Venezuela: The Rise and Fall of a Petrostate
Venezuela’s descent into economic and
political chaos in recent years is a cautionary tale of the dangerous influence
that resource wealth can have on developing countries.
A man stands near a state-owned refinery in Punto
Fijo, Venezuela. Carlos Jasso/Reuters
WRITTEN BY
Amelia Cheatham and Rocio Cara Labrador
UPDATED
Last updated January 7, 2021
Summary
·
Venezuela is an example of a decaying petrostate,
where the government is highly dependent on income from fossil fuels, power is
concentrated in an elite minority, and corruption is widespread.
·
Petrostates are vulnerable to what economists call
Dutch disease, a dynamic in which a government develops an unhealthy dependence
on natural resource exports, and other important industrial sectors are
deprived of investment.
·
Venezuela has descended into economic and political
turmoil under President Nicolas Maduro, as its once-substantial oil outflows
have slowed to a trickle. Absent a power transition, analysts say the country’s
prospects are grim.
Venezuela,
home to the world’s largest oil reserves, is a case study in the perils of
petrostatehood. Since it was discovered in the country in the 1920s, oil has
taken Venezuela on an exhilarating but dangerous boom-and-bust ride that offers
lessons for other resource-rich states. Decades of poor governance have driven
what was once one of Latin America’s most prosperous countries to economic and
political ruin. If Venezuela is able to emerge from its tailspin, experts say
that the government must establish mechanisms that will encourage a productive
investment of the country’s vast oil revenues.
What
is a petrostate?
Petrostate
is an informal term used to describe a country with several interrelated
attributes:
·
government income is deeply reliant on the export of
oil and natural gas,
·
economic and political power are highly concentrated
in an elite minority, and
·
political institutions are weak and unaccountable, and
corruption is widespread.
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Countries
often described as petrostates include Algeria, Cameroon, Chad, Ecuador,
Indonesia, Iran, Kazakhstan, Libya, Mexico, Nigeria, Oman, Qatar, Russia, Saudi
Arabia, the United Arab Emirates, and Venezuela.
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What’s
behind the petrostate paradigm?
Petrostates
are thought to be vulnerable to what economists call Dutch disease, a
term coined during the 1970s after the Netherlands discovered natural gas in
the North Sea.
In
an afflicted country, a resource boom attracts large inflows of foreign
capital, which leads to an appreciation of the local currency and a boost for
imports that are now comparatively cheaper. This sucks labor and capital away
from other sectors of the economy, such as agriculture and manufacturing, which
economists say are more important for growth and competitiveness. As these
labor-intensive export industries flag, unemployment could rise, and the
country could develop an unhealthy dependence on the export of natural
resources. In extreme cases, a petrostate forgoes local oil production and
instead derives most of its oil wealth through high taxes on foreign drillers.
Petrostate economies are then left highly vulnerable to unpredictable swings in
global energy prices and capital flight.
The
so-called resource curse also takes a toll on governance. Since petrostates
depend more on export income and less on taxes, there are often weak ties
between the government and its citizens. Timing of the resource boom can
exacerbate the problem. “Most petrostates became dependent on petroleum while,
or immediately after, they were establishing a democracy, state institutions,
an independent civil service and private sector, and rule of law,” says Terry
Karl, a professor of political science at Stanford University and author
of The Paradox of Plenty, a seminal book on the dynamics
of petrostates. Leaders can use the country’s resource wealth to repress or
co-opt political opposition.
How
does Venezuela fit the category?
Venezuela is the archetype of a failed petrostate.
Venezuela
is the archetype of a failed petrostate, experts say. Oil continues to play the
dominant role in the country’s fortunes more than a century after it was
discovered there. Oil prices plunged from more than $100 per barrel in 2014 to
under $30 per barrel in early 2016, sucking Venezuela into an economic and
political spiral. Conditions have only worsened since then.
A
number of grim indicators tell the story:
Oil
dependence. Oil sales make up 99 percent of
export earnings and roughly one-quarter of gross domestic product (GDP).
Falling
production. Starved of adequate investment and maintenance, oil
output has declined to its lowest level in decades.
Spiraling
economy. GDP shrank by roughly two-thirds [PDF]
between 2014 and 2019, and experts forecast that, with plummeting demand for
oil amid the coronavirus pandemic, it would decline by roughly another 30
percent in 2020.
Soaring
debt. Venezuela has an estimated debt burden of $150
billion or higher, more than double the estimated size of its
economy.
Hyperinflation. Annual
inflation is running at 6,500 percent.
Growing
autocracy. President Nicolas Maduro and his allies have
violated basic tenets of democracy to maintain power.
