Carlota Bonnet
Venezuela and China: Investments in the Oil Industry
I) History of petroleum in Venezuela
a) Discovery and foreign investors
b) Industrialization and nationalization
II) Economic and political crisis
b) General Oil Strike of 2002-2003
c) Venezuela's oil industry since 2004
III) China's investments in Venezuela
a) The difficulty of investing
b) China's insvestments in the previous years
c) Last years and China's new precaution
Introduction
Venezuela is a South American country located on the coasts of the Caribbean Sea (see fig. 1). Since the nineteenth century, Venezuela has been one of the biggest actors in the oil industry, attracting investors from all around the world. Venezuela is the fifth producer of oil, and holds the larger confirmed oil reserves in the world. However, it has faced an important economic and political crisis for the last twenty years, making foreign companies hesitant to invest in the country. Only one country continues to invest without fear in the country: China. Today, China is the largest investor in Venezuela. Chinese loans are maintaining Venezuela's economic afloat. However, China has shown doubts regarding the government's stability, and promises to be an important factor in the country's future.
Fig. 1: Map of Venezuela ("Road Map of Venezuela").
In this report, we will investigate China's role in Venezuela's oil industry. To do so, first we must understand Venezuela's situation. First, we will narrate the history of petroleum in Venezuela. Then, we will explain the economic and political crisis Venezuela is facing. Lastly, we will detail China's investments in Venezuela, emphasizing loans projects relating to the oil industry. Moreover, we will explore China's new angle on Venezuela's political environment.
I) History of petroleum in Venezuela
a) Discovery and foreign investors
b) Industrialization and nationalization
When the Spaniards arrived to Venezuela in the seventeenth century, they didn't see any commercial value for the oil they found (Wirth). For a long time, Venezuela was ignored and forgotten by the foreigners industrializing South American countries (Tinker). It is only in the twentieth century that the petroleum was seen as a good as valuable as —or even more valuable than— gold and pearls. In the first half of the twentieth century, Latin America had an impressive oil development, second only to the United States (Wirth). Many foreign companies were interested in investing in Latin American countries. However, when these companies tried to claim the petroleum reserves, a wave of nationalism ran through the area. Venezuela, with his larger oil potential and "late developing economic nationalism," was the only country unaffected by this movement (Wirth). In particular, Juan Vicente Gomez's dictatorship between 1908 and 1935 helped foreign companies purchase excavation sites and production deals in Venezuela (Tinker). In 1914, Caribbean Petroleum (that would later become Royal Dutch Shell), found the first major oil field in Venezuela, called the Mene Grande. Between that date and 1917, many different fields were discovered all over the north of the country, slowly turning Venezuela into a petroleum-dependent State (Tinker). Later, in December 1922, a well on the shores of Lake Maracaibo (in the North West of the country) erupted, spewing 100,000 barrels a day (Tinker). This event is the last straw that propels Venezuela from a mostly ignored country to one of the biggest actors in the oil development of the twentieth century (Wirth).
Twenty years after the first well was dug, Venezuela became the biggest petroleum producer in the world after the United States. In 1935, petroleum exportation accounted for 91% of total production (Tugwell). Moreover, farmers left their fields to try their luck in the new world of petroleum, causing the agricultural sector to diminish considerably. This phenomenon, known as the "Dutch disease," caused Venezuela's economy to become completely petroleum-dependent by the middle of the twentieth century (Tinker; Wilpert).
In 1943, the government passed a reform called the "Hydrocarbons Act" (Tinker). With this, the Venezuelan government affirmed its right to intervene in the industry. After becoming President in 1952, Marcos Pérez Jiménez took advantage of Venezuela's new wealth to strengthen his power and "legalize" his dictatorship in the eyes of the world (mostly the United Sates.) President Pérez Jiménez used petroleum revenues to industrialize the country in an incredibly rapid pace, and to appease the population despite his status of dictator. In the mid-1950', due to a worldly over-supply of oil, the price of petroleum fell. After overthrowing Marcos Pérez Jiménez and becoming President in 1959, Rómulo Betancourt originated the foundation of the Organization of Petroleum Exporting Countries (OPEC) in 1960. Created by the world's leading oil producers, the organization's role was to protect their industry from oil prices fluctuations. This organization, whose original members were Venezuela, Iran, Saudi Arabia, Iraq, and Kuwait, and that now includes eight more countries (see fig. 2), controls more than 80% of the oil reserves, and 40% of the petroleum production in the world. Because of this, the OPEC has an important power over the oil industry.
