Of Note: Chavez's Populism Threatens the Economic Engine of His Revolution

Chavez's Populism Threatens the Economic Engine of His Revolution



Oil-rich states are getting richer. With higher commodity prices worldwide, extractive industries are proving very profitable. Indeed, governments are noticing the upsurge in profit, and are actively seeking more control over national resources. In Venezuela, such policies have already taken a large toll on current, and possibly future, energy production.

To finance his extensive social spending increases and aid grants to political allies, Venezuelan President Hugo Chavez has increased the government's control of and taxes on the country's energy sector. Among President Chavez's largest targets has been the state-owned oil company Petróleos de Venezuela (PDVSA). Beyond simply relying on higher oil prices and taxes to generate income, in 2005 Mr. Chavez required PDVSA to spend roughly $4.4 billion of its $19.5 billion budget on social programs. This left only around $3 billion for critical investment projects after meeting the company's expenses—an astonishingly low figure given that PDVSA's wells have a natural decline rate of 25 percent per year, requiring an estimated $2.5 billion of investment annually to maintain current production levels.¹ In 2006, the amount PDVSA set aside for social expenses rose to above $6 billion.

Additionally, PDVSA revenues are siphoned off to fund the Fondo Nacional del Desarollo (Fonden), the government's national development fund. According to the finance ministry, as of July 7th the Fonden had received $4.6 billion from PDVSA since its inception in late 2005.²

Unfortunately, it is not just energy revenues that Venezuela uses inefficiently. The state's consumer-oriented energy subsidies keep prices low, and encourage Venezuelans to consume the highest level of electricity per capita in South America.³ Venezuela is also among the world's leaders in the amount of energy required to produce a unit of GDP.

To this list, Venezuela can add inefficient human capital management. Shortly after his election, Chavez declared his desire to overhaul what he has called a "state within a state." His initial attempts to reform the state oil company met considerable resistance from large segments of the company's own management who had in prior years operated increasingly independently. Their independence ran directly counter to Mr. Chávez's vision for the company's role in a Venezuelan socialist renaissance. When many of the company managers participated in the December 2002–February 2003 general strike, Chavez responded by firing over 20,000 of the company's 45,000 employees. ⁴

Although Venezuela has large oil reserves, President Chavez's policies are crippling production. Underinvestment in capital needs, awarding of oil service contracts based on companies' ideological orientation, and politically motivated layoffs of experienced personnel have combined to diminish current production and the future potential of Venezuela's complex oil reservoirs. The country's 79.7 billion barrels of proven conventional oil reserves, 151 trillion cubic feet of natural gas, and roughly 270 billion barrels of reserves of extra-heavy oil in the Orinoco Belt, mean that it remains the most important oil and gas producer in the hemisphere. Yet its output has fallen substantially.⁵ In February 1999 when Mr. Chavez took office, PDVSA was producing 3.3 million bbl/d and only 200,000 bbl/d was being produced by private oil companies. Currently, Venezuela's production capacity stands at 2.6 million bbl/d, but for the above stated reasons, PDVSA's overall capacity has dropped 1.8 million bbl/d.

Venezuela is failing to meet its potential. Although Venezuela houses roughly three-times the number of oil reserves compared to the United States, America produces four-times as many barrels of oil per day. Overall, Venezuela's oil sector is now starved of technology, capital, and experience. Consequently, Venezuela has seen a pronounced slowdown in oil revenue growth from 62 percent in 2005 to just 21 percent for the first six months of 2006, despite strong world...