Potential Hot Spots: Venezuela And The Chinese Agreement



Items About Areas That Could Break Out Into War

September 13, 2018: Government control in Venezuelan is collapsing along with the economy and much else. This will apparently not lead to another regional war, but it is a huge and disruptive mess for Venezuela and neighboring countries. What is replacing the government in Venezuela is a military dictatorship commanded by a small group of socialist politicians who have managed to maintain control over the major assets (oil production) while the rest of the economy collapses. Even with oil production increased there would still be a problem with the fact that the socialist government has destroyed the economy. That includes the oil industry, which was always state-owned (as PDVSA). For the last fifteen years, the government has fired most of the management and technical people in the oil industry and replaced them with loyal, but often unskilled (in running the oil company) socialists (or opportunists). In the first six months of 2018, production averaged 1.22 million BPD (barrels per day) a historic low and continues to fall. In late 2016 production fell below two million BPD, a level not seen since 1989. From 1973 until 2017 production averaged over two million BPD and that level of production will not return until the state oil gets competent staff and lots of money for deferred maintenance and repairs.

The oil situation got worse in late August when there was a tanker collision at Port Jose, the main tanker loading facility (that can load tankers holding as much as two million barrels). This incident shut part of the port down. That made a bad situation worse because most oil waiting to be loaded was destined for the larger tankers. When the tanker collision shut down the Jose at least twenty tankers were waiting (some for over a week) to load oil or discharge lighter petroleum products (like naphtha) that must be added to the thick Venezuelan oil before it can be shipped. Until the Port Jose facilities are repaired (and oil industry managers are not sure when that will happen) shipments (from smaller loading operations) will keep shipments below a million BPD. Some of the ships that were waiting to pick up oil left because it costs a lot of money to operate these huge tankers. Most oil exporters are required, in contracts with their buyers, to pay a daily demurrage fee (of over $20,000) if they delay tankers from loading or unloading. PDVSA has long gotten away with not having these demurrage fee clauses in its contracts because before Maduro there were few delays. That has changed and most major customers for Venezuelan oil are insisting on a “Venezuela clause” in their contracts which specifies demurrage fee and other penalties if Venezuela cannot load tankers on the agreed upon date.

It’s not just being able to pump and ship oil that is needed. For oil wealth to somehow solve the problems oil prices must return to earlier (pre-2013) levels and stay they for long enough for the Venezuelan oil facilities to be rehabilitated. That is urgent because oil production and shipping facilities are falling apart, mainly because technically competent managers and workers are not available. It has gotten so bad that more of the oil industry workers are dismantling the unused facilities and selling the parts on the black market or for scrap. The government has sent in lots of soldiers to protect the oil facilities (from external threats as well as dishonest employees) but many of the troops will take a bribe and the disintegration of the oil production infrastructure continues.

The well-run state oil company took nearly a decade of increasingly bad management to produce persistent declines in the ability to produce and ship oil. Venezuelan oil production hit a peak of 3.5 million BPD in 1999 when the current socialist government took power. By 2015 it was down 34 percent (to 2.654 million BPD) and by it fell to 2.373 million BPD. The production decline accelerated in 2017 and at the start of 2018 estimates were that production would fall to an average of 1.6 million BPD or less for all of 2018. It turned out to be less and given the accelerating collapse of the economy and PDVSA oil production could easily fall below a million BPD by the end of the year, and keep going down.

This reduction in oil income was made worse by socialist economic policies that destroyed the non-oil economy and eventually helped make it more difficult for the oil industry to revive production. The government has brought in some foreign contractors (mainly Chinese) to help repair the damage to the oil industry but the Chinese have discovered that the economic infrastructure, in general, is collapsing and operating in Venezuela is even more dangerous and difficult than in chaotic and violent parts of Africa, Southeast Asia and Afghanistan where the Chinese have succeeded (some of the time) to adapt to a violent neighborhood and minimal local infrastructure.

Compounding Venezuela’s production problems was the decline in oil prices. The world oil price for Venezuelan crude fell from $100 a barrel in 2010 to $35 a barrel in 2016. The price has recovered somewhat (to $45 a barrel in 2018), in part because Venezuelan production is declining and unreliable. If production does recover that would cause oil prices to decline unless other nations cut their shipments. The oil industry is a mess with much maintenance way behind schedule and equipment failures becoming more common. That means it costs more to get a barrel of oil out of the ground and onto a tanker. Oil profits (that all go to the government) are down to less than a third of what they were in 2010.

