I have seen a number of interesting stories on Venezuela this week. First was:
With petroleum prices down around $71 a barrel from a high of $147 the Venezuelan government is struggling to make up for the revenue shortfall to save programs that placate the poor by providing cheap food, fuel and other government giveaways.
Making matters worse, the once mighty Venezuelan petroleum industry has been laid low by politicization, corruption and mismanagement; rather than producing 3.3 million barrels per day, industry analysts believe the production is closer to 2.3 million. Instead of maximizing profits by producing its quota, Venezuela’s state-run oil fields are either underperforming or have collapsed altogether.
I have warned numerous times about the risks Chavez was taking by siphoning off oil revenues to fund other programs. If you are going to do that, you must do is to make sure you aren’t siphoning off too much, as the oil industry is capital intensive. If you pull out too much, then you kill the goose laying the golden eggs. Norway has a very successful model for how the oil industry can be used to benefit society as a whole. One thing they didn’t do was siphon off all of the oil companies’ revenues.
But because reelection is coming up, don’t expect Chavez to shift course:
Venezuela’s currency devaluation should give state oil company PdVSA an immediate and much-needed boost to its budget. But President Hugo Chavez is likely to procure a large part of that windfall for social spending ahead of this year’s congressional elections.
Then there was the story about Chavez searching for scapegoats when his decisions start to have consequences:
Chavez sacks energy minister after rolling blackouts
Venezuela President Hugo Chavez has indefinitely suspended rolling blackouts in capital city Caracas just a day after they began, and sacked his electricity minister.
Chavez said that the minister was responsible for mistakes in the way the rationing plan was applied.
Mr Chavez’s announcements were a significant strategic shift in his attempts to prevent a widespread power collapse in the coming months through rolling blackouts of up to four hours a day across the country.
But no worries. He believes that after stealing the assets of oil companies, he can invite them back in and they will come running:
Jan. 15 (Bloomberg) — Petroleos de Venezuela SA, Venezuela’s state oil company, said it expects bids today totaling $8.3 billion to develop the Mariscal Sucre offshore natural-gas project, daily El Universal reported.
The company known as PDVSA seeks partners to take stakes of as much as 40 percent in the project, Eulogio del Pino, vice president for exploration and production, told the Caracas-based newspaper.
PDVSA and the Energy Ministry asked companies including Russia’s OAO Gazprom, Norway’s Statoil ASA and Japan’s Mitsubishi Corp. to participate in the bidding, del Pino said.
I don’t know. I will be surprised if these companies trust Chavez enough to put serious money down on any of these projects. As he has shown before, if the profits start to look good, he will change the terms. Who wants to take risk only to let Chavez reap the reward? On the other hand, these aren’t the same companies Chavez cheated the first time around, so maybe they will be a little more trusting. But if so and they lose their investment, shareholders shouldn’t be the least bit surprised.
I am just finishing up Biofuel Contenders, and should have that up later today or first thing tomorrow. Until then, a topical post from the latest from Money Morning, which as I previously explained will be featured here whenever they have relevant material to offer. As always, normal caveats apply: I am not an investment advisor. I don’t endorse any specific stocks mentioned in the following story nor the ad at the end of the story.
Is Venezuela’s Stagflation the Beginning of the End for Chavez?
By Jason Simpkins
Managing Editor – Money Morning
It wasn’t long ago that Venezuelan President Hugo Chavez’s decision to nationalize state oil company Petroleos de Venezuela SA (PDVSA) resulted in a failed coup that very nearly cost him his post.
Now, Chavez’s aggressive economic policies are again being called into question, this time as the country slides into what could be a protracted period of stagflation, which is defined by the exasperating mixture of torpid economic growth and high inflation.
Before that, however, the period from 2004-2007 was marked by rapid economic growth – punctuated by a miraculous 19.42% burst in 2004. Since that time, unfortunately, Venezuelans have watched as their standard of living was slowly eroded by restrictive price controls, rapid inflation, unsustainable public spending, and widespread nationalizations that have put a stranglehold on industry.
Even as these problems festered, an unprecedented surge in oil prices allowed Chavez to maintain his questionable – and ultimately unsustainable – economic policies. When the bull market in commodities abruptly stalled last year, Venezuela’s economy lumbered to a stop.
Venezuela’s economy grew by 3.2% in the fourth quarter of 2008 and just 0.3% in the first quarter of 2009. Then – for the first time in more than five years – that country’s economy contracted, shrinking 2.4% in the second quarter.
Unfortunately for Venezuela, the decline in gross domestic product (GDP) did little to quell surging inflation. The annual rate of inflation climbed to 26.2% in July, according to the Central Bank of Venezuela. Many foreign sources have it higher.
President Chavez insists his country is not in the midst of a financial crisis, but analysts believe this is just the beginning of a bad-news saga that will trip up a country whose heavy-handed economic policies have made it few friends.
