Last time, I explained it like this: it’s as if you had a small abasto that spent more money than it takes in in sales each month. The abasto can hardly come up with its monthly loan payments, and so it sure feels like it’s broke. But there happens to be an unfeasibly huge amount of wealth in the form of morocotas — old Colonial gold coins — buried in its backyard.

In what sense can we say that abasto is broke? 

If you’re in Washington today, you can pop down to Brookings this afternoon and hear Francisco Rodríguez and Ricardo Hausmann hash this out live. If you’re not, you can read the for-dummies version right here.

How to be rich and broke

One possibility is that the abasto isn’t really broke, but rather circumstantially broke because the encargado, the guy who runs it, has gone stark-raving mad. In this interpretation, the wealth the abasto needs to right its finances is right there for the taking. A skilled caterpillar operator could start digging it up tomorrow, but it just so happens that every time the encargado goes out and hires a caterpillar driver to dig it up he loses it and shoots him in the head.


This interpretation leaves critics like Hausmann, who’ve argued strongly that the abasto needs to declare bankruptcy, in a strange kind of Catch-22.

In this interpretation, the abasto is bankrupt, but only in a highly peculiar sense. That its wealth is inaccessible is not a characteristic of its wealth, but of its leadership. If you could pry the keys to the store away from the encargado you would very quickly find that the store isn’t really bankrupt at all. It’s just criminally mismanaged.

This interpretation leaves critics like Hausmann, who’ve argued strongly that the abasto needs to declare bankruptcy, in a strange kind of Catch-22. The store is bankrupt because its managers are crazy. The managers are so crazy, in fact, that they refuse to see reason and declare bankruptcy, even though they run it in a way that’s plainly incompatible with servicing its debts.

What the store needs most right now is new leaders with the clarity of mind to see that. But if the store had leaders with the clarity of mind to see that, it wouldn’t be bankrupt at all, because a minimally sane leader would just hire a caterpillar operator, get him to dig up the gold, and refrain from shooting him!

I think this is a powerful argument. At the very least, it has an intuitive plausibility that you can’t dismiss. But I don’t think it’s the end of the story. It relies on a bit of rhetorical sleight-of-hand that doesn’t really fly in the real world: it confuses a flow problem for a stocks problem, it confuses the balance sheet and the income statement.

It’s about Flows, not Stocks

If you look at the total stock of Venezuela’s public debt ($150 billion, give or take) and compare it to the total stock of its oil reserves (300 billion barrels) then the problem seems childishly simple. There ain’t nobody between here and Timbuktu who would value a barrel of oil at less than 50 cents. By any conceivable stretch of the imagination, 300 billion barrels are worth more than $150 billion. Case closed. Right?

Well, maybe. If you had 300 billion barrels of oil already produced and delivered to port and ready to ship, they would obviously be worth much more than $150 billion. But the reality is you don’t: you have 300 billion of oil stuck in bumfuck nowhere Guarico, under a few kilometers of dirt, and there’s no technologically feasible way to get them all out at once. (And, environmentally speaking, a very good thing that is, too.)


Even if you quintupled Venezuelan production to 12 million barrels a day you’d only pump out about 27% of our reserves out of the ground in the next 25 years.

The 300 billion figure is actually a bit of a red herring. You can spreadsheet it any which way you want, but even if you make genuinely heroic (read=crazy) assumptions about how much you’re going to increase production, you come back to the conclusion that the vast bulk of those barrels will never see the light of day. With technological advances closing in on the oil industry from every direction, it’s hard to imagine oil making it more than another quarter century as a leading transport fuel. And even if you quintupled Venezuelan production to 12 million barrels a day (which nobody remotely sane thinks is feasible) you’d only pump out about 27% of our reserves out of the ground in the next 25 years.

The other three-quarters? Never coming out.

