- KPB & Co Research
Nicolas Maduro is facing a tough battle to maintain power, and a significant portion of the Venezuelan people are in the fight of their lives to take back their country from his leadership. Needless to say that the country is facing a severe humanitarian, political, and economic crisis that is about to get worse as international support for the country wanes. The Trump administration has levied tough economic sanctions on PDVSA - the state-owned oil and gas company - essentially preventing the company from collecting funds from oil exported to the USA, the Bank of England recently blocked representatives from Maduro's governing team from withdrawing US$1.2Bn in gold reserves. Juan Guaido who is now President of the National Assembly of Venezuela has appointed himself as the de facto president of the country and has been working with the international community to alienate Maduro. As if Maduro's problems were not enough, instagram took the added step of removing the authentic badge from his instagram account and then made it public.
While some may argue that the current crisis stems from weak political institutions, and or a failure to adopt a western system of governance, we think that low oil prices played a huge role in the country's current struggles. Venezuela is no stranger to a socialist regime, and there was a period of stability under a portion of Hugo Chavez's leadership. Hugo Chavez is well known for his anti capitalistic sentiments and was essentially a staunched socialist. During a significant part of his reign from 1999 to 2013, he oversaw socialist-type economic and social transformations, including the nationalization of several key industries and expanded access to food, housing, healthcare and education. These actions saw his popularity rise to over 60% at one point in time. Of course, at that time the country was riding high off its oil and gas revenues, which allowed him to take on massive unprofitable projects and social programs. As oil prices declined in late 2010 his style of leadership became unpopular. Maduro is now facing similar challenges as Chavez did, which in the face of less financial resources how do you keep people happy?
Let Us look into the economics
Venezuela's Foreign-exchange reserves which include some of the gold reserves stored at the Bank of England has declined by approximately 74% between the peak in 2009 and June 2018 to US$8.4Bn. The Foreign-exchange reserves is money the country stores for use in times of crisis or when facing challenges in paying bills owed to mainly parties outside of the country. The reserves build up over time from the sale of oil and gas to the USA, which is the country's biggest oil trading partner. Between 2012 (just around the time power was handed to Nicolas Maduro) and the end 2017, the money earned from oil and gas exports declined by -51% on the back of similar rate of decline in oil prices. As oil prices declined, the amount of money flowing from the sale of oil and gas also declined and made it difficult for the Venezuelan government to fund social programs in the country. The ability of the country to find money to purchase much-needed food and medical supplies lead to food shortages, frustration, and anger.
Many in the business community would argue that along with the challenges in the political sphere, the country also suffers from the "Dutch disease". The Dutch disease is a case where a country neglects to diversify its economy from one source of economic activity because that one source produces extra-ordinary financial resources. This usually happens in countries that rely heavily on commodities while neglecting to build up their manufacturing capabilities. In the case of Venezuela, approximately 60% of government revenues, and 90% of exports are tied to oil and gas related activities. The level of economic diversification is virtually nil. As such in times of low oil prices, the country will be on the ropes and would virtually find it difficult to meet their needs without aid.
Venezuela will face a long and hard struggle ahead in the face of rising political tensions, and declining financial resources. Oil prices will likely remain low for some time given the level of dormant supply waiting on the sideline to be reactivated. The US and much of the western world has seized the opportunity to demand a change in leadership, and of course, Russia, China, and other socialist leaning countries have chosen either lack of interference or the status quo. Given Russia's position on international hedgemony, the close relationship they have with the current leadership, and the USA's "all options on the table approach" the situation is certainly combustible.