Fig. 2: Members of the OPEC (Cambanis).
In 1973, the OPEC members of the Persian Gulf decided to raise their oil prices by 70%, and to put in place an embargo on Israel-friendly countries —including the United States— to protest against the Arabic-Israeli conflict known as the Yom Kippur War (Tinker). After this petroleum crisis, the countries of the Persian Gulf no longer exported their oil to the United States, and the oil prices —along with the Venezuelan government's revenues— quadrupled from 1972 to 1974 (Wilpert). The newly named President Carlos Andrés Pérez took advantage of the revenues in order to "stimulate alternative forms of development" and create "la Gran Venezuela" (the Big Venezuela) (Tinker). He promised that Venezuela would grow in the following years, using petroleum revenues to increase the number of jobs, fight poverty, and diversify the economy (Wilpert). In January 1976, the Venezuelan petroleum industry was nationalized, and Petroleums of Venezuela (PDVSA) —the State's petroleum company— was created. Foreign companies didn't fight the nationalization, since the new law allowed them to continue to operate in Venezuela's soil as service companies under PDVSA's jurisdiction (Bonnet).
Until 1980, President Pérez's plan to make a new Venezuela real was going very well. The biggest cities were crowding with new automobiles, shopping malls, and high-rise buildings. Consumerism penetrated even the poorest sectors, turning hamacas (hammocks) into beds, bodegas into malls, and cardboard structures into permanent edifices (Tinker). However, despite a promising future, the economic boom didn't last long.
c) Premises of a crisis
Venezuela's prosperity resulting from the 1973 petroleum crisis was short-lived. While Venezuelan leaders focused on constructing a new Venezuela, many OPEC members weren't fulfilling their production quotas, and petroleum prices fell drastically in the 1980', pushing Venezuela down the recession (Wilpert). By 1982, Venezuela faced a major debt crisis. Indeed, the debt, which had been of eleven billion dollar in 1978, increased to twenty seven billion dollars in 1983, and to thirty-four billion by 1984 (Tinker). The Venezuelan currency, the Bolivar, was devaluated in 1983, as the country faced an unprecedented inflation.
In the 1990', the Dutch disease symptoms were once again felt by the population, as Venezuela was totally dependent on oil and oil prices. Industrial production was cut to half. To attract new investors, President Pérez created the Oil Opening (“aperture petrolera”). This program granted foreign companies with shares in different oil fields ("La Apertura Petrolera"). Large projects of exploration and excavation in the Orinoco Belt —home to the largest crude reserve in the world— were given to foreign companies operating as service companies. The biggest enterprises that joined the program were ExxonMobil, Royal Dutch Shell, Chevron, and Total, all still major oil players in the world today (Wilpert).
II) Economic and political crisis
a) Chávez first years
In December 1998, Hugo Chávez is elected President. To say he caused the beginning of Venezuela's decline is missing the reason he was elected in the first place. He took advantage of the Venezuelans' frustration against the country's current political leaders to gain the support of the lower-class, and even some middle to upper-class citizens (Tinker). He had strong ideals of socialism, and many plans to reform the country. During his first year in office, his approval rating was extremely high, reaching 80% (Nelson). Today, members of the opposition claim that this was mostly due to his charismatic speeches and populist views. At the time, his declarations of "giving back to the people" was extremely appealing to the struggling lower-class, that had seen their money devaluate considerably from 1994 to 1998 (Belloso; "Venezuela Inflation Rate"). This devaluation was mostly due to the drop in oil prices described before. In 1998, the inflation adjusted price of a barrel reached an all-time minimum, causing Venezuela's gain to drop drastically (McMahon). Using his high popularity, President Chávez initiated the drafting of a new constitution, giving him unprecedented power over all three branches of the government (Nelson). In the petroleum management front, President Chávez gave OPEC a rebirth. Indeed, the organization was unreliable, with its members —including Venezuela— regularly overseeing its quotas. President Chávez organized OPEC's second meeting in Caracas in 2000, and he visited oil-producing countries to convince them to follow production quotas. This way, they could maintain the oil barrel's price between $22 and $28. This goal was almost immediately reached, since by mid-2002 the prices were over $27 per barrel (Wilpert).
