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Currently in the final stage of my doctoral work on the political economy of national oil companies. Here you'll find some of my findings--as well as other musings on oil-related topics. All comments -- civil, civilized or barbarian -- are welcome

Is China looking for a way out of Venezuela?

Is China looking for a way out of Venezuela?

Venezuela is on the brink of default—and possibly civil war. China, which is Venezuela’s only relevant ally and lender, has few options in Venezuela, owed some US$20 billion by a country that has no real chance of paying it back. In recent months, China has seemed to have shifted to a wait-and-see approach. This means no more lending, no more rolling-over, and no involvement—whether to make Venezuela’s crisis better or worse

August 2018 – Scott McKnight

Venezuela’s descent, steady and tragic, is now nearing a breaking point. The five-year-old regime of Nicolás Maduro has ruined Venezuela’s economy, decimated democratic institutions, and turned the country into an international pariah. Refugees now compete with oil as the country’s main export. Now the regime’s time may be up. Venezuela is on the brink of default—and possibly civil war, too. Oil production—always Venezuela’s exit door—has sunk to a 33-year low. China, for years Venezuela’s last-resort lender and only relevant ally, now appears at wit’s end. China is no longer willing to roll over Venezuela’s debts, much less extend new credit. This piece argues that China itself is playing a limited hand: without a ‘sell’ option, China must be satisfied with the next-best thing: buy-and-hold, while putting no pressure to affect Venezuela’s crisis—for or against Maduro.

How did Venezuela get to this point?

No economy that isn’t at war is performing worse than Venezuela’s. Between 2013 when Maduro came to power and 2017, the country’s gross domestic product (GDP) has shrunk by a third. Now it’s getting worse and fast.

So, how did the country with the world’s largest oil reserves become unable to import enough food and medicine, suffer through blackouts and water shortages, and have some 2.3 million Venezuelans (about 7% of the population) flee for neighbouring countries (Graph 1)? How did Venezuela become a cruel and tragic extreme-case of the ‘resource curse’, the thesis that countries rich in natural resources are paradoxically poor in economic vitality, democratic institutions and respect for human rights?

Maduro blames the ‘imperialist’ plotters—the United States (of course), along with some ‘far right’ cabal uniting Colombia’s outgoing president and dark forces in Miami. In speeches, the Venezuelan leader rails against their ‘economic war’ against Venezuela and plots to squash Venezuela’s socialist paradise. The recent failed assassination attempt by means of drone (video here) shows how many enemies Maduro has accumulated. Donald Trump only helped feed these conspiracy theories when, in August 2017, he openly spoke about a ‘military option’ for Venezuela and later added a group of government officials and their immediate relatives to his infamous travel ban.

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Graph 1: Where and how many Venezuelans are fleeing (source: The Economist)

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The real cause of Venezuela’s catastrophe is the dysfunctional statist model that Hugo Chávez (1999-2013) started under the cruel misnomer of ‘21st century socialism’. After Chávez’s passing, Maduro continued the chavista project, apparently inspired by a message from a reincarnated Chávez who spoke to Maduro in bird form (and which comedian John Oliver, never one to pass up a chance to provoke a dictator, seized upon).

The chavista model itself features a mind-boggling mix of irresponsible behaviours: spending profusely, stuffing key government posts with political cronies (however unqualified or incompetent), side-payments to political allies (especially high-ranking military officers), and, as the last months have shown, running the government printers non-stop. Taken together, they’ve recently set off an epidemic of hyperinflation in which a dead chicken at the market costs 14.6 million bolivars, with prices doubling every 25 days (at the time of this writing).

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The government resorted to price controls and outright expropriations, too, which has predictably stymied production, scared away investment, and pushed capital out of the country. This stifling of private business in Venezuela has turned oil into the generator of 96% of Venezuela’s exports. This excessive focus on oil has only accelerated Venezuela’s crisis, first since the oil price collapse in mid-2014 and only partial recovery since; but more importantly, both Chávez and Maduro have had an especially destructive impact on the oil sector and PDVSA, the country’s national oil company. Maladministration and corruption at PDVSA has caused oil output to fall to 1.3m barrels per day (bpd), or half of what it was in 2014 (2.9m bpd) and just 40% (3.18m bpd) of production levels in 1997—the year before Chávez first took power.

How did China get involved?

Since becoming a net oil importer in the mid-1990s, China went on a rabid search to secure oil supplies for its oil-hungry economy. In the process, China’s party-state realized that this resource drive was often most warmly received in countries that either couldn’t draw significant investment or that had prickly relations with the West (read: Iran, Sudan, Kazakhstan). Venezuela was both. For a decade since 2007, China has showered Venezuela with generous financing arrangements, extending a total of US$56.3 billion in credit to the country. In return, Venezuela agrees to ship crude oil and fuel to pay off the debt. The open secret, however, is that a good portion of this oil never reaches China’s shores and instead gets resold by Chinese oil companies on the international market (more below), especially to refineries on the Gulf coast.

