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Dropping oil prices pinch Venezuela's economy

After riding high on surging oil prices, Hugo Chavez is facing tough economic choices.

View of Venezuela's Amuay oil refinery at daybreak in Punto Fijo, 340 miles west of Caracas May 18 2006. (Jorge Silva/Reuters)

CARACAS, Venezuela — On a rooftop bar in Caracas, Venezuelans clad in Ralph Lauren shirts and Gucci shoes sip $16 cocktails and discuss their latest shopping trips to Miami.

These are the sort of people who would fit Venezuelan President Hugo Chavez’s description of the “fetid oligarchy”: families that, over generations, accumulated fortunes from the country’s vast oil reserves at the expense, Chavez says, of the country’s poor. Standing shoulder-to-shoulder with those longtime members of Venezuela's upper crust are one or two "boligarchs" — a new political class that has amassed its fortunes by backing Chavez's Bolivarian revolution.

All became increasingly wealthy during an oil boom that saw the price of a barrel of Venezuelan oil rise from $8 when Chavez came to power to a high of $126 last year. The country as a whole has also benefited: The economy has been growing at an annual rate of 8 percent for the past five years, and Chavez has funneled money to social programs. With little foreign investment to worry about, Chavez initially gloated over the fall of Lehman Brothers, blaming it on the failings of capitalism.

But Venezuela is no longer immune. The sharp collapse in oil prices — the Venezuelan crude basket averaged $33.93 last week — has prompted the government to change its rhetoric.

“If this carries on for two or three years, which is possible, one would think that it would lead to difficult consequences,” Finance Minister Ali Rodriguz said on Tuesday.

Some analysts believe Venezuela could feel the pinch sooner — even within the next year. “We are heading towards a certain crisis next year,” said Asdrubal Olivares, director of Ecoanalitica, a financial consultancy firm in Caracas. “What most worries us in 2009 is that we're going to have an economy in stagflation — with a very strong stagnation of the economy and a very, very high level of inflation.”

The government saved up large reserves during the boom years, believed to be in the range of $47 billion, which should see it through the year, said Olivares. But beyond 2009 the outlook is bleak.

Inflation has already been hitting consumers hard. While poverty fell in recent years from 51 percent to 28 percent — in part because of massive government spending on social programs — inflation is now eroding the gains Chavez has made in reducing poverty. Prices rose by more than 30 percent last year, and by as much as 50 percent for essentials such as food.

“In 52 years living here I’ve never seen something like this,” said Pascuale Giacinto, a retired carpenter from Italy now living in Los Simbolos, a middle-class area of the capital. “My pension goes on electricity, telephone bills, but not much else.”

The government has set up food markets that sell basic food staples at controlled prices, but Giacinto said, “I don’t like going there because the things are awful."

Meanwhile, a black market exchange rate for the dollar — almost three times the official price — has encouraged a flight of capital to the tune of $22 billion, Olivares said. In the recent Stanford Bank scandal, it emerged that Venezuelans had invested about $3 billion out of the $9 billion that is believed to have been lost.

Venezuela's economy is tied up in oil, so the decline in oil prices has hit the country hard.

Venezuela depends on oil for about 90 percent of its exports, and oil revenues make up almost 50 percent of its budget. The government claims it is producing about 3.3 million barrels of oil a day, but independent analysts believe the figure is closer 2.7 million barrels a day, of which 700,000 are sold at subsidized prices on the domestic market.

Of the oil that is exported, 500,000 barrels are sold to countries on deferred payment deals under a scheme known as Petrocaribe, while 400,000 barrels that come from the heavy tar fields of the Orinoco Belt in the west of the country cost $15 to $20 a barrel to upgrade into conventional oil, which cuts into profits.

Signs that Petroleos de Venezuela (PDVSA), the national oil company, is struggling with its finances emerged earlier this month: It delayed payment of $8 billion to other companies.

“Production is declining because regrettably Venezuela has not been a good steward with its windfalls — with the high price of oil for the last two years,” said Jorge Pinon, an energy fellow at the University of Miami. “That money has gone into social programs instead of going back into PDVSA.”

Pinon said that to make Chavez’s popular social programs sustainable, PDVSA should be investing in the maintenance of existing oil wells – and even upping production. He estimates that production fell by 11 percent last year.

Many speculate that the government may be forced to devalue the bolivar, the Venezuelan currency. It has been fixed at a rate of 2.15 to the dollar since 2003, in what was initially intended as a temporary measure to bolster Venezuela’s foreign reserves. But many economists believe a devaluation would provide the liquidity the government needs to maintain its significant public spending.

Rodriguez said Tuesday, however, that he feared a weak bolivar would curtail the government’s ability to import essential commodities — Venezuela imports 70 percent of its food.

Chavez has ruled out cuts in spending on the popular "missions" — projects that have brought free health clinics and literacy classes the country’s many barrios. But he either needs the price of oil to dramatically increase, or he needs to figure out a way to bolster the economy so the programs can continue beyond 2009.

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http://www.globalpost.com/dispatch/venezuela/090227/dropping-oil-prices-pinch-venezuelas-economy