Venezuela

During his recent visit to Brazil, Venezuela's President Hugo Chavez received Brazilian President Henrique Cardoso's support for the idea of integrating two Latin American regional economic groupings -- the Common Market of the South (Mercosur) and the Community of Andean Nations (CAN). The two politicians agreed on concrete measures that would lead to establishment of a free trade zone in Latin America. As part of their effort to create a Latin American economic bloc, the two countries agreed to establish a continental-wide company for exploration and development of oil by merging parts of national oil companies of major Latin American oil producers. The stated purpose of their efforts is to counterbalance the United States' economic power in the region. While the plan for regional economic integration is significant in intent, its realization, demanding the delegation of individual state's powers to supra-national bodies, may prove impossible in the current Latin American economic environment.

At their meeting, Chavez and Cardoso agreed to establish a preferential tariffs agreement between Mecrosur and CAN, stressing that the measure would enable a speedy creation of a free trade area. Cardoso said that the integration between the Mercosur member countries (Argentina, Brazil, Uruguay, and Paraguay) and the CAN member countries (Bolivia, Colombia, Ecuador, Peru, and Venezuela) would produce one of the most powerful economic blocs in the world. The two leaders openly defined the objective of the economic integration, which would be to prevent the Latin American countries from becoming "increasingly dependent on the United States." Reportedly, certain Brazilian diplomats expressed their hope that such an economic bloc would have "greater autonomy to negotiate with the European Union and counterbalance the United States' economic power."

As part of the Caracas-initiated effort to integrate Latin American economies, Brazil and Venezuela plan to establish a new continental-wide oil company called Petroamerica. Venezuela's Energy Minister Ali Rodriguez said on May 11 that the two countries intend to merge part of their state-owned oil companies -- Petrobras and PDVSA -- to form the new company, Petroamerica, likely be created before the end of this year. Consequently, other Latin American companies would be invited to join the international enterprise. Chavez had also introduced his Petroamerica proposal during his recent visit to Colombia. With regard to future members of Petroamerica, Chavez emphasized that the venture should not be limited only to the South American continent, but that an important North American oil producer, Mexico, should also join the negotiations.

Venezuela, Brazil and other Latin American countries are stepping up their integration efforts as a consequence of and in an attempt to deal with their dramatically declining economic performance in 1998 and the first part of 1999. Venezuela's oil- dependent economy was particularly hard hit by low oil prices last year and the future prospects are grim. According to the latest figures released by the country's central bank on May 17, Venezuela's economy is expected to shrink by 7.9 percent in 1999, which would be the economy's worst performance in a decade. Specifically, Venezuela's petroleum sector is expected to shrink by 12.1 percent, and the non-petroleum sector by 6.4 percent. Brazil, according to an OECD report published on May 18, will suffer "a severe recession" in 1999, with the economy contracting 3.0 percent and inflation increasing to 15.0 percent from 1.7 percent last year. According to the OECD report, Brazil "remains the key source of uncertainty" for South America. The OECD forecasts that most countries in the Latin American region are headed for recession this year.

Facing a grim economic reality and its possible political implications, Latin American leaders are looking for someone to blame. In the case of Venezuela, the rhetoric of a nationalist Chavez is directed against the United States, a primary consumer of Venezuela's oil. Chavez claims that the main reason for his country's economic troubles is Venezuela's economic dependency on the U.S. Chavez is offering his nation a solution in his vision of an economically united Latin America that would be able to counterbalance the economic power of the U.S. and expand into new markets. The idea of a unified and strong Latin America is, undoubtedly, appealing to an economically struggling population. The question is, however, whether Latin American nations, with their diverse economies and limited mutual trade, are able to create a viable supra-national economic body. In other words, it remains an open question as to whether the creation of a successful supra-national economic body precedes or follows the emergence of commercial ties among nations.

The idea of a continent-wide oil company may, in fact, pose the first serious problem for Latin American integration. Currently, oil-dependent countries, such as Venezuela, are surviving economically only due to the fact that they are able to secure foreign loans backed by the state oil company's assets. This, however, would not be possible, in the case of an international merger between several oil companies. The oil-dependent Latin American economies simply cannot afford to give up the control over their own oil companies or the profits that those companies generate in favor of a multi-national venture. This would result in declining confidence and potentially in economic collapse.

Similarly, the creation of an independent economic grouping is extremely difficult due to deep structural differences among the individual Latin American economies. Moreover, mutual trade and specialization of production have not proceeded far enough among the Latin American nations to make them potentially independent of the United States. Because the grand vision of regional economic integration is practically unattainable in the current Latin American circumstances, its only objective is to serve the domestic political objectives of its populist and nationalist creators.