These
issues—coupled with international sanctions and the coronavirus pandemic—have
fueled a devastating humanitarian crisis, with severe shortages
of basic goods such as food, drinking water, gasoline, and medical supplies.
According to a recent survey, 96 percent of
Venezuelans live in poverty, the highest proportion in Latin America.
Since
2015, more than five million people have fled to neighboring countries and
beyond. However, over one hundred thousand Venezuelan migrants have returned
home since the coronavirus pandemic began, often after losing their jobs in
other Latin American countries.
How
did Venezuela get here?
A
number of economic and political milestones mark Venezuela’s path as a
petrostate.
Discovering
oil. In 1922, Royal Dutch Shell geologists at La
Rosa, a field in the Maracaibo Basin, struck oil, which blew out at what was
then an extraordinary rate of one hundred thousand barrels per day. In a matter
of years, more than one hundred foreign companies were producing oil, backed by
dictator General Juan Vicente Gomez (1908–1935). Annual production exploded
during the 1920s, from just over a million barrels to 137 million, making
Venezuela second only to the United States in total output by 1929. By the time
Gomez died in 1935, Dutch disease had settled in: the Venezuelan bolivar had
ballooned, and oil shoved aside other sectors to account for 90 percent of
exports.
Reclaiming
oil rents. By the 1930s, just three foreign companies—Royal
Dutch Shell, Gulf, and Standard Oil—controlled 98 percent of
the Venezuelan oil market. Gomez’s successors sought to reform the oil sector
to funnel funds into government coffers. The Hydrocarbons Law of 1943 was the
first step in that direction, requiring foreign companies to give half of their
oil profits to the state. Within five years, the government’s income had
increased sixfold.
Punto
Fijo pact. In 1958, after a succession of military
dictatorships, Venezuela elected its first stable democratic government. That
year, Venezuela’s three major political parties signed the Punto Fijo pact,
which guaranteed that state jobs and, notably, oil rents would be parceled out
to the three parties in proportion to voting results. While the pact sought to
guard against dictatorship and usher in democratic stability, it ensured that
oil profits would be concentrated in the state.
OPEC. Venezuela
joined Iran, Iraq, Kuwait, and Saudi Arabia as a founding member of the Organization of the Petroleum Exporting Countries (OPEC) in
1960. Through the cartel, which would later include Qatar, Indonesia, Libya,
the United Arab Emirates, Algeria, Nigeria, Ecuador, Gabon, Angola, Equatorial
Guinea, and the Republic of Congo, the world’s largest producers coordinated
prices and gave states more control over their national industries. That same
year, Venezuela established its first state oil company and increased oil
companies’ income tax to 65 percent of profits.
$100 billion
State oil wealth embezzled between 1972 and 1997
Source:
Gustavo Coronel, Cato Institute
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The
1970s boom. In 1973, a five-month OPEC embargo on countries
backing Israel in the Yom Kippur War quadrupled oil prices and made Venezuela
the country with the highest per-capita income in Latin America. Over two
years, the windfall added $10 billion to state coffers, giving way to rampant
graft and mismanagement. Analysts estimate that as much as $100
billion was embezzled between 1972 and 1997 alone.
PDVSA. In
1976, amid the oil boom, President Carlos Andres Perez nationalized the oil
industry, creating state-owned Petroleos de Venezuela, S.A. (PDVSA) to oversee
all exploring, producing, refining, and exporting of oil. Perez allowed PDVSA
to partner with foreign oil companies as long as it held 60 percent equity in
joint ventures and, critically, structured the company to run as a business
with minimal government regulation.
The
1980s oil glut. As global oil prices plummeted in the 1980s, Venezuela’s
economy contracted and inflation soared; at the same time, it accrued massive
foreign debt by purchasing foreign refineries, such as Citgo in the United
States. In 1989, Perez—reelected months earlier —launched a fiscal austerity
package as part of a financial bailout by the International Monetary Fund. The
measures provoked deadly riots. In 1992, Hugo Chavez, a military officer,
launched a failed coup and rose to national fame.
Timeline
Venezuela’s Chavez Era
1958–2013
View Timeline
Chavez’s
Bolivarian revolution. Chavez was elected
president in 1998 on a socialist platform, pledging to use Venezuela’s vast oil
wealth to reduce poverty and inequality. While his costly “Bolivarian missions”
expanded social services and cut poverty by
20 percent, he also took several steps that precipitated a long and steady
decline in the country’s oil production,
which peaked in the late 1990s and early 2000s. His decision to fire thousands
of experienced PDVSA workers who had taken part in an industry strike in
2002–2003 gutted the company of important technical expertise. Beginning in
2005, Chavez provided subsidized oil to several countries in the region,
including Cuba, through an
alliance known as Petrocaribe. Over the course of Chavez’s presidency, which
lasted until 2013, strategic petroleum reserves dwindled and government
debt more than doubled [PDF].