President Maduro refuses to admit that his policies caused the mess. He blames it on foreign agents, saboteurs and agitators. Maduro also refuses to enact known (to work) solutions for the current crises. An obvious case in point is inflation. This condition is caused by printing money that is not backed by taxes or loans (in stable currencies). Venezuela then uses this worthless money to pay government employees, or those who provide goods for the government. Anyone using this inflated currency finds that the value keeps dropping because there is no economic activity in the country to generate goods and cash to ensure that prices for scarce goods does not spiral upward (or inflate).

Now Venezuela has hyperinflation (an inflation rate of over a million percent a year.) Maduro got on TV recently and announced his solution: new bank notes with fewer more zeroes but worth the same and backed by a new (but fictional, it turned out) cryptocurrency (like bitcoin but worthless). This is called redenomination and it does not work without something more than a fictional cryptocurrency to back it up. For example, back in 2008 the Zimbabwe central bank dropped ten zeros from the currency. The 10,000,000,000 (ten billion) Zimbabwean dollar bill became one dollar. This did not work and inflation rate soared to more two million percent a year. Before the “big lop” a 100 billion Zimbabwean dollar had been issued. By the time it hit the streets, the ten billion dollar bill could not quite buy a loaf of bread.

The only cure for hyperinflation is to base your currency on a stable foreign one (like the Chinese yuan) and live with the fact that you are broke and your currency is controlled by a foreign entity (the Bank of China). Maduro is not ready to accept reality yet. This despite the fact that he has been avoiding the inflation problem for years. The government food rations, which are supposed to be sold at a fixed price often have additional “transportation and handling” charged added. Sometimes a bribe is demanded. Everyone realizes the Venezuelan currency is worthless except the Maduro (and some clueless aides) who have special stores that are kept well stocked. Even those special stores (something the Soviet Union adopted in the 1980s before the Soviet Union dissolved in 1991) are not enough because many senior officials see those stories as a sign of failure. A growing number of senior officials have already quietly sent their families overseas (usually to Spain where Spanish speaking South Americans can easily gain citizenship if they can prove their Spanish origins, which many upper-class Venezuelans can do). Now those senior officials are quietly joining their families overseas and doing so permanently.

The Phantom Migration

Maduro feels he is safe from armed opposition because he has not tried to prevent emigration. He may have learned that from his Cuban security advisors who noted that when the communists took over in Cuba during the late 1950s they let the middle class and most of the professionals leave, mainly for the United States. That eliminated many of the people who could organize and lead a counterrevolution. But Venezuela today is different from Cuba back them. Some senior Maduro officials still believe they can turn it all around and do what Cuba did. But Cuba is an island and was able to create its stable dictatorship in a different time (the 1960s) because Russia was able to provide very professional and effective help in establishing a communist police state. Before the revolution, the Cuban market economy had made Cuba the wealthiest nation in the Caribbean. That was destroyed during the 1960s but the Russians provided large annual subsidies (oil, food and cash) to keep everyone fed. Venezuela has access to none of that and, despite the huge oil reserves, is facing a catastrophic collapse. Venezuela has no wealthy and heavily armed patron. China has come, looked and said: “let’s talk.” Russia and Iran are broke and under heavy sanctions meaning that these two countries have their own problems obtaining needed equipment and tech to keep their oil exports going.

What Venezuela does have is massive corruption, especially among the senior officials. There are a growing number of armed men (pro-government militias) and a growing number of criminal gangs that the government cannot afford to feed. Some of these gunmen are migrating and neighbors like Brazil and Colombia are noticing that and cracking down on illegal Venezuelan migrants in general. If there is a war in Venezuela it will likely be between the armed haves and the armed have-nots. Venezuela already has the highest crime (and murder) rate in the region (and perhaps the world). While some of hungry gangsters and militiamen are migrating the neighbors are wise to this problem and violent migrants are not welcome and treated harshly when discovered. This is why Maduro is so obsessed with loyalty (even at the expense of competence). Over six percent of Venezuelans had already left and Maduro plays down the extent of the migration. At the same time, he makes public appeals for skilled Venezuelans to “come home” and get a better job than “cleaning toilets” in a neighboring country. Few skilled migrants take Maduro up on that because the new out of Venezuela is that even having a good (well paying) job does not give y9u access to scarce basic goods.