“To sum up, we could say that such scenario of stagflation has two basic components,” Orlando Ochoa, an economist and professor with Andrés Bello Catholic University (UCAB), told El Universal. “On the one hand, price control, exchange control, nationalizations and restricted distribution of foreign currency damage supply. On the other hand, lower oil prices curtail revenues and have an impact on demand.”
Going forward, Venezuela’s currency controls are perhaps the biggest hurdle for the economy to overcome. Chavez and his cabinet have said they are preparing to announce measures to stimulate the economy, but that may not be enough.
The problems that come with over-reliance on oil and a vast net of unwieldy social programs and the cost burden of nationalized industry aren’t going anywhere. And the nation’s other obstacle – the gap between its official and parallel exchange rates – won’t be addressed until at least the end of September.
An Unparalleled Problem
Indeed, the problems facing Venezuela are many. But President Chavez and his cabinet believe they have the solution.
“There is a remedy,” Venezuelan Finance Minister Ali Rodriguez said in an interview broadcast on state television. “The differential between the official dollar and the [so-called] ‘parallel dollar’ can be reduced.”
Rodriguez was referring to the difference between the country’s “official” exchange rate – which remains at 2.15 bolivars per U.S. dollar – and the so-called “parallel market,” which suggests a rate of about 6.5 bolivars per U.S. dollar.
The official exchange rate of 2.15 bolivars per U.S. dollar was arrived at in 2003, when Chavez imposed currency controls that force Venezuelans who want to import goods to apply for a government permit. Importers that are unable to get permits to buy currency at the official exchange rate have been forced to turn to the parallel market, where they pay three times the official price.
The problem now is that a large drop in oil revenue has sharply reduced the amount of dollars the government has available to exchange. That has driven more importers to the pricier parallel market. Some have stopped importing entirely.
With limited access to imports, Venezuela’s manufacturing sector contracted by 8.5% in the second quarter.
“The manufacturing sector is going to have a negative performance, mostly because of the restriction in imports and dollars, which has caused a drop in the supply of primary materials,” Miguel Carpio, an economist at Banco Federal CA in Caracas, told Bloomberg News. “Add to that the drop in consumption, and this is going to be a very difficult year.”
Now, with the threat of stagflation looming large, Chavez has no choice but to take action. But economists are unsure of what the government will do.
Few analysts expect the government to order an outright devaluation, because it would push inflation beyond the 28% annual rate. (Venezuela last devalued the official rate in 2005, weakening the currency by 11%.)
Instead, the government could try to lower the parallel rate by issuing dollar-denominated debt, by creating a second, separate exchange rate for “necessary” industries, or by doing both those things.
Traditionally, the government chooses to subsidize certain favorite industries – mainly heavy machinery, foodstuffs and medicines – by allowing them to trade bolivars at the official rate and driving other non-essential goods producers to the parallel market.
This could be taken a step further by imposing a tax on lower priority industries seeking dollars at the official exchange rate, Russ Dallen, head trader at Caracas Capital Markets, said in a research note. Or the government could simply create multiple “official” rates for different industries. Venezuela may create four different exchange rates to help the government deal with a drop in oil revenue.
“This complicated system, if implemented, would satisfy the requirements of the government of pretending not to have a formal devaluation of the exchange rate,” Dallen said.
Credit Suisse Group AG (NYSE ADR: CS) said in an Aug. 28 report that it expects the government to avoid devaluating its currency by selling dollar-denominated debt to the parallel market. In 2008, after an aggressive sale of dollar-denominated bonds, the administration was able to bring down the parallel rate to around 3 bolivars.
Ultimately, it’s Chavez – who opened the door to speculation in August by saying he would “restore balance” to the parallel rate – who will decide what to do about his country’s quandary. But he won’t be making a decision until later this month.
“Is there going to be an adjustment? I can’t respond to that right now,” Chavez said Sunday at the presidential palace in Caracas. “If any adjustment comes, it will be in September, towards the end of the month.”
But whatever Chavez decides to do, his remedy is likely to fall short, analysts say. That’s because the parallel rate is not the problem – it’s actually a symptom of flawed economic principles. The restrictive price-and-exchange-rate controls, government expansion, and political obtuseness that Chavez has made the cornerstones of his economic policy will continue to conspire against Venezuela until there is reform.
“We always said the situation was only tenable for the government if oil prices not only remained high, but also rose constantly. But that has not happened, and the fall in oil income is now clearly in evidence,” UCAB’s Ochoa told Inter Press Service News Agency. “That’s the first factor contributing to stagflation, to which are added price and exchange controls and restrictions on hard currency availability, which harm supply and investment, and thirdly, the policy of nationalization.”
Venezuela’s Crude Oil Slick
In the years leading up to the financial crisis, Chavez used PDVSA’s growing revenue to finance large social programs, as well as the nationalization of other industries.
Spending on social programs soared 340% from 2000-2005, according to the Center for Economic and Policy Research. It rose even higher as oil prices soared into 2008, boosting purchase orders and fueling a spending spree among even the poorest Venezuelans.