However, President Chávez's politics weren't acclaimed by everyone. Very soon, his radical agenda worried some Venezuelans, mostly from the middle and upper-class. In 2002, his approval rate had fallen to 30 percent, and anti-Chávez protests became common. In the oil industry, President Chávez was in conflict with PDVSA, whose leaders were mainly opposed to the government. The Venezuelan oil company had been focusing on producing as much oil as possible for the past decade, regardless of OPEC's quotas. Now, with OPEC's new management encouraged by President Chávez, PDVSA often fought with the government, resulting in an all-out confrontation between Chávez’s government and the oil industry (Wilpert).
b) General oil strike of 2002-2003
By 2002, some military forces were against the government, and President Chávez's alliances weren't as strong as they had been. On April 11th, a group of military officers tried a coup against President Chávez (Tinker). Despite the coup's failure, the military —and the people— remained divided. In December 2002, leaders of PDVSA, along with the labor federation, called for a national strike. Its main goal was to shut down the oil production to cut the government's source of revenues and to create chaos (Tinker; Wilpert). Indeed, with the price of a barrel being around $30, these three months of strike costed a lot to the country. Moreover, without access to fuel, the country was in a virtual standstill (Nelson). To fight the strike, the government ordered employees to go back to work, or risk losing their jobs — or even their home, since many oil employees lived in oil camps owned by PDVSA (Tinker). Some countries, like Brazil, offered support to the government by sending more than 500,000 barrels in December. Government supporters also stood guard at PDVSA's installation, and by the end of December the strike's failure became evident.
Even if it failed in his goal to overthrow President Chávez, this strike had important consequences on the country's oil management. It costed PDVSA more than $14 billion dollars in oil revenues ("The Sabotage Against the National Industry"). Moreover, it caused some long-term damage on the oil camp installations that were shut down abruptly (Tinker). President Chávez used this strike in his favor, declaring that PDVSA needed to be "re-nationalized," since it had become too powerful, like a state within a state (Wilpert). PDVSA's employees that had outed themselves against the government, either by announcing it or by stopping to work despite the government's orders, were fired and placed in a "black list" forbidding them to work at any national company in the future. More than fifteen thousand workers were fired. The government put the Ministry of Energy and Petroleum in charge of PDVSA, and finally gained full power over the company as it was restructured (Wilpert).
c) Venezuela's oil industry since 2004
After the oil strike of 2002-2003, PDVSA was completely under the government's control. This control was strengthened in 2005, as the titles of Minister of Energy and Mining of Venezuela, and of President of PDVSA were granted to the same person ("Ministro"). While the government's control over the oil industry became indisputable, oil prices grew to unprecedented numbers, as we can see in figure 3. In 2008, the oil barrel price reached $100 for the first time (Stumpf). Between 2011 and 2014, the oil barrel price fluctuated between $84 and $103. From 1999 to 2014, Venezuela's annual average oil income was of 56 billion dollars per year; summing up to 960 billion dollars in seventeen years.
Fig. 3: Price of the oil barrel from 1988 to 2015. We can see a drastic rise in oil prices since 2008, and a higher average of prices since President Chávez reorganized the OPEC (Anderson)
In addition to oil income, the government received millions of dollars of loans, increasing the country's debt (Bermúdez). According to the Inter-American Development Bank, China lent more than 65 billion dollars to Venezuela between 2007 and 2015 (The Dialogue). Paradoxically, as the government's income increased, the situation in Venezuela seemed to get worse. According to the government, petroleum revenues were used to fund social plans. However, the opposition argued that the country didn't improve despite enormous economic gains. PDVSA, despite the rise in oil prices, began to accumulate debt (Bermúdez). The company —with new pro-government leaders— adopted a strategy of total production, without doing the scheduled maintenance to the oil infrastructures, or taking the necessary precautions. Because of this, refineries and oil camps began to fail, and production was altered.
