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Write up on Venezuela, Chavez

Released on 2012-03-15 04:00 GMT

Email-ID 3387123
Date 2011-09-15 21:31:16
Hi Alfredo,

Here is a write-up that our Latam analyst, Karen, did this week for
another project. I have invited Karen to join our call on Monday to
discuss Venezuela and Chavez. She would also like to discuss Argentina
briefly if that's possible.




Venezuelan President Hugo Chavez has built around himself a personalized
system of governance that requires his specific oversight and involvement.
Furthermore, he has built up a system of political support structures that
are mutually adversarial, to disincentivize his removal. We therefore
consider the removal of Chavez to be an event that would significantly
destabilize the country. The key pillars of support are (in order of
importance): Public support, oil production and sales, the military, the
Bolivarian peasant militias and access to the Cuban intelligence system.

I. Popular Support

The first pillar of support is of course popular acceptance of the
Venezuelan government. Despite the highly centralized nature of Venezuelan
governments throughout history, they inevitably serve at the pleasure of
the masses. Even the military dares only to overthrow the government in
times of extreme delegitimization of the elected or appointed political
elite. To understand why Chaveza**s popularity and political strength
endure despite the serious challenges facing Venezuela, it is necessary to
remember the circumstances that led to his rise to power.

Surging income from the oil-price spikes of the 1970s and early 1980s led
to economic instability throughout the next two decades. Caracas moved to
rapidly expand government expenditures in order to satisfy the populist
demands of an underdeveloped country. This spending brought about a steep
rise in corruption and spiraling inflation. Venezuela attempted to correct
these imbalances through neoliberal reforms, including eliminating
subsidies and raising taxes. The most damaging response to the new
policies was the1989 riots a** known as the a**Caracazoa** a** which were
triggered by a rise in the price of gasoline. The riots left nearly 300
people dead in Caracas.

Shortly thereafter Chavez, a young lieutenant colonel, entered the
national spotlight during a failed coup attempt. Well-spoken and
charismatic even in defeat, Chavez made an impression at a time when the
Venezuelan political system was clearly breaking down. After Chavez was
released from prison, he was able to seek leadership of the country again
a** this time through the elections that brought him to Miraflores in
1999. Chavez appeared at a pivotal time and was able to move on from his
mistakes and seek power democratically. As a leader, he satisfies
Venezuelaa**s need for a strong central figure capable of reining in
factions competing for power. Chavez also appeals on a very personal level
to swaths of the population who identify with his persona and with
policies that place poverty at the forefront of the national agenda.

Much more important than his personal appeal or even his ability to manage
the various needs of competing factions, is his commitment to populist
policies that focus on the redistribution of wealth to the poor. Food
distribution in poor areas along with free health care and housing are key
ways that Chavez seeks to maintain popular appeal. So far, Chavez remains
the most popular politician in the country, with his approval rating
hovering around and generally over 50 percent. However, there is cause for
serious concern for his long-term popularity in light of a number of
challenges, including consistently high inflation, food shortages,
electricity failures and a number of highly publicized failures in
implementing social projects.

The government consistently makes moves to reform economic policies in an
attempt to control for market distortions and cut back government
spending. So far, there has been no strong backlash to price hikes on
basic goods, but it is a hot button issue. Gasoline is a particularly
critical good that the government fears to raise the price on, despite the
booming black market with Colombia that means that a huge portion of
Venezuelaa**s subsidized gasoline is sold at high profits across the
border in Colombia. The fear is that a hike on gasoline could cause
another Caracazo, so instead of raising prices, the government is

Venezuelans are not shy about protesting, and protests are on the rise. If
the number of protests by everything from the political opposition to
labor unions so far in 2011 is anything to go by (and therea**s nothing to
suggest that this will decline), 2011 will experience the highest number
of protests since Chavez took power. This is somewhat deceptive, as the
efficacy of unrest is rests more in the size and duration of the protests
than in the strict quantity of events. Nevertheless, the rise in unrest
and general dissatisfaction among organizations all across the political
spectrum is an indicator that problems in the Venezuelan economic and
political system are having a broad impact.

