…And This is Your Company on Socialism: A Cautionary Tale of Nationalization in Venezuela

The Venezuelan economy is in free fall and its currency is hemorrhaging value

By Jon Vreede, Lynx Global Intelligence

 

For those with an interest in business and Latin America, one question has dominated recent discussion: what has gone wrong in Venezuela? For years, Venezuela’s economy appeared to be booming, and that economic boom was allowing its government to combat social ills and build “socialism for the 21st century”. Yet that boom has turned to bust in dramatic fashion, and the Venezuelan economy is in free fall and its currency is hemorrhaging value. Economic hardship has in turn sparked political unrest, as opposition to President Nicholas Maduro and the ruling chavista government has taken to the streets— sometimes with bloody results. As companies doing business in Venezuela scramble to respond, they are threatened by a crisis of their own: the seizure of their increasingly-worthless assets by the government. The threat of nationalization was most recently brought home by the seizure of General Motors’ facilities by the Venezuelan government. Yet Venezuela’s renewed nationalization should not come as a bolt from the blue; there have been warning signs present for years, and the trend is likely to continue.

The nationalization trend predates the current political crisis in Venezuela, and indeed the broader economic crisis as well. The origins of this problem lie in 2003, when then President Hugo Chavez imposed strict controls on currency exchange and capped the prices on basic consumer products like food, medicine and raw materials[i]. The stated goal was to reduce inflation and combat speculation, as well as ensure that basic products were accessible to poor Venezuelans. In the same vein, Chavez began expropriating farmland which was lying idle or was of unclear ownership in 2005 and redistributing it to increase productivity and combat persistent food shortages. For the following two years, the government set its sights on the petroleum industry: the backbone of the Venezuelan economy. Historically the Venezuelan petroleum industry had been under state control, but previous governments had allowed private firms to enter the market in the 1990s, mostly in the oil-rich Orinoco Oil Belt. But a 2006 law allowed the government to unilaterally abrogate agreements signed during the previous decade, and laws the following mandated that companies must give the state-owned oil company a majority stake in their Orinoco Belt projects or else forfeit their rights. A few oil companies decided to soldier on under these new conditions, but the majority—including ExxonMobil, ConocoPhillips and Total—left the market in 2007. Other companies swept up by the state in that year included Venezuela’s largest telecommunications company, its largest privately-owned electric company, and the nation’s largest iron mines[ii].

At this point, businesses could be forgiven for not worrying about the Venezuelan market. After all, there was historic precedent for the state having a dominate role in the oil and gas sector as well as the iron business, and land redistribution has been the common plank in the platforms of left-leaning Latin-American political leaders for decades. As for telecoms and electricity? In the developed world, many of these services are provided by state-owned utilities. But business owners and investors should have been wary. The Venezuelan government had already displayed a worrying habit of solving problems by taking over businesses. Those land and utility seizures meant cheaper prices for goods, and these subsidies and other social programs were being paid for with that new state-owned oil money. And more trouble was clearly on the horizon. That same year, Chavez threatened to nationalize everything from hospital to steel mills and banks to farms if they did not play ball with his government.

True to his word, Chavez and his government went on a spree of nationalization between 2009 and 2011. This campaign touched all parts of the economy including banks, agribusiness, steel, cement and any company providing supplies and services to the nationalized oil industry[iii]. This campaign of increasing state-control occurred against a backdrop of economic uncertainty and calls for political change. During these three years, oil prices declined significantly while growth rates plummeted and inflation shot back up to around 30% per year[iv]. What is more elections for both the National Assembly and presidency were due to take place in 2011 and 2012 respectively; elections in which the opposition planned to mount a serious challenge to the ruling party. The government’s nationalization campaign can thus be seen as an attempt to right the economic ship and curry favor with the populace. Nationalization allowed the government to guarantee jobs while allowing them to lower the cost of consumer goods; both of which help secure the loyalty of the working-class Venezuelans who make up the core of chavismo support.

For businesses operating in Venezuela, this nationalization campaign should have been the signal to exit this market. The problem was not just that the government was expropriating industry; unsettling though that seemed. Instead, the dangerous development was the it appeared to be working. Slowly, inflation began to creep back down, and GDP began to grow again. From the government’s perspective then, the nationalization program would appear to be recipe for economic recovery. That oil prices rebounded during that same period, thus allowing the government to continue funding its programs was left unsaid. For those who realized the dangerous precedent this set, it was clear that Venezuela was no longer a welcoming market. But many others ignored the trends and decided that things were getting better. Initially at least, that seemed to be true.