The government refuses to deal with political opponents or acknowledge the fact that most Venezuelans would vote the current government out of office if they had the chance. The currency is worthless, most commercial enterprises have been driven out of business or simply shut down by the government. In GDP terms the economy is less than a third of what it was in 2013 when the crises accelerated because of falling oil prices and the death of Hugo Chavez, the charismatic founder of the socialist state in Venezuela. The current GDP has most (about 90 percent of the population) with a smaller percentage share of GDP than in 2014. The government has do divert enough resources to the senior officials and the military to maintain control over the population. Maduro still refuses to accept foreign aid because he insists there is no need. Easy enough to say now that Maduro has eliminated elections and has a near monopoly on weapons.

The UN and all of the neighbors condemn Maduro but the international community is unwilling to do much more than that. Some South American nations have expressed a willingness to join in on sanctions. In part that is because it is no secret that millions of sick and hungry Venezuelans are preparing to flee to neighboring countries, mainly Colombia and Brazil. Many will find they cannot get to and across the border because of health or financial problems, but this demonstrates how desperate the situation has become.

International efforts to get the government to abide by the rules (of the original Venezuelan constitution and most of the voters) have failed. With the economy wrecked food is in short supply and the government controls most of what is available. In many parts of the country, the government supporters (mostly soldiers, police and members of pro-government militias) are sufficiently numerous to make locals do just about whatever Maduro wants.

Despite diverting most food and other consumer goods towards the security forces, that did not prevent a growing number of soldiers and policemen from complaining that their families were going hungry, often because one soldier or policemen was under pressure to help get food for his extended family and was unable to do so. Commanders are seeking solutions to this growing problem but there is no easy fix. What many commanders do is informally tolerate their subordinates stealing from any Venezuelans that can be seen as Maduro opponents, or simply having anything worth taking. This now includes most Venezuelans so there are plenty of potential victims. Commanders who are caught doing this often get away with it by explaining it is an effective way to reduce open opposition to the Maduro government. The new leadership of the security forces was selected mainly for loyalty not competence in the military of police work. The government is aware that a growing number of its military units are unreliable and is having a hard time keeping track of who can be trusted, who can be accommodated (make a deal with in an emergency) and who is becoming more of a liability. Disbanding disloyal units is difficult and can be devastating for the morale of the loyal troops who have to do the dirty work. So that sort of thing is avoided and untrustworthy units are slowly dismantled by starving them of resources. With more criminals and shrinking and less reliable security forces, Venezuela now has one of the highest crime rates in the world.

What with all the hunger and brutal treatment of protestors the military has tried to counter the bad effect of this on morale with media stories backing the government lies about the bad behavior being the work of foreign agents. But the military represents a larger and less well-off segment of the population and the average soldier cannot ignore the growing poverty and crime throughout the country. More and more commanders report that they are not sure most if their troops could be trusted to fire on angry civilians if there were widespread anti-government demonstrations the police could not handle. Since the economic problems went critical after 2014 thousands of people have been executed or killed during protests. Some commanders are apparently less willing to use that kind of force now although it is increasingly difficult to get reliable data on such deaths. As long as Maduro can afford a secret police force to enforce discipline on the other security forces he is safe. That is why tracking down the cash Maduro and his supporters stole is so important. This is the real war but it is not the sort of thing mass media want to report. It is not exciting, forensic accounting never is unless you’re an accountant.


China is the only country willing to put up cash and personnel to fix the problem but that is mainly because Venezuela still owes China billions of dollars and most of it is supposed to be repaid in oil. China is not optimistic but apparently believes Maduro is desperate enough to give the Chinese a free hand to bring in their own engineers, management and skilled workers. Maduro may not agree with all the Chinese terms (like a priority in paying off Chinese debt via increased production and giving China a percentage of Venezuelan oil assets), but he has to realize that no one else is willing to do the job and there are few countries that can. China has already coerced Maduro to pay off most of the Chinese debt.

In early July China agreed to invest as much as $5 billion in an effort to repair and restore oil production but has only delivered $250 million so far and more cash is dependent on how cooperative Maduro and his associates are. Apparently, China is not optimistic but sees the situation as worth a try. China has worked with a lot of dysfunctional governments and rulers worldwide and knows how to measure the odds. Venezuela appears to be a longshot, even though it has the largest oil reserves in the world.