But since the financial crisis eviscerated commodities prices, Venezuela’s oil bounty has all but evaporated. Oil brought in $22.8 billion in the first six months of 2009. That’s less than half of the $52 billion it brought in during the first half of last year. For 2008 as a whole, oil generated about $90 billion in revenue for Venezuela.
Meanwhile, FONDEN – Venezuela’s development fund – has already committed all but $3 billion of the nearly $20 billion it had available at the end of January, as the government used most of the money in the first half of the year to sustain fiscal spending.
And while Venezuelan oil traded at an average of $53 a barrel in the second quarter, up from $40 a barrel in the first three months of 2009, that’s still a far cry from last year’s levels.
That means borrowing has had to rise to compensate for the decline in revenue. Venezuela’s domestic debt jumped 44% during the first half of the year to $20.42 billion from $14 billion at the end of 2008.
“Public spending keeps rising and is financed by more public debt, which increases spending in a vicious circle, while the government defers or postpones workers’ demands, which is itself another sign of the approaching recession, although the government seeks to deny it,” economist Domingo Maza Zavala, a former head of the Central Bank told the IPS.
Calculations based on official figures suggest domestic and foreign debt repayments will total about $19.6 billion between the second half of this year and 2011, the Latin American Herald Tribune reported. Roughly $10 billion of that total will be due on foreign debt, with the remaining $9.6 billion destined for the domestic account. Total state debt is estimated at $50.3 billion.
What’s the government figures don’t include is the cost of compensating private companies that have been taken over or bought out under Chavez’s nationalizations and expropriations.
Chavez’s government earlier this year seized the assets of more than 70 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by PDVSA.
PDVSA demanded that service companies accept a 40% cut in their bills; when they refused, the Venezuelan government seized at least 12 drilling rigs, more than 30 oil terminals, and about 300 boats.
The demonstration was a pointed reminder of a 2007 incident, which is still playing out in the international courts. Two years ago, Venezuela forced six oil majors to hand over equity stakes of 60% or more to PDVSA. However, Exxon Mobil Corp. (NYSE: XOM) and Conoco Phillips (NYSE: COP) opted to walk away from their contracts rather than accept a minority role.
This conflict is still being disputed, and last year Exxon won a court order to freeze $12 billion in assets from PDVSA as compensation for its lost projects. Additionally, Chavez’s heavy-handed policy has cost the country untold billions worth of oil-related investments, as many oil majors now refuse to operate there
“There is the uncertain outlook over how the extensive nationalization pursued over the past 12 years will pan out,” Alvise Marino, an analyst at Ideaglobal, told The Wall Street Journal. “Based on the government’s unimpressive track record on the economic management front, we tend to take a less-than-optimistic view.”
The Colombia Conundrum
In addition to alienating foreign oil majors, Chavez has also sequestered Venezuela from many of its neighbors, especially Colombia. Chavez has ordered his country to prepare for an outright “rupture of relations” with Colombia after that country gave the United States permission to use its military bases.
The United States says access to the bases will help it fight drug trafficking, but Chavez has his own theory. He says American use of the bases could be used as a launch point for an invasion of his oil rich nation.
“Those seven military bases are a declaration of war,” Chavez said last week. “We must prepare for the rupture in relations with Colombia. There is no possibility of a return [to normal relations] with Colombia, an embrace.”
However, cutting off ties with Colombia poses yet another economic hurdle for the Venezuelan economy to overcome. Colombia provided about $6 billion in products to Venezuela in 2008, or about 15% of Venezuela’s total imports, according to Venezuela’s government statistics institute INE.
In fact, when Chavez closed the border for three days in 2006, there was shortage of food in Venezuela. Chavez can turn to other South American countries, but his credit extends only so far.
“Nobody wants to sell to Venezuela if payment isn’t made in advance,” José Rozo, president of Fedecámaras Táchira, the region’s main business association, told the Latin American Herald Tribune.
About 70% of trade activity in Venezuela depends on imports from Colombia, Rozo said, adding that the only country that had been willing to export on credit had been Colombia.
Without Colombia, Venezuela will have to settle for trade terms that heavily favor its partners.
For instance, Argentine President Cristina Fernandez de Kirchner made a visit to Venezuela last month, and signed no less than 22 accords. Virtually all of the deals were in Argentine’s favor, the Tribune reported.
“We’re going to drive a horse and cart through all the regulations if they want to do business with us,” an Argentine official told the paper prior to the signing of the deals. “Prompt payment. Simple procedures. Fewer controls. Less bureaucracy. No delays. Hard currency. I’ll tell you the rest when I’ve thought of them.”
That means if Venezuela wants to keep doing business with Argentina, it’s going to have to pay more.
And that will fuel inflation.
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At this point, you have to wonder who in their right mind will ever do business in Venezuela again as long as Chavez is in power. The risk that Chavez will steal your property is simply too great. During his administration, Chavez has seized phone companies, electric utilities, private real estate (just this week he ordered seizure of a private shopping mall), oil field investments, mines, steel plants, food processing plants, farms, (shades of Mugabe) and cement plants – to name a few.
