Photo courtesy of Pew Research

Oil, Debt, and Venezuela on the Brink
| published January 9, 2015 |

By R. Alan Clanton
Thursday Review editor

Drivers in the United States and Canada may have a lot to celebrate because of those falling gas prices. If the trend continues through late spring and early summer, the typical American household will have saved about $1100 over 12 months—even more if prices dip lower.

In many U.S. states the price of gasoline has already dipped well below $2 per gallon, and oil and energy analysts don’t think we’ve hit the bottom yet. Retailers and economists are optimistic that all of that windfall will make it back into the economy as a sort of unplanned stimulus—boosting spending and investment on things long-deferred by consumers because of the lingering fears of recession and unemployment. That injection could spark a cycle of hiring, wage increases, and growth.

Still, not everyone is celebrating. While Saudi Arabia floods the world markets with cheap oil—now dropping to well below $50 per barrel—and while U.S. and Canadian energy firms continue to show robust output of shale oil, gas, and other improved forms of extraction, there are fears in a few towns of an energy recession. That multi-billion dollar game of chicken between the Arabian Gulf oil producers and the North American energy firms instills fear in some analysts. Wall Street’s mini-selloff in early January was in direct response to the crisis: otherwise optimistic investors unsure of where to redirect those dollars as energy prices continue to slump.

But those market worries in the U.S. and in other world markets tend to pale in comparison to Russia’s situation, where the dramatic drop in oil prices has sparked a serious recession amidst an already shaky economy suffering from the effects of 11 months of sanctions. The United States and European Union nations—along with others—have punished Moscow for its meddling and interventions in the Crimea and the Ukraine. Limited at first, the sanctions were ratcheted up more after the downing of a Malaysian jetliner over war-torn Ukraine.

Moscow’s Central Bank has largely failed to craft a solution to a terrible spiral of inflation, shortages, and a sudden drop in productivity. To keep up, and in a desperate attempt to generate some cash flow, Russian oil fields are pumping faster than they have in decades; better to sell a lot of oil at rock-bottom prices, so the thinking goes among Russia’s economists, than to try to rein-in production at a time when the production in Saudi Arabia and Iraq has reached all-time levels. Russian President Vladimir Putin blames the West for the troubles, and continues to grumble about military options. Putin has also sought several out-of-the-box, long-term solutions, including a massive high-capacity oil pipeline to connect Russian oil and gas fields with China’s industrial centers. But this fix could take a decade or more to become a reality, and in the meantime Russia is caught in a dangerous spiral, with the ruble taking its hardest hit in more than ten years.

But, as Thursday Review writer Kevin Robbie pointed out last week, “Russia has survived much worse, and it will survive this crisis too.” Putin may be gambling that the U.S. and EU will grow weary of sanctions, or, become distracted by other world events—eventually lifting some of the harshest restrictions on trade and cash flow. Putin—having publicly warned Russian citizens to prepare for a long downturn—may also be hopeful that the output race between Saudi Arabia and the U.S. comes to a quick conclusion (as some economists project) no later than this spring. If oil prices stabilize and return to “normal,” he can expect his economy to steadily regain its footing.

But Russia’s crisis also bears comparison to another, even worse macro-economic meltdown, this one much closer to the United States: Venezuela.

In Caracas, Venezuela’s President Nicolas Maduro faces the worst situation his country has had to contend with in generations. Those dropping oil prices have plunged Venezuela’s debt-ridden economy into chaos—a nasty combination of runaway inflation, shortages, and an economy shrinking faster than that of any other oil-producing country. The country’s currency, the bolivar, is at its lowest value in years. So worthless is the bolivar, that in both the open markets and on the black market of Caracas, it takes more than 190 bolivars to buy one U.S. dollar.

So bad is the situation that the Central Bank in Caracas has refused to publish data—such as inflation rates, productivity numbers and national income—since mid-summer, when inflation hit an all-time high of 63%. International bankers and credit-rating companies have said that Venezuela has such a severe cash-flow problem that it will be unable to make its next debt payments, and some of the leading credit watchers say that the odds of a Venezuelan default are approaching 100%. This could have a powerful negative effect on the mutual funds and investments of some Americans, especially those with energy stocks and investments in Venezuela. Nearly 10% of the assets of the Morgan Stanley Emerging Markets Debt Fund, for example, are in Venezuela (according to a recent article in Barron’s).

