By Adam Kott. 04/15/2009
- OPEC recently decided to curb production levels in order to raise oil prices
- The Summit of the Americas will likely clarify the future of oil in Latin America
- Both Venezuela and Ecuador are inordinately dependent on oil revenues to help
finance domestic budgets
- The rise of alternative energy threatens oil’s dominance of this sector
- Andean nations must diversify their economies to thrive
Despite recently reaching a four month high, the price of oil has remained dangerously low for the requirements of OPEC member-nations. This could prove problematic for Venezuela and Ecuador, as both countries are highly dependent on their petroleum output — their primary export and an overwhelming source of their revenue. While the price of oil reached nearly $150 per barrel last summer, it has tumbled in recent months and is currently at $51 per barrel. The Organization of the Petroleum Exporting Countries (OPEC) has been frantically trying to arrest falling prices by curbing some of their production. Rather than making substantial cuts in each country’s oil output, the cartel is aiming to more rigidly enforce the current quotas, which are often under calculated by member-nations in order to hype-up additional profits. How Venezuela and Ecuador plan on dealing with these expected cuts and their subsequent impact on state income is a matter for what could be a troubled future. The future of these nations may become clearer in the next few days during the Summit of the Americas meeting in Trinidad, where energy security will be among the top discussion points. Unfortunately for the oil-producing countries of the western hemisphere, much of the talks on energy will be focused on how to create sustainable alternatives to oil consumption.
Growing demand from emerging economies such as China, India, and Brazil has contributed toward driving up the price of oil up during the first half of 2008, peaking at over $147 per barrel in July of last year. At the same time, the falling U.S. dollar made oil more affordable for many countries all over the world. Moreover, demand dropped greatly once prices reached their eventual ceiling and slowly began to decrease. In recent weeks, the price of oil has once again climbed, but at a much slower pace due to decreased demands attributable to a fragile globalized economy facing dire economic problems. Only recently have the OPEC nations begun to work in a concerted manner towards shoring up the prices of crude oil so that they can make up for lost revenues dripping from stagnating sectors in the midst of today’s worldwide economic crisis.
Chávez and Venezuela: Difficult Choices Ahead
Venezuela, one of only two OPEC countries in the western hemisphere, is responsible for exporting vast amounts of oil to both the United States and Latin America. Contrary to what it promised months ago to its oil-producing OPEC allies, Venezuela has failed to curb its production by the agreed-upon 11 percent. Rather, led by the outspoken Hugo Chávez, Venezuela increased its production (a habit that the country mechanically followed even during the pre-Chavez era) in order to earn sorely needed foreign exchange funds. Chávez’s government is facing a financial crisis of its own, as his current budget was passed under the assumption that oil prices would remain around $60 per barrel. Because of the oil glut, this price has not been reached in months, and Chávez was forced to slash his budget by 6.7 percent and raise the value added tax (VAT) by 3 percent.
Venezuela’s failure to abide by OPEC’s production limits has been a very curious move on its part. On the one hand, Venezuela continues to pump a steady flow of oil-generating income, allowing it to continue to meet all of its conventional sales requirements to the United States and many developing nations. On the other hand, if Chávez were to follow OPEC’s productive model, the price of oil would most likely significantly increase, creating an even larger positive cash flow. Although Venezuela’s president recently vowed to curb his country’s oil production by 364,000 barrels per day by reducing exports to the United States, he may find such a move unwise, even from his own narrow interests. Economically speaking, Venezuela’s most important trading partner is the U.S., which has both an insatiable demand for oil and the deep pockets to finance it. The United States is the destination of 60 percent of Venezuela’s exports and continues to trade high volumes of goods with it despite the steady stream of two-way antagonistic remarks being exchanged between the Chávez and the Obama administrations. If a choice must be made, high shipping costs logically point to cutting trade with distant China and other Asian nations. The rising price of transporting oil via transoceanic sea routes is making a Sino-Venezuelan alliance less viable everyday. Even if Venezuela were to cut trade with its Asian partners for economic reasons, it might be a risky move as vital foreign investment coming into Venezuela from this geographic region remains is in its infancy, but nevertheless is essential for Venezuela’s development. Furthermore, Chávez would also jeopardize damaging this newfound relationship with the Asian tiger if he were to deprive Beijing of its most sought after demand from its blossoming friendship with the Venezuelan leader.
Another possible way that Venezuela could increase its oil revenues is to reduce the amount of discounted oil it sells to its allies throughout Latin America such as Cuba, Nicaragua, Dominica, and Bolivia, among others. The consequences of this move could be very negative as well as far-reaching, as low oil prices have been Chávez’s most effective bargaining chip when it comes to gaining diplomatic leverage in non-traditional international venues. Chávez depends on this diplomatic backing to further the egalitarian goals of his Bolivarian Revolution as well as ALBA. Any cut-off would be a potentially provocative move because not all of Venezuela’s allies are ideologically aligned with Chávez and his party, the PDUV. Chávez has attempted to bolster his clout in Latin America by working out oil sale arrangements that counter U.S. primacy in the region. When oil was selling at over $100 per barrel, the recipient countries were hard put to turn down the subsidized petroleum. Decreasing the amount of subsidized oil Venezuela sends to other nations may persuade them to turn once again to the United States, an extra-hemispheric power, or some multilateral lending agency for support amidst today’s global economic crisis. If Chávez strained these current clients by raising the price of oil, he could lose their long-term backing and see his hopes of establishing a more balanced distribution of power in the hemisphere ebb.
