VENEZUELA - Historical Background & The Oil Curse.

Venezuela's petroleum wealth was known from the pre-Colombian era, when the indigenous peoples made use of oil and asphalt seeping to the surface. It was then used mainly for medicinal purposes and some of the oil was used for limited home heating in areas where it surfaced. In 1912 the first oil well was drilled. Shortly thereafter, first Shell and then Rockefeller's Standard Oil, became major oil producers in Venezuela. By 1929, Venezuela had become the world's second largest oil producer, after the US, and the world's largest oil exporter.

Between 1920 and 1935 oil's share of exports went from 1.9% to 91.2%. This had an immediate and dramatic impact on the country's economy, known as "The Dutch Disease" or "The Oil Curse", the most important consequence of which was that agricultural production declined to almost nothing and Venezuela fell behind in industrialising, relative to other Latin American countries. In 1943 Caracas reformed its oil policy with the Hydrocarbons Act, which made the state's income heavily dependent on oil production. While previously oil income was mostly based on concessions and customs, the new act tied oil revenues to taxes based on income from mining. The law established that the foreign companies could not make greater profits from oil than what they paid to the state.

Steadily rising oil income led to an ever increasing reliance of the state on this source of revenue in lieu of individual income taxes. From the 1950s, however, the world had a oil glut, especially after increased output in the Middle East and the imposition of import quotas in the US. The result was a chronically low oil price.

In 1960 the world's main oil exporting states, largely due to prodding from Venezuela, decided to form the Organisation of Petroleum Exporting Countries (OPEC). Also in 1960, Caracas created the Venezuelan Oil Corp., which later formed the basis for the nationalisation of the oil industry.

By 1974, when the Arabs imposed an oil embargo, world oil prices - and, along with them Venezuelan state income - had quadrupled from 1972. This sudden and sizable rise in state income was historically unique in Venezuela and to the other OPEC member-states.

This made a newly elected president, Carlos Andres Perez, promise the Venezuelans they will become a developed country within a few years - Shah Mohammed Reza Pahlavi vowed to make Iran the world's fifth power. Perez's, "La Gran Venezuela", was to "sow the oil" through a combination of fighting poverty, via price controls and higher income, and diversifying the economy through import substitution. Part of his plan was the nationalisation of Venezuela's oil industry, which took effect in 1976 with the creation of PDVSA.

While the oil boom appeared to be a tremendous blessing, it had negative implications for Venezuela and other major oil exporters, such as chronic inflation and, paradoxically for Caracas and some other OPEC capitals, rising indebtedness. These problems were exacerbated when, in the mid-1980s, the price of oil began to plummet due to OPEC over-production. By 1998, the price of oil had fallen to $3.19/b (in real 1973 cash terms for the US dollar). This had a devastating effect on Venezuela's economy, particularly on per capita income, which had been in steady decline since the mid-1980s. Even after world oil prices rosen in 2000-03, thanks to an OPEC price defence pact reached in March 1999, Venezuela's economy by mid-2003 had reached the point of collapse (see below).

When Chavez was first elected in December 1998, it did not look like he had any particular plans for PDVSA. He did, however, have very clear plans for OPEC which, under the leadership of Ali Rodriguez (who now is the foreign minister but then served as energy minister and later headed OPEC), was to be turned into a strong bloc once again. Until Chavez came to power, OPEC had become a shadow of its former self, with member-states regularly ignoring their production quotas. Venezuela, especially, had turned into one of the member-states' most unreliable partners. Production over allotted quotas, combined with the expansion of oil production in non-OPEC countries, such as Russia and Mexico, led to a steep decline in the price of oil.

Chavez promised to put an end to this, by organising OPEC's second-ever meeting of heads of state in Caracas in September 2000. Also, Chavez spent the first years of his presidency visiting the leaders of OPEC and non-OPEC states to convince them to adhere to production quotas in the case of the former and output cuts by the latter, so as to maintain an oil price of band of $22-28/b.

Chavez' efforts bore nearly immediate results as the price of oil rose for the first time since 1985 to over $27/b (in nominal prices). Very soon, however, Chaavez ran into conflict with the management of PDVSA which, for the past fifteen years, had been focusing on producing as much oil as possible, regardless of OPEC quotas. The result was a steady rotation of PDVSA presidents and, later, an all-out confrontation between Chavez and the oil industry. Chavez then argued that the industry needed re-nationalisation because it had become a "state within a state".