That is until 2014, when the price of oil fell dramatically, and with it the Venezuelan economy. To continue providing jobs and services, the Venezuelan government kept printing money, resulting in out-of-control inflation. By 2016, inflation was estimated to be over 700%  (the exact figure is unknown since the government stopped reporting the number) and consumer prices rose by an astounding 2200%[v]. The result has been mass shortages of everything from food to medicine and the shuttering of factories for lack of raw materials. President Nicholas Maduro (who succeeded Hugo Chavez after the latter’s death in 2013) has responded with thundering denunciations of wealthy Venezuelans and shadowy foreign forces; and of course, nationalization, with Maduro pledging to seize any shuttered factory and restarting production[vi]. This process has already begun with the seizure of a Kimberly Clark plant in 2006 and most recently of GM’s Venezuelan plant. The fact that this response will likely not solve the underlying problems will be of cold comfort to those businesses still operating in Venezuela.

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Facing twin economic and political crisis, the government has returned to its favorite response, although they maintain that these “asset freeze” and not expropriations[vii]. For those still doing business in Venezuela, this is a no-win situation. With the aid of experts like Lynx Global Intelligence, their losses might have been avoided. Our analytical tools and techniques could have helped identify the warning signs, and allowed our clients to close down their Venezuelan operations before the economy imploded. Instead, they are left with factories they cannot operate, funds that— thanks to currency controls— are worth less and less every day, and a government willing and able to confiscate whatever maybe left.

 

[i] “Venezuela Announces Currency, Price Controls”. Sydney Morning Herald. February 7, 2003. http://www.smh.com.au/articles/2003/02/06/1044498917650.html.

[ii] Mrquez, Humberto. “Venezuela: Chavez Announces Broad Nationalization Drive”. GIN/IPS. May 14, 2007.

[iii] “Venezuela’s Nationalizations Under Chavez”. Reuters. October 7, 2012. http://reut.rs/2pXAgZI.

[iv] International Monetary Fund. http://www.imf.org/external/datamapper/PCPIPCH@WEO/WEOWORLD/VEN.

[v] “Let Them Eat Chavismo: As Venezuela Crumbles, the Regime Digs in”. The Economist. January 28, 2017.  http://econ.st/2peaP7e.

[vi] “Venezuela Seizes Kimberly Clark as New Plan to Tackle Shortages Launched” TeleSUR. July 12, 2016. http://bit.ly/2pVk5vA.

[vii] “Venezuela Freezes GM Assets After Managers Ask Government to Kick Workers Out of Factory”. TeleSUR. April 21, 2017. http://bit.ly/2qTNfc2.

photo: Oil workers hang a Venezuelan flag at the Jose Complex during celebrations in Barcelona, Venezuela, May 1, 2007. (Photo: Reuters/Jorge Silva)

The Contested Caspian Sea: Oil, Gas, and Legal Disputes. An Overview and Forecast.

The Caspian will be a hotly contested piece of water thanks to its oil resources, naval navigation, and access to the Middle East and Europe for pipeline routes.

By:  Matthew C. Bebb, Lynx Global Intelligence

 

The Caspian Sea is surrounded by 5 littoral states: Azerbaijan, Iran, Russia, Turkmenistan, and Kazakhstan. Each has different vantage points and political capital in the region in order to advance their status in the Caspian. Advancing their presence in the Caspian offers access routes and oil extraction from the sea bed. However, the legal status of the Caspian as to whether it is a lake or a sea is disputed. Once the legal definition of the Caspian is resolved, it will create a legal foundation for each of the state to operate (or not operate) in the Caspian. Until then, the Caspian will be a hotly contested piece of water thanks to its oil resources, naval navigation, and access to the Middle East and Europe for pipeline routes.

