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Venezuela: Oil as a Base for Diplomacy

From Stratfor

06.12.04 | Summary Venezuelan President Hugo Chavez is leveraging his country's oil resources to build new geopolitical relationships with key regional powers like Russia and China. While oil is at the leading edge of Chavez's geopolitical moves, increased bilateral cooperation in other areas is also likely. This will expand the influence of countries like Russia and China in the northern Andean region. For Russian, Chinese and other non-U.S. oil companies, the Chavez government's oil-based foreign policy also will translate into profitable investment opportunities in Venezuela in coming years.

Analysis

Venezuelan President Hugo Chavez is using oil increasingly as a political bargaining chip to build regional and global alliances that seek to expand his international influence. These new relationships, particularly with countries like China and Russia, are also placing increased geopolitical distance between Caracas and Washington, D.C. Chavez is not seeking to reduce Venezuela's oil-based economic relationship with the United States. Venezuela exports about half of its crude oil production to the United States, which imports about 8 percent of its foreign oil supplies from Venezuela. The stability of that relationship is strategically and economically important to both governments. However, Chavez also views the U.S. government in adversarial terms and is using oil to build strategic alliances to insulate Venezuela from U.S. pressures internationally. Chavez met with Russian President Vladimir Putin in Moscow on Nov. 26 to discuss bilateral energy, space technology and military-technical cooperation. Lukoil and Gazprom are at the leading edge of the expanding Russian-Venezuelan relationship with likely contracts to modernize aging refineries and build a gas pipeline in Venezuela. Before traveling to Moscow, Chavez stopped in Spain where he announced his approval of a joint venture between Repsol-YPF and Petroleos de Venezuela (PDVSA) to expand the Spanish oil company's crude output levels in Venezuela from 20,000 bpd to 35,000 bpd over the coming year. Chavez also visited Libya, another likely player in his plans to expand Venezuela's oil and gas production capacity.

Chavez is reaching out in several directions simultaneously -- China, the Middle East, Africa and South Asia and Russia. However, Moscow is a particularly vital strategic partner in Chavez's geopolitical plans for Venezuela. Besides courting Russian investment and equity participation in the expansion of Venezuela's oil industry, Chavez also is leveraging his substantial oil revenues to embark on a military modernization plan that would align Caracas militarily with Russia. Chavez is buying $400 million worth of Russian attack and transport helicopters. Recently Chavez also said his government would buy 50 MiG Fulcrum fighters with plasma stealth systems in a $5 billion deal that included advanced weapons systems and Russian technical support in Venezuela. Chavez reportedly is also negotiating the purchase of a still-unknown quantity of assault rifles that would replace the obsolescent FAL-7.62 mm light assault rifles used by Venezuela's armed forces.

If all of these weapons purchases are made, the Russian military mission in Venezuela likely also would increase. Moscow would gain a larger military footprint and greater geopolitical influence in the northern Andean region of South America, where Colombia is the epicenter of the U.S. war on narcoterrorism. A stronger bilateral military relationship between Russia and Venezuela also would give Moscow a strategic edge over China in northern South America. So far, Beijing's efforts to build stronger strategic relations with countries like Argentina, Brazil and Venezuela have been driven by trade and economic issues, including offers of Chinese cooperation in space technology. Increased bilateral cooperation in energy and military issues would give Chavez a valuable Russian strategic partner that would support the modernization of Venezuela's military and the expansion of its oil industry. U.S. oil companies currently operating in Venezuela would not be shut out of the country, but likely would not be the dominant players in the future expansion of Venezuela's oil industry. Instead, Chavez would seek strategic associations in oil with his new Russian, Chinese and Middle Eastern allies, including countries like Algeria, Libya and Qatar. Closer to Caracas, Chavez has used oil successfully to neutralize the U.S. government in forums like the Organization of American States (OAS). Chavez does this by selling crude oil and refined products to numerous Latin American and Caribbean countries under preferential pricing formulas that allow buyers to finance 25 percent of the purchase price over 15 years. By discounting part of the Venezuelan oil sold to these countries, PDVSA's potential earnings dip slightly in the near- to medium-term since the full purchase price is not collected for up to 15 years.

