Venezuela is at a breaking point. The political, economic, financial, social and humanitarian crisis that has gripped the country is intensifying. This unsustainable situation raises several urgent questions: Which path will the embattled OPEC country take out of the current turmoil? What type of political transition lies ahead? What short-term and long-term impact will the crisis have on its ailing oil industry, economy and bond debt? What would be the best and most effective prescription for oil and economic recovery under a new governance regime? To discuss these matters, the Center on Global Energy Policy brought together on June 19, 2017 a group of about 45 experts, including oil industry executives, investment bankers, economists and political scientists from leading think tanks and universities, consultants, and multilateral organization representatives. This note provides some of the highlights from that roundtable discussion, which was held under the Chatham House rule.

This paper documents negative cumulative abnormal returns (CARs) to five exchange rate devaluations in Venezuela within the context of stiff exchange controls and large black-market premiums, using daily stock prices for 110 multinationals with Venezuelan subsidiaries. The results suggest evidence of statistically and economically significant negative CARs of up to 2.07% over the ten-day event window. We find consistent results using synthetic controls to causally infer the effect of each devaluation on the stock prices of global firms active in the country at the time of the event. Our results are at odds with the predicaments of the efficient market hypothesis stating that predictable devaluations should not impact stock prices of large multinational companies on the day of the event, and even less so when they happen in small countries. We interpret these results as suggestive indication of market inefficiencies in the process of asset pricing.

Venezuela has one of the most abundant geological endowments in the world. Oil proven reserves are among the largest globally, even if a more conservative criterion than the one used by the current government is applied. However, these resources are qualitatively different than those of other abundant regions such as the Middle East. The large majority constitutes extra-heavy oil, which generally requires higher oil prices to be extracted profitably.

During the last decade, the Venezuelan oil industry wasted a unique opportunity to increase investment and production. At the high oil prices that prevailed, the massive oil reserves could have been monetized by rapidly increasing production with a large margin of profitability. Quite to the contrary, production steadily dropped due either to lack of investment in the new unconventional oil projects or for failing to compensate the decline of the older conventional fields. It is a tragic story of great potential with dismal performance.

A series of trends were negatively impacting the Venezuelan oil industry even before the oil price collapse in 2014. From the revenue side, although oil prices showed an increase in real terms of 120% between 2000 and 2014, the barrels that effectively generate cash for Venezuela have shown a continuous decline. This is not just because production has been declining for the most part during the last eighteen years (a trend that has gotten significantly worse during the last year), but also because of a number of developments. First, during that period, total exports have declined more rapidly than production, and recently, net exports have declined more than total exports. Consumption in the massively subsidized domestic market increased until 2013 (when it started to decline likely because of the recession in the local economy), while imports of oil products for the domestic market have increased since 2012. The domestic market not only generates negative cash-flow for the national oil company (NOC), PDVSA, but also its expansion reduced the barrels available to export. More recently, there has also been an increase in imports of light oil and naphtha as diluents for the extra-heavy oil. Second, the Venezuelan production basket has become heavier and the share of unconventional production, generally less profitable, has increased. Third, the production wholly operated by PDVSA has been falling much more rapidly, while the production share of joint-ventures increased. Fourth, a significant share of the exports to Latin America and the Caribbean is subsidized (although these exports have declined recently). Fifth, some oil exports are committed to repay debts of PDVSA and specially the Venezuelan government, limiting the actual cash flow received by the company. In particular, the government’s debt agreements with China involve a significant and increasing amount of production, although recently those agreements were restructured, allowing for a grace period with no capital amortization. From the expenditure side, PDVSA was increasingly responsible of carrying social expenditures and activities not related to the oil industry, which limited the resources for highly profitable investments. That is in addition to the increased fiscal take due to changes in the tax legislation. Also, higher investment requirements due to an increase in the equity share of PDVSA in joint venture projects, has had an impact on its cash flow.

The explanations for the underperformance of the Venezuelan oil industry basically fall into two connected categories: the multiple problems facing PDVSA; and the increase in above-ground risks for foreign investors operating in the country. The deterioration of the institutional framework, led to radical fiscal and regulatory changes, and to the nationalization of the majority of the industry. In 7 addition, the substantial over-extraction of resources from the NOC, the significant macroeconomic distortions affecting the cost structure of oil companies, and the constraints imposed by the energy infrastructure and human capital availability; have combined to produce dismal results. The massive firing of the majority of the management and technical experts from PDVSA in 2003 following the political conflict that led to a strike, has left the company with limited capabilities to operate effectively.

The recent decline in oil prices, and the changes in the international market structure, have exposed more dramatically the difficulties facing the Venezuelan oil sector, and call into question its ability to prevent a continuation of the declining trend in oil extraction. This situation becomes particularly severe if we take into account the cash flow constraints facing PDVSA, as well as its multiple operational problems, power cuts, and conflicts with oilfield services providers. These challenges are proportional to the enormous investments required to finance the projects in the Orinoco Oil Belt, where most of the reserves in Venezuela are located, and where the quality of the crude and the lack of development of the region, are just two of the many issues that need to be addressed.

Since this paper is part of a wider project to understand the macroeconomic challenges facing the country in 2016-17, it focuses narrowly on the financial problems of the oil industry in the short-term and the operational challenges that could impede its recovery in the next couple of years. Within this context, it largely analyzes the upstream operations, i.e. oil extraction, rather than the downstream, given that in the former is where the oil rents are generated and constitutes the main source of foreign exchange and fiscal revenues of Venezuela. Other areas for further research are mentioned at the end of the document.²

Official figures are used to the extent that they are publicly available. An important aspect that prevents an exhaustive evaluation of the oil sector in Venezuela is the lack of available information regarding key performance indicators affecting the cost structure of oil projects, the cash flow of PDVSA, and the fiscal contributions of the oil sector to the government, among other important variables. Thus, on occasion, estimations for variables of interest and explanations for their divergence from official figures are provided.

The paper has two main sections. The first one analyzes the issues affecting the cash flow of PDVSA, the effects of macroeconomic and fiscal variables on both revenues and costs, as well as other financial issues affecting the performance of the company. The second section discusses some of the operational challenges facing the industry and mentions areas for further research.

²For a more general overview of the recent developments of the oil sector in Venezuela see Monaldi (2015).

Venezuela’s business environment is systematically evaluated as one of the worst in the world. Producing and investing in the country imposes costs and risks arising from macroeconomic instability. Beyond the problems of inflation, fiscal deficit and trade balance; firms and entrepreneurs also face enormous difficulties and discouragement going from the uncertainty about property rights to lack of electricity. To identify binding microeconomic constraints for investment in Venezuela, we reviewed international rankings and experiences about key elements of the business environment and conducted interviews with members of guilds and managers at large companies in the country. We find that the most biding constraints to investment are within the functioning of institutions, including weak property rights, and arbitrary, unbalanced and unpredictable enforcement of the law. Also binding is the flawed functioning of markets, including access to inputs and price controls.