Venezuela Economic Crisis: Perfect Storm Brewing

Venezuela, a member and the 6th largest producer of oil within OPEC, (Organization of the Petroleum Exporting Countries,) is on the verge of bankruptcy. That is what happens when the larger, more dominant member of your oil cartel acts in its own best interest, not yours. Ever since the 166th Meeting of the OPEC Conference on November 27th, 2014 in Vienna Austria, where it was decided to leave oil production output unchanged, prices of the liquid gold took a nosedive. Back then, oil was still hovering around $115 per barrel and oil-producing nations were doing well.

That all changed when Saudi Arabia, the largest member of OPEC, decided that it would rather give up temporary profits in the oil market in exchange for winning back market share from other, non-OPEC, producing nations. The aim was simple: The group, who’s combined rate of oil production representing 40% of the world’s total in 2014, and accounting for 73% of the world’s “proven” oil reserves, including 48% from just the six Middle Eastern members, would make an announcement to the world that they would not cut production or attempt to prop up the price of oil. The purpose was to let high-cost producers go bankrupt as the price of oil dropped, only to raise the prices again afterwards and reap the benefits of having less competition afterwards.

As it turns out, things are not so simple, especially when some of your fellow OPEC members run their country’s budget based on expectations of oil revenues. For Venezuela, they need oil prices to hit $111 a barrel just to break even so that the country can operate. Instead, they’ve had to watch oil prices constantly fall lower since that meeting almost 15 months ago. Saudi Arabia also would like to see higher oil prices in order to avoid running a budget deficit; however, there is one major difference for them. They have deep pockets and they can tap into those savings to cover any budgetary shortfalls temporarily. As of December 31st, 2015 the Kingdom of Saud had $660.1 billion U.S. in currency reserves. This would let them survive for a handful of years even at today’s oil prices. Venezuela has barely $15 billion U.S. left, almost nothing to fight a collapse with. The International Monetary Fund estimated that Venezuela’s economy contracted by at least 7% in 2015.

With prices of crude falling to unbearable levels where smaller nations like Venezuela and Nigeria cannot run their countries, this has led them to put pressure on the Saudis for more than a year now to finally announce some type of production cut in order to boost prices. There are many factors in play here but what is most important is that they didn’t listen, and just kept letting prices fall.

Venezuela is now suffering from hyper-inflation, the worst it has experienced for a long time, but there seems to be no escaping what is just around the corner. Their money is now worthless outside of their country but they have an estimated $185 billion U.S. in external debt. With many other problems going on in the nation, including a shortage of water caused by El Nino making hydroelectric dams not able to produce electricity, stores halving their open times to conserve energy, to shortages of drinking water that people are now stockpiling in their homes and unfortunately creating the perfect breeding ground for mosquitos carrying the Zika virus, as well as a political crisis on the streets, the last thing the country needs is a total banking failure or default. The country is now in a state of emergency on more than one level. It is only a matter of time now until this economic crisis turns into social unrest.

The country’s heavy reliance on oil, coupled with the fact that their cost of production is higher than any other OPEC nation, is a recipe for disaster anytime oil prices plunge. Just as Chavez had done, the government’s social spending may have been nice at the time, but only dug the country into a hole from which they will not be able to get pumped out. Time will run out any day now.

Robert Patyk has 15 years’ experience trading stocks, options, commodities, futures options, & currencies. At age 17 he won first place in an international stock trading competition. Robert predicted the market crash of 2008 two years early. He is a contrarian, top-down macro trader achieving high returns by studying geo-politics, fundamentals, and technical indicators.