EMERGING MARKETS: Venezuela’s oil bonanza disguises decaying economy

Select a clutch of Venezuela’s macro numbers, say GDP or government revenue, and you find an economy that looks robust and growing. The surge in oil prices has pushed up revenues at nationalized oil firm PDVSA, helping boost international reserves and underwriting extensive social programmes. The dominance of oil is growing ever more absolute as the rest of the economy crumbles. It is a dangerous crutch in a time of great volatility and is accompanied by worsening levels of transparency and growing political instability.

The importance of PDVSA to the Venezuelan is difficult to overestimate. It accounts for 90% of exports and close to 50% of government revenues, explaining why each announcement from the firm is scrutinized so closely. 

Venezuela watchers were surprised by the level of detail in the company’s first half report for 2008. It contained more information in almost all areas, from production details to who is producing what where, notes Alejandro Grisanti, director for Latin America at Barclays Capital in New York. 

For optimists, that is a sign of good progress. PDVSA reported a staggering 958% increase in net profits thanks to oil price hikes, revenues too hit $72.42 billion compared to $42.86 billion compared to the same period last year and the firm announced a 3.5% increase in production, says Grisanti. The firm is sounding a bullish note on its future, aiming to produce over 4.9 million barrels per day by 2013 and 6.5 million by 2021. 

“You can see a lot of strengths in Venezuela’s balance sheet. The country is running a huge current account surplus and is significantly building up reserves as well as allocating money to FONDEN (the National Development Fund),” points out Roberto Sifon-Arevalo, director at Standard & Poor’s in New York, who covers the sovereign. Growth is strong too: His conservative estimate for GDP growth this year is 5.5% and 4.2% for next year.

Furthermore, PDVSA’s transition to working new fields in the Orinoco belt as exiting wells become exhausted seems to be progressing well, says Grisanti. He points out that of the four projects operating, PDVSA is operating with partners in three and notes that there has not been destabilising management change.

The country’s track record on debt payment has been good and the oil economy positions Venezuela well. If these results were in a stable political environment, the country would be rated much higher than its BB- level, Sifon-Arevalo notes, adding: “We really need to see some kind of predictability for us to feel more comfortable.” Moody’s, which was long more cautious on the country than S&P, has just turned more optimistic and has put the country rating on positive outlook watch. 

Others are more skeptical. Robert Bottome, the editor of respected Veneconomia, doesn’t lend much credence to the numbers. “That PDVSA published the numbers in itself is a miracle as they are notoriously unforthcoming. But I get the impression that they’re not accurate,” he says. He points out that the International Energy Agency and OPEC believe that Venezuela is producing close to 2.5 million barrels per day, substantially less than the published figures. 

Bottome adds that the more you look at the accounts, the more discrepancies you find. Investments have nearly doubled in one year from $3.4 billion to close to $6.5 billion. A section labeled “other outgoings” nearly tripled over the first half of 2007 from $800 million to $2.36 billion. There are signs are that they are acting like a company that is having a cash crisis, Bottome says. 

Grisanti agrees that there’s much scepticism surrounding the numbers but says that recent research he carried out supports the numbers PDVSA released, at least those for 2006. Ingeniously, Barclays surveyed the Venezuelan oil imports registered in 60 countries. He found that he could account for 87% of PDVSA’s figures using these import data and estimates most of the remaining 13% could be accounted by imports to countries not surveyed.

Nationalisation 

Whatever the truth behind the numbers, PDVSA seems to be thriving on the back of global thirst for oil. But the rest of Venezuela’s economy is undergoing wrenching changes as president Hugo Chavez continues with an extensive programme of nationalisation, funded in large part on the back of petrol income. The government will pay close to $11.6 billion for the nationalisations to date, including those in the petroleum sector, according to paper Ecoanalitica. 

The positive side of this is that the government has tended to indemnify firms for their losses at levels not that distant from market price, says Sifon-Arevalo. Santander originally paid some $600 million for Banco de Venezuela in 1996 and the government paid $1.2 billion this year to acquire the assets and only bought after Santander was pitching the asset at other buyers, he notes. But critics say the Spanish bank made substantial investments in its Venezuelan operations and was looking to sell at $1.8 billion. 

Other nationalisations have been resolved, if in an ad hoc way. Two cement companies, France's Lafarge SA and Switzerland's Holcim, finally accepted the government’s offer to buy majority stakes in their Venezuelan operations, for $267 million and $552 million, respectively. 

But many are holding out. Mexico’s Cemex has rejected an offer of $650 million for its Venezuelan operations. Techint has threatened to go to international arbitration after an earlier announced takeover deal apparently fell through for the Sidor steel plant in Bolivar state, in which it has a 60% stake. Brandes is contesting the takeover of phone company Cantv and Vestey Group is unhappy with offers for a farm nationalization. And meanwhile, the earlier wave of oil company take-overs that included Exxon and ConocoPhillips continue to be snarled up in bitter legal disputes. 

The big question is whether the recent spasm of nationalisations is the last. Many believe that other large companies will soon become targets, provided oil prices remain around the $100 per barrel mark. Regulations that allow the government more scope to nationalise have stoked speculation. Commonly-mentioned targets include Empresas Polar, the country’s largest food firm, as well as the Venezuelan subsidiaries of Coca Cola and General Motors. Both US firms were hit by labour unrest in the country in August, points out Bottome, who says the government tends to foment labour issues at target firms so that it can use worker complaints as an excuse for a take-over. 

Naturally, the government intervention has discouraged investment in the country, which is witnessing net negative foreign direct investments. And take-overs of industries are reducing competition and efficiency in key areas, from telecoms and banking to construction materials, most Venezuela watchers agree. 

One banker, who believes that Chavez’s social programmes were initially necessary, relatively well targeted and certainly highly popular, is concerned that the effectiveness of government spending is going down as it spends more on nationalisation at the expense of expanding social programmes and it is increasingly unable to deliver what the people want. “What we’re increasingly seeing is fears over a lack of security, scarcities of basic goods and soon black outs,” he says. 

Politics rears its head 

In this climate of business and economic uncertainty and instability, further anxieties are being generated by upcoming local elections, slated for November 23. 

Like everything else in Venezuela, these elections are a source of fierce contention with analysts unable to agree just how much they matter. The country is divided between those who see the elections as a referendum on Chavez, those that see them as more local and those that believe they fall somewhere between. Chavez himself has been pushing voters to make the vote a plebiscite on his own record, as some of the Chavista governors are personally wildly unpopular while Chavez continues to command some loyalty. The opposition is calling for a vote on the record of the local individuals.

In the run-up to the election, further spending is likely which will stoke an increasingly uncontrolled inflation, which has been running at 32%. That is continuing to pressure the fixed peg of the Bolivar Fuerte to the dollar. Chavez has continued to flatly deny that there will be a devaluation, but this is a key weak point. 

The government is trapped: if it makes this adjustment to the exchange rate, as is widely expected, further political instability can be expected, but the government realizes that it needs to act soon or inflation may spin out of control, says one Caracas-based banker. For the previous two adjustments, Chavez could blame the previous government or the opposition. 

The bond issues that the country carried out on behalf of Argentina and other allies in the region that kept the parallel rate from widening further by absorbing domestic demand for dollars do not look so attractive thanks to highly volatile bond spreads, that have touched 1,000 basis points. 

Now, Chavez will have to accept responsibility for his actions, says one local banker. As his power weakens and opposition grows, the risks for the country’s political situation grow commensurately. Continued high cash flow from oil, that most capitalist and volatile of enterprises, is becoming ever more vital in sustaining the socialist Bolivarian revolution.

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