Ultimately, Hugo Chávez faces a difficult situation because steady low oil prices will not allow him to maintain the status quo with each of his traditional or trading partners. If he continues to ignore OPEC’s strictures, he may be forced to cut production even further in the future. By decreasing sales to the United States or China, which currently total about 1.5 million barrels and 500,000 per day respectively, Chávez will surely see his short-term revenues decrease — a disastrous prospect for a government already increasingly short on funds. Furthermore, if the leader were to turn his back on his fellow Latin Americans, he faces the unwelcomed prospect of losing multilateral support for a number of his favored projects aimed at creating a hemisphere that is multipolar in its construction, including ALBA and the Bank of the South (BancoSur). These two institutions are vital to the Venezuelan president’s goal of reducing Latin America’s lack of autonomy from the United States. If ALBA and BancoSur succeed, Latin America would have alternatives available to them when it comes to unfair trading and lending practices often espoused by the United States, such as its resorting to agricultural subsidies, thus making its products less competitive with local goods. Given these prospects, Chávez is in an unenviable position that if Venezuelan petroleum sales continue to sag, he will be forced to diversify his country’s economy, and end its current overdependence on oil.
Correa and Ecuador
Ecuador’s relationship with OPEC may be even more complicated than that of Venezuela. Originally incorporated as a member in 1973, Ecuador pulled out from the organization in 1992 due to a variety of disputes. Most prominent amongst these was Ecuador’s refusal to pay a $2 million membership fee. Furthermore, the small nation felt that its production quota was too low, especially in the face of a sagging economy with rising inflation rates and meager industrial growth. The small Andean nation rejoined OPEC in 2007 and has since built up to a pumping capacity to the impressive sum of 500,000 barrels per day. But the poor quality of its oil makes Ecuador’s variety more expensive to refine, and consequently, the product often sells slightly below market price. In spite of its relatively low-grade petrol, Ecuador recently signed a $1 billion deal with China in which Beijing will provide much needed capital for local infrastructure projects in exchange for oil. It is expected that as a result of this deal, Ecuador will be able to construct important public infrastructure such as roads, refineries, and hydroelectric plants.
After OPEC’s March 15 meeting, Ecuador has vowed to cut its oil production by up to 8 percent. Like Venezuela, Ecuador is highly dependent upon its oil sales, as the commodity is the nation’s primary export and finances more than 30 percent of the federal budget. Complicating the economic situation even further is that the country’s other main source of income comes from remittances, which, like oil, can not be relied upon during times of economic instability. In the fourth quarter of 2008, remittances being received Ecuador (most of them coming from the U.S.) dropped by the staggering rate of 22 percent. His critics insist that President Rafael Correa’s fiscal policies have largely failed to create long-term stability.
According to a March 26 article by Jonathan Lynn, millions of Ecuadorians are facing poor prospects that have only been magnified by a recent rise in tariffs and quotas that affect 8.7 percent of all imports. While raising these tariffs may encourage Ecuador’s domestic sectors to develop, Correa has yet to enact the necessary measures to promote the domestic production of goods, thus ultimately proving them to be futile. By substituting imports with domestically produced goods, Ecuador has the ability to keep financial resources within its borders if it properly stimulates local demand for domestically produced goods. If Ecuadorians begin to buy domestic goods instead of imported ones, this demand factor will help propel the economy and put money into the pockets of its people. Since Ecuador’s oil revenues have plunged nearly 75 percent since this time last year, Correa must take action soon or else face the risk of losing control of the congress to opposition parties.
Model for Long-Term Growth
With the price of oil having precipitously declined, it is easy to understand the logic behind OPEC’s desire to streamline production by edging the prevailing price upwards. However, in doing so, OPEC risks driving developing nations away from a dependency on oil. Rather than using oil to industrialize, these young economies may instead look towards alternative forms of energy so that they are not so dependent on a resource whose supply and price has proven to fluctuate so greatly. OPEC member-nations would be better served keeping prices affordable in order to create long term growth for these developing nations. If developing countries throughout the world begin to industrialize outside of a system of dependency on oil, they may not require it once they have worked out the nature of their economies. Alternatively, if OPEC can supply cheap petrol to these nations in their developing stages, they may be more inclined to build up a strategy that uses this resource rather than have industries that use alternative forms of energy.
The world already has witnessed countries everywhere reducing their demand for oil as a result of rising concerns over environmental factors, high prices and tighter credit lending. In 2006, fifteen African nations formed the Pan-African Non-Petroleum Producers Association, a “green” OPEC that aims to produce biofuels that would combat the rising price of oil. The green revolution could very well threaten the long-term viability of OPEC. While the cartel’s leading oil producer, Saudi Arabia, has sensibly recognized the need to maintain stable oil prices instead of cutting production to boost the price, it has gained very little support from its fellow OPEC members.
The Saudis unilaterally have cut or raised their own energy production in the past in order to maintain oil prices at a relatively stable level. Nonetheless, without a more overarching change in oil politics either from all OPEC members, or from individual countries, Venezuela and Ecuador may be prepared to trade long-term prosperity in exchange for an immediate band-aid approach to their financial problems. It seems very unlikely they will be able to maintain such strong ties with their current trading partners, when many of these relationships were built on low oil prices which may have a very short life span.
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