The problem with the territorial claims among the 5 littoral states of the Caspian Sea starts with the dissolution of the Soviet Union where 3 new states emerged (Azerbaijan, Turkmenistan, and Kazakhstan). These 3 states did not exist at the time during the original 1920 and 1941 agreements over the Caspian Sea between Iran and the Soviet Union. Furthermore, the question of the Caspian Sea’s boundaries or mineral exploitation weren’t broached in the two bilateral treaties between the Soviet Union and Iran. They were concerned mainly with fishing rights and coastal matters. So, the question since 1991 is whether the status of the Caspian Sea is an inland lake or a sea? If it’s a sea, then it would follow the UN Convention of the Law of the Sea that sets out norms. There have been disagreements among the 5 littoral countries over the right to access these natural resources of oil and gas under the sea, which are argued through different interpretations of the law. As often is the case, these countries are using their interpretations of geography and international law as an argument for their national interests. Thus, the opposing national interests have prevented a consensus on the status of the sea.

 

There have been efforts to come to a resolution to this, but discussions are going nowhere. So, what are the main causes of the dispute?

One of the main issues is the way that Iran interprets the status of the Caspian. Iran considers it a “sea” hence using argument of international maritime law, which allows for freer navigation and using that to get a bigger share of the sea. This is problematic for Iran because Turkmenistan and the other countries are satisfied with the preexisting median line. Then there is Russia which has had a conflicting position since the early 90s. Since then, the Minister of Foreign Affairs and Minister of Energy along with oil and gas firms have all taken differing positions. The Russian Ministry of Foreign Affairs tends to be more supportive of it being a “sea” in order to appease its Iranian partner who’s fighting with them in Syria. The Ministry of Energy and Russian energy extraction firms are more concerned about mineral and energy exploitation. They want an agreement to be made as soon as possible in order to begin drilling without political tension. This has gradually emerged into a position that is often referred to as “common waters divided bottom”. With this policy, Russia is able to maintain surface navigational rights, and therefore naval supremacy, which it views as very important in the Caspian. Furthermore, it has taken a more pragmatic approach to the natural gas exploration and ownership thanks to its naval presence. In 2002, Azerbaijan and Kazakhstan agreed to this “common waters, divided bottom” approach by signing agreements with Russia over sectorial claims of the sea bed. It’s in Russia’s interest that this matter remains unsettled so they maintain the status quo and prevent Turkmenistan from developing their Transcaspian Pipeline, which would be give European states an alternative energy source. This makes it more difficult for the Trancaspian Pipeline to be realized, and that gives one less alternative for Europe that bypasses Russian energy resources. It is doubtful that we’ll see any initiative from Moscow on unlocking this issue.

 

This raises the question of whether Kazakhstan, Azerbaijan, and Turkmenistan have a shared interest to counter Russia?

These 3 countries were not countries when the first agreements were made so they weren’t included. However, Kazakhstan and Azerbaijan have already started developing major projects in their parts of the Caspian. Turkmenistan less so, and they haven’t had as much success because of Russian and Iranian pressure. The Turkmen have been developing their own sectors with outside help from some European firms, especially with their big project is the Transcaspian Pipeline. However, this is the only project that the other littoral states have objected to being crated (especially Russia and Iran). It’s interesting that Russia, Kazakhstan, and Azerbaijan make pledges to protect the environment and the sea, but Kazakhstan had a major pipeline leak and no one raised any fuss about it. Then, Turkmenistan has a pipeline leak and everyone raises hell, especially Iran and Russia. Turkmenistan appears to be the odd man out in the Caspian Sea politics thanks to Iranian-Russian pressures.

 

We’ve assessed the former Soviet states positions. What’s the Iranian position then?

Iran has signed a number of agreements concerning maritime resources, security cooperation, search and rescue, and emergency situations. But all of these agreements are hinged on the unresolved legal status of the Caspian sea. So, some of them in a way cant be implemented without resolving this status of the sea. About 68-70% of the Caspian Sea has been divided between Russia, Kazakhstan, Azerbaijan, and Turkmenistan. It only leaves about 30% for Iran, Azerbaijan, and Turkmenistan to fight over within Iran’s disputed area. Nonetheless, it leaves Iran in a minority holding position. Therefore, it’s important for Iran to have the legal status clarified. Turkmenistan and Azerbaijan will not be willing to change their mind over the existing status quo.

Iran is an interesting position because the bit of the Caspian they believe to be theirs is the deepest of the Caspian that holds 2/3 of the water in the Caspian, which is not very favorable for extracting. The extraction would be extremely difficult and not very profitable with current technology. Iran’s interest of oil extraction is focused more toward the Gulf. That being said, they have much on their hands in the middle east with geopolitical turmoil and oil fields to their south. But when the Caspian Sea does become a priority, it will most likely seek close offshore exploitation with the help of foreign investment (e.g. European countries) now that the majority of their sanctions have been lifted. They currently have help from a Swedish company to build submersible platforms for deep sea drilling. That’s not to say they can’t drill for oil. The technology is there. It’s more of a question of the political will to contest the waters, and even if they win, will they invest in expensive deep water extraction technologies?