Now this week he has stolen the assets of oil field services companies:
In the wake of the seizure of foreign and domestic oil service companies and assets by armed troops following the orders of Venezuelan President Hugo Chavez, experts began to count the cost to Venezuela — which holds the Western Hemisphere’s largest oil reserves — in lost oil production, lost jobs, lost foreign investment and lost foreign expertise.
This one is ironic, because he was “forced” to seize these assets based on his miscalculations on his previous thefts. Let me explain. In 2007, when oil prices were rising, the heavy oil investments of ExxonMobil and ConocoPhillips (Full disclosure: My former employer) finally began to pay off. It is very expensive to extract and process the heavy oil from the Orinoco Belt in Venezuela. It requires a lot of capital investment and significant expertise, but it also doesn’t pay off until oil prices rise. But when oil prices did rise and Chavez saw the goose start to lay golden eggs, he decided to seize the goose for himself. The problem is that Chavez doesn’t know how to care for a goose, so what has happened in the wake of these seizures should come as no surprise.
It was bad enough that oil production has fallen sharply under the Chavez regime. The reasons for that are simple enough, and have been covered here before. In a nutshell, the issue is this: It takes a lot of capital to maintain the heavy oil business, and Chavez was siphoning off profits to pay for his social programs. Now some (extreme-leftist) people might think that’s just great, but the only reason any money was there to siphon off was due to the high investments to begin with. By not reinvesting back into the business, Chavez set the stage for the plunging oil production we see now – but now the goose is on life-support so there will no longer be money for those social programs.
Much higher oil prices for a while dampened the blow of falling production, but once oil prices started to fall, plunging revenues became a real problem. You would think he would have saved some money for a rainy day, but he is just like that irresponsible person who spends their entire paycheck every week, no matter how much money they make. Although I guess you don’t have to save for a rainy day if you are willing to just rob a bank when the rainy day comes.
But first, he had the bright idea to invite Western oil companies back in to invest again. Surely they can let bygones be bygones? Apparently not, because there doesn’t seem to be a rush to come back in. After all, does anyone doubt that Chavez will steal the investments as soon as prices/production turn back up?
This all leaves Chavez in a bind. He hasn’t made the investments that he needs to make, and nobody else is doing it for him. Production and prices are falling, and he has social programs to pay for. Debt started to pile up with oil services companies, and Chavez demanded lower prices from them. Given that he simply has no money for investment, he does what he always does. Threaten and then steal when he doesn’t get what he wants:
Chavez’s government and seized the assets of 60 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by the country’s state-owned energy company, Petroleos de Venezuela (PDVSA).
Irate over a growing backlog of invoices, many of the companies threatened to halt operations – something PDVSA and Chavez can ill-afford. The company accounts for about half of Venezuela’s revenue, and is largely responsible for funding and administering the social programs that Chavez has employed to court popular support.
PDVSA brought in more than $120 billion in revenue in 2008, but this year, it will likely make just $50 billion. With its back against the wall, PDVSA is demanding that service companies accept a 40% cut in their bills. Last Friday, the government began expropriating equipment and projects from foreign oil service firms that refused to renegotiate their debt. At least 12 drilling rigs, more than 30 oil terminals, and about 300 boats were seized, the according to The Financial Times.
But the brash gesture will also bring negative consequences that could significantly jeopardize the nation’s oil production, which is already in decline.
“PDVSA has to invest in the business,” James L. Williams, heads of oil consultancy WTRG Economics told BusinessWeek. “You have to feed a cow if you expect it to give milk.”
Hey, this is about geese and golden eggs, not cows and milk. But, point taken. The fact is that Chavez continues Venezuela’s slide toward becoming Zimbabwe. One wonders if he truly lacks the ability to plan, or was just too stupid to see the consequences of this road he has chosen to go down. The only thing that can save him at this point will be for oil prices to go up. Ironically, that’s the same thing I would like to see happen, but if we are lucky Chavez will be ousted before prices get much higher. Then again, if production continues to fall it won’t matter how high prices go; they won’t be able to offset the drops in production.
Chavez is now rattling sabers with Coca-Cola, so don’t be surprised if they go down next. Seriously, I don’t know why we don’t just seize Citgo as a response, auction off the refineries, and then pay damages to those whose assets have been expropriated. Chavez has said he doesn’t want to operate in the U.S., so we should extend a helping hand. It is the least we could do.
Note that in the following essay, I am not trying to come down either for or against ethanol tariffs, but rather to discuss what I see as the key issues surrounding them. U.S. energy policy is slanted to favor U.S. farmers and ethanol producers, and I am merely trying to explain the tariffs within that context.
You are probably aware that the U.S. imposes a $0.54/gallon tariff on ethanol that we import from Brazil. Brazil’s President Luiz Inacio Lula da Silva met with President Obama last week and implored him – in the name of a better environmental policy – to remove the “absurd tariffs on ethanol.” In response President Obama said the situation is “not going to change overnight.”