However, Chavez wins a much bigger and immediate political payoff. He earns the good will of the regional governments that buy Venezuelan oil at a discount. Countries like Argentina, Brazil, Dominican Republic and the Caribbean community states will side with Venezuela against the United States in multilateral entities like the OAS, the World Bank and the International Monetary Fund. Chavez's oil diplomacy has been moderately successful so far thanks to high oil prices. With oil prices currently averaging more than $49 a barrel, Chavez has sufficient oil revenues to cover his local spending needs and simultaneously facilitate Venezuela's preferential oil sales plan, which charges buyers only 2 percent interest annually over 15 years on 25 percent of the total sales price. However, the total supply of oil Chavez has available to leverage for his oil diplomacy is not very large.

Venezuela's government claims that crude oil production currently averages 3.1 million bpd. Analysts with OPEC estimate that Venezuela's real production levels are about 2.5 million bpd, including 1 million bpd produced by foreign oil companies in strategic associations and marginal oilfield operating contracts. Of this total output, 400,000 bpd are consumed locally and slightly less than 1.5 million bpd are exported to the United States. Theoretically, this leaves Chavez with a "surplus" of about 600,000 bpd that can be used directly to advance his foreign policy agenda.

Venezuelan preferential oil sales are done under several agreements. For example, under the San Jose Accord that Venezuela has sponsored jointly with Mexico for more than two decades, both countries supply 11 Central American and Caribbean countries with 80,000 bpd. The countries in the San Jose Accord include Barbados, Belize, Costa Rica, El Salvador, Guatemala, Haiti, Honduras, Jamaica, Nicaragua, Panama and the Dominican Republic. Also, since 2000 Venezuela has supplied Cuba with at least 53,000 bpd, although private oil traders believe that Venezuelan shipments to Cuba average closer to 85,000 bpd or even more. Recently Venezuela also subscribed the Caracas Energy Accord pledging another 80,000 bpd to the same countries that subscribe to the San Jose Accord. Additionally, Venezuela now sells nearly 20,000 bpd to Paraguay, and recently resumed oil shipments to the Dominican Republic at 50,000 bpd. Chavez also has sold oil in the recent past to Argentina and Bolivia. In all, Venezuela sells about 300,000 bpd of crude oil and refined products to various countries in the region under its preferential pricing formula. This means that Chavez still has a "cushion" available of about 300,000 bpd that he can bring to bear immediately in preferential oil supply agreements intended to strengthen his political capital internationally. Moreover, future capacity expansions undertaken jointly by PDVSA and partners from Russia, China and other countries will provide Chavez with more crude oil to swap at low prices for political support. However, price is a critical factor in the sustainability of Chavez's oil diplomacy.

With oil prices currently close to $50 a barrel Chavez has substantial oil revenues at his disposal. If prices fall below $30 a barrel Venezuela's oil revenues would drop sharply, leaving Chavez with substantially less room to maneuver geopolitically with oil. Pentagon analysts said recently that if oil drops to $23 a barrel or lower the Chavez government would quickly run into cashflow troubles, despite having more than $20 billion on deposit at the Central Bank. However, even if oil prices fall sharply in coming months Chavez likely will not abandon his discounted oil sales to key Latin American and Caribbean allies. The alliances these oil sales have helped to create assure Chavez of significant regional support in his adversarial relationship with U.S. President George W. Bush's administration, and Chavez will not dissolve those alliances if he can avoid it. Instead, Chavez likely would redouble his efforts to attract new foreign investment to expand Venezuela's crude oil production capacity.

(c) 2004 Strategic Forecasting, Inc. All rights reserved.

http://www.stratfor.com



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