Falling Oil Prices Push Venezuela, Maduro Closer to the Edge.
By Paul Shortell, Oct. 22, 2014, Briefing
With crude oil prices down 25 percent since June and holding at roughly $86 a barrel on Tuesday, Venezuela is getting nervous. Lower prices will put greater strain on Venezuela’s oil-reliant economy as its government struggles with growing macroeconomic imbalances. Yet even with all the problems that reduced oil prices create for his administration, President Nicolas Maduro is doubling down on his current policies. By stalling in the hopes of a bailout in the form of higher oil prices or Chinese credit, instead of attempting politically unpopular restructuring, Maduro is ignoring cracks in his political and economic program.
Booming commodity prices allowed Venezuela, which boasts the world’s largest proven oil reserves, to spend beyond its means for much of the past decade. But slack demand, coupled with a partial recovery among Middle East producers and booming shale oil output in North America, have triggered a reverse in prices. Crude oil values plummeted from an average of more than $105 per barrel earlier this year to a four-year low of $82.60 last week on the Brent index. These changes will be keenly felt in Venezuela, where oil accounts for more than 95 percent of the country’s exports and approximately 45 percent of government income.
The drop in crude prices will diminish Venezuela’s export earnings, exacerbating the country’s fiscal deficits and curbing its ability to accumulate foreign exchange. The country’s budget deficit already exceeded 10 percent of GDP in 2013, a year when oil prices remained relatively high. The government’s shortfall should further increase this year if the value of Venezuela’s only major export stays well below the estimated $120 per barrel needed for the country to balance its budget. Meanwhile, tight trade restrictions and a distortionary exchange regime have reduced non-oil fiscal revenues to just 14 percent of the country’s GDP, leaving the government with few options for raising additional funds.
A lack of cash should have Maduro sounding the alarm, as Venezuela must pay off more than $28 billion of debt over the next two years. The country’s liabilities continue to mount while foreign reserves hit a 10-year low in October. The World Bank’s International Centre for the Settlement of Investment Disputes (ICSID) recently awarded ExxonMobil $1.6 billion for the expropriation of its assets in the country and similarly ruled that Gold Reserve was owed $740 million. More than a dozen additional cases still pending in international tribunals could increase Venezuela’s obligations by the billions. Earlier this year, Standard & Poor’s gave Venezuela a 50 percent chance of sovereign default in the next two years. Some new estimates put that number closer to 100 percent.
Weak oil prices will only make these challenges more acute. However, default is far from a fait accompli, even if conditions worsen further. Venezuela’s government controls significant assets and has shown occasional willingness to tackle economic hurdles, such as incremental adjustments of the country’s exchange rate adopted in recent years. The Maduro administration could ease escalating pressure on the national economy through a variety of means, including cutting costly fuel subsidies, reining in rampant inflation and liberalizing the movement of goods in and out of the country.
But internal politics have impeded these crucial reforms. Earlier this year, Maduro floated proposals to cut the country’s gasoline subsidies and sell Citgo, the U.S. subsidiary of Venezuela’s state oil company, PDVSA, two pragmatic measures that would have raised much-needed cash. The president backtracked on both, however, in the face of popular backlash. Meanwhile, a recent Cabinet shuffle bumped Rafael Ramirez, widely regarded as a pragmatic voice within the administration, from his former post as oil minister and head of PDVSA to minister of foreign affairs. The move has been widely interpreted as a shift toward hardliners within Maduro’s coalition.
Responses in Caracas to tumbling oil prices suggest that Venezuela’s government will maintain its current course in the coming months. Last week, Maduro publicly blamed the fall on “foreign adversaries” intent on “destabilization,” while telling journalists that he expects prices to rebound. If these predictions are more than rhetorical, as seems to be the case, then Venezuela’s president is making a risky bet. His administration’s efforts to reverse the price drop are unlikely to succeed, while continued reluctance to address domestic liabilities leaves Venezuela vulnerable to highly uncertain changes in the value of crude.
Venezuela has called for an emergency meeting of the Organization of Petroleum Exporting Countries (OPEC) to ask its fellow members to reduce output. But OPEC countries will not reach an agreement until late November at the earliest. Saudi Arabia, the only country with the ability to make major production cuts, is unlikely to challenge the status quo so long as lower prices protect its diminishing market share. And even a prompt decrease in Saudi production would not guarantee a price rebound; OPEC’s price-setting power has weakened as U.S. shale output erodes the monopoly held by traditional suppliers, while global demand for oil has lagged.
China may be more willing and better positioned than Saudi Arabia to come to Maduro’s aid. Beijing has pledged more than $50 billion in financing to Caracas since 2006, much of which is scheduled for repayment via regular shipments of oil tied to market prices. Additional assistance could support spending by the Maduro administration or provide the liquidity needed to stave off default. But Venezuela is already struggling to meet its current loan obligations. China’s government decided earlier this month to loosen the terms of the multibillion-dollar China-Venezuela Joint Investment Fund by removing minimum quantities for oil shipments and extending the deadline for repayment.
Ultimately, recovering prices or Chinese credit can only temporarily buoy Venezuela’s economy. The slump in oil prices has exposed the country’s fragile situation. Further delay of much-needed tradeoffs will erode Venezuela’s ability to maintain much-touted social programs and regional clout, potentially threatening the viability of Maduro’s government. Chronic shortages of basic goods have already generated discontent among many Venezuelans. If new economic realities restrict the flow of cash to corrupt officials, Maduro could also face growing opposition from the country’s elite. His balancing act is getting harder to maintain.
Paul Shortell is a program assistant at the Inter-American Dialogue.