How change in Venezuela could hit oil price

Change is in the air in Caracas

Venezuela is in an economic crisis.

Inflation is running at more than 50%. There are shortages of basic goods including water and toilet paper.

Last month, the central bank was forced to restrict the amount of dollars that it sells at the official exchange rate, a de facto devaluation.

The current crisis may lead to a regime change in Venezuela.  That could push down the oil price. It could also open new opportunities for Western oil companies in Venezuela…

Time is running out on revolution

Of course, this isn’t the first time that Venezuela has faced tough economic conditions. Since Hugo Chavez took power in 1999, growth has lagged behind the rest of Latin America, with recessions in 2002-3 and 2009-10. Social problems, like crime, have also exploded.

However, Chavez died of cancer last year. While his handpicked successor, Nicolás Maduro, won the subsequent election, it looks like time may be finally running out for the ‘Bolivarian Revolution’. Protestors have taken to the streets and experts think there is a good chance they could win.

Why Venezuela is such a mess

Chavez made many mistakes whilst in power, but perhaps the most serious was to greatly expand the role of the state in the economy. Over 300 private firms were taken over by the government.

What’s more, large sums of money were wasted on buying political support, or on foreign policy gestures (such as support for Iran and Cuba).

These policies generated huge amounts of inflation. Rather than reverse course, the government doubled down on control. The prices of a large swathe of consumer goods are now capped, with shops and supermarkets forced to sell their goods below cost.

However, despite strict ‘anti-hoarding’ measures, many people are stockpiling goods, as inflation destroys the value of their savings.

The only thing preventing a complete collapse is the oil sector, which now accounts for virtually all exports. However, even this sector has been hit by interference and lack of investment. Chavez’s decision to scrap plans for a greater private role, meant that the industry couldn’t take advantage of foreign funds and expertise.

The state firms were also hampered by the tendency to make decisions on political, rather than business, grounds. Experienced managers were fired and replaced with Chavez’s cronies. As a result, despite the fact that prices have risen, production is below the level when Chavez took over and US exports are down to levels last seen in 1985.

Growing discontent

As we’ve pointed out before, Chavez was a master in the art of running a ‘soft dictatorship’. A big part of this has been traditional strong-arm tactics. For instance, those who speak out against the regime face intimidation.

Nonetheless, thanks to all the spending and patronage, the regime has managed to retain the genuine support of a significant minority of people. Chavez’s charisma also helped. This allowed it to maintain the illusion of a democracy and avoided reliance on the armed forces, many of which might not obey orders.

The problem for Maduro is that the economic crisis is now hitting the regime’s natural supporters. As a result protests have been gathering pace, with students setting up blockades in Caracas, the capital.

Despite repeated orders to leave and the use of tear gas, they have vowed that they will stay until their demands, which include Maduro’s resignation, are met.

Why this matters

A change of government could have major implications for the global oil market. This is because huge amounts of oil and gas are contained in the waters off the Venezuelan coast.

Indeed, one estimate suggests the country’s oil reserves are the largest in the world, bigger than those in Saudi Arabia. Even the US Energy Efficiency Agency puts Venezuela’s reserves in second place.

At the very least, an efficient oil industry, run on commercial lines and working in partnership with the private sector, could reverse the downward trend in production.

This would increase global supply, pushing oil prices downwards. A post-Maduro Venezuela would also be likely to use its Opec membership to push the organisation towards a more moderate stance.

Of course, it is possible that Maduro could ride these problems out and remain in power for the near future.

However, it’s clear that the regime is facing its biggest challenge in years and that its fall would represent a big downside risk to the oil price. If you’re investing in oil, or energy-related stocks (including shale gas), it’s certainly something to keep an eye on.

One company that could benefit from a relaxation of rules on foreign investment in the Venezuelan oil industry is the Brazilian oil company Petrobas (NYSE: PBR). Indeed, it was one of the few major foreign companies to be granted a (very small) lease in the Orinoco Belt last year.

It currently trades on a remarkably slim 5% premium to net asset value (NAV), while its price/earnings ratio is just six.

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