Brazil is a world leader in biofuels and the world’s largest exporter of ethanol. But Silva, who met with President Barack Obama on Saturday, has made little progress persuading the U.S. to reduce the tariffs, which are in place to protect American farmers who make ethanol from corn. Brazil makes ethanol from sugar, in a process that is much more efficient and costs less.
By all accounts, ethanol from sugarcane is a more sustainable model than ethanol from corn. The key to this – as I explained here – is that a true waste product (bagasse) is generated and used to fuel the boilers, mostly eliminating the need for fossil fuels for the production of the ethanol. So why do we penalize Brazilian ethanol? Is it pure protectionism?
While I am no fan of the perpetual subsidies we have put in place to prop up our corn ethanol industry, I think the tariffs do make sense in light of what policy-makers are trying to achieve. Gasoline blenders receive a credit of $0.51/gal (soon to drop to $0.45/gal, which should be this year since the farm bill said the credit would drop “beginning in the first calendar year after the year in which 7.5 billion gallons of ethanol is produced”).
While the credit indeed goes to the gasoline blender, since it reduces their costs for ethanol, it provides an incentive for ethanol producers. That is why ethanol producers – and not gasoline blenders – are the ones who always scream the loudest when the discussion turns to removing the credit. The question on the ethanol tariff becomes “Do we want to extend that incentive to Brazilian ethanol producers?” In other words, do you want your tax dollars going to incentivize sugarcane ethanol producers?
Here is how the tariff prevents that. A gasoline blender could buy corn ethanol or sugarcane ethanol, blend it into gasoline, and get the same blender’s credit in either case. Because ethanol produced from Brazilian sugarcane is cheaper than ethanol produced from corn, without the tariffs in place blenders would likely get all of the ethanol they could from Brazil. Given that this is completely contrary to the goal of creating a U.S.-based ethanol industry, the tariff makes sense in that context. One could argue the point that the tariff isn’t there to punish Brazilian ethanol, but rather to prevent them from taking advantage of a provision designed to spur U.S. ethanol production with taxpayer money.
Of course the fact that the tariff is $0.54 while the blender’s credit was $0.51 and quickly falling to $0.45 is a different matter. If the tariff is equal to the blender’s credit, then indeed one could argue that this is merely the removal of U.S. taxpayer support from Brazilian ethanol. However, if the tariff is greater than the blender’s credit, it begins to look like a punitive tariff, designed to do more than just remove U.S. taxpayer support. There is a senate bill currently under consideration to level that playing field back out:
A bipartisan group of senators is seeking to lower U.S. tariffs on ethanol imports to achieve “parity” with the blender’s credit, which was reduced in last year’s farm bill.
The farm bill knocked the blender’s credit from 51 cents per gallon to 45 cents per gallon. A new Senate measure (pdf) is aimed at knocking down the 54-cent-per-gallon import tariff and the 2.5 percent ad valorem tariff to achieve “parity” with the lowered blender’s tax credit.
Sen. Dianne Feinstein (D-Calif.), one of the sponsors, said in a statement that the higher import tariff creates a barrier for sugarcane-based ethanol from Brazil, and hence gives gasoline imports a “competitive advantage.”
I don’t find myself agreeing with Senator Feinstein very often on energy issues, but here I think she is correct. This is the other side of the coin. While the tariff may have the effect of ensuring that the blender’s credit only goes to U.S. ethanol producers, it also has the impact of putting Brazilian ethanol at a competitive disadvantage to gasoline or crude oil imports. Is this desirable? I don’t think so. To the extent that we require fuel imports, I fall into that camp of preferring to deal with Brazil over Venezuela.
So, how might I write a better policy than the one we have now but still protect U.S. ethanol producers? First, eliminate both the blender’s credit and the tariffs. This removes the barriers to Brazilian ethanol, while leveling the playing field with gasoline imports. Second, given that the present policy is designed to protect U.S. ethanol producers, require that some percentage or some volume of ethanol blended into the fuel system must come from them. Third, even with the current blender’s credit in place, U.S. ethanol producers are struggling to survive. If they had to sell their ethanol in a competitive (unprotected) market, they would all go bankrupt. Therefore, you have to keep the mandates in place regarding the amount of ethanol that must be blended into the fuel supply. This ensures that even if they can’t compete in an open market, they still have a captive market.
Of course I have said many times that I don’t favor mandates at all, nor do I think the corn ethanol industry will ever be viable in an open marketplace. However, it would be disastrous for Midwestern economies to completely pull support from under the industry. I would favor a policy in which we no longer encourage expansion of the industry, and over time phase the mandates out. This would in my opinion be the end of the corn ethanol industry, but a slow end without a shocking impact. If it isn’t, and they can survive in a world without mandates, then more power to them. But if they still can’t manage to live without subsidies after receiving them for 30 straight years (and even that wasn’t enough, hence the mandates), why should we expect that they ever will?