For all intents and purposes, then, Venezuela’s oil reserves aren’t large, they’re infinite. Within the period of time when you can reasonably figure oil will have any value at all, there’s no feasible way to get at them all. They are like 433 Eros, the far off asteroid made of solid gold: the wealth they contain is as theoretically limitless as it is practically irrelevant.

What markets are really concerned about isn’t the stock of reserves but the financial flows they can sustain. The question isn’t how much oil there is, but how much of it you can turn into money and at what rate and how much debt you can finance out of that flow. And this…this is where things get dicey.

Borrowing against decomposed zooplankton (a.k.a., oil)

If you have wealth that’s virtually limitless, why wouldn’t you continue to borrow against it in perpetuity? Offer investors semi-reasonable conditions and they’ll be lining up around the block precisely because — did we mention? — your resources are basically infinite. Isn’t this is the exact type of problem credit markets were invented to address?

Credit, of course, comes from the latin credere, to believe. Aye, there’s the rub. Investors have to believe that future you is going to honor the promise present you is making. And what calculus will go into making that decision?


If your borrowers are smart too they’ll price your next expropriation into your cost of credit today.

Well, let’s see. First they’ll look at your track record. They’ll realize that you have this nasty habit of reneging on your promises to investors every few decades…sweeping new oil laws in 1943, 1975, 2004 fundamentally changed the rules of the game, each time against investors’ interests.

If they’re smart, they’ll realize that the reason you do this is not that you’re nasty, but that you’re smart: a sovereign has a permanent built-in motivation to expropriate concessions that produce outsized rents. If your borrowers are smart too they’ll price your next expropriation into your cost of credit today.

If they do that, they’ll implicitly underbid for the resource stream, charging you today the cost of the expropriation they figure they face tomorrow. But if they do that, they won’t offer all the credit you need to develop the stream!

This kind of situation can reliably lead credit markets to fail, and not because the encargado is crazy but because he is sane.

In a situation like this, borrowers have no good incentive to make promises they can keep and, as a result, lenders have no good reason to believe the promises made to them. Market failure of this kind can create a situation where it’s impossible to raise the capital you need today to develop financial flows out of a stock of wealth that is, in some sense, unlimited.

In the economist’s jargon the provision of credit will be sub-optimal: less than would be efficient in a market where the promises made were worth keeping, and therefore worth believing. This doesn’t mean there’ll be no credit, just that it will be costly.

Too costly to be worth contracting? Too costly to service?

Conceivably. And if you add in the cost of servicing pre-existing debts taken out by the old, psychopathic encargado too…well, then it’s more and more conceivable.

It’s a deeply thorny question…and one to which, for sure, we’ll keep coming back.

 

20 COMMENTS

  1. But Quico, you don’t understand. The encargado is not bonkers. It’s just that evil imperialist forces seeded the tierra with land mines so the skilled caterpillar operator can never properly dig. This is no fault of the encargo nor the caterpillar driver and certainly no fault of socialism itself. The problem lies “out there.”

  2. What a complicated way to address the issue. Is not the essence of the issue simple?
    Liquidity crisis vs insolvency. The people who think they can monetise the oil and repay think we have a liquidity crisis, the others think we are insolvent. You could also argue that if you judged Venezuelan using historical data, you would also need to apply a haircut to the actual oil reserves that can be monetised (for theft, you know those billions stashed up in Miami, Panama, Andorra and Switzerland….yes them).

    • Claro, the challenge I give myself is to tell that story with zero jargon.

      People who can understand what “Liquidity crisis vs insolvency” means don’t really need this explanation…but then, trying to explain it to them in those words is useless!

  3. its like this , in order to monetize those inmmense reserves you have to have huge amounts of capital to invest in its extraction, transport, upgrading etc , plus you need to have an organization with the managerial and technical expertise , knowhow , technology and expert personnel to do whats needed to monetize such reserves , For those organizations and capital to become available you need to create external conditions that will make the movilization of those capital and organizational resources worth while from a business perspective … Absent the above conditions and resources those reserves aren’t worth all that much …….,!!