Meanwhile, the production decline continues not so much because the government refuses to clean up the mess in the national oil company and production facilities but because it cannot figure out how to do it. To make matters worse the Venezuelan oil is exceptionally expensive to process for local or export use because it is “sour” and tar-like. That makes it more expensive to refine and Venezuela must blend its sour crude with imported “light” crude or other diluents (like naphtha) to make their crude oil suitable for foreign refineries. Venezuela is so short of cash that it is not paying for these diluent imports and suppliers are refusing to ship anymore unless they get paid. Same with many other essential services for the oil industry.

This became critical by 2017 because the Venezuelan refineries, also state-owned, suffered more accidents largely because they received less adequate maintenance over the last decade. As a result, domestic refining capability fell to about a quarter of normal and have been getting worse. Shipping sub-standard crude is a violation of the sale agreement and customers are running out of patience. At the moment the largest source of cash sales for Venezuelan crude are Americans. Those buyers have invested heavily in foreign (mainly U.S. based) refineries modified to handle Venezuelan crude. If the U.S. customers give up on Venezuela they will reconfigure their equipment, at great expense, to handle crude from other sources and Venezuela will have to find new buyers and that will mean selling their sour crude at an even larger discount to more distant and less reliable customers. In August an American judge authorized one of the major holders of Venezuelan debt to go after PDVSA assets in the United States and Curacao (a Dutch island off the Venezuelan coast that has refineries processing 15 percent of Venezuelan crude with the help of some other refineries in the Caribbean).

Currently, most of the oil exports go to barter customers (like China) that made large loans that are repaid with oil. These customers are also not getting their oil on time or to the specified quality. Except for China, no foreign investors are willing to commit the billions needed to update and revive the Venezuelan oil operations, mainly because of the massive corruption and the sense that the government is not rational nor dependable. The collapse of the Venezuelan oil industry is doing long-term damage to the ability of Venezuela to process and sell its sour crude.

Total Collapse Or Chinese Supervision

Venezuelans face unpleasant choices; submit to a Maduro dictatorship, support a civil war or flee the country. Submitting to the dictatorship is looking grimmer as more of the population literally starves. Brazil and Colombia get enough refugees on a regular basis to understand (via questioning new arrivals) how bad things are getting. Indicators are that factions in the leadership disagree with how to proceed and Maduro less certain each day who he can trust.

To make matters more interesting yesterday (the 12th) Maduro left to visit China and personally negotiate some kind of rescue deal with the Chinese. There is already a team of Maduro loyalists in China discussing terms so there is probably already an agreed upon deadline.

It is unclear how many Venezuelans would (or could) fight and Maduro and his followers are betting on being able to suppress whatever armed opposition develops outside the ruling factions. Aside from the desperate poverty the Venezuelan gangs are more numerous in part because the government armed many groups considered pro-government militias. But when shortages, especially of food, reached the point where even the pro-government gangs (and family members) were going hungry many of these pro-government militias went outlaw. Adding to this is low morale in the military, where troops are still fed but are getting less food and their pay is worthless to buy food for their families. Desertions are increasing and this was noticed when some 2,000 active-duty troops did not return from Christmas leave and more are still walking away, often fleeing the country with their families. Another cause of falling morale in the military is the bad behavior of the secret police and special army units, which has been killing prominent government opponents and going after anyone suspected of bad behavior.

If there is going to be any organized armed opposition it will happen with most of the people with skills having fled the country. These exiles see the situation as getting worse and not likely to recover any time soon with or without a revolution. That’s why the opposition political leaders still in the country are trying to keep a political opposition intact because another option Maduro has is to admit Venezuela is in trouble and offer to make political reforms in return for aid. That appears to be a longshot because Maduro appears to be living his fantasy that all the problems are caused by foreign interference (especially the United States) and only a true socialist and revolutionary can get the country back on its feet. As long as Maduro can feed the security forces he can live his dream while the rest of the country crumbles. That may be what the trip to China is all about.

Economists and those with experience in similar large-scale catastrophes in Africa note that what is left of the Venezuelan state could last another year or two. At that point, the country would dissolve into local fiefdoms who could ask for and receive foreign aid. But one unique thing about Venezuela is all that oil wealth, concentrated in the north, near the coast. That will also be up for grabs and that battle would involve a mélange of lawyers, bankers, diplomats and the risk that many of the oil facilities might literally go up in flames as chaos, no matter how brief, breaks out in areas where the oil and all the pumps, pipelines and port facilities are. However, this ends it won’t end well for Venezuelans.


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