Argument

Tapped Out

Why Hugo Chávez's friends can't save his petrostate.

When Hugo Chávez announced late last year that Chinese energy companies had been awarded access to oil reserves in Venezuela's Orinoco River basin, it seemed the mercurial strongman had moved one step closer to achieving his vision of a "new world order." President Chávez seeks a United States -- el imperio, in his terms -- with its ambitions severely curtailed and hemmed in by "[stronger] new poles of world power." In a 2009 visit to China, Chávez gushed: "No one can doubt that the center of gravity of the world has shifted toward Beijing.... A new world is being born,... the multipolar world that we have all dreamed about for a long time."

The charismatic Venezuelan leader has long envisioned his country's vast natural resources fueling the emergence of that "multipolar world." Unable to unseat the United States alone, Chávez plans to combine his country's hydrocarbon might with the economic and military strength of China. In return for access to energy supplies, China has agreed to loan billions of dollars to Venezuela, accepting repayment in oil. Unmentioned are the additional inducements likely accompanying these deals. Last year, Venezuela sent its first communications satellite into space and acquired three JYL-1 aircraft radar systems, all with Beijing's generous assistance.

And it is not just China that has been active in the Latin American country. Caracas also granted Russian companies blocks in Orinoco in February, with Chávez acquiring $2.2 billion in Russian tanks and anti-aircraft missiles on credit. Since 2005, Venezuela has spent $4.4 billion on Russian weapons, including fighter jets, combat helicopters, and 100,000 Kalashnikov assault rifles. The two countries recently held joint exercises in the Caribbean, bringing the Russian navy there for the first time since the Cold War. After calling this part of a strategic alliance with Russia, Chávez snickered, "Go ahead and squeal, Yankees."

But Chávez's plan is not quite working out as he hoped -- indeed, he has discovered it takes more than handshakes and public displays to get oil out of the ground and onto the market. Venezuela's decaying oil industry and mounting domestic problems have prevented the Chávez government from effectively tapping the country's reserves, even with Chinese and Russian help. And they have forced Chávez to invite back the private energy companies he pilloried as the "overthrowers of governments" just three years ago.

Venezuela's oil industry is in crisis. Mismanagement and lack of investment have caused production to fall from a high of 3.5 million barrels per day in 1998 (when Chávez was elected) to 2.5 million barrels today. With oil trading at half its peak 2008 value, el presidente's profligacy has emptied the state coffers. Blackouts are common; violent crime is rampant; and inflation is high and rising, forcing the currency's devaluation. In an ironic bit of timing, the power went out during one of Chávez's interminable televised speeches on Feb. 25, just as he started to lambaste former U.S. President George W. Bush. It flickered back on to reveal a stern Chávez glaring and being served a cup of coffee. Far from negotiating from a position of strength, Chávez needs investment and hard currency to stay in power.

The roots of his current predicament go back nearly a decade. In 2002, a coup attempt briefly removed Chávez from power. Less than a year later, in an effort to force the president to call early elections, thousands of managers and employees at PDVSA, the state oil company, shut down production and went on strike. Chávez responded by firing nearly 18,000 of them, replacing them with loyalists who swore oaths of allegiance to his government. The replacements sorely lacked the decades of experience working Venezuela's tricky oil systems that their predecessors possessed, leading to a critical shortfall in expertise.

Human capital is particularly important in Venezuela because of the nature of much of the remaining oil found there. Unlike the light, sweet crude found in West Texas, the North Sea, and Saudi Arabia, Venezuela's shallow Orinoco oil belt holds what's known as "extra-heavy oil" -- crude full of sulfur, coke, and metals. Special on-site refineries have to strip the minerals from the viscous, tarlike oil and dilute it just to make it soft enough to move via pipeline from the wellhead to a second refinery, which heats and treats the oil to remove the remaining contaminants. Only then -- after an expensive and energy-intensive upgrade -- is the oil ready for export and sale.

Maintaining and running this "upgrader" system requires human capital, technological know-how, and constant reinvestment. But most of the replacement workers Chávez hired after the strike lacked those skills and knowledge. Moreover, PDVSA's politicized management hobbled the company, which employed excess workers, for instance. Yet Chávez's vindictiveness has prevented him from rehiring much of the talent that was fired, including the expert-trained petroleum engineers.

Despite firing most of the competent managers and engineers at PDVSA, Chávez was able to temporarily stave off trouble for several years, thanks to rising oil prices and the continued work of foreign oil companies, which possessed skilled workers and generally maintained the upgraders. Perhaps intoxicated with ever-increasing revenues, however, Chávez soon decided to take aim at the private companies. Empowered to rule by decree in early 2007, Chávez announced that six foreign oil companies had to either cede control of their Orinoco operations to the state or renegotiate their contracts, even referring to executives at one company as "imperialist bandits" and "white-collar criminals."

As the companies pulled up stakes or reluctantly trudged back to the negotiating table, Chávez began trying to mitigate the loss of capital and expertise by enticing state-owned oil companies from countries he thought would bolster him against the United States with access to Venezuela's vast oil reserves -- countries such as Belarus, China, Iran, and Russia. But those countries lacked the technological know-how to run the upgraders as well. Beijing and Moscow were nonetheless eager to get their stake. But instead of ponying up cash in the spirit of anti-imperialist solidarity, they insisted on attractive commercial terms and sovereign guarantees against expropriation. Notwithstanding the bluster about a "new world order" coming out of Caracas, Chávez has allowed China to opt for a safer state-to-state deal guaranteeing it access to supplies. And Russia has insisted on recourse to outside arbitration in the event of an investment dispute, an especially biting condition because ExxonMobil is seeking at least $5 billion in damages through the World Bank's arbitration body, a forum Chávez suspects is inherently biased against him.

Conceding that these state-owned companies cannot reinvigorate Venezuela's oil industry on their own, Chávez held competitive auctions on Feb. 10 for the more prolific spots in Orinoco. Many of the world's largest private international oil companies attended the auctions, the first to take place since Chávez took power more than 11 years ago. But, unlike the heady days of early 2007, when Chávez demanded that foreign oil companies renegotiate or leave, his tone was quite different. A chastened Venezuelan leader explained, "Foreign oil investment is absolutely necessary to develop our reserves.... We can't do it alone."

If anything, the willingness of international oil companies to dive back into Venezuela only three years after Chávez kicked them out and politicized the oil business is a sign of the global oil supply picture today and for decades to come. The vast remaining reserves of untapped oil in the world today lie in three types of settings: in a handful of countries where development is off-limits to international energy companies, such as Saudi Arabia and Kuwait; in unstable or unfriendly countries, like Iran, Iraq, and Libya; and in technically challenging and expensive environments, such as the Arctic Ocean seabed and Canada's Alberta tar sands. The "easy oil," the enormous undiscovered or undeveloped oil fields open for competitive commercial development by the most efficient technologies, is likely gone forever.

Venezuela, despite its real issues and the cost of extraction, is one of the few places companies can still book real reserves and add significant production figures. The fact that the geological, or below-ground, risk is so low means it is worth the political, or above-ground, risk for many international oil companies. That is why both the international oil companies and Venezuela are eager to dance again.

For all the bluster in Caracas, commitments of billions in assistance, arms, and oil, and excited pronouncements of global realignment, the basics of the oil business are immutable. It takes advanced technology to produce oil in Orinoco. For now, it is the private international oil companies that have it, forcing Chávez to shelve illusions of geopolitical grandeur and pragmatically take the necessary steps to produce his country's heavy, sulfuric crude.

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