Venezuela on the Precipice

Not only does Chavez give away half Venezuela’s oil to outsiders, he gives it away at home too. Thanks to mass subsidies, Venezuela has the cheapest gas prices in the world. You can fill up for your tank for twelve cents a gallon in Caracas... and that’s only the tip of the subsidy iceberg.

Not to put too fine a point on it, Chavez is a self-styled “revolutionary” with no concept of basic economics. He assumed the oil gusher would last forever, and spent money accordingly.

As if all the spending weren’t enough, Chavez has grossly neglected the maintenance and upkeep of PDVSA, the state-owned oil company. Rather than investing in technology and engineers, Chavez has ordered PDVSA to waste its time on hare-brained community schemes. He has installed political cronies in important positions, driven out key employees, and generally let the whole apparatus go to pot.

Now, like Putin, the falling price of crude is delivering the mother of all wake-up calls. Various sources estimate that if oil stays below $80 for long, Venezuela will have trouble paying its bills. Chavez is the type of guy who needs a frying pan to the face to see the error of his ways... and he is about to get it.

An Old Play From the Dictator’s Handbook

So what are Putin and Chavez going to do? Both men are in dire straits, and a ramp-up in oil production is not the answer.

Expanded oil output won’t help the oligarchs at this point. They need a higher price per barrel to shore up market values on their battered and bleeding holdings. And Chavez couldn’t expand production even if he wanted to. (Mazhar al-Sheridah, an oil expert with the University of Venezuela, says his country will need $32 billion and five years’ construction time to raise output.)

One option for both men is to lean hard on OPEC, and hope a round of deep cuts does the job of pushing oil higher. We’ll talk more about that in a minute. But there is another, older, more reliable play too... one that’s proven its effectiveness time and again in recent years.

Putin and Chavez can stir up turmoil on the cheap.

If there were such thing as a “dictator’s handbook” (or maybe a petrocrat’s handbook), you would find this play early on in the list of basic maneuvers. When things are going to hell at home, distract the populace (and the world) by starting a firestorm elsewhere.

It’s hard to solve a pressing problem with long-range tools like diplomacy and fiscal policy... but much easier to light a match and drop it in a drum of kerosene.

Return of the Fear Premium

For the past few years, crude oil traded with a hefty “fear premium” built in. The thought was that, with the supply and demand balance so tight, even the smallest conflict or disruption could have big ripple effects on the price and availability of oil.

Now that the markets are worried more about slowdown than runaway global growth, the fear premium in oil prices has gone away. If anything, it’s been replaced by a new deflationary mindset as “demand destruction” takes hold.

But “fear in the hearts of men” is back in the ascendant... in the hearts of Putin and Chavez anyway. As the walls crumble down around them, both could easily be on the verge of panic. Both know that oil prices must move higher if their regimes are to be saved from oblivion. And both are willing to do whatever it takes to save their own skins.

This is why falling oil is a geopolitical time bomb. Putin and Chavez could already be considered two of the most dangerous men on the planet. Now both men find themselves backed into a corner like wounded animals. And remember, the most dangerous animal of all is not the one hunting for its supper. It’s the one fighting for its life.

Whither OPEC?

We can’t know what’s taking place behind the scenes... what Putin and Chavez are saying to their closest advisers in their most urgent moments and so on. But we can know there’s a real powder keg brewing here. And OPEC is potentially a part of that mix too.

All I know is, if I were a ruthless petrocrat trying to save my regime from a downward spiral in crude oil prices, I would think big. I would try to set off the biggest, most explosive tinderbox possible, just to make sure my message gets through and the new “fear premium” takes full effect.

And if I could time that action with the actions of another powerful group, so much the better. That would just mean more bang for the geopolitical buck.

That’s where OPEC comes in...

In case you weren’t aware, OPEC is meeting later this week to discuss an emergency cutback in crude production. (Russia is not officially a part of OPEC, but Venezuela has long been a member.)

The market has been a tad jittery ahead of the OPEC meeting, but general expectations seem tame. Wall Street analysts are predicting a one million barrel per day production cut. There is also a general consensus that one million barrels won’t be enough to keep the price of oil from falling further.

Remember, too, that it isn’t just Russia and Venezuela who are hurting here. Many of the OPEC countries -- not least Iran -- have a lot riding on a high oil price. I suspect that OPEC will have to engage in a little “shock and awe” this week if they really want to get their message through. In 1973 they really took the gloves off, and we saw what happened the rest of that decade. Who’s to say they won’t do it again.

So there you have it. Mix geopolitical TNT with a paper currency fuse, and you’ve got a good chance of seeing energy prices spike higher before too long. Possibly much, much higher.

Justice Litle is Editorial Director, Taipan Publishing Group
Courtesy: www.taipanpublishinggroup.com