Incidentally, one final note on Brazil. People sometimes ask me which countries I think have a bright future, despite the prospect of peak oil. I think it is hard to make a case that anyone is going to be better off than Brazil. They are sitting on top of huge oil reserves, they can produce ethanol very efficiently and have the infrastructure in place to utilize it, and they have good solar insolation for solar panels, solar hot water, etc. I just don’t know of other country as well-positioned as they are. Not only do I think they will survive peak oil, I think they will thrive and their economy will continue to grow. That’s just one of the reasons I have invested money in Brazil.
Now this is pretty funny:
CARACAS, Venezuela — President Hugo Chávez, buffeted by falling oil prices that threaten to damage his efforts to establish a Socialist-inspired state, is quietly courting Western oil companies once again.
Until recently, Mr. Chávez had pushed foreign oil companies here into a corner by nationalizing their oil fields, raiding their offices with tax authorities and imposing a series of royalties increases.
But faced with the plunge in prices and a decline in domestic production, senior officials have begun soliciting bids from some of the largest Western oil companies in recent weeks — including Chevron, Royal Dutch/Shell and Total of France — promising them access to some of the world’s largest petroleum reserves, according to energy executives and industry consultants here.
Let’s see. Invite oil companies in, steal their investments when oil prices go up, kick them out, invite them in again when oil prices fall. That sounds fair. Every oil company with a few billion dollars burning a hole in their pocket is probably lining up – presuming they don’t mind losing 100% of their investment based on Chavez’s whims.
In all seriousness, I have said on numerous occasions that the oil industry in Venezuela couldn’t survive with Chavez siphoning all the profits and using them to fund his social programs. The oil industry is capital intensive. You neglect those capital requirements at the peril of future production. Someone commented on a previous essay that it was arrogant to assume that Venezuela couldn’t expand oil production without outside help. As I pointed out, heavy oil production is technically challenging. Chavez’s move here is an admission that things haven’t worked out for him as planned, and that in fact they do need outside help; help that Chavez has thoroughly alienated.
As the article points it, the biggest irony is that Chavez has celebrated the demise of capitalism in Venezuela, even though it was capitalism that enabled him to carry out his social programs. So, he is going to give capitalism another chance – but we have seen what happens when prices go up. His motto is “You take the risk, I will reap the reward.”
Update: As Maury pointed out in the comments, Chavez has reconsidered:
Venezuelan-owned Citgo Petroleum, which had earlier indicated it might end a home heating oil assistance program for low-income Americans, yesterday said it had decided to continue the program.
Joseph P. Kennedy II, chairman of Citizens Energy, said yesterday that the renewal of the program was evidence of Venezuelan President Hugo Chávez’s “genuine concern for the most vulnerable, regardless of where they may live.”
Does that mean that he was no longer concerned for those people when he cancelled the program? With comments like that, Joe Kennedy’s $400,000 salary won’t be in jeopardy.
You may have seen the recent announcement that Hugo Chavez is cutting off the free heating oil for low income residents in the Northeast:
Citgo Petroleum Corp., the U.S. refiner owned by the Venezuelan government, will suspend charitable contributions of home heating oil to poor U.S. households — a sign that falling oil prices may hamstring Venezuelan President Hugo Chávez, whose administration has used an oil windfall to win voters’ loyalty at home and allies abroad.
In a surprise announcement, former U.S. Rep. Joseph P. Kennedy II said Venezuela would stop deliveries to his Boston-based nonprofit, Citizens’ Energy, which last winter received $100 million of fuel that was distributed throughout the Northeast. Mr. Kennedy said Citgo cited falling oil prices and the world economic crisis for forcing the company “to re-evaluate all of its social programs.” Neither Citgo nor the Venezuelan government had any comment.
That alone is an interesting story. Chavez has siphoned money away from the oil industry in order to pay for social programs, which has resulted in underinvestment that will eventually come back to haunt him. (See this story that I wrote last year highlighting the issues). To this point, high oil prices have been a blessing for him, but falling production and low oil prices are combining to put the squeeze on Chavez.
But that isn’t the point of this essay. In a discussion on this at The Oil Drum, someone linked to a bit of additional information:
It’s hard to avoid the commercials starring former Congressman Joseph Kennedy II explaining how friendly Venezuela and Hugo Chavez are to the American people. After all Chavez and Kennedy are bringing relief to the poor people of America who suffer under the evil tyranny of high fuel costs. However, reality has a tendency to get in the way of press events for Citgo and Citizens Energy Corporation such as the scenes of Joe Kennedy driving up to house in a Citgo truck to deliver 40% cheaper heating oil from his “not-for-profit energy company.” The last thing anyone involved in this program wants is for someone to look behind the curtain.
First, Citizens Energy Corporation is not the organization that is directly involved with the program. Rather, one has to first look to a holding company, which is a for-profit and wholly owned subsidiary of Citizens Energy’s called Citizens Enterprises Corporation: first, eighty-six percent of Mr. Kennedy’s over $400,000 annual salary comes from this organization.