    Because we wasted and lost all the money we had , because we destroyed the only local organization (the old Pdvsa) that could handle the job to monetize those reserves right now those reserves cant be counted as ‘buried wealth’ because until we create believable conditions to attract the capital and resources to monetize them with a certain degree of proficiency, they cant be monetized !!

    So first order of business : bring about a change in the political regime which can be trusted to remain stable for a long time and then start creating the conditions and organizations to take on the gigantic task of beginning to monetize those reserves to the extent that technological progress doesn’t make the task obsolete …..!!

    By the way the same diagnosis applies to other mineral resources the country possesses within its territory , including iron , gold etc.

    We need more than credit we need the help of top notch organizations to start with the job…!!

  4. I was at Brookings today P.M. and I must say I was disappointed. It had not much to do with the panelists, they were all excellent, but, rather, with the limitations within which they had to perform, They were requested not to talk about politics. The title of the panel, however, was “Post Chavez Venezuela: A roadmap for reconstruction”. I wondered how can we come up with a road map for the reconstruction of Venezuela if we do not discuss the essence of the problem, which is the horrendous regime we have in place.
    Hausmann was the most articulate and, probably because of this, he was the one I agreed with. For Rodriguez many of the financial problems facing Venezuela were not “minotaurs”,as in Moises Naim’s book but Paper Tigers. Ricardo Hausmann saw minotaurs everywhere, specially at PDVSA.
    The meeting brought together a very distinguished group but they could not tackle the job that was implicit in the theme of the panel. Mr. Santos, Ms. Palacios, and the two gladiators did well but I left the room not much wiser than when I came in. Could be my fault.
    The pin did not drop.
    .

  5. Not surprising that establishment pundits talk all around the real issue and never mention it: state ownership of all natural resources (without free market reality) harms the state and makes it poorer. That’s especially true of poverty Marxism.

    Why not examine large scale long term success stories like, say the US, to model their success? Identify their competent and benevolent encargados and mimic them? No, because that will shine the awful light of truth on your beloved Marxism, and you don’t want that. (Clue: the “competent and benevolent encargados” don’t exist.)

    Venezuela’s only hope is to give back mineral rights to every property owner and let them sell or develop them on a level regulatory playing field, but humanism’s envy will never permit it.

  6. There are limits to the benefits of having all of the industry in he hands of many private international oil companies , because they will prioritize the oil operation which on a corporate basis makes them the most money even if that operation is sited outside Venezuela, if you make more money producing/ marketing Angolan oil will you make the investments to keep Venezuelan oil flowing or send that money to Angola ,?? Their marketing operations being fragmented wont optimize a venezuelan marketing strategy but their own specific corporate marketing strategy , if there is a specific venezuelan crude which can only be processed to produce a particular kind of lube which competes with lubes made from oil found in other places , will they (as a matter of strategy) keep the oil from such reservoir flowing prioritize the venezuelan crude or the crude produced elsewhere …..?? there are dozens of areas where just giving the oil to a private international company will not benefit Venezuelan interests …….

    Because we have lost the internal capacity to manage the oil industry with any measure of efficiency we must then have international oil company participation to rescue it from its current state of ruin , but at some level it is key to keep some Venezuelan participation in the industry to maximize the potential benefits of the industry at the strategic national level…..!! There were important benefits which the old PDVSA (run as a business and not as the economic tool of the regimes politics) brought to Venezuela which its international predecesors could not bring it !!

    This requires some thought and caution , just handing the whole industry to private interests will not be enough …!! Maybe we should think of creating a kind of Statoil to replace the current Pdvsa acting in association with private companies in a strictly meritocratic business fashion …!! building such Statoil Pdvsa will take a generation to create…..!!

    • Those are all really great ideas. I have little to disagree with, but it is simply not going to happen. A pipe dream at best.

