The crossroads of the Venezuelan oil industry

Hugo Chavez, then-president of Venezuela, claimed on television in 2009 that Venezuela had surpassed Saudi Arabia as the country with the greatest oil reserves.

It was a formal pronouncement made on national television, forecasting that a resource-rich nation will become even more prosperous.

In the south of Venezuela, a formation known as the Orinoco Oil Belt is situated immediately below the riverbed with the same name. It is equivalent to 42 times the size of the city of Los Angeles, or the entirety of Croatia.

Overnight, Chavez and his XXIst Century Socialism project won the lotto.

In the not-too-distant past, fossil fuels played a crucial geopolitical and economic role in international relations, regional cooperation, and even a nation's creditworthiness.

The current rank of oil reserves is as follows:

The Orinoco Oil Belt has approximately 235 billion barrels of extra-heavy oil (between 4 and 16 API grades), which, despite being difficult to extract, were made accessible by the existing technology. In comparison to the market price of the barrel, which averaged around US$85 from 2010 to 2012, issues like as the refining cost were of little consequence.

A Socialist approach to oil

It would only be a matter of time before heightened nationalism took control of the oil company, and it would take a few years before the industry resisted being dominated by nationalist, socialist, and anti-elitist approaches. They based their intervention on the thesis that oil was a tool of the wealthy and served only a few, thereby increasing class disparities.

The oil industry itself necessitates a high level of reinvestment of capital obtained, amortization of equipment, and acquisition of new devices. However, the government chose to invest the proceeds from the sale of oil in social programs known as "missions."

Even though these programs helped to alleviate some of Venezuela's social injustice and inequality, they were also a source of corruption. They served as a political propaganda tool to increase the influence of the XXI Century Revolution in sectors with limited resources.

The perverse process was on its way. Not only was there a reduction in investment in exploration, prospecting, extraction, and refining, but the state oil company was also losing a significant portion of the talent that had been developed over decades.

Simultaneously, a second phenomenon was occurring; the general decline of the country's capacity to conduct business diminished the ability to produce in other economic sectors. The number of tourists decreased, and the textile, food, and auto-parts businesses, among others, closed their doors and, in some cases, relocated their plants overseas.

As a result, oil was not only the main source of money, but its proportion of total export revenue was expanding, giving the government more authority.

Carbon Footprint and Global Warming

Today, in 2020, these two concepts are commonly used, both by institutions and their leaders, and by the media, even by girls as young as 15 years old, who are demanding in front of their country’s parliament in the “Skolstrejk för klimatet.”

If we consult Google Trends, we will see that it was in 2006 when the term ”Global Warming” became popular, the year Al Gore made public the documentary “An Inconvenient Truth,” showing clearly the direct relationship between carbon emissions and rising temperatures.

Even though the UN had been working since the 1990s on conferences such as the Kyoto Protocol, the problem itself did not reach the rank of a global threat until mid-2007 onwards. In 2015 the Paris Climate Agreement was signed, whose first objective is to achieve carbon neutrality through the transition to new forms of energy. Oil-producing countries are still digesting the idea.

Paris Agreement’s central aim is “to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius”.

The main instrument to achieve this is to make the planet carbon neutral by 2030, that is, making greenhouse gases (GHG) volume equal to the volume the planet is capable of absorbing.

The interesting point about this agreement is that it does not speak of ‘stopping using fossil fuels,’ but of being ‘neutral,’ so it leaves the window open for new technologies (carbon sequestration perhaps) to continue with the business as usual and still meet the goals of the agreement.

Nowadays, the main ways to deal with emissions are either reducing them or through the carbon offset market. Assuming that carbon sequestration tools won’t be developed, these two visions will have different implications for the future of Venezuela’s oil activity.

Stranded Asset

In November 2020, the Financial Times published an article in which it raised the possibility of Venezuela to use its reserves in the midst of the new energy scenario.

Pundits were consulted for writing the article, from which we can extract two opinions from people that really know the scenario where the Venezuelan oil industry would have to play, first is Ricardo Hausman, former minister, who said: “[oil ]“will never be as important a driver of the economy again as it was”

And the second is Francisco Monaldi, “You can already see there are companies leaving Canada because of climate change. None of them will even consider Venezuela . . . there’s no doubt that there is a finite window for investment.”

When looking at Venezuela’s oil industry history, we notice that it has been deeply linked to politics, leading it to continuous power struggles and sudden changes in its objectives.

Beyond the immense value of what is under the country’s earth, which raises the doubt to its extraction’s impossibility is to determine if it is realistic to think whether or not to this situation will change soon.

The graph shows how Venezuela has been losing production capacity as the socialist government remains in power. The oil industry has been decimated by corruption and mismanagement of available resources, leading to an abrupt fall in production and refining capacity.

Getting oil out of the ground requires large investments, so having an abundance of it is no guarantee that it can be exploited. It is an activity that can only be carried out if the returns from extraction are positive.

If a country like Venezuela, in which oil belongs to the state, and whose government lacks any credibility concerning the capacity to repay its debts, most probably won’t have access to the necessary capital to invest in exploration, prospecting, and therefore extraction.

Additionally, oil prices are expected to fall (or at least remain relatively low) due to a clear mandate from the large consumer countries to transcend the use of fossil fuels. Even in those where there is no government pressure, consumers opt for new forms of energy, arising the question about whether or not it is worth to make large investments to keep the oil flowing in.

The only window that remains open (which represents a zero-sum game for the planet) is that the transition to greener options could be slowed down or even discouraged by developing countries governments. The reason for this is simple; the profitability of oil use is much higher than that offered by renewable energy.

In terms of Return on Energy per unit invested (EROEI), fossil fuels have no competition, except nuclear energy.

Potential Future Scenarios

Venezuela currently has limited options, despite the conditions, and the more time goes by, the possibilities of developing them will diminish. These are:

1. Opening to international capital

Dismantle the system in which the government regulates all economic activities, allowing the free circulation of capital. Suppose this measure is accompanied by an aggressive fiscal measures package, with exemptions for those who create jobs and invest in gross fixed capital formation. In that case, it can bring about a domestic economic reactivation.

This can boost the development of the domestic economy as well as production for export. Venezuela could be host to companies searching for cheap energy for their industrial activities or hosting of virtual infrastructure (crypto-currency, servers in general).

This scenario includes the privatization of the industry or public-private co-ownership, promoting confidence in the producing company.

2. Playing with ‘neutrality’ as a concept

The country could easily propose schemes to raise funds from the fight against climate change. It could generate income for the non-pollution that its resources could cause, allocating enormous amounts of resources to developing other forms of energy (hydroelectric, for example) and developing a business network promoting a green economy.

Despite looking complicated at the beginning (the total carbon credit market reaches only 215 billion dollars), it is a valid scheme if we consider how monetary policy is managed in large economies. It is common to see how the Central Banks’ (or Federal Reserve) balance sheets multiply and extraordinary magnitudes to energize the economy in difficult times. If this concept is extrapolated to the ‘health of the planet,’ the countries with high productivity can finance those with lower productivity to keep them away from fossil fuel production.

It may seem distant, but as the UN Secretary-General mentioned, the “central objective” for next year (2021) will be to build a global coalition around the need to reduce emissions to net-zero.

There are at least two concepts that are accepted as valid in this analysis; the first is that Venezuela has systematically destroyed its capacity to produce oil, and the second is that the weight of oil in geopolitics is decreasing and will continue to decline as new generations of leaders take the reins of their respective countries.

Juan Carlos Golindano S.

Originally published on Dec. 6th, 2020

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