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Crisis in Caracas as Venezuela's economy falters

What do you do if you’re the leader of a country facing rampant inflation, shortages of basic goods such as milk and toilet paper, a dollar shortage and sinking popularity that threatens to drag down your party in upcoming local elections?

If you are Venezuela’s president Nicolas Maduro, you declare war and send in the troops. Maduro, in November, deployed the national guard to “occupy” a popular electronics retail chain, Daka, and other shops around the country and forced them to sell appliances, TVs and other goods at cut-rate prices. For good measure, around 100 shopkeepers and business owners were jailed. “I broke the spine of the economic war and the economic coup they were planning. We have more than 100 of the bourgeoisie behind bars,” Maduro said.

The crackdown was crass electioneering. By hosting a nation-wide fire sale and shifting the blame for the country’s economic problems onto the private sector, Maduro hoped to provide a short-term boost to his United Socialist Party of Venezuela (PSUV) ahead of local elections. It was also ham-fisted economic crisis management aimed at bringing down short-term inflation.

Maduro was then granted power to rule by decree through at least November 2014 by the PSUV-dominated parliament, a power his predecessor Hugo Chávez enjoyed for much of his time in office. Maduro says that he plans to use the powers to impose price controls and cap private-sector profits. Most analysts expect another currency devaluation in 2014.

Many, though, doubt these measures will go far enough to deal with Venezuela’s deep economic troubles. Inflation is running at over 50%, one of the highest rates in the world. A dollar shortage and tight currency exchange controls have forced most Venezuelans to turn to an active black market for dollars, where the greenback goes for as much as 10 times the official rate of 6.3 bolívars.

If Maduro was serious about addressing Venezuela’s structural economic problems, he would take steps to put the oil industry on a firmer footing. Oil accounts for about 95% of the country’s export income and the industry accounts for around half of total government revenue. A strong oil industry, and sensible energy policy, is needed to right the ship.

The stagnation in Venezuela’s oil sector is well documented. The country claims the world’s largest proven oil reserves, but for the last decade output has fallen. The latest figures from the International Energy Agency put production at 2.47 million barrels a day (b/d) through the first 10 months of the year, down from 2.5m b/d in 2012, and about 1m b/d lower than the later 1990s. At the same time, PdV has increasingly been leaned on to fund, and often implement, social policies.

Years of high oil prices have fuelled economic growth and allowed the government to claim its energy policy a success. But the industry’s failures are now coming back to haunt Venezuela. In 2005, state oil company PdV set a production capacity target of 5.4m b/d by 2012, with a raft of new Orinoco heavy-oil projects ensuring Venezuela’s place among the world’s top oil producers. Policies that have scared off foreign investment and drained PdV’s finances have prevented that from happening.  If Venezuela had managed to come even close to that target, it would not be in the economic mess it is now.

Fiscal terms should be improved to attract new spending and convince investors already in the country to shift out of wait-and-see mode and press ahead with projects. PdV should be given more freedom to re-orient itself towards its core mission of exploiting the country’s vast natural resources, where it would do far more good than as a tool of social policy. It also needs to find a way to pay its bills, which is causing increased tension between PdV and its suppliers.

“Venezuela needs a dramatic policy shift towards a more business friendly climate that encourages investment, especially foreign direct investment in the oil sector,” say analysts at Morgan Stanley, an investment bank.

Over the short term, the industry should shift more of its attention towards easier production gains to be had from rejuvenating and redeveloping conventional fields in the country’s historic oil heartland in Maracaibo.  The long-term future of the industry clearly lies in the Orinoco Belt, one of the largest resource plays in the world. But output from Orinoco is effectively capped until billions of dollars of investment is made to add the upgrading infrastructure needed to process heavy oil. That investment appears to be some way off.

The government should consider easing itself out of the PetroCaribe programme, under which countries across the Caribbean get oil shipments on favourable terms. Abandoning the programme would cause real economic harm in the region, where many countries have grown reliant on cheap Venzuelan crude. Participants pay around $40 a barrel and repay the rest over 25 years at around 1% interest, with some countries allowed to repay in food and other goods. Dropping the programme would also hurt Venezuela’s standing in the Caribbean. But it is a policy the country cannot afford.

These would all be sensible steps towards getting the industry back on track. And there have been some encouraging signs from Maduro’s first months in office. Adjustments were made to exempt certain strategic projects from the country’s high windfall tax. PdV also floated a pilot project to allow private domestic and foreign companies to takeover around 1,000 mature and shut-in wells in Maracaibo in a bid to lift production in the area.

But these proposals have not yet produced concrete results. Meanwhile, Russia’s Lukoil and Petronas have pulled out of major Orinoco belt projects in a sign of growing frustration with the slow pace of development and unattractive terms. An inability to deliver on its promises has hurt Caracas’ relations with Beijing, the Venezuelan government’s most important energy partner. The government also did itself a disservice by nationalising around $1m of drilling equipment from a US services company. The damage done to its credibility will have far outweighed any economic benefit of the action.

And the country looks to be headed for a sustained period of upheaval - economic, political and social. The opposition, feeling the wind at its back after strong electoral showings, is determined to see Maduro off before the end of his term and appears increasingly likely to launch some sort of challenge to his leadership in 2014. If so, PdV will be a key part of the government’s strategy to maintain power. The worst-case, for the Venezuelan economy and global oil markets, would be a major disruption to production. More likely, it will mean more of the same struggles for Venezuelan oil.

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