II. Oil

The second pillar of support is oil production. With the discovery of oil
in Venezuela in the early 20th century the county became immediately and
almost entirely focused on its production. Though the post WWII period
until the mid to late 1990s, the economy diversified to a degree, using
oil money to finance development of secondary industries such as steel and
food production. With the rise to power of Hugo Chavez and the subsequent
coup in 2002 that involved the upper level management of PDVSA, Chavez
crippled the company by firing most of the higher level and technically
skilled staff. Since that time, oil production in Venezuela has been on a
long slow decline. Oil production dropped 25 percent from a high of 3.2
million barrels per day (bpd) in 2001 to an estimated 2.4 million bpd in

However, the decline in production volumes is a result of a decline in new
exploration and production, as well as a deterioration of production
capacity at extant oil producing facilities. Furthermore, the oil mix in
Venezuela has become heavier and sourer as reserves in the Maracaibo
region decline, and the Orinoco deposits become more important. This
quality of deposit requires greater levels of investment, greater
commitment from investors and a higher risk level. Already risky operating
environment, Venezuela in its current state is unlikely to receive
investments from technically skilled (read: Western) oil companies that
are necessary to boost production.

Though Chinese companies have shown an interest in both maintenance/repair
contracts as well as drilling contracts, it is not at all clear that they
possess the technological capacity to develop Venezuelaa**s geographically
and technically challenging deposits. Furthermore, the Chinse arena**t in
it for charity, and are also wary of the risks associated with very
serious Venezuelan investments.

Without serious and technologically adept investment worth tens of
billions of dollars, the industry faces a slow and inevitable decline.

This ongoing decline is in part compensated for by the fact that prices
have more than quadrupled since 2001. Government revenues remain heavily
dependent on oil income to fund its activities. The nominal budgetary
reliance on oil income is 22 percent. However, a series of slush funds
into which oil money is funneled directly from PDVSA and from which
discretionary spending is non-transparent belie the official stats. These
expenditures have shot up and over the annual planned budget over the past
several years as the government seeks to use cash transfers to mitigate
income disparities and market distortions. Borrowing has increased
alongside the use of oil revenues. So far in 2011, the national debt
increased by 10 percent to about $85 billion. While debt remains quite
manageable, the pattern of behavior suggests that any shock to
Venezuelaa**s income levels could severely destabilize government
spending, social programs, economic stability and Chaveza**s popularity.

In the event of a destabilization scenario, any potential Venezuelan
leader has an incentive to maintain stability and output in the oil
sector. However, the danger to the physical assets the oil industry owns
will come in the form of potential widespread infighting and unrest. Oil
installations make for obvious targets for militancy, and oil output, as
Venezuela's only real asset, is the real prize to be won in any struggle
for control over the country. Also, strikes and labor struggles that
impact the oil industry cannot be ruled out if a power struggle ensues in
Caracas. From a security standpoint, any destabilization of the government
that involves unrest or violence would be a direct threat to personnel on
the ground.

There are other threats to the industry that will result from even a
slight escalation of the ongoing economic and political struggles in the
country. The lack of investment in PDVSA will be exacerbated if Chavez is
forced to spend more money on ensuring the loyalty of the populace, the
military and his inner circle. This trend is already worsening even as
output declines. In 2009, PDVSA contributed 93 percent of its income to
the government through various taxes, grants and deposits into government
accounts. In 2010, that amount increased to 97 percent of net income. The
margin of error is shrinking for PDVSA, and the company's well-documented
decline in technical capacity will be exacerbated as finances become even
tighter. Though we do not necessarily expect the recent release of
strategic oil reserves to have a significant or long-term effect on oil
prices, any severe fluctuations in either oil price or oil output would
hit the government hard.

III. The Military

As the main proprietor of Venezuelaa**s weaponry, the military is a
critical consideration in any destabilization scenario. The military has
been involved in three failed coups since 1992. In each case, elements of
the military either sought to generate an upwelling of public support for
regime change, or were attempting to capitalize on already extant unrest.

The military is unlikely to do anything but support (at the very least by
refusing to become involved) the current government until a complete
destabilization scenario. Even in times of unrest, the military will stand
back from conflict until it is certain the current government has lost
legitimacy. Should Chavez fail to return, or return but be unable to
control the situation in-country, the military will be in a position to
either support one of the power brokers of Chavez's inner circle or put
forward its own representative.

However, the military cannot be considered a unified force. The past three
coup attempts failed in part because there was not enough political
support for a change in government and the military itself was not united
behind the effort. It is therefore possible that elements within the
military could miscalculate, moving before Chavez has lost full
legitimacy. In this scenario, clashes between different military factions
should not be ruled out.