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As Venezuela has gradually sunk into a prolonged recession, made worse by its government’s rampant spending, the Chinese government has found itself wandering deeper into the rabbit hole. As recent as September 2015, with Maduro on a state visit to Beijing, China agreed to a new US$5 billion loan. The timing was inauspicious: oil prices had started a hard and fast tumble. The crash of oil prices sent Venezuela’s oil-dependent economy into a downward spiral. And the loan turned out to be the last one that China has since issued to Venezuela. Now, as Venezuela teeters on the brink of default, China’s financial diplomacy—what The Economist calls ‘rich but rash’—has hit a wall, sending Chinese policymakers into some soul-searching about the wisdom of financing high-risk, resource-rich countries.

Who pushes for these oil-backed loans?

China’s headlong rush to secure ‘equity oil’ in foreign countries has cooled, the result of lower oil prices, China’s growing strategic stockpile, and hard lessons learned since the mid-1990s when China’s national oil companies (NOCs) first went abroad. President Xi Jinping’s anti-corruption purge of dozens of NOC managers also helped restrain these companies urge to spend. As several managers of Chinese NOCs have told me, decisions about where and how much these companies invest in oil-rich countries are driven more by market fundamentals than state directives, knowing that the managers will be held responsible for bad decisions.

So, China’s now well-known ‘oil-backed loans’ (OBLs) in fact are a sort of team effort, bringing together China’s national oil companies (most notably, CNPC 中石油), Sinopec 中石化 and CNOOC 中海油), its state-owned banks (especially China Development Bank or CBD 国家开发银行) and a myriad of construction companies who fight for contracts in these resource-rich but infrastructure-poor countries. Since Venezuelan oil—‘heavy’ and far from Chinese shores—rarely makes into the tanks of Chinese, these companies resell it for a profit. Likewise, OBLs often mean China’s NOCs are getting that oil at a discount. For the banks, it’s a good deal, too. Since the money behind these loans is in fact recycled from countless Chinese savings accounts—which the government rewards with paltry interest rates—China’s state-owned banks, especially CBD, can loan these funds out to foreign countries at higher rates. No wonder China’s national oil companies and state-owned banks have emerged as dominant—and often wildly profitable—economic giants in the Chinese economy.

Does China want out of Venezuela?

Since Venezuela now seems trapped in an unending cycle of debt—about US$20 bn is owed to China alone—what is China to do? The Chinese government’s lending to high-risk, resource-rich governments is now facing its biggest test; or as Ricardo Hausmann put it, in no other country has China dealt with an ‘addicted borrower’ the likes of Venezuela.

Giving more money to Venezuela seems off-the-table—and for good reason: the Maduro regime’s most pressing need is not oil-field investment (though it could definitely use it). What the regime really needs is cash to pay for imports, pensions, and the salaries of government employees; in other words, money to keep the state from collapsing, not investment for the future.

Is China cutting off Venezuela? There have no doubt been signs of change: the last time China lent any (more) money to Venezuela was three years ago. More recently and of consequence, in April 2018, the Chinese government let a grace period on its loans to Venezuela lapse. This may actually be the fatal blow. The cut-off has deprived Venezuela of billions of dollars—and probably a good reason for Maduro to have the currency printers running non-stop in the past weeks.

But how—if ever—will China get its money back? A well-connected Chinese insider told me that in Venezuela China has a type of ‘triple insurance policy’—the first and most traditional, an agreement with the Maduro government; the second, an unspoken entente with the (now decimated) opposition; and the third, the reserves themselves. Several well-informed commentators in China—one a well-connected academic and the other an executive at one of the NOCs—have said that so long as Venezuela has oil, China will get its money back with interest. But, as they acknowledge, it may take decades.

China’s financial diplomacy has resulted in lending copious amounts (US$56.3 billion since 2007) to oil-rich but dreadfully governed Venezuela. That Venezuela under Chávez and now Maduro have been so virulently anti-American while being located in America’s backyard may help explain why Chinese credit was so generously extended. Oil and anti-Americanism can have an intoxicating effect in certain circles in Beijing. But it seems that even the characteristically patient Chinese have limits.

Speculation is swirling that China may take the same approach it took to long-time ally (and international pariah), Robert Mugabe of Zimbabwe. With Mugabe having subjected Zimbabwe to hyperinflation, international ostracism and economic collapse, his ouster last year seemed to have been met with collective shrug in Beijing. Although seemingly unable to walk away from Venezuela, there is no sign that the Chinese government is committed in any way to Maduro’s future tenure. An ancient Chinese proverb may capture China’s updated approach to Venezuela: China would not ‘drop stones on somebody who has fallen into a well’. It doesn’t seem to be willing to throw down a rope either.

 

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