Venezuela sinks ever deeper into a political and economic calamity every day. It has the world’s worst negative growth rate (-8%), inflation is above 700%, and GDP is more than a third below 2013 levels. Financial experts indicate that the economy could shrink 10.4 percent this year. The country with the world’s largest proven oil reserves, with more than 300 billion barrels of proven reserves, is now the world’s most indebted country – no other nation has a larger public external debt as a share of GDP or of exports. The country was being crippled by shortages, water is rationed and living standards have truly collapsed. Twenty years after the 1998 election of Hugo Chavez initiated the “Pink Tide” era in Latin America, Venezuela is heading towards open civil war and remains more vulnerable to the diktats of US power as ever before.
Many factors have contributed to Venezuela’s current crisis including failure of Hugo Chávez to diversify the economy and escaping from the trap of oil dependency, the U.S. aggression against Venezuela and its role in collaborating with Venezuela’s oligarchs to escalate chaos and overturn the social and political achievements of Chavez, Maduro’s overly-bureaucratic government and his use of the state as a repressive agent.
While all of these have undoubtedly had a part to play in exacerbating the current crisis, the severe and sharp fall in oil price, which has substantially reduced the income accruing to the state, is the most significant factor. Venezuela has been deeply dependent on its vast oil reserves, which account for 96 percent of export earnings and nearly half its federal budget. All other factors from mismanagement to black-market have been there for many years, and that was still manageable when oil was selling at more than $100 dollars a barrel. During the presidency of Hugo Chavez, when the price of oil reached a historic high of above $100 a barrel, billions of dollars in revenue were used to finance social programmes and food subsidies. When the price of oil fell, however, those programmes and subsidies became unsustainable. Oil prices started falling from 2014, and in 2015 the oil price was cut in half, which resulted in the state revenues going down sharply in Venezuela. When oil prices collapsed it was inevitable the government would enter a deep crisis. Even to fulfil its minimum commitments with a reasonably balanced budget, now Venezuela needs oil prices to reach $121 per barrel.
Even though affected in the worst possible way by the falling price of oil, Venezuela had almost no direct part to play in the fall of the price of crude oil. Venezuela currently is the world’s 11th largest oil exporter. What’s going on in Venezuela is the unintended consequence of Saudi Arabia’s policy of keeping oil prices deliberately low for political reasons.
The price of oil, as with any other commodity, is regulated by traders who bid on oil futures contracts in the commodities market. There are essentially three factors that commodities traders take into consideration when developing the bids that create oil prices. First is current supply in terms of output. Second is access to future supply, which depends on oil reserves. Third is oil demand. When demand increases, or supply decreases, the price goes up, and when demand decreases, or supply increases, the price goes down. The traders in the futures market base their estimations on their collective knowledge of the total supply and demand for oil at any given time.
Before 2014 the global supply and demand for oil was fairly balanced, production was around 4m barrels ahead of the demand. But production started to escalate thereafter, and by late 2015 the average daily supply increased to almost 100m barrels a day, more than 2.2m barrels additional oil a day. This surplus caused a sharp drop in the price of oil. Market fundamentals, supply and demand, can explain the fall in oil prices only partly as it was essentially a politically motivated Saudi decision played the key part in this.
Part of this increase in supply was from American shale oil, extracted through fracking, but mostly it was the result of the Saudis deliberately refusing to limit pumping large amounts of oil for political reasons. As the only oil-producing country with sufficient reserves to regulate the market in this way, Saudi Arabia is considered the “swing producer”. Adjusting production levels to bring about a preferred balance between supply and demand, and thus realizing a certain price level, is the characteristic function of a swing producer. Saudi Arabia is the only producer that exports large enough and has the centralized control, with one major company, Saudi Aramco, to exercise a clear degree of market power in the global oil market.
Even though US shale production has reduced some of the Saudi Arabia’s swing power capacity, the oil kingdom has still the ability to determine the price of oil globally by varying the amount of oil coming to the market. Saudi Arabia is one of the lowest-cost and most efficient producers in the world of petroleum with huge capacity for export. For economic reasons, as the swing producer, Saudi Arabia, the biggest OPEC oil exporter and the strongest player in the world oil market, should normally have reduced its output as prices fell in order to try to put a floor under prices. It did not do so, but instead set new records for its production levels in 2016, because of non-economic factors. The primary responsibility for the collapse of oil prices can thus be attributed to Riyadh’s foreign policy concerns more than anything else.
It seems the Saudis are trying to achieve two aims with this low oil price strategy. The first is to drive US shale producers out of business and consolidate the Gulf state’s leading role in global oil. Producing oil from shale via fracking is expensive, above $50 a barrel, while the cost of natural oil is no higher than $7 a barrel. Saudi Arabia hopes the drastic decrease in oil prices, to well below $50 a barrel, will make it unprofitable for American shale producers to drill at their current rates.