III) China's investments in Venezuela
a) The difficulty of investing in Venezuela's oil industry
In 2006, Chávez initiated the "re-nationalization" of the oil industry. Indeed, he declared that employing private companies as service companies, and letting them work freely on the oil camps, was against the ideals of the nation. The Venezuelan government used the concept of "joint ventures" for the re-nationalization. A joint venture is a company owned by PDVSA and a foreign company, PDVSA holding 60% of the shares. PDVSA declared that joint ventures demonstrated their willingness to continue to work with private companies while ensuring the country’s control over its soil ("La CVP y las Empresas Mixtas"). Previous contracts that had been signed by PDVSA and foreign companies working on current projects were brutally dropped, and given to newly created joint ventures, causing previously employed companies to lose large amounts of money. This new system was greatly disadvantageous for foreign companies. Indeed, they had to pay more taxes to PDVSA, and their freedom of operation was limited (Bonnet). Moreover, a few years later, the government started nationalizing these companies' goods without warning or compensation, and telling them to leave the country. This created fear among foreign companies investing in the country, as agreements and contracts were no longer respected. Many foreign companies, like ExxonMobil and ConocoPhillips, have taken Venezuela to arbitration for the takeover (Ellsworth). The number of foreign investors interested in forming joint ventures with PDVSA decreased greatly.
In addition to the contracts' insecurity, Venezuela's actual situation scares foreign companies seeking to invest. In December 2015, the inflation was of 180% ("Venezuela Inflation Rate"). Moreover, the government rarely keeps their word regarding payments. For example, in 2011, PDVSA announced a partnership with Petrobras, its equivalent in Brazil, to build the Abreu e Lima refinery. However, after two years of delaying the construction, Petrobras revealed that PDVSA hadn't fulfilled their part of the deal, and dropped the partnership ("Petrobras Drops Partnership with PDVSA on Abreu E Lima Refinery"). Today, only one major investor stays in the country. China, mainly through the China Development Bank, invested more than 65 billion dollars in Venezuela since 2007 (The Dialogue).
b) China's investments in the previous years
Since Hugo Chávez's arrival to power in 1999, China has been the major investor in Venezuela, particularly in the Venezuelan oil industry. Both countries found valuable allies in each other. When the former Venezuelan president started his anti-American politics, China turned out to be the United States' perfect replacement. For China, Venezuela was an easy access to the American continent and to the oil reserves (Kesler). Since 2007, China has lent 65 billion dollars to Venezuela, including 42 billion dollars directly for the oil industry (The Dialogue). Indeed, President Chávez negotiated a deal with China allowing Venezuela to receive loans by tranches of 5 billion dollars in 2007, in exchange of shippings of oil ("Why China is lending $5 billion to struggling Venezuela"). Moreover, the Venezuelan government grants Chinese companies priority in the projects sponsored by the loans (Kesler).
This system has many defects. Indeed, since the loans are to be paid back in oil, they don't need to be established as part of the national debt by the government, allowing a false sense of security. Moreover, there is no official need to justify the spending of the loan, even if it is expected to be invested in oil ("Why China is lending $5 billion to struggling Venezuela"). The opposition argues that this allows corruption on the government's part, as projects supported by China's loans are often dropped or delayed. For example, China financed the 470-kilometer Tinaco-Anaco railway, which had been promoted as the first South American high speed train. The project —that costed more than seven billion dollars— started in 2009 and was due to end in 2011. However, today only portions of the railway are in place, and the project seems to be abandoned (Durden; Kesler).
Despite numerous cases of missing funds for Chinese-sponsored projects, China has continued to invest in Venezuela. However, the cuts in budget often cause damage for the fields' production. An example is the use of Meta 30 instead of Upgraders. In Venezuela, the oil is very heavy — therefore, it is expensive to produce. In order to extract it from the reservoir, companies use Nafta (a diluent similar to the gas used in our cars) to dissolve the heavy crude. Once it arrives to the surface, the crude is separated from the Nafta, and made lighter using an Upgrader. This equipment is very expensive, as it can cost up to 12 billion dollars (Bonnet). Since funds go missing in diverse projects in Venezuela, and Upgraders are damaged due to a lack of maintenance, Chinese companies have resorted to use a lighter crude, like Meta 30, to dissolve the heavier crude, avoiding the use of an Upgrader. This causes Venezuela to trade their lighter crude, which is more expensive, with a contaminated and cheaper crude (Ellsworth).
