, quite literally, lethal to the planet when it's burned. At some point in the not-too-distant future the pressure to make oil obsolete as a fuel is going to become massive. For now, the fossil fuel lobbyists have been winning more than they lose, but their situation reminds me a lot of what happened with the cigarette companies, who also seemed invincible for decades. At some point something happens that changes everything, and suddenly the political hammer crashes down on the formerly invincible industry. As with cigarettes, the problem is known. And as it was with cigarettes for a long time, the evidence of lethality is building. That evidence can't be denied forever.
Venezuela is on the wrong side of this. And it has no control over the outcome. In the end, it's a small, backward economy. When push comes to shove and oil needs to be discarded as a fuel, the effect this will have on Venezuela's economy won't be anyone's concern in the developed world. It will be left behind.
Right now it's on the next-to-last rung of the international economic order: a supply region, that is, a place that produces one or a few raw materials for use by the world's developed economies. Once oil is discarded, it will be demoted to the last rung of the international economic order: it will be a bypassed place, a place that doesn't produce anything anyone else wants to buy.
Why can I categorically say that? Because, as noted above, 94% of its export earnings come from oil. As of right now Venezuela isn't selling anything else to the outside world but oil. So, what happens if because of CO2 the world rapidly moves to renewables and conservation, far more rapidly than anyone is now expecting? It would be an unmitigated disaster for Venezuela.
(Eritrea is probably the best example of a bypassed place these days.)
3 - Outsized Leverage to the Price: But let's get back to price. Venezuela has a very particular problem with the price of oil: it sells heavy crude, sludgy stuff that's hard to refine. This is a good thing in a way, since this kind of oil is ideal for being turned into a multiplicity of oil-based products, much more so than light oil. The very disadvantage of having to go through many steps to be refined into fuels of various sorts also means it can be refined into more kinds of fuels than light oil, and can be turned into more products along the way as well. But it also means the break-even price, that is, the price over the cost to refine and extract it, is also pretty high. That means Venezuela is more leveraged to the oil price than, say, Saudi Arabia, where the cost of extraction is certainly much lower, and which also produces some lighter grades of oil, which cuts the cost of refining it.
Leverage to the price means this: say crude oil sells for 90/barrel. If Saudi Arabia can produce it for a cost of 15/barrel, then a price cut from 90 to 60 cuts its income per barrel from 75 to 45. Not a good thing, but at least you're still making something decent.
But if your break-even is 40, which is more or less Venezuela's (see chart embedded in this article for the production break-even costs of various oil producers), then a cut from 90 to 60 means a drop in your profit from 50 per barrel to 20 per barrel. Or: a one third decline in the price produces a 60% decline in your net profit.
That's leverage to the price.
The problem is over the long term, the amount you get for selling any raw material is a little bit over the cost, since over the long term that's all anyone is going to be willing to pay. Venezuela's had a run of luck the past decade or so, the same run of luck as Chile when it comes to copper: China has been rapidly industrializing and therefore vacuuming up resources from all over the globe at a very rapid rate, which has supported the price of everything, even if, like Venezuela, most of what you sell goes to the US. That effect was of course magnified by its leverage to the price: a rise of 30 bucks to 120 would, after all, raise Venezuela's net profit from 50 to 80 per barrel, a 60% increase.
Point being, as a result of China's influence on the oil price Venezuela has up to now been on the good side of its leverage to the price. But that won't last forever.
4 - Politics: As the article cited above re break-even costs shows, the US is concerned, as it always is, with being too dependent on oil for its energy, and you can be sure all those tax credits going to renewable sources are in place in part to help out with that problem. Substitution via alternate sources of energy or via conservation (replacement of incandescent bulbs by CFLs and LEDs, for one example) is going to continue, and will put relentless downward pressure on the price of oil and other fossil fuels.
Particular to Venezuela is that Mexico also produces heavy grades, and as a result of the ongoing hostility between the US and Venezuela the US has a big incentive to use Mexico's oil instead of Venezuela's (http://openchannel.nbcnews.com/_news/2013/04/01/17519026-how-the-us-oil-gas-boom-could-shake-up-global-order?lite). Look for lots of deals to be signed in the next few years aimed at increasing Mexico's oil production with American help.
Chavez's rule coincided with a once-in-a-lifetime opportunity for Venezuela to make a crapload of money from its oil and use that to finance a move in its economy away from that total dependence on its price. That opportunity has been missed so far, and Maduro may not have much time left; it may be gone sooner than anyone is expecting. Even if oil isn't discarded as a fuel source (which I know seems unlikely now, but things like this have a way of changing very fast once the momentum gets going), if the shale oil boom now underway drops the global price of oil significantly, Venezuela will still suffer mightily because of its leverage to the oil price, as noted above.
The point is not that any one of these risks, political (Mexico), economic (oil price) or environmental (CO2) will materialize. The point is all of them are risks, and all are either plausible or happening right now, and should therefore be addressed by Venezuela's leadership. Chavez and now Maduro have been in power for nearly a decade and a half, more than enough time to have lowered that 94% dependence on oil for its export earnings.
Putting all your eggs in one basket is never a good idea. Inheriting that problem from your predecessors and proceeding to not only ignore it but put all your newly hatched eggs in there too is completely irresponsible. Maduro's single most important task is to start selling something to the rest of the world besides oil, in non-trivial amounts. Like, now.
= new reply since forum marked as read
