No folks, it’s not Bernie Sanders’ Vermont nor Jerry Brown’s California Democratic Republic that’s about to get flushed down the economic toilet. We are talking about Nicolas Maduro’s Venezuela that he inherited from his predecessor Hugo Chavez. With the recent collapse in crude oil prices that account for roughly 95% of the country’s export revenues, the red lights are flashing that the country is once again on the cusp of widespread civil unrest with the additional prospect of a possible overthrow of the socialist government. From a fiscal standpoint, the country is also only a few steps away from defaulting on its debt. The country’s current plight is a culmination of fifteen years of profligate spending on all manner of social programs and subsidies while failing to reinvest in PDVSA’s oil production and refining operations and to set aside adequate cash reserves for potential downturns in the commodity cycle.
The seeds of the failure of the Bolivarian state were sewn throughout the period of Hugo Chavez’s dictatorship. From the time he took office in 1999, plans were implemented to dramatically transform the country’s economy. Over time, private property was confiscated, the entrepreneur class of the population was largely stripped of its wealth and oil revenues were funneled increasingly into constructing a welfare state. Along the way, in 2002, the state-owned oil company, PDVSA, went on strike with the end result that thousands of trained engineers were fired from their positions and replaced by Chavez party loyalists. PDVSA soon became just another cog in the country’s cultural metamorphosis, increasingly taking on the role of provider of funds for Chavez’s socialist revolution. Thus, the oil company took on a greater role of passing along cash flows to social programs while investing less in maintaining the refining infrastructure and the exploration and production activities of its oil operations. A Reuters article in April of 2013 noted that in 2012 PDVSA contributed $44 billion to spending on social programs. While the spending level for these programs has largely been maintained, PDVSA currently generates only roughly $32 billion of crude oil revenues with oil now trading at $50 per barrel. At the same time, the underinvestment in the company’s oil business has had a pernicious effect on operations. The lack of spending on oil infrastructure was a likely contributor to the massive explosion and fire at the 645,000 barrel a day Amuay refinery that killed 48 in 2012 and for ongoing operational problems that have kept the company’s Isla refinery operating at half of capacity for the last few years. Likewise, despite investment from the Chinese and other foreign players, PDVSA’S upstream division has lacked the attention it needs to attain production goals.
In evaluating Venezuela’s options, none of the country’s courses of action appear to be without great risk. Reduced spending on social welfare programs and reduced subsidies for gasoline (currently at $.18 per gallon at a cost of $22 billion per year) runs the risk of stoking civil unrest and creating further disenchantment with a Maduro administration that currently has only a 22% approval rating. The second option involving further currency devaluations is likely to lead to further inflation problems, creating greater financial hardship among the general population. Venezuela also could try to restructure its debt with the Chinese, having already sold a great deal of future production to the country in exchange for loans. The Chinese, however, appear to be increasingly wary of loans to Maduro’s regime and are likely to make the terms of any future loans more stringent. In light of its financial predicament, the country’s CCC-rated sovereign bonds currently sell for around $.44 on the dollar, are yielding around 22% and the credit default swaps that serve as a barometer of the bonds’ quality suggest a greater than 90% chance of default.
Combined with an inflation rate approaching 60%, ongoing currency devaluations, widespread scarcity of basic consumer goods and an extremely high crime rate, the country indeed appears on the cusp of some type of major upheaval. As the tenuous situation looks to become more dire, an overthrow of the current regime looks increasingly possible as the country’s inhabitants reconcile themselves with the idea that socialism, once again, has proven to be a failed experiment.
Paul Crovo currently works as an energy analyst for a major financial institution in Philadelphia, and is a Policy Advisor to The Heartland Institute.