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Where do western countries stand in this?

There’s not a lot the west can do to unlock this because of the issues in the Middle East and Eastern Europe with Iran and Russia being the two biggest players. The US has very little leverage in this area. America and the EU are not going to want to spend political capital on this the Caspian issue given the back and forth relations with Iran, Russia, and the United States. However, it is in the EU’s interest to find new markets aside from Russia oil and gas. This gives Iran an opportunity to sell to EU if sanctions are rolled back again. It’s in America’s interest that EU has an alternative to Russian oil and gas because it keeps them out of the Kremlin’s grip. Russia can easily cut off oil and gas to certain European countries with their pipeline transit regime, which has security implications…which has NATO implications…which means US implications. Should America have a say in the matter, it would be in America’s interest if the Caspian’s status was deemed with the law of the sea. It’s in America and Europe’s interest for the Transcaspian Pipeline to be realized. Energy resources from Central Asia can be pushed to Europe, but this is a hard feat to accomplish.

Turkmenistan’s foreign policy is not very conducive to working with partners outside of the country even though they need to rally Western support. They have a fairly aloof attitude, “if you a build a gas pipeline to our fields, we’ll give you gas”. However, the EU doesn’t want to be antagonistic toward Russia by supporting Turkmenistan. Turkmenistan doesn’t have a lot of partners on their side to push their project successfully. In order for a legal argument to stop Turkmenistan’s goal of creating a Transcaspian Pipeline would require a proper legal agreement with total consent. However, Russia, Iran, Kazakhstan, and Azerbaijan are not technically in violation of hindering Turkmenistan because there hasn’t been an established law in the sea.

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A pipeline that’s been under the radar, but recently agreed upon is a pipeline under Azerbaijan and Kazakhstan. After ten years of planning, the two countries recently signed an agreement. Russia attempted to block this. Kazakhstan is looking to export their oil. Kashagan Field (Kazakh) oil needs more markets than its current one. The development of Kashgan field has been continuously postponed due to political pressures and pipeline damage. The recent repairs of the Kashgan pipeline will now allow it go online soon. The pipeline will consist of links through Kazakhstan to the Kazakh port of Kuryk (which is under construction to become a multimodal port) to the port of Azerbaijan. Then diverted to the Transcaspian pipeline to Baku where the oil would go to the BTC pipeline and off to the Turkish Mediterranean coasts, and then to Georgia by rail, and tanker to Odessa in Ukraine and then through Poland for world markets. However, Iran is against this pipeline because the legal of the question of the Caspian is still unresolved and would push out Iranian firms. Iran has opposed the unilateral agreements between the rest of the former Soviet Union littoral agreements of the sea bed. The 47th Working Session of the Iran foreign minister has even mentioned that it has Caspian ambitions by shipping it through Iran or Oman.

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There’s a growing military presence in the sea. Russia recently fired missiles into Syria from the Caspian Sea. They’ve also been the backer of regional training exercises in the area with their CTSO partners. Depending on future sanctions relief, Iran could default back to its independent power stance as it returns to the world stage (and not have to rely on Russia for support). Therefore, Iran could be an instigator as a revisionist power in the area. More likely, there could be a misunderstanding on the local level that could spiral out of control between smaller allied countries that would drag in Russia and Iran. However, these are both unlikely. Russia has levers in the region that it can pull to either mitigate risk or escalate tensions (e.g. neighboring FSU countries, Armenia, and Ngoro Karabakh). There’s a lot of noise coming from Azerbaijan and Turkmenistan about possibly butting heads in the Caspian Sea, but neither have the naval force to assert their claims. Their navies are more like a coast guard that are used to intervene with smugglers. That being said, Russia is the main player in the Caspian Sea due to its geopolitical influence and military presence.

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To conclude, this will be unresolved until the middle of the next decade when these projects can be realized. As long as Iran contests the legal status of the sea, the Caspian Sea will not be resolved. There’s an x-factor, and that is if Putin abdicates power or is relieved from his position, which would change the dynamics of the region.