      The value of your arguement rests on having a functioning gubmint that will not pick winners/losers based on corruption but on market capitalism. Socialists never back the best choice but the most politically connected. I have yet to see an example of this in any SA country that is run by their type. Not once.

      Please point is to where that 3 headed pink unicorn with solid gold shoes exists in Venezuela these days? These is not one person on either side of the political spectrum there who would stand behind such an idea instead of in front of it.

      • Thats the challenge , but there was once such a system in Venezuela , it survived and thrived for decades before being destroyed by Chavez , it can be rebuilt but adapting the task to current conditions ….will take time , will take luck , but its doable !! Specially today because things have changed , the oil business has changed and will keep on changing … if the pols want to survive they have to improve conditions and to do that they cant just follow the old corrupt populist ways , its a new oil business out there , much more daunting and challenging, its no longer feasible to be mediochre and opportunistic and not go under , professionalizing their stuff is now an imperative of their own survival….., the old days of easy oil money being enough to grease every palm are gone forever. !!

        The US was once a very corrupt place , full of obscenely corrupt rings and business interests, no professional civil service , even if imperfect much was done to improve the functioning of the State , an american would see the flaws but a Venezuelan would see the virtues and overall basic functionality of the system !! in time we should at least try to reach such goals for ourselves……

  7. Default on the debt and let the creditos run the oilfields and then tax the hell out of them and use the oroceeds to build a more broad based economy.

  8. Hello Mr. Toro,

    Good article. I prefer these type of articles as opposed to your one-sided ones.

    Talking about flows, what about the whole mismanagement of 600-800k barrels of oil per day which get sold almost for free? Daily flow of oil wasted and sold below market price and at a loss, even in terms of production cost. So if you are going to focus on flows, you might as well highlight the whole picture. Also important to define what is the right food imports level in Venezuela? $10bn.? $5bn.? It was mostly below $5bn. up until 2008 when the CADIVI racket/tarjeterismo went mainstream…So then did the population magically doubled? Can you attribute all the increase to lack of local production? I doubt it. I still think there is overbilling on imports even if shelves are empty. There is a big corruption scheme in the background at play and unfortunately a limited amount of money, all of which is further worsened by price controls.

    And given that we are talking about flows, I would also like to know where are countries like Brazil, Pakistan, Russian, China, etc. going to obtain money to change fossil-based infrastructure to renewable-based infrastructure? However, for you it is all very simple and all pieced together by the assumption that Venezuela won’t be able to monetise future production-> “In one single plumazo it all makes sense”:

    “…you come back to the conclusion that the vast bulk of those barrels will never see the light of day. With technological advances closing in on the oil industry from every direction, it’s hard to imagine oil making it more than another quarter century as a leading transport fuel”

    Technological advances closing in on the oil industry from every direction = oil won’t make for more than another 25 years as a leading transport fuel… Sigh…Sure, maybe in Scandinavia, etc. But please tell me (and do not send me a 5 min cartoon video done by BP about renewables) how will it work in practise? Where is the money going to come from for countries like Pakistan, Russia, China, Brazil, India, etc. to be able to install and substitute all the existing infrastructure (substitution cost) and replace it for non-fossil based infrastructure? There is no money to even pay for public pension funds in developed markets (See Spain, Italy, US) and some countries can’t even get their act together on solar energy (See Spain again where there is a tax on energy generated from solar panels owned by individuals who installed these at their own homes (!)) and you are telling us that the countries where the majority of world population is located (and which are typically underdeveloped) are somehow going to magically be able to afford all these? I would very much like to see that happen in 25 years time. Even the US is struggling to replace their crumbling physical infrastructure (see McKinsey’s latest report on global infrastructure), bridges, tolls, etc. (not even renewables and sophisticated sources of energy) so there is a BIG IF in your assumption.