The Orinoco Belt, holding the largest oil reserves in Venezuela (and probably in the world), is mainly home of Chinese companies, through joint companies contracts with PDVSA (Bonnet). One major field is Junin 1, a reservoir discovered in 2009. It was estimated to hold 282 million of tons of oil. The targeted daily production was of 200,000 barrels. Sinopec, one of PDVSA's Chinese equivalents, invested 14 billion dollars in the field (Keck). Today, the field is operated by PDVSA, but there is no proof the field is in production.
In July 2014, the XIII Venezuela-China High Level Joint Commission, held in Caracas, consolidated Chinese's role in Venezuela's industry (Lorenzo Ferrigni). During the conference, 38 contracts —many of them oil-related— were signed, and China once again emphasized their desire to help the South American country (VTV). This conference, along with numerous allocutions of both Venezuelan and Chinese officials, lead the world to believe China was going to be Venezuela's savior from the economic crisis. However, despite a few more loans and projects granted to Venezuela, China has slowly stopped its investments in Venezuela since 2015.
c) Last years and China's new precautions
In January 2016, Venezuela bought 500,000 barrels of oil from the United States, a sign its national production can't keep pace with the country's consumption (Scharfenberg). With the drop in oil prices, Venezuela's exports are not sufficient to maintain the country. Even if the government doesn't publish its official numbers, they produce an estimated 2.7 million barrels daily, almost half of the five million President Chavez had promised they would be producing at this time. This number is not enough to provide for both imports and repayment of debts. According to the government, the drop in oil prices caused a decrease of 80% in the country's revenues. The worsening of the economic crisis caused the opposition to gain strength against the government. In August 2016, Venezuela's National Electoral Council (CNE) approved the opposition's demand of a recall referendum against President Nicolas Maduro (Koerner). Even if many obstacles still need to be overcome to achieve the referendum, the government's future is unclear.
If the economic collapse of Venezuela seems inevitable, many experts believe China could delay or even prevent it. Indeed, the country could keep granting loans and offering projects to its South American ally. However, some critics argue that the mismanagement of loans by PDVSA has irritated Chinese officials (Gill). Today, Venezuela is negotiating a one-year grace period to repay the loans with China, after its first petition was refused (Pons, Ulmer & Parraga). While China might give Venezuela the grace period and renew a few loans, it is unlikely they will sign new accords. Indeed, with the unstable government's future, China seems to be waiting for the outcome of the referendum to decide how to proceed with Venezuela. China sent unofficial envoys to negotiate with Venezuela's opposition, with the hope they will honor Venezuela's debts to China in case of a change in power (Hornby and Schipani). China seems to be a crucial piece that could shift the balance one side or another.
Conclusion
Since the nineteenth century, Venezuela's history is closely tied to the oil industry's history. Indeed, having the largest reserves in the world, Venezuela's revenues quickly became dependent on oil exports. Over the years, Venezuelan politicians have used petroleum as a tool to control Venezuela's population, and to strengthen their international position. Despite the nationalization of the oil industry in 1976, oil fields stayed in the hands of foreign companies like ExxonMobil and ConocoPhillips. While the national debt increased, lower and middle class citizens believed the economic crisis was caused by foreign investor stealing their goods. This popular discontent allowed Hugo Chávez's arrival to power in 1999. After a national oil strike in 2003 and numerous waves of "re-nationalization", Chávez's government gained full access to the oil industry in Venezuela. Foreign companies flew the country, and investors grew scarce. Only one major investor remained: China. The Asian country has been granting generous loans to Venezuela, and promoting oil-related projects for the past decade, in exchange for Venezuelan oil, despite Venezuela's incapacity to fulfill their part of the agreement. However, after being a reliable ally for years, China has started to modulate their loans to Venezuela. Indeed, Venezuela's government is facing more opposition every day, and will have to face a recall referendum —that could destitute President Maduro— in the next year. Due to this unstable future, China is reluctant to renew contracts and loans, waiting to see if Venezuelan leaders change in the next years, or possibly months.