Venezuela Circling the Drain

Jim Brown
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The socialist experiment being performed by Hugo Chavez in Venezuela is about to end. His nationalism of nearly every major private enterprise along with kicking all his past oil partners out of the country has sealed his fate and his grand experiment in copying Fidel Castro's Cuba is gaining speed as it heads for the drain.

Hugo Chavez took office in 1999 and Venezuela was producing 3.5 million barrels per day of oil. Most of that oil is very low quality and sells for a steep discount but it was a huge revenue source. Today Venezuela pumps about 2.5 mbpd and that is dropping fast. Many of the fields in Venezuela have a very steep decline rate of 25% or more. That means they have to drill enough new wells to replace 25% of their production every year or they will continue to lose production. Their current active rig count is less than half of what is needed to maintain production.

Venezuela has a large resource base of close to 100 billion barrels of conventional oil and another 100-300 billion barrels of extra heavy oil and oil sands like deposits. Extracting this oil is very difficult and expensive and requires reprocessing to be usable in most refineries.

For decades Venezuela exported much of their oil to the U.S. because our refineries had the flexibility to process it and the transit time was short for tankers. Those exports to the U.S. have fallen by more than a third due to the decline in production and because of new contracts for delivery to China.

Chavez took office on a power to the people ticket. He was going to be the provider of everything and the poverty stricken masses were looking for a hero to save them. In order to give people welfare and subsidize everything they use like food, gasoline and electricity a socialist government has to take it from someone else.

Chavez has nationalized oil fields and the assets of numerous oil companies and service companies. He nationalized the phone companies, banks, utility companies and just last week he confiscated a French owned grocery chain. He devalued the Venezuelan currency several weeks ago and told stores they could not change their prices. If you were charging a dollar for a loaf of bread that cost you 85 cents then you had to continue charging a dollar even though that dollar was now worth 50 cents. If a supplier producing that bread had costs of 75 cents in salaries and components they can no longer produce the bread and sell it for basically half of what they were getting before. The only way to survive was to raise prices to cover your costs and Chavez threatened to close stores who raised prices. In the last two weeks over 1,500 stores have been closed or taken over by the government because they raised prices or could not operate in the current price structure.

The food situation was already serious with people being forced to take a number and wait over an hour to buy a chicken. Now they have nowhere to shop and no food on the shelves.

Chavez perfected the nationalizing part of the plan in taking over every business and utility imaginable. Unfortunately he never perfected the running the businesses as part of the plan. Every business he nationalized is failing because he transfers the money from the business to the government treasury to pay for welfare and government subsidies. Companies without money to perform maintenance, pay employees and run the business are unable to continue in other than a caretaker mode with minimal services.

The electricity is off much of the day. There is a severe drought, which is hampering electrical generation, crops, sanitation etc. Trash pickup has vanished, medical services are non-existent and food is becoming increasingly scarce.

In order to take the people's minds off their problems and convince them to trust in Chavez he created various enemies of the state to rail against. You may remember his attacks on Bush who he called the devil. Now that president Obama is his friend, at least according to the pictures he spreads around showing them meeting at an event, he had letup on his American paranoia. At least until recently when the Venezuelan economy took another turn for the worse.

Last week he blamed the U.S. for using its "earthquake weapon" on Hati in order to prepare for a coming invasion. According to one source this story made it to the Iranian press. He also said Americans were setting up bases to attack Venezuela from Columbia and blew up a bridge to prevent troops from moving across it into Venezuela. Obviously all of these stories are fake and created by Chavez to keep his people in line.

That line is about to unravel with elections approaching. In the past when he was in favor he tried to make himself ruler for life and could not get the votes. Now he is rapidly falling out of favor and odds are good he will be out of office soon. He will be luck if he is not found lying in a ditch somewhere with a gunshot to the head. Constant knowing hunger is a powerful motivator for civilian unrest. The failure of his social policies, inability to pay for new handouts because of squandered funds and continued crackdown on civil liberties like the ability to buy alcohol and medicine is creating an environment where he must remain wary about his guards and military. The potential for a political overthrow is growing.

If by remote chance he was elected again that overthrow would become an even greater potential. If he is not elected the odds are very good he will try to retain power by force.

Regardless of what transpires in the coming weeks his days are numbered. If he does suddenly disappear off the scene the oil production from Venezuela will disappear with him since many PDVSA workers are forced to work. If he is no longer in charge they will no longer work. Since there is no money to pay workers there will have to be some drastic and immediate changes made to get production started again. This will be the first task for Chavez replacement because without revenue from oil there can be no restart of the Venezuelan government and economy.

If Chavez disappears or loses control we can expect oil prices to rise sharply on fears that 2.5 mbpd of supply could be turned off for many weeks. OPEC members could quickly increase production but it would take a couple weeks to make it happen and there is always the problem of transporting the new oil to new locations in the right grade for the refineries. There is also the possibility that OPEC members might drag their collective feet with oil prices spiking over $85 on the news.

Your plan should be to buy the USO or crude futures the instant you hear of any change in Chavez status.

Jim Brown