Tuesday, August 08, 2006

Castro With Oil?

This weekend's Washington Post Outlook section (similar to the NY Times' Week in Review) was chock-full of articles speculating about whether Venezuelan President Chavez will assume the mantle of Castro's revolutionary leadership, once Fidel finally passes. Se├▒or Chavez has had a busy travel schedule lately, making more stops on his world tour of anti-globalization and anti-Americanism, as described in another column in Monday's Post, culminating in an arms deal with Russia's President Putin. This would be worrying enough, geopolitically, if Venezuela weren't also our fourth largest oil supplier.

While several of the Post's contributors were skeptical that President Chavez has the charisma, stamina, or authentic revolutionary chops to step into Fidel Castro's shoes, they neglected to mention his remarkable run of luck. He has survived two separate coup attempts, once as instigator, once as victim, and a referendum that many thought would dislodge him. Francis Fukuyama's Sunday op-ed highlighted the role of oil in making Chavez's "Bolivarian Revolution" economically feasible, but it's worth recalling that Chavez's actions had put Venezuela's future oil revenues into a death spiral, by breaking the 3-month strike of the national oil company, PdVSA, and firing 18,000 managers and workers. By a bizarre quirk of fate or good luck, this was just about when the long march to $75/barrel began, with the US invasion of Iraq. So even though Venezuela's oil production has never entirely recovered from the strike, its oil revenue has risen dramatically.

As if that weren't enough, President Chavez has managed to increase, more or less unilaterally, both the royalties and ownership interest in the foreign-financed heavy oil conversion projects that were instrumental in preventing a complete collapse in Venezuelan production. The international oil companies involved may not be smiling, but they are still doing business with him, with the exception of ExxonMobil.

According to the Oxford Institute for Energy Studies, Venezuela's oil export revenues in 2000 were $27 billion, but their net from that was only about $11.3 billion, after accounting for tax and royalty rates that were intended to make the country's challenging oil reserves more attractive to international investors. At current prices, gross revenue on today's lower volumes should be roughly $50 billion, but their net take has probably tripled, after factoring in the recent changes in terms. That's quite a track record, but where does it go from here? While oil may yet hit $100, that won't necessarily add another $25/barrel to the price of the heavy oil Venezuela specializes in. We are into diminishing returns, here. Venezuela has only a few more levers to pull on oil revenues:
  • Completing the recent partial nationalization. However, if the companies involved actually know more about running these complex facilities than PdVSA's downsized staff, production would fall again.
  • Expanding production via more international investment. This would probably have to be done with a different group of companies, since the political risk models of the folks who've already been semi-nationalized must be flashing all sorts of warnings. Unfortunately, those same companies are the ones that best understand the intricacies of Venezuela's Orinoco Belt geology and the necessary upgrading technology. There's also a significant time lag involved in bringing new upgraders on-line.
  • Cutting off oil exports to the US. They'd have to hope that the resulting rise in world oil prices would more than offset the much higher freight costs to Venezuela's alternate markets in Asia or Europe, and that this could be done without triggering a direct response from us. This looks like a fool's bet.

So, unless the proponents of Peak Oil are correct and global production will never again keep pace with demand growth, Mr. Chavez could just be looking at the high-water mark of his oil revenues, at the same time that he has committed himself to foreign activities and transactions that will tie up an increasing share of them, on top of an ambitious domestic social agenda. There's no better antidote to good luck than hubris, and an extra $20 billion or so in oil money only goes so far in a region with an aggregate GDP of $2-4 trillion.

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