Sovereign Bolivar Is Combustible

August 20 wasn’t just a simple national holiday in Venezuela. It marked the beginning of President Nicolas Maduro’s currency reform and will potentially mark the acceleration of hyperinflation and the worsening of Venezuela’s economic collapse.

Maduro devalued the bolivar currency by roughly 95%, lopping five zeroes off the old currency to launch the new “sovereign bolivar”, which is pegged to its oil cryptocurrency, el petro. The plan touted as saving the economy and tackling hyperinflation, has so far paralyzed the country, Kallanish Energy reported.

To put the chaos into context, Ricardo Hausmann, a Venezuelan professor of economic development at the Harvard University Kennedy School said “Venezuela is undergoing an economic collapse.”

Confusion reigns. Businesses have closed to adapt to the new currency and price controls. Withdrawals of the new money from cash machines are restricted. Inflation on Aug. 23 was estimated at 54,860% by economist Steve Hanke, while the IMF has forecast inflation will hit one million percent in 2018.  

  Face Lift?

Hanke, a professor of applied economics at Johns Hopkins University, said “Maduro has a plan to curb hyperinflation, like a fireman has a plan to pour gasoline on fire. The sovereign bolivar is combustible.”

“The bolivar’s redenomination will be like going under the knife of one of Caracas’ famed plastic surgeons. Appearances change but, in reality, nothing changes. That’s what’s in store for the bolivar: a face lift,” said Hanke.

So far, the economic reform pledged by Maduro, which also includes the end of fuel subsidies in the domestic market and an increase in the minimum wage by 3,000%, seems to be too little, too late—too contradictory.

Luis Vicente Leon, president of Caracas-based pollster Datanalisis, noted “the exponential increase in salaries, massive requests for advancement of benefits, and an increase and change of frequency of tax payments put companies in a situation of catastrophic cash flow.”

Linking the new bolivar to the petro is a “scam”, because the oil-backed cryptocurrency is “dysfunctional and non-existent,” Hanke added.

  Production Declining

At the epicenter of such a negative outlook is the collapsing Venezuelan oil industry—the source of over 90% of the country’s revenues. The much-talked about “death spiral” of state oil company PDVSA could accelerate with the so-called reforms, Kallanish Energy learns.

According to Francisco Monaldi, a fellow in Latin American energy policy at the Baker Institute, Venezuela’s oil output is declining fast, with the largest chunk of the fall—1.25 million barrels per day—happening in the last two years.

PDVSA-only operated production is currently estimated at 600,000 barrels per day, compared to 1.5 mbpd in 2016, and 3.1 mbpd in 1998, when Hugo Chavez became Venezuela’s president.

Output operated by joint ventures with foreign firms are also dropping, although at a slower pace. Production is now estimated at 750,000 bpd, compared to 1.1 mbpd in 2016.

  The Death Spiral

Around 60% of Venezuela’s oil production, roughly 800,000 bpd, is extra crude—which is sold at a lower price than lighter oil, with profit margins usually lower, too. The country imports approximately 125,000 bpd of diluents to blend and export its crude, Monaldi explained.

“Less than half of PDVSA’s oil production, roughly 550,000 bpd, generate liquidity,” he added. “Over 350,000 bpd are consumed in the subsidized domestic market—a massive loss; more than 400,000 bpd are used to pay debts with Russia, China and other creditors; and around 50,000 bpd are sold at a subsidized price to Cuba.”

The “death spiral” resulted from the collapse in cash flow, which then led to a collapse in investments. Maduro’s recovery plan to increase production by 1 mbpd in one year, by reactivating 1,000 inactive wells through services contracts, seems a “remote possibility”, Monaldi noted.

To increase output by roughly 200,000 bpd a year, Venezuela would need to invest an average of nearly $20 billion a year for a decade, and the government could only finance a small fraction of that, the Venezuelan oil expert estimated.

To add pressure to the delicate situation, the Trump administration is said to be once again considering further sanctions against the Maduro regime. Reports last week suggest the US is planning “strong and swift” action against Caracas, banning the sale of US oil and oil products to the Opec member—estimated at some 3.5 mbpd.

If this goes forward, Venezuela would have to source its diluents elsewhere at an expected higher cost. Production, imports and exports would be affected, and consequently, the country’s ability to raise its revenue and control its economic collapse.

“Unless Venezuela adopts a completely new currency regime—like a currency board, or dollarization—the bolivar will face the same fate as did the Yugoslav dinar. Hyperinflation will soar and the bolivar will more frequently come under the knife,” warned Hanke.