Chavez
also harnessed his popularity among the working class to expand the powers of
the presidency and edged the country toward authoritarianism: he ended term limits,
effectively took control of the Supreme Court, harassed the press and closed
independent outlets, and nationalized hundreds of private businesses and
foreign-owned assets, such as oil projects run by ExxonMobil and
ConocoPhillips. The reforms paved the way for Maduro to establish a
dictatorship years after Chavez’s death.
Venezuela: From Oil Boom to Bust
Venezuelan crude oil production
(millions of barrels per day)
3
2
1
0
2000
2005
2010
2015
2020
Price of crude oil per barrel (West
Texas Intermediate)
$100
$75
$50
$25
$0
2000
2005
2010
2015
2020
Note: Data from 2020 represents the
average over the first six months of the year.
Sources : Federal Reserve Bank of St. Louis; U.S.
Energy Information Administration.
Descent
into dictatorship. In mid-2014, global oil prices tumbled, and
Venezuela’s economy went into free fall. As unrest brewed, Maduro consolidated
power through political repression, censorship, and electoral manipulation. In
2018, he secured reelection in a race widely condemned as unfair
and undemocratic. Nearly sixty countries, including the United
States, subsequently recognized opposition figure Juan Guaido, head
of the National Assembly, as Venezuela’s interim leader.
In
recent years, Washington has escalated sanctions against Caracas, which have
curtailed the Maduro government’s income. Still, Venezuela has retained
oil-trading partners, and analysts say that support from China, Cuba, Iran,
Russia, and Turkey is keeping the Maduro regime afloat.
In
January 2021, Maduro and his allies took leadership of what was the last
opposition-controlled power center in the government, the National Assembly,
after claiming victory in legislative elections. The opposition, including Guaido,
boycotted the vote, alleging that it was fraudulent, a charge supported by the
United States and other foreign governments. Some analysts predict that, with
the legislature now under his sway, Maduro will step up his repressive tactics.
Is
there a path away from the oil curse?
A
country that discovers a resource after it has formed robust democratic
institutions is usually better able to avoid the resource curse, analysts say.
For example, strong institutions in Norway have helped the country enjoy steady
economic growth since the 1960s, when vast oil reserves were discovered in the
North Sea, Karl writes in her book. In 2019, the petroleum sector accounted
for close
to 14 percent of Norway’s GDP. Strong democracies with an
independent press and judiciary help curtail classic petrostate problems by
holding government and energy companies to account.
Strong democracies with an independent press and
judiciary help curtail classic petrostate problems.
If
a country strikes oil or another resource before it develops its state
infrastructure, the curse is much harder to avoid. However, there are remedial
measures that low-income and developing countries can try, provided they are
willing. For instance, a government’s overarching objective should be to use
the oil earnings in a responsible manner “to finance outlays on public goods
that serve as the platform for private investment and long-term growth,” says
Columbia University’s Jeffrey Sachs, an expert on economic development. This
can be done financially, with broad-based investing in international assets, or
physically, by building infrastructure and educating workers. Transparency is
essential in all of this, Sachs says.
Many
countries with vast resource wealth, such as Norway and Saudi Arabia, have
established sovereign wealth funds (SWF) to manage their investments. Globally,
SWFs manage about
$9 trillion worth of assets.
Analysts
anticipate that a global shift from fossil fuel energy to renewables such as
solar and wind will force petrostates to diversify their economies. Nearly two
hundred countries, including Venezuela, have joined the Paris Agreement, a
binding treaty that requires states to make specific commitments to mitigate
climate change.
Economic
diversification will be an especially difficult climb for Venezuela given the
scale of its economic and political collapse over the last several years. The
country would likely need to revitalize its oil sector before it could
cultivate and develop other important industries. But this would take enormous
investment, which analysts say would be hard to come by given Venezuela’s
unstable political environment, trends in oil demand, and rising concerns about
climate change.
Recommended Resources
In
a Council Special Report, CFR’s Paul J. Angelo evaluates how
the United States can help alleviate Venezuelans’ suffering.
This
In Brief explores the critical relationships that Venezuela
has with China, Cuba, and Russia.
This
Bloomberg photo essay looks at how Venezuela’s collapsing oil sector is creating an environmental disaster.
Through
interviews with Western oil companies, the Inter-American Dialogue
explores what conditions would draw investors back to
Venezuela’s collapsing oil sector.
In The Paradox of Plenty:
Oil Booms and Petro-States, Terry Lynn Karl compares the effects
of oil wealth on the economies of six countries.
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