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By Antoine Halff, Francisco Monaldi, Luisa Palacios and Miguel Angel Santos
Executive Summary
Venezuela’s oil-reliant economy has been battered over the past three years, as ongoing production problems were magnified by the drop in oil prices that began in mid-2014. The country’s acute financial crisis has spiraled into a full-blown humanitarian crisis marked by deteriorating public health, spreading malnutrition and contagious diseases, and skyrocketing crime. Hyperinflation has exacerbated the country’s woes. Meanwhile, the government of Nicolas Maduro has refused to recognize the National Assembly elected in December 2015, in which opposition parties won a supermajority (two-thirds), and has called for the election of a new Constitutional Assembly on July 30, in a bid to revise the constitution, undermine the legislative and judiciary powers, and consolidate his grip on power.
The outlook for the Venezuelan oil industry and the broader economic and political challenges facing the country are intrinsically linked. The recovery of its oil sector is essential to getting the country on track, but the oil sector itself cannot recover without greatly-delayed investments and a prior recovery in the underlying economic conditions, needed to restore investor confidence. To a great extent, Venezuela’s economic and oil-related outlook depends on the outcome of Maduro’s bid to rewrite the constitution, yet no government, whether dictatorial or democratic, can hope to hold on to power without curing the country’s economic woes.
The workshop sought to chart the possible political scenarios ahead of the July 30 constitutional election; assess the scope of the challenges facing the oil industry and identify possible remedies that could restore needed oil export revenues; and size up the various economic issues that plague the country and undermine investor confidence in its oil sector, and sketch elements of a prescription. This brief report summarizes some of the opinions expressed during the discussions and does not necessarily reflect the views of its authors. Key takeaways include:
There is no constitutional cure to the country’s descent into economic chaos. Even if Maduro succeeded in convening a Constitutional Assembly and installed himself as absolute ruler, his inability to fix the economy would keep his hold on power tenuous at best. A Maduro success on July 30 could set the stage for an internal coup later on.
A transitional government would be best to bring the oil sector and the broader economy back on track but would need broad support to take on far-reaching reforms. On the plus side, so much belt-tightening (quite literally) has already occurred that an economic adjustment package cannot make things worse for the population: with the minimum wage down to $1 per day, the political costs of a package have already occurred, without the benefits. On the other hand, the wellspring of popularity that is likely to greet a transition government leader could weaken his or her resolve to pursue an agenda of economic reform, making it a false start.
There is a long list of hurdles facing the country’s oil industry, both sector specific and more broadly connected to the country’s structural woes. Those include, but are not limited to, endemic corruption, bloated payrolls, a dysfunctional foreign exchange regime, rampant crime, and an overwhelming debt burden. Corruption-driven cost increases have done as much to undermine the oil sector as the oil price collapse. Most participants agreed that fixing these problems was a prerequisite to rekindling foreign oil investment and oil production growth.
There was broad agreement among participants that the country’s hydrocarbon law needed to be revised, but opinions diverged as to whether such a reform should be a top priority of a new government or whether the current legislative framework was attractive enough to bring in foreign investment and get the oil industry back on track.
No matter how quickly Venezuela restarts its oil production, it cannot hope to rebuild its economy without debt restructuring. At current oil prices, the country cannot grow its oil export revenue fast enough to service its debt, resume needed imports, and jump-start the economy. Caracas will have to negotiate simultaneously with multiple types of lenders, including financial markets, bilateral lenders such as Russia and China, and International Financial Institutions (IFIs), one of the few sources left untapped by the Chavez-Maduro administrations. Beijing’s willingness to take a haircut on its debt will be key to Venezuela’s reconstruction and will be a test of China’s international leadership.
Comprehensive structural reform is needed. This includes the full restoration of market mechanisms such as lifting price controls, reestablishing a unified and free-floating exchange rate, reprivatizing nationalized companies to raise cash and restore production capacity, and replacing indirect subsidies with direct assistance to vulnerable households. Only with a broad economic reform package deep enough to rebuild international confidence can foreign investment in the country’s oil and gas sector be rekindled. The oil sector is essential to nurse the Venezuelan economy back to health but will itself not recover without a broader restructuring.