The problem is that—unlike Saudi Arabia, Qatar, and the United Arab Emirates—Venezuela carries a lot of debt, much of it accumulated over a long period of time. Venezuela was able to sustain those payments thanks largely to its massive and reliable intake of petroleum cash. But with Saudi Arabia, Russia and Iraq flooding the world markets with oil, and with the North American supply reaching such robust levels that U.S. reserves are at their highest level in years, Venezuela cannot compete.

Venezuela is one of several OPEC countries which have demanded that OPEC take stronger, more proactive measures to intervene in the oil overproduction crisis. At OPEC’s meeting in late November, Caracas lobbied vigorously for a general slowdown in worldwide oil production. If production could be ramped downward, the price of crude oil would again regain its once-sturdy value, and countries like Venezuela could, just maybe, make their debt payments. But in November (and in statements since then), Saudi Arabia balked at any suggestion it—or any OPEC producer—cut production. The move further damaged any possibility that Venezuela will be able to make its next debt payments. With Venezuelan oil selling for less than $55 per barrel, things do not look good for Maduro’s government; its oil must sell at a minimum of $85 per barrel for six months for the country to have even enough cash to pay the interest on that debt.

Maduro, a protégé of Hugo Chavez, once surfed easily on the latter’s popularity at home. But Maduro now faces the tough political challenge of keeping his job until the end of his current term in 2019. There have been widespread calls for his voluntary resignation, and still more conversation about a massive ouster of the current majority party from parliament next year. Maduro has, in the style and tone of his quasi-Marxist-Leninist predecessor, tried to convert the crisis into his own political fortune by blaming it on a conspiracy of international bankers, energy financiers, Wall Street, and credit-rating kingpins. But for many Venezuelans, the harsh conditions are of an economy in meltdown. Crime is on the rise, and average Venezuelans have taken to social media to post photos of empty shelves in grocery stores, and depleted shelves in clothing shops and shoe stores. Protests reached a violent crescendo last spring when inflation and shortages began to affect grocery stores throughout the country.

Maduro has made it clear he does not intend to tamper with the $15 billion in subsidies which help underwrite the Venezuelan lifestyle. And true to his government’s loyalties to other Marxist regimes in the neighborhood—i.e., Cuba—he is not interested in raising the price of the deep-discount oil he sets aside for Havana. Maduro has asked for help from China and other deep-pocket patrons, and China recently agreed to an injection of some $20 billion into Venezuela in exchange for better treatment in its negotiations for better oil prices. China needs the oil, and Venezuela is willing to sell it. Furthermore, Venezuela has, by some geological estimates, one of the world’s largest reserves of untapped fossil fuels—enough, even at current levels of extraction, to last for many decades.

But all those vast fields of crude may be for naught in a world where oil prices are already south of $50 per barrel, and still dropping.

Maduro has also tried to take the high road, at least in appearances, by steadfastly maintaining that Venezuela will make it next payment as planned. Whether this patently unreachable promise has been made for internal consumption—to calm fears and keep a semblance of stability at home—or for external benefit, is hard to say. Some analysts suggest it is a little of both. Either way, those firms and organizations whose job it is to analyze the credit risk of heavier borrowers—including all those companies that insure against defaults through credit-default swaps—say that Maduro’s assurances ring hollow considering the severity of Venezuela’s crisis.

Venezuela’s financial crisis should serve as a clear warning to other countries which have placed so much of their stability on a single product or set of products. Russia will surely rebound, especially if—after grudgingly negotiating its way back from the brink in the Ukraine in the near future—it is able to return to normal economic relations with its trading partners in Europe and other places. Besides, Russia also boasts technology and food production among its strengths.

But Venezuela may be facing its worst nightmare in ages. So touchy is the government in Caracas about the crisis, it has requested that soldiers and police intervene when they see citizens taking photos of long lines for food, or when they witness people using smart phones to take photos of completely empty store shelves. One man was recently warned by police to stop taking photos of a grocery store or face arrest, but when a reporter from the BBC intervened—telling the police they would have to arrest him as well—it quickly turned into a national protest, with Venezuelans of all walks of life posting images of those depleted markets, shops and store shelves.

Can social media turn around Venezuela’s financial crisis? Not likely. But those photos may serve as a strong, early warning that Maduro’s political capital is failing in a world where not everyone reaps the rewards of low oil prices.

Related Thursday Review articles:

Oil Prices & Saudi Arabia’s Endgame; R. Alan Clanton; Thursday Review; January 8, 2015.

Energy Uncertainty Sparks New Year's Dow Plunge; Thursday Review staff; Thursday Review; January 6, 2015.

Can Russian Economy Avert Recession?; Thursday Review staff; Thursday Review; December 30, 2014.