IV. The Militias

Built as a tool to counterbalance the military, the Bolivarian militias.
Organized around neighborhoods throughout Venezuelan cities and in the
countryside, the Bolivarian militias are Chavez's insurance policy against
a military coup. By arming citizens, Chavez has made any direct action
against the government more uncertain and has increased the chances that
any threat to his government will trigger widespread violence. Adan Chavez
raised the threat of these militias when he quoted Ernesto "Che" Guevarra
on June 26, saying, "It would be inexcusable to limit ourselves to only
the electoral and not see other forms of struggle, including the armed
struggle." There are, however, some limits to the ability of these
militias. The military has maintained strict control over the weapons used
by the militias in practice. It is not known at this point if the militias
have access to alternative sources of weaponry.

V. Cuban Intelligence

Cuba plays a critical role in keeping Chavez in power by serving as an
outside and loyal observer of political affairs in Venezuela. Using the
intelligence assets of an outside player with a key interest in keeping
cheap oil flowing has helped Chavez maneuver carefully and manage a
potentially poisonous domestic political situation in exchange for
Venezuelan oil shipments to subsidize the islanda**s economy. Though the
Cubans will be willing to deal with whoever is in power, the natural
ideological tint to any relationship between Venezuela and Cuba means that
the Cubans could well lose their petroleum lifeline should a more
pragmatic domestic player such as Cabello take power or should the country
fall into chaos. Any diminished commitment from Cuba to protecting the
personal interests of Chavez could severely cripple the Venezuelan leader.
With that said, there would have to be a complete regime change in Cuba
for that to happen. There is enough continuity built into the Cuban
government, which has kept most of the old guard in power despite the
handoff to Raul. Chavez should be able to count on a continued commitment
to his regime and the oil it delivers.

The Illness

Chavez is reportedly undergoing his third phase of chemotherapy, this time
in Caracas. Though he claims he is already cured and the chemotherapy is
preventive, his condition appears to be more serious than he is letting
on. One source claims Chavez has stage 4 prostatic cancer that has spread
to his anus (hence the claims of colon cancer). The prognosis his Cuban
medical team has reportedly given Chavez is a 50 percent chance of
surviving another two years if his treatment is limited to the medical
team in Cuba and Cuban facilities while his survival expectancy could be
four years with Western technology and medical care. Russia has offered
its medical team and services to Chavez, and there have been some hints in
open-source media of Russian doctors joining Chaveza**s medical team.

The Succession

There is no clear line of succession in Venezuela. No politician in
Venezuela has the credibility with the populace or political clout of
Chavez. This is both because Chavez is in himself a unique leader and also
because he has undermined and outright sabotaged opponents and potential
opponents. As a result of this fact, the fact of Chaveza**s illness brings
the stability of the regime into serious question. General elections are
scheduled for the last half of 2012, and there are rumors that Chavez may
seek to push the elections up earlier. In a best-case scenario that takes
into account this prognosis, Chavez either picks and promotes a successor
to win the election in 2012 or he wins the elections and appoints a VP
that could credibly succeed him. In the event that Chavez chooses a
competent successor, s/he would still have to manage an economic situation
that is volatile at best, and further destabilization is likely,
particularly if the government loses control of the factions w/in the
political elite.

There are two worst case scenarios, both of which are quite possible. In
the first scenario, Chavez dies or is disabled without having appointed a
competent successor. In this scenario, a political fight will ensue among
the various factions. The military will attempt to gain control, but
Chaveza**s militia may find the strength and arms to fight back. In this
case, a scenario where American citizens in Venezuela would need to be
evacuated is likely. A second destabilization scenario would be economic
in nature. A sudden downward shift in oil prices would destabilize the
governmenta**s social programs, spark an economic collapse, and provoke
widespread civil unrest.

Forecast: While there remain many layers of control over stability in
Venezuela, a confluence of factors has weakened the country along economic
and political lines. Given his illness, the death or disabling of Hugo
Chavez is a serious possibility in the next three years. A sudden decline
in oil prices triggered by a global recession, which is somewhat less
likely but not at all impossible would also cause a collapse of social
outreach programs and thus the social stability. With these factors
combined, there is a high likelihood of severe social destabilization in
Venezuela over the next three years that woudl require the evacuation of
American citizens and cause a cessation of oil exports to Cuba.