Chavez's Big Oil Bluff

Peeved by Exxon's legal victory, Venezuela's President is threatening to end oil exports to the U.S.a move that would probably backfire
Venezuelan President Hugo Chavez. Pedro Rey/AFP/Getty Images

Venezuelan President Hugo Chavez is famed for his incendiary oratory. But in his recent threats to cut off oil shipments to the U.S., a move he says could propel world prices to $200 a barrel, he's probably blowing smoke, not fire. The U.S., after all, is the No. 1 market for Venezuela's oil exports. More important, the U.S. is home to refineries specially equipped to handle Venezuela's brand of heavy, high-sulfur crude. Finding other customers for the country's oil in a hurry would hardly be a cinch.

"This threat could backfire for Venezuela and Chavez," says Pietro Pitts, a Caracas-based oil analyst who publishes Latin Petroleum magazine. "Any embargo would hurt Venezuela far more than the U.S. Venezuela supplies about 11% of U.S. oil, but the U.S. accounts for the bulk of Venezuelan oil exports."

Rallying the Faithful

Chavez threatened on Feb. 10 to cut off Venezuela oil shipments to the U.S. if an arbitration panel rules in favor of Exxon Mobil (XOM). The American oil major is seeking compensation from Caracas and the state oil company Petróleos de Venezuela (PDVSA), which in July expropriated Exxon's equity stake in two oil ventures. Last week, Exxon won court orders freezing more than $12 billion in assets belonging to PDVSA. The orders effectively prohibit Venezuela's national oil company from selling any of its overseas assets pending a ruling.

Exxon's victory in court gave the Chavez propaganda machine a new opportunity to go into overdrive. "If they hurt us, we are going to respond," Chavez said yesterday during his weekly TV broadcast Àlo Presidente. "We aren't going to send oil to the U.S. Take that, Mr. Bush!" Chavez, who has repeatedly charged the Bush Administration with seeking his overthrow, also warned that Venezuela would be joined by other countries in an "economic war" against the U.S. but gave no details.

Chavez's rhetoric may be intended to rebuild his flagging support among his countrymen, especially in the face of soaring inflation, food shortages, and rampant crime. Chavez supporters have already scheduled marches in support of Petróleos de Venezuela throughout the country, while the state television station is running ads in support of Chavez and PDVSA, saying Exxon has a history of "converting oil into blood." Comments Pitts, "It's a crazy comeback but something you would expect from Chavez."

A Toothless Threat

Any embargo would also lose its effectiveness in about 30 days, the time the U.S. needs to tap oil from Saudi Arabia and other alternative producers to replace lost Venezuelan crude, says James Williams, who heads the London (Ark.)-based WTRG oil consultancy firm: "Yes, Venezuela could cut sales, and there would be a spike in prices, but its effectiveness would only last as long as long as it took to find alternative supplies." Any impact would also be mitigated by the U.S. drawing down its strategic reserves, he says.

Venezuela currently produces about 2.4 million barrels of oil a day, of which it exports an average of 1.8 million to 1.9 million barrels daily. Two-thirds of that go to the U.S. Oil accounts for about 70% of Venezuela's exports and more than half of government revenues.

That dependence on oil limits room for Chavez to maneuver. "Unless Chavez cuts off his nose to spite his face, it's an empty threat," says Craig Pirrong, professor of finance and energy markets at the University of Houston's Bauer College of Business. Pirrong says that PDVSA has been "cratering" financially, even as Chavez has built expectations for massive expenditures on social programs.

Oil markets are jittery nonetheless. The price of a barrel of the benchmark West Texas Intermediate crude climbed $1.82 to settle at $93.59 on the New York Mercantile Exchange Feb. 11. In daytime trading the price spiked as high as $94.72.

Venezuela to Appeal Exxon Ruling

PDVSA is expected to appeal court rulings in the U.S., the Netherlands, and Britain that put the freeze in place. The Venezuelan company could probably get the rulings overturned if it were to open its books to the courts, something it is loath to do, as it would reveal how much it is sending Chavez to pay for his social programs, say analysts. Opening the books would also reveal the company's true rate of oil production—a closely guarded secret.

Chavez says Venezuelan oil output is now 3.2 million barrels a day, a number rejected by OPEC as well as most analysts who put output at least a quarter lower. Oil output has fallen 25% since Chavez took office in 1999, partially due to the firing of more than 20,000 PDVSA employees in 2002-03 during an abortive strike to force Chavez from office.

If an agreement with Exxon isn't reached quickly, Brazil and Mexico may profit over the long haul, says Pitts. Although Venezuela has the region's largest reserves, international companies could turn to Brazil and Mexico, especially if the latter moves to open its energy industry to private investment. Brazil also is revving up its energy industry and has found significant offshore reserves. Exploiting those reserves, however, will take years.

Demanding a Share of the Wealth

Venezuela's seizure last year of several heavy oil projects, including Exxon's, is the latest example of emerging oil producers placing greater demands on global oil giants. The heavy oil projects are based in Venezuela's Orinoco Belt, a basin near the Orinoco River, which is believed to hold up to 235 billion barrels of recoverable crude. Global oil companies were awarded contracts in the 1990s to take the extra-heavy crude, which has the consistency of tar, and refine it to higher, more profitable blends for export. Venezuela began changing its royalty agreements with the oil companies in October, 2004. At that time, companies were paying 1% of the value of oil extracted from the ground. That was unilaterally raised to 16.67%, and then to 30%. Last July, Venezuela forced six oil giants to hand over equity stakes of 60% or more in four important ventures to PDVSA. Four of the companies agreed to the handover, but Exxon balked—and went to court to seek what it considered just compensation.

Will Chavez's threat soon be revealed as an empty bluff? Probably, but there is always a slim chance he might try something. "Chavez is losing his No. 1 enemy, Mr. Bush, and he likes to interfere in elections," says Williams. "I think there is a chance he could do this, but before November."

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