Venezuela's Economy

Why Venezuela May Default

Venezuela
Venezuela had bright promise until it fell into economic ruin. Photo: Silvestre Machado/Getty Images

Venezuela Is an Important Source of Oil

Venezuela supplies 8% of U.S. oil imports, the fourth-largest foreign source of oil after Saudi Arabia, Canada, and Mexico. At the same time, Venezuela has the 7th largest oil reserves in the world. That's more than Russia, Libya or the United States.

Venezuela’s economy is dependent on oil exports, which contributed 12% to GDP, but 45% to the government's revenues, since the major oil producer, PdVSA, is state-owned.

 

As long as oil prices remained high, Venezuela's economy boomed. Unfortunately, the government spent the proceeds. It hiked the minimum wage and allowed the central bank to increase the money supply by 70%. (Source: CIA World Factbook, 2013 Estimates)

That sent the value of the local currency, the bolivar, plummeting when compared to the dollar. It helped create 56% inflation in 2013.  Since the government sells its oil in dollars, it has a lock on the exchange rate. That means local businesses can't afford to buy dollars to pay foreign suppliers. In addition, businesses must pay high wages but sell for low prices to conform to the government's wage-price controls. This has caused a shortage in everyday products. (Source: WSJ, Venezuela Heads to a Default Reckoning, September 15, 2014)

Venezuela’s President Nicolas Maduro took over when former President Hugo Chavez died in March 2013. Chavez was very popular because his social programs, financed with oil money, promised to improve people’s lives.

But Maduro and Venezuela's economy are paying the price now.

Venezuela Nationalized Its Oil

In 2007, Venezuela nationalized its oil industry, forcing firms such as ExxonMobil, Chevron, and BP to become minority partners in the state-run oil company, Petroleos de Venezuela SA (PDVSA). Chavez had nationalized PDVSA earlier.

It became the source of half of the government’s revenues and 80% of export earnings. Foreign companies have only a 40% ownership in projects they have built, operated and profited from for years. Many companies are hesitant to continue investing in Venezuelan oil ventures.

In the Orinoco oil fields, PDVSA increased its ownership from 39% to 70%. These fields were valued at $30 billion and produce 600,000 barrels of oil a day. These fields supplied 18% of Venezuela’s total oil production. The foreign companies included France's Total, Norway's Statoil, the U.S. ChevronTexaco, Britain's BP and Italy's Eni. (See BusinessWeek, "Two Oil Giants Exit Venezuela," June 26, 2007)

Venezuela Also Nationalized Its Utilities

In 2007, Venezuela also nationalized the country’s electricity and telecommunications companies, Electricidad de Caracas and C.A. Nacional Telefonos de Venezuela, as a way for the government to control these key public services. Both companies were majority owned by foreign companies.

If companies cannot safely invest in Venezuela, and expect a healthy return on their investments, then Foreign Direct Investment (FDI) will decline. The competition, innovation and capital provided by FDI is a key indicator for a healthy economy.

Venezuela Was a Proponent of "Bolivarism"

Chavez campaigned for “Bolivarism”, or pan-South American unity. Only Nicaragua, Bolivia and Ecuador became solid members. Most South American countries prefer a good trade relationship with the United States. They shied away from Chavez' anti-U.S. stance. 

Chavez became aligned with other countries, such as Russia and Iran, that are using their oil and natural gas reserves to further political aims. He prodded OPEC to restrict production in an effort to keep oil prices high.