Will Venezuela Follow Iran's Footsteps?

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Can you imagine a place where a gallon of premium gas is only 4 cents? Does that sound too good to be true? Well that is what Venezuelans pay because of generous government subsidies. 

With oil being so cheap, you would expect the Venezuelan economy to be booming. Things are not as great as they may seem, however.

An untenable Venezuela macro-enviroment
Venezuela has around the same population as Saudi Arabia at around 30 million people, and 35 billion more barrels of proven oil reserves at around 300 billion barrels versus Saudi Arabia's 265 billion barrels. 

Unlike Saudi Arabia, where oil can be extracted easily, Venezuela needs substantial investments to extract its oil.

Venezuela's previous president, Hugo Chavez, had a socialist streak. During his rule, he chose to focus on socialist programs and anti-American foreign policy rather than investing in the oil industry. His neglect caused his country's annual oil production to decline by about a quarter and oil exports to decline by nearly half since he took power. 

The declining oil production has put financial pressure on the Venezuelan government, which derives 45% of its federal budget from oil. Because of its large socialist programs and lower oil revenues, the Venezuelan government is running an annual fiscal deficit of around 17% of GDP.

One consequence of a high federal deficit is high inflation. Venezuela's inflation rate was 58% in October, up from around 20% at the end of 2012. Some experts predict that Venezuela might see triple-digit inflation next year. 

Many believe that Venezuela's current economic situation is untenable, and that the government will have to reopen up its oil sector to foreign investment. 

Companies that are likely to benefit if Venezuela opens up
In 2006, Mr. Chavez instituted a nationalization program that mandated PDVSA, Venezuela's oil company, get at least 60% share of all production projects. 

Sixteen companies including Royal Dutch Shell and Chevron  went along with the new rules. As a reward for going along with the rule, Chevron was allowed to continue to develop in the Orinoco extra heavy oil belt and signed a multi-billion dollar deal in 2010.

ExxonMobil and ConocoPhillips chose to fight Mr. Chavez's mandate and saw their holdings nationalized.  

In 2007, ConocoPhillips wrote down its Venezuelan investment with a $4.5 billion charge but also sued Venezuela for $30 billion. Venezuela offered to settle for $2 billion and the case remains open. If Venezuela should invite ConocoPhillips back, ConocoPhillips could see a much higher settlement offer. 

After it left, ExxonMobil also sued Venezuela for $12 billion in compensation and was offered a $1 billion settlement. Like ConocoPhillips, ExxonMobil may see a higher settlement offer if Venezuela should invite the oil super-major back.  

The large difference between the oil company's request and Venezuela's offer have to do with the fact that oil companies value their projects around current market prices while Venezuela values projects around book value, which is typically much lower.

The bottom line
There is past precedence for Venezuela reopening its oil industry. Venezuela nationalized its oil industry in 1976 but reopened its oil fields to foreign investment in the 1990's. It gave some multinationals very favorable deals to come back. 


With the recent Iranian Geneva accords as a leading indicator and the macro environment deteriorating, Venezuela may also do rapprochement with the U.S and open up its oil industry.

If Venezuela opens up its oil industry, government revenues will increase, its fiscal deficit will narrow, and inflation will come down. Both Venezuelans and large multinational oil companies such as ConnocoPhillips and ExxonMobil will benefit. 

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The article Will Venezuela Follow Iran's Footsteps? originally appeared on Fool.com.

Jay Yao has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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