Venezuela's most important economic sector is the oil industry. Venezuela has the second-largest reserves of any country in the world. Since the discovery of crude reserves in the early 20th century, the majority of investment in Venezuela has gone to the production of petroleum and its derivatives. Because the country never developed a robust manufacturing base or agricultural sector, Venezuela's economy is dominated by the petroleum industry and related services. As a result of high oil prices and declines in other industries, oil made up 93 percent of Venezuela's export revenue in 2010, up from 83 percent in 2001, and oil exports account for 23 percent of the country's gross domestic product.
Because the oil industry development has come at the expense of other sectors, Venezuela has had to rely on imports to satisfy domestic needs, particularly food. The staple grains of Venezuela are corn, followed by wheat. The country relies on imports for about 50 percent of corn consumption and 100 percent of wheat consumption. Most of these imports come from the United States, Canada and Argentina, making the cost of key food products in Venezuela dependent on the dollarized international trade of food commodities. For private entities to import food, they must first exchange Venezuelan bolivars for dollars. This has become increasingly difficult, and delays in the government exchange agencies drive Venezuelans to seek out black market exchanges where the value of the bolivar is much lower than the official exchange rate.
Furthermore, limited entry points for critical food commodities provide opportunities for corruption and hoarding. Individuals and organizations labeled "speculators" by the government have been known to import large quantities of food but then store them to cause scarcities and thereby increase prices. In some cases this has caused whole warehouses of food to spoil, creating actual food shortages.
Reliance on dollar-denominated imports and distortionary import policies are drivers of the high inflation rate, and food is particularly vulnerable. While general annual inflation in Venezuela was 24.6 percent in April, food inflation hit 31.3 percent. Government efforts to control inflation have been expanded in recent years. The Law of Fair Costs and Prices, which came into effect in April, imposed strict price controls on consumer goods. Though these measures supposedly took costs to the supplier or manufacturer into account, reports have already emerged about producers within Venezuela who cannot cover their costs at the government-set prices, even for basic goods like milk or corn meal. The net effect of this turmoil will likely be to drive companies out of business, worsening goods shortages and increasing the country's reliance on imports. Strict price controls also drive economies to operate in the black market, where inflation can be even worse.
Beyond the regulations in the private sector, the government also provides subsidized goods and services to poor neighborhoods. Having come to power at a time of high public dissatisfaction over poverty levels, government spending including direct cash transfers, subsidized food and health care has been a cornerstone of the Chavez regime's support. Determining the precise amount of this spending is difficult, since much of it is implemented by Venezuelan state-owned energy company Petroleos de Venezuela (PDVSA) through subsidiary companies. Most of the rest is handled through a set of discretionary slush funds like the National Development Fund, known by its acronym Fonden, that are under the direct control of the president. These direct transfers put more spending money into the hands of consumers and can drive up demand for a limited amount of goods, contributing to overall inflation.
With elections approaching in October, government spending on imported consumer goods and especially food is expected to increase. As one way to pay for this spending, Venezuela has increased its commitments to sell China oil to increase the borrowing ceiling from China from $4 billion to $8 billion. But there appears to be mounting logistical challenges facing importers as well. Recent reports indicate that dockside infrastructure has been failing, and ships loaded with cargo unable to reach offload facilities are stacking up offshore.
More important are ongoing problems with trade financing. Despite billions of dollars entering the country each month, the competition for those dollars is high, and the Venezuelan central bank is having a difficult time meeting demand. Foreign exchange delays have been a persistent problem for years, though this problem is underscored by the recent sale of $1 billion-worth of PDVSA bonds to the central bank in what appears to have been an attempt to increase the central bank's international financing options using PDVSA assets as backing. This, combined with increased borrowing from China, implies that the government itself could be having a cash flow problem in financing its spending.
Energy Sector Challenges
Despite the centrality of oil production to the Venezuelan economy, there are deep problems in the energy sector. A series of nationalizations over the course of Chavez's presidency has left the majority of the industry in government hands. The botched 2002 coup attempt led by PDVSA employees prompted Chavez to sack the most technically competent staff at the company. Since then, the staff has doubled while output has declined significantly from its peak at 3.5 million barrels per day (bpd) in 1999 to 2.4 million bpd in April 2012. At the same time, rising domestic consumption (and smuggling) of subsidized petroleum products reduced export volumes by 40 percent from 2005 to 2010.
The contractors and investors who remain frequently go unpaid by PDVSA, whether through poor management or as a result of the company's increasingly slim operating margins, and inefficiencies and management challenges will worsen over the next year as a result of a new law that will force PDVSA to incorporate contractual employees into PDVSA's full-time work force.
The electricity sector is in even worse shape. The system is dilapidated and blackouts are starting to reach even Caracas. The country is no longer under threat of drought like the one that nearly brought energy production at Venezuela's massive Guri dam to a halt in 2010, but the deterioration of electricity infrastructure combined with energy consumption beginning to surpass production capacity means a comprehensive overhaul is required. This type of revitalization was recommended by a government commission in 1999, but very little has been done to improve the network since then.
No Easy Solutions
All of these challenges have existed for some time, but years of neglect by the authorities have caused them to worsen. Any government coming to power in Venezuela will have to face them, but the solutions are not obvious.
Foreign investment will help bring in the additional capital needed to stabilize the economy, as well as increase oil output and government revenue. It will not, however, relieve many of the underlying factors that have put Venezuela in its current position, including corruption and market distortions exemplified in the food hoarding cases. Any efforts to increase efficiency at PDVSA, for instance, will likely involve eliminating jobs or cutting government spending drawn directly from PDVSA's coffers. Both of these policies could damage a leader's popularity at best, or cause widespread unrest at worst — a poor choice for any politician.
Venezuela's best tool for dealing with these challenges will be its massive energy reserves. Global supplies of cheap, easy-to-access crude are declining, incentivizing development of harder-to-access deposits like Venezuela's and putting upward pressure on the price of fuel for the foreseeable future. With significant oil reserves and an oil-dependent global economy, Venezuela will always have a constant stream of foreign currency available. The challenge is ultimately political. How those revenues are distributed and who benefits is the fundamental question in Venezuela and will be the biggest challenge for the country's next government.