The second aim is to destroy the economy of Iran, the Saudi kingdom’s main competitor in the Middle East. This would thus limit Tehran’s ability to continue funnelling hundreds of millions each year to the Syrian regime, and Shia militias fighting against Saudi-supported Sunni groups and regimes in Iraq, Yemen and elsewhere in the Middle East.
Oil markets have always been at the heart of the Saudi-Iranian struggle for regional hegemony. Back in 1977, when Iran was planning extensive nuclear power plants and envisaging the spread of its influence throughout the Middle East, the Saudi regime flooded the markets, expanding oil production from 8m to almost 12m barrels a day, sharply cutting the oil prices. Iran watched billions of dollars in anticipated oil revenues vanish, Iran’s economy plummeted and the Shah was forced to abandon his plans for nuclear investment. Manufacturing collapsed, inflation skyrocketed, unemployment rose steeply, and before long economic troubles had destroyed all support for the Iranian monarchy. The rest is history: the regime collapsed in two years, the Shah was forced to flee Iran, and the Ayatollah Khomeini’s rebellion brought theocratic rule of Islamic republic to Iran.
Michael Reagan, the son of the late US President Ronald Reagan, writing in March 2014, claimed that another Saudi action to lower the oil prices played an important role in bankrupting the Soviet empire. In 1985, Saudi Arabia opened its spigots with the alleged reason of defending its global market share. Between 1985 and 1986, Saudi Arabia increased oil production from 2m barrels to 5m barrels a day, as a result of which the oil price tumbled from $30 to $20 a barrel in just a few months. The result was to wreck the economies of many other major oil producers including some of OPEC member states. The Soviet Union, however, suffered the biggest blow when practically its sole source of foreign currency earnings was eradicated overnight. In order to close the sudden financial gap, the Soviets borrowed heavily from Western financial institutions. As the Soviet economy stalled, borrowing needs increased, putting a heavy strain on the already fragile balance of regime legitimacy. By 1989, the Soviet Union needed $100-billion just to avoid food shortages. Within a year Moscow was bankrupt and unable to subsidize the crumbling Eastern Bloc of client states it had maintained since the end of the Second World War.
Low oil prices naturally hurt Saudi Arabia too as it relies heavily on oil income to fund its government and to float its economy. However, Saudi Arabia’s economy is far better prepared for a sustained period of low oil prices than ever before as the country has savings rate of 44 percent and one of the lowest debt-to-GDP ratios in the world, according to World Bank. But they negatively impact Iran in a much greater way and it hinders Iran’s ability to support Shiite movements in Saudi Arabia’s backyard. It seems, after some hesitation and discussions in the early part of 2014, Saudi Arabia launched this oil price war in tandem with the US. America supported the policy as it wanted to undermine the influence of oil-dependent Russia, something it apparently considered more important than supporting its own fracking industry, while access to cheap imported oil is good news for US consumers and economy in general. Whether or not there was a clearly planned and agreed strategy, there seems to be an unmistakable convergence of interests between the Saudi and US positions as it seems there is an expectation in Washington that low oil prices may destroy the Russian economy.
This strategy of keeping the price of oil down has not necessarily destroyed either the Russian or Iranian economies however. Between mid-2014 and mid-2015, OPEC petroleum export revenues fell by 45.8 per cent to $518.2 billion, marking the lowest level seen since 2005. Instead, the hardest hit oil-producing nations are in South America and Africa, where petro-states such as Libya, Angola, and Nigeria are suffering. But the worst affected country of all is Venezuela, the most disastrously oil-dependent state in the world.
It is still unclear whether the Saudi-US oil price strategy will ever achieve its main goal of crushing Russian and Iranian power and influence. The history, however, is full of examples where unintended consequences occur from even the best-planned campaigns and plots, and those unintended consequences can really bite back when least expected. Furthermore, there are many other unplanned and uncontrolled factors affecting oil prices, such as the devastating impact of Hurricane Harvey, in the US, centred on the hub of American oil industry in Texas. Goldman Sachs estimates that Hurricane Harvey so far has taken 3 million barrels a day, about 17%, of refining capacity offline, due to the shutdown of oil refineries and key transportation hubs. Even though it is almost impossible to make any reliable predictions on what will happen next, one thing is clear: we are in an era of extreme uncertainty in the geo-economics of oil. The world oil market will continue to be particularly volatile, and smaller, less powerful and less prepared nations will continue to be embroiled in the wider disturbance.
- An earlier and shorter version of this piece was published in the Conversation.