Will pdvsa sink Venezuela? Woes at Latin America's largest company swamp the economy. (Special Report).

How much pressure can state oil giant Petroleos de Venezuela (Pdvsa) take before it--and Venezuela--cracks?

Depends on whom you ask, but the consensus is that while the company itself is in no real danger, millions of ordinary Venezuelans who depend on the oil business are hanging by a thread. Venezuelan President Hugo Chavez must get the oil flowing again soon or his country's economy, already on the mat, could be knocked out cold.

Control of roughly US$45-billion-revenue Pdvsa means control of Venezuela, and both Chavez and the strikers flooding the country's streets know it. The oil sector employs just 1% of Venezuelans, but Pdvsa is the economic motor responsible for some 70% of Venezuela's foreign exchange income and 43% of government income.

Shaking the Pdvsa tree for the benefit of Venezuela's poor is Chavez's plainly stated goal. "We want to favor the people who've never seen a drop of petroleum," says Luis Vierma, the Energy Ministry's hydrocarbons director.

Laudable, but estimates of the strike's impact on the national economy during the first 50 days hit $14 billion in lost revenues, or 15% of gross domestic product (GDP). Economists predict that national output could plummet 10% in 2003-40% in the first quarter alone.

"The oil business contributes 50% of the economy of Venezuela, so a 40% decline in GDP is a realistic number," says Fadel Gheit, senior energy analyst at Fahnestock and Co. in New York. "Absolutely, the economy is going to be a basket case."

Can Pdvsa itself prosper after these hits? If it can get the oil pumping again soon, probably so, analysts predict. Under normal conditions, the company needs anywhere from $2 billion to $4 billion to operate. In addition, the company must make $1.6 billion in debt payments in 2003, more than $800 million of which is due by the end of March. Pdvsa must continue servicing $3 billion in long-term unsecured debt despite the strike that through the end of January had erased an estimated $600 million in revenues tied to pending oil sales, analysts report.

The government told analysts in January that it will meet obligations using Pdvsa's $900 million in cash and the company's $2.4 billion macro stabilization fund.

The fund was established to provide a cushion against macroeconomic instability by setting aside a percentage of Pdvsa revenues. Chavez has gone to great lengths to use it to extract money from Pdvsa since 2001. He recalculated Pdvsa's macro fund contribution, nearly doubling its payment to 30% from just under 17%. Now, though, it looks like he'll have to spend a good part of that macro fund fixing Pdvsa--if the money isn't gone. Chavez admitted taking at least $1 billion from the fund in December 2001 to pay government salaries and bonuses.

"We don't know if the money is there," says Edgard Leal, a former Pdvsa executive and director, now a senior associate at the Caracas office of U.S. consultant Cambridge Energy Research Associates. "We don't know if the government has used it Pdvsa is no longer managed by a board but by an individual [Pdvsa CEO All Rodriguez] who has close links to the government."

Pdvsa says it could restart operations and be back to nearly normal levels in less than two months, but it is not clear how much damage might have been done to equipment by departing strikers. Venezuelan heavy crude oil, if not pumped, hardens in the pipes, experts say. ("It just turns to rock," says one analyst) Nor is it clear how the government might run a huge state oil company after firing thousands of seasoned professionals. Critics say four months is a more likely time-frame for resumption of full operations.

Apertura. Former Pdvsa CEO Luis Giusti, a Chavez critic, figures the company needs to spend $4 billion a year or lose ground at a rate of 25% of production each year. Under Giusti, who headed Pdvsa for five years until 1999, the petroleum sector opened to foreign investment and dozens of multinational oil companies rushed in. Exports grew as capacity increased.

"By widening the constituent base of the oil sector you expand the economic activity in the country," says Giusti, now a consultant with the Center for Strategic and International Studies in Washington, D.C. "You generate steady growth."

Yet four vital heavy-crude projects partly owned by foreigners being built in the country's vast Orinoco oil belt--Petrozuata, Cerro Negro, Hamaca and Sincor--shut down during the strike; the projects can meet immediate debt payments, analysts predict, but after a couple of months it is unclear how operations can continue. The top 10 foreign oil companies working in Venezuela were losing an estimated $6.7 million in revenue a day, reports energy research firm Wood McKenzie. Foreigners in the country produce 400,000 barrels per day--15% of Venezuela's normal output--and were expected to double that figure.