It’s always been a pet peeve of mine when ‘charities’ pay outrageous salaries to their employees. If I send a charity a check, I really don’t want it paying for a vacation home in France. $400,000? Are you kidding me? Poor Joe may have to take a pay cut and join so many others who have been impacted by the economic turmoil.
I have always heard that if you want to get rich, you should start your own religion. But it looks starting your own charity can also offer up a path to riches. Now, if I can just come up with a catchy name…
In a post I wrote just over a year ago – Peak Oil: End of the World? – I posed the following:
If you think the public is outraged now, wait until gas is $10 a gallon, people are suffering as a result, the economy is tanking, and ExxonMobil posts the first ever $100 billion annual profit.
The vast majority of the country will blame Big Oil for their woes, and they will resent that Big Oil is profiting from it. How will the public react? How will the government react? No doubt there will be legislation designed to combat the problem, but of what form? Will the government institute rationing? Will they attempt to nationalize the oil companies?
This wasn’t the first time I have mentioned the prospect, and it won’t be the last. You may have seen Representative Maxine Waters yesterday threaten to nationalize the oil industry during a house hearing on fuel prices:
The thing is, I can only see these calls for nationalization gaining in popularity. Our government – if it behaves in the predictable fashion that I have come to expect – is incapable of stopping the climb in prices. Long-term, prices are going higher – and oil companies will benefit. Even as oil majors struggle to replace their reserves, oil prices are rising at an even faster pace. Thus, the value of the oil that they do produce more than offsets those declines. So what I expect to see is oil companies become more and more profitable as oil prices continue to climb. The only things our government can do to stem the pain are things they can’t collectively agree to do. What they can collectively seem to do is offer pandering solutions that appease the public’s anger by “sticking it to the oil companies.”
So I foresee more calls to nationalize. If the goal is to bring prices down, it would be a disaster. If the government took over, what would they do with the profits? They would end up getting diverted down other channels. That is not sustainable, as this industry is very capital intensive. Venezuela is seeing their production decline accelerate as they fail to invest enough money back into the business.
Ironically, I wrote an essay just a few days ago on this topic for Resource Investor:
After pointing out that 1). Most of ExxonMobil’s profits are derived from overseas operations; and 2). Government has had a handsome windfall as well from rising prices; I lay out what I see as the risk if we creep toward nationalization:
What does the government risk by implementing creeping nationalization and open hostility toward such a key industry? One need look no further than Venezuela, where ExxonMobil and ConocoPhillips both left the country as Hugo Chavez increased taxes to the point that the risk was no longer worth the reward. Of course countries like Iran and China were more than willing to move into the void, which further diminishes the access the U.S. companies have to global oil reserves.
But with the constant threat of higher taxes hanging over their heads, it is not inconceivable that some U.S.-based oil companies would simply relocate to countries with more consistent energy policies. After all, that’s what Halliburton did, which ironically sparked political outrage from the same crowd calling for windfall profits taxes on oil companies.
Nationalizing the industry is not going to bring prices down. Using history as a guide (Venezuela, Mexico), it would likely accelerate the decline in production, driving prices even higher. But that doesn’t mean that the government won’t eventually tire of the annual rite of tongue-lashing the oil companies, and move on to more drastic action.
I ran across the following today:
It’s difficult — make that impossible — to justify taxpayer subsidies for an industry whose top five companies made $123 billion in profits last year. Oil at $100 a barrel ought to be plenty of incentive to drill without extra encouragement from taxpayers.
OK, sounds like a challenge. I will accept. First off, does it matter how much capital is being invested to make those returns? What if the required investments are 10 times that $123 billion? What if another industry – like say Hollywood studios – makes much higher profit margins, yet qualifies for exactly the same tax deduction? Does that make a difference? No? Is it just because $123 billion is a big number? How big should it be? What should the allowed return be to justify the cost and risk of building a floating city in the ocean? And what is the justification for denying the tax deduction to the largest companies of a single industry?
Is it really fair to exempt Citgo, after Hugo Chavez has already seized investments of U.S. companies? Believe it or not, these same companies whose investments Chavez has seized (COP and XOM) are being singled out for more punitive measures by a pandering Congress, while a Venezuelan oil company operating in the U.S. would continue to receive the tax deduction.
Further, with oil at $100 a barrel, understand that all costs associated with drilling have rapidly increased. Should that matter? Or does is still just boil down to $123 billion is so gosh-darned big? Well, get your mind wrapped around the capital expenditures. They also dwarf those of other industries. Should it matter that these projects take many years to bring to fruition, and yet politicians attempt to change the rules every year? If you are an oil company CEO, is it more likely or less likely that you will make marginal investments in the U.S. – given the uncertainty that the law will remain constant?
