At the beginning of May, the Associated Press reported that Chavez had admitted that production levels in Venezuela's Western oil fields were less than expected. Chavez, according to AP was concerned because production had fallen at least 100,000 barrels from the expected one million barrels per day that the fields can potentially produce.

This was a significant event, as Chavez has never admitted to any kind of production problems in Venezuela before, even though analysts, including OPEC's in house team have been saying that Venezuela's production was far below the officially quoted levels.

On May 4th multiple sources reported that the Venezuelan military had taken over key oil installations in the country that were run by the state run oil company PDVSA, and that several thousand contract workers had been fired. About half of them had been immediately rehired.

The actions followed an announcement a few days earlier that Venezuela had broken all military contracts with the United States, that Venezuela was accusing the CIA of sabotaging key oil installations, and that PDVSA, was turning Havana into its Caribbean hub for oil related business.

Why is Venezuela in such trouble?

Stratfor.com estimates that since Chavez became president, starting in 1998, "PDVSA has lost about 1.5 million bpd of its net crude oil production."

The main reasons have been the replacement of capable engineers and workers who disagreed with Chavez's revolutionary views, with inexperienced, and in many cases incapable replacements, and the lack of attention to infrastructure maintenance and improvement.

The result of the bad management and neglect, has been the steady erosion and near incapacitation of a major oil-producing region of Venezuela, the Western portion of the country, where as many as 10,000 wells have been estimated to have been rendered mostly useless. Venezuela is nominally the world's fifth largest oil producer.

What's behind the sudden push?

As a consequence of the production shortfall, Chavez's political agenda, and his efforts to export a Castro-like 'revolution' throughout Latin America, are at risk. From the speed of events, it looks as if he and Castro are trying to catalyze events in order to move their goals forward while they still can.

The recent developments suggests that the path charted by Venezuela and Cuba, toward becoming a joint political and pseudo-commercial alternative to the United States, in South America is moving at what can only be described at lighting speed.

Here are some signs. Venezuela has made several deals requiring cash of late, including the purchase of 100,000 rifles from Russia. Venezuela has recently signed an agreement that places a PDVSA office in Havana along with the promise of a $400 million injection of capital into Cuba. The goal here is to make Cuba a Caribbean oil hub. Chavez has also been exploring the funding of an expansion of the Panama Canal in order to expedite oil shipments to the Pacific and to China.

Because of the apparent cash crunch, which may have put a damper on his expansion plans, Chavez has resorted to threatening international oil companies with collecting back taxes, that according to independent sources may not be applicable given the fact that the amount of taxation is reportedly due to agreements that were in place prior to Chavez' election.

The results of the increasing pressure, has been negative. Recently, Brazil's Petrobras, usually a willing partner to PDVSA, told reporters that they were weighing their options for further deals in Venezuela.

The United States has also been putting forth greater efforts to contain Chavez, as with Secretary of State Rice's recent trip to Brazil, where there were unsubstantiated reports of serious closed-door conversations about Chavez with Brazilian President da Silva.

Further signs of trouble

If the Venezuelan military (FAN) is taking over PDVSA, the possibility exists that Cuba, which is widely believed to have infiltrated FAN, then will become a major player in global oil, and a de facto member of OPEC, even if only behind the scenes. It is an extremely significant factor that the oil markets have not begun to consider.

This agenda, if fully implemented, has the potential to directly affect the United States and the global economy.

The next major potential development could be a decrease in Venezuela's oil receipts, due to its potential inability to meet delivery of its oil contracts. This may have already happened, as reports of a shortfall in PDVSA cash deposits to Venezuela's central bank may have fallen short, perhaps by as much as $2 billion. This is not totally verifiable, since PDVSA has not filed papers with the SEC in at least two years.

The shell game

The official oil production from Venezuela is pegged at 3.2 million barrels per day. According to intelligence service Stratfor.com, independent analysts, including OPEC's own, estimate that the actual figure is more like 2.6 million barrels. A good portion of that comes from non-PDVSA production delivered by foreign oil companies. Stratfor estimates the foreign oil company production to be "about 1 million bpd" that is produced "under strategic associations in the Orinoco Heavy Oil Belt and the recently nullified 32 operating contracts and strategic associations."

That means that PDVSA is only producing some 1.6 million barrels per day under the best guess scenario.

If Chavez' own oil production is only 50% of what it is supposed to be, where is all the money going to come from to pay for all his revolutionary adventures?

Two possibilities come to mind.

First, is a massive asset liquidation, including U.S. bonds, and U.S. dollars. PDVSA is already trying to sell its U.S. refineries. This would reverse the recent trends in the markets.

Second, is the specter of a Yukos-like nationalization of foreign oil company assets in Venezuela. Such a debacle would have huge ramifications across the oil industry, and could further increase the market's volatility, as it would put a big chill on global oil production and investment everywhere and increase the worry factor for international companies and the financial markets.

The latter is more likely at this point, than the former. But both would be very negative.

The market angle

For the financial markets, as this scenario unfolds, the repercussions could be huge, not the least of which is likely to be increasing volatility.

Crude oil prices have been falling steadily, despite the potential for a supply crunch, if Venezuela is indeed in as big a hole as the reports indicate.

The U.S. dollar has been holding steady, trading well off of its December and March double bottom, despite multiple reports that are showing a weakening U.S. economy.

U.S. bonds, of which Venezuela owns a significant amount, have been extremely volatile, with yields trading as high as 4.25% and as low as nearly 4%.

To be sure, falling crude prices make no sense in this situation. But falling bond yields, and a rising dollar could well be signs of a flight to safety.

Conclusion

The easy conclusion is that the price of oil should start to rise, given that Venezuela, a key U.S. supplier, has less oil available than it claims. But, the situation is subtler and much more complex than that.

With the speed and purpose that Chavez and Castro have been moving, it would not be surprising to see one, more, or all of these events come down the line sooner rather than later, especially the nationalization of foreign oil assets in Venezuela.

Unless we're missing something, Chavez, Castro and their now jointly endorsed Bolivarian revolution seem to be building their hopes of empire expansion on a very fragile house of cards -- the assumption that crude oil prices would stay at record highs forever. Their recent maneuvering suggests that there is a sense of some urgency now in their strategy, and could be a sign that they understand their predicament.

For OPEC, it could mean that a rebalancing of the power structure is on the way, with even more power going to the Saudis and their allies, who have been reportedly pumping at near capacity, and have been loudly announcing that they will continue to do so, at least for the rest of 2005.

Much still remains up in the air. If oil prices rebound, Chavez will be able to fund his plans in the short term. But, if he has less oil to deliver, than what he's advertising, the pace of his implementation could be slowed significantly, and not be as smooth as it has been so far.

If you're looking for a catalyst, watch what happens if and when the Fed raises rates high enough for people to start worrying about their ability to obtain credit. That could be at one of the next two meetings.

The one intangible at the moment is that as global economies slow down, decreasing demand for oil could keep the Venezuela production issue under wraps, or unnoticed.

If that happens, and there is no correction of the oil production problem in Caracas, the next time the global economy starts to surge, we could see a major surprise.

Indeed, we may be witnessing one of the most intense multi-level geopolitical clashes in history, unfolding as the market trades.

© 2005 Joe Duarte, M.D.
Dr. Duarte's Bio and Archive

 
Joe Duarte, M.D.