A 2001 Chavez law restricted foreign ownership of new projects, dampening investor enthusiasm. Nevertheless, concessions will have to be a large part of Pdvsa's future, says Alejandro Bertuol, senior director of the Latin America Energy Group at Fitch Ratings. "[There] is cushion enough, but not for long-term operations and investment," says Bertuol. "The fastest way for Venezuela to recover is through [foreign] investments."

Even though oil output has declined in recent years, Pdvsa CEO Rodriguez has said the company will spend $40 billion by 2007 to increase its potential output to 5 million barrels per day from 3 million barrels. Of the investment target, more than $18 billion is expected from foreign partners.

Increasing capacity, however, doesn't mean Pdvsa will produce more oil. Recently head of the Organization of the Petroleum Exporting Countries (OPEC), Rodriguez understands the cartel's cagey quota game as well as anybody. OPEC-enomics is pretty hard to fathom at times, but here's the bottom line: Everyone wants to add production capacity, but no one can afford to overproduce.

That's because OPEC calculates each country's export quota based on its potential output. It figures out a target price, and then sets production levels accordingly. Since the cartel says each country can export 70% of its potential--not actual--output, it behooves each to have as much capacity as possible, even if the extra capacity remains unused.

Venezuela tried to double output a decade ago, only to find that busting the cartel meant lower overall prices. Since assuming power in 1999, Chavez has transformed the company from an OPEC quota cheater to a strict quota adherent. Production, which once reached 3.6 million barrels per day, dropped to 2.7 million barrels.

Cutting production has boosted international oil prices, but it left thousands of oil workers idle. Pdvsa managers on strike say that pouring more money into government and less into the pockets of oil workers is no way to run a modern economy. "It's a short-term vision," says Juan Fernandez, leader of Gente de Petroleo, an organization of dissident Pdvsa executives. "(Pdvsa) is sacrificing market."

Oil industry suppliers are fed up over the sector's slow decline during the Chavez years, says Fernando Cival, owner of oil and gas processing machinery maker Industrias Vander-Rohe. "Businessmen prefer to close their doors now rather than continue under these conditions in which companies go out of business little by little," Cival says.

The clearest loser in the battle for Pdvsa is Venezuela's already-battered economy. Using the stabilization fund to pay short-term Pdvsa debts leaves the country itself with no cushion should the price of oil fall. Anxious to curtail the beleaguered bolivar's slide, Venezuela's Central Bank stopped selling dollars in late January. The government, meanwhile, will cut $2.4 billion from spending to offset lost oil revenues. It also announced price and foreign exchange controls.

Fallout. Francisco Toro, an editor at the VenEconomy newsletter, predicts that the strike's losses in export revenues and taxes will push Venezuela's public deficit to $15.2 billion, equal to the government's entire year 2002 budget. "What are they going to do?" Toro asks.

Policy analyst Mark Weisbrot, co-director of the Center for Economic and Policy Research in Washington, D.C., figures Pdvsa is missing a pile of money on bad deals with foreign oil companies struck by previous administrations. Venezuelan oil drilled by foreign licensees in 2000, he points out, represented 11% of output but 45% of Pdvsa's costs--four times the company's internal cost of drilling. "That's just not explainable," Weisbrot says. "There's only so much bullshitting you can do."

Weisbrot believes Pdvsa management made money hard to find to avoid giving it to Chavez. "They want a big company, because that increases their salaries and their power," he says. "And there's probably some corruption in there."

What's so bad, then, about running Pdvsa the way Chavez proposes, as an institution to benefit all Venezuelans? "Pemex," says ex-Pdvsa director Leal, referring to Mexico's corruption-ridden state oil giant.

Striking oil company employees face house payments, children's school fees and utility bills, yet they say the sacrifices are worthwhile. Teresa Centeno, 44, a marketing manager in Pdvsa's natural gas subsidiary, has spent nearly half her life at Pdvsa.

Centeno has two children and now no income, but defending Pdvsa is more important, she says. "This is way beyond my personal situation."