I have to agree with the OMB:
“The administration must strongly oppose” the legislation, the Office of Management and Budget said Tuesday, “because the bill would use the tax code to target tax increases on a specific industry in a way that will lead to higher energy costs to U.S. consumers and businesses.”
But here’s the political spin:
Rep. Rahm Emmanuel (D-Ill.) said “Americans are being asked to pay twice” — once at the gasoline pump and then through tax subsidies to the oil companies.
Are they really being asked to pay twice? Don’t oil companies pay far, far more in tax revenues than this little tax break? Sounds to me like oil companies are being asked to pay twice. And I guess that you also forgot that if your argument is true, Americans are paying three times. The government take from gasoline sales is huge – so you apparently forgot that payment. But I am sure politicians aren’t eager to highlight that point.
And if it is really this simple:
Supporters of the measure noted that rescinded tax breaks would amount to less than 2 percent of the profits of the five biggest oil companies. Even if the companies were to pass along that entire cost to gasoline consumers, it would amount to about a penny a gallon.
– then I have an idea. Raise gas taxes by a penny a gallon. My guess is that this would have much less opposition. But this isn’t really about the money. This is just politicians playing games and pandering for the public.
When ExxonMobil and ConocoPhillips walked out of Venezuela last year instead of accepting radical changes to their previously agreed upon contracts, I think they could see the handwriting on the wall. As long as Chavez has influence down there, oil companies are not going to be allowed to consistently make money. If oil prices are up, he is going to demand a bigger cut. But if oil prices are down, he isn’t likely to reduce tax rates. So I think XOM and COP viewed the situation as high risk, low reward, and decided to exit instead of continue to play games with Chavez.
It should come as no big surprise to the companies who decided to stay – Chevron, BP, Statoil, and Total – that the deals they agreed to would be voided if it looked like they were going to start making money:
CARACAS, March 24 (Xinhua) — Venezuela will impose a new tax on oil companies for their “unexpected earnings” from the soaring global oil prices, President Hugo Chavez said Monday.
“They’re earning money that they haven’t accounted for,” Chavez said in a speech televised Monday, adding that those large additional earnings are not “a product of any extraordinary effort.”
The government has prepared a bill outlining the tax, he said, but the tax rate has not yet been determined.
The tax will represent the fourth rise in oil taxes in as many years as part of Chavez’s drive to increase revenue from the oil industry and tighten state control over oil fields.
Over the past two years, the Venezuelan government has raised taxes for oil exploration, extraction, processing and selling to foreign companies.
This is the business climate in Venezuela: Take risks, and if there is a reward Chavez will take it. This is already hurting investment there, and I think Venezuela – after seeing an initial windfall – will see much lower revenues in the future as investment there dries up. He is employing an incredibly short-sighted strategy.
CARACAS, Venezuela: President Hugo Chavez warned that some milk plants may be expropriated to ease shortages, singling out Italy’s Parmalat SpA and Switzerland’s Nestle SA.
Chavez mentioned the two companies during his weekly program Sunday, saying international companies sometimes “pressure” Venezuelan farmers to obtain their milk for export.
“It’s no use for us to be setting up plants (if) then there is no milk for the plants because Parmalat or … Nestle take it all away,” Chavez said. “That’s where I say this government has to tighten the screws.”
If companies ensure a supply through “blackmail, offering money up front” while leaving state-run plants without enough milk, “that’s called sabotage,” Chavez said. He added that in such cases, “the plants must be taken over and expropriated.”
This is long overdue, given the atrocities committed by the milk industry in South America. The Swiss and Italians are clearly milking Venezuela. Call it a hunch, but something tells me that chicken, flour, and sugar plants will be next on the expropriations list:
There have been sporadic shortages of basic goods like milk, chicken, flour and sugar for months, and the problem has been considered a political liability for Chavez since he lost a vote last year on constitutional changes that would have let him run for re-election indefinitely.
Of course critics were quick to lie about the situation, as critics do:
Critics blame government price controls and a poor investment climate. The government says strong economic growth has boosted demand for meat and milk and other products.
The companies involved apparently get news of items like this from the media, and not through official channels:
Parmalat declined comment. Francois-Xavier Perroud, a spokesman for Nestle in Vevey, Switzerland, said he read news accounts quoting Chavez but that “the company in Venezuela has not received any official notification, any official statement that anything is being thought about or considered or being planned.”
And then as expected, it turns out that it is really the plotters behind this. Venezuela’s problems are always caused by someone else:
Chavez also accused opponents of plotting to ensure food shortages by hoarding supplies ahead of state and local elections in November. He did not elaborate but said, “We’re facing an economic conspiracy, and we’re obliged to act.”
Like I said, this move is long overdue. Let the government take over, and show Big Milk how an efficienct operation should be run. Lessons from the oil industry expropriation are that you can shirk maintenance and investments for a quick short-term gain. Longer term, Chavez can hope it will be someone else’s problem. But as far as actually increasing milk supplies as a result of taking over the industry, lessons from the oil industry should have citizens concerned about starving to death.
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