    And also, what about relative value? Once again, you can’t look at PDVSA and Venezuela in isolation. Moreover, when you talk about track-record and nationalisation, for instance: “…They’ll realize that you have this nasty habit of reneging on your promises to investors every few decades…sweeping new oil laws in 1943, 1975, 2004 fundamentally changed the rules of the game, each time against investors’ interests!”

    You do realise that actually PDVSA’s track record is quite good? I mean the above is nothing compared to sovereign defaults in Greece, Argentina, defaults in other credit markets, etc. So on a relative basis, those nationalisation laws don’t really mean much to a current investor who has to decide whether to put money on Portugal, Spain, Brazil, etc.

    I like your overall analysis but I just think is all pieced together by the fact that future production can’t be monetised. This is a complex topic, you can’t just take shortcuts around it.

  9. Monetizing very costly and difficult to extract , transport , upgrade extra heavy crude with a ultra high sulphur – metal content is not the same as monetizing conventional crudes , the economics are very different , daunting in fact , specially now , specially in a country which lacks the stable more favourable economic and social conditions of other places …, Venezuela is a place now where criminal gangs routinely assault working field teams , drilling units or steal any thing not bolted down in a non protected site ……where pilfering is rife and where inflation is running at a 600% a year level …..!!

    Don’t think that oil will cease to be a marketeable commodity just yet , but the demand is bound to be hit hard by new technologies which substantially reduce its consumption and make the production of formerly uneconomic oil deposits cheaper and easier….!!

    Remember Fuel Oil , how its consumption sunk in just a few years, brings back memories of riding along a very long avenue surrounded by very high buildings in Washington DC accompanied by the head of a large heating oil business , ‘all these buildings were our customers for years , we even installed the heating units for free to help the business and now none of them use our oil¨

    It wont be anything like the highly luchrative business of the past , there will be more competition , less demand , more constraints in how it is produced , well run organizations will have to struggle hard to make it profitable , be very efficient or perish …….!! The half razed Pdvsa installations that now exist will have to be replaced , the investment money needed to make the oil yield a half decent profit will be enormous , the management will have to be top notch and totally meritocratic or the business will either produce razor thin profits like those of the coal industry or none at all .

    The Venezuelan oil industry, FOR THOSE WHO KNOW is now in its death throes , it wil have to put in a life support system , to try and see if it can be recovered to health ……!! its been run to the ground in a way that is hard to believe ……!!

    • Thanks for your views Bill. My question remains: where is the money to pay for the upgrades going to come from? More specifically in poorer countries where the majority of the world’s population resides. That is no simple answer and therefore, a forecast saying oil will cease to be a main source of energy within the next 25 years is frankly, useless.

  10. The biggest portion of the crude oil produced in the word is transformed into fuel and used in transportation , some 60 to 70% of the total world production , new electric cars consume only a fraction of the gas used by regular cars , the use of motor engines that minimize the use of gasoline is expected to increase exponentially over the next 20 years , more and more cars will depend on electricity to charge themselves, very little crude oil products are used in the generation of electricity ( perhaps less than 5%) , ergo we will see the demand for crude oil fall progressively in the next 20 years with the fall being more pronounced after the 1st 10 years ………Oil will still be used in the manufacturing and petrochemical industries accounting for some 15% of current oil production but as machines engines and appliances are converted into low users of oil products and supply of oil increases from improved methods of production only the best run oil operations will be able to keep up operations in the future…..!! Don’t know that we can predict with certainty when the oil business will become a marginal profit business such as coal is at present , but 25 years doesn’t seem to be a far fetched estimate !!

    One thing Venezuela can do in future is to specialize in developing industries that can make profitable use of low cost crude oil in their productive processes , i.e producing goods that it can then export at a competitive advantage but that will require us to produce oil at minimum cost and optimal efficiency which in turn requires building business organizations (with some level of state involvement) that are capable of such kind of efficiency. That’s quite a task !!

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