Venezuelan President Hugo Chavez Frias announced he would deny permission for the U.S. to use Venezuelan airspace in conducting counter-narcotics (CN) missions. In justifying the decision, Venezuelan Interior Minister Luis Miquelena said his country was very concerned with national sovereignty. Additionally, Miquelena said his government was concerned with the fact that F- 16 aircraft would be stationed on Aruba and Curacao, Caribbean islands to the north of Venezuela. The U.S. "not only has surveillance planes in the Curacao and Aruba bases, but also F- 16s, which are warplanes," Chavez said.

The U.S. government requested authorization to fly over Venezuela to conduct CN operations over Colombian territory. With the recent closure of Howard Air Force Base (AFB) in Panama, the U.S. moved CN operations to three locations: Aruba, Curacao, and Manta, Ecuador. As part of a proposed deal to use Venezuelan airspace, the U.S. offered to allow Venezuelan Air Force personnel to ride along on flights that went through Venezuelan territory, and to share narcotics-related information obtained on the flights with Venezuelan law enforcement agencies. Interestingly enough, Chavez suggested his country has its own fleet of aircraft that could assist U.S. authorities.

Approximately 2,000 sorties per year were flown out of Howard AFB before it closed, and not being able to fly over Venezuela from Curacao and Aruba would seriously hamper CN efforts in the region. The U.S. government will surely try to persuade Chavez to reverse his decision. It is unclear whether Chavez will relent and allow the U.S. to use his nation's airspace. Nor is it now known if a 1994 agreement between the U.S. and Venezuela that included an "aerial hot pursuit clause" in the case of CN operations will be abrogated. The more important question, however, is why Chavez has now refused to authorize the use of Venezuelan airspace.

The public explanation is the issue of Venezuelan sovereignty -- a legitimate concern and a central plank in Chavez' political platform. During last summer's presidential race, Chavez waged a populist, nationalist campaign and won by a landslide. Even though, as the race wore on, Chavez showed a more moderate side in an effort to allay the fears of foreign investors, opposition to foreign influence in Venezuela plays well to Chavez' constituency. He has continued with this theme since the election, stumping for a regional free-trade bloc and united Latin American petroleum operations as a way to break free from U.S. economic dominance. Still, while Chavez has shown he can be a staunch nationalist, he has also shown he can remove his paratrooper beret and don a pinstripe suit when necessary. Sovereignty is a highly charged issue, but it is also a useful lever in international political and economic negotiations. A host of nations cooperate in the drug war without becoming vassals of the United States, and Chavez may simply want a better deal.

While the U.S. offered to let Venezuelan Air Force personnel accompany U.S. pilots on CN flights, Chavez may want more before he is willing to adopt a conciliatory tone. Chavez may be concerned the U.S. will not share as much information as it claims it will, that the cooperation will be lopsided, and that the U.S. is as interested in keeping tabs on Chavez and Venezuela as it is on fighting drugs. The U.S. did not exactly embrace Chavez prior to the election. Chavez also emphasized Venezuela has its own aircraft that could assist in CN operations, and there would certainly be a price for that should the U.S. take him up on the offer. This would mean more U.S. aid for Venezuela, which could be used to upgrade its air fleet.

Political posturing and financial gain may both play roles in Chavez' refusal to permit U.S. overflights, however, there have been persistent rumors linking Chavez to the Colombian rebels and, by extension, to narcotics traffickers. Colombian guerrillas have been linked to the drug trade in Colombia, and allegations surfaced last year that Chavez has links to these rebels. Evidence supporting this link remains thin, but refusing to allow the U.S. to fly over Venezuela gives the impression that Chavez is tacitly helping his "narco-guerrilla compadres" in Colombia. It also sets Chavez up for the kind of serious ostracism the U.S. saves for those it deems uncooperative in the drug war.

Chavez' announcement was undoubtedly a surprise to the U.S., as it would be extremely foolhardy of the U.S. to plan to use Curacao and Aruba without an assurance of the availability of Venezuelan airspace. Given that Chavez changed his mind, the U.S. will certainly mount a diplomatic initiative designed to get him to change it back.

Unless Chavez has concluded that he has more to gain politically through confrontation with the U.S. than he does economically by cooperating with the U.S., there is room to negotiate. Chavez wants to be seen as a new Simon Bolivar, standing up to U.S. pressure and asserting Venezuela's autonomy and interests. But he does not want to sacrifice Venezuela in the process. Considering his eagerness to soothe the fears of foreign investors in Venezuela and considering Venezuela's position in the U.S. oil market, Chavez is not likely to let this dispute escalate too far. It is more likely that Chavez is attempting to extract maximum concessions from the U.S., both in securing a larger role in CN operations, and in obtaining additional aid with which to build up his military -- thereby satisfying both his political and economic goals.

Roberto Mandini resigned August 30 from his position as head of Venezuela's state-owned oil company, Petroleos de Venezuela, SA (PDVSA). Mandini reportedly said he stepped down so as not to interfere with the Venezuelan government's oil policy, but the El Observador newspaper cited unofficial sources that claimed the Chavez administration asked for Mandini's resignation on August 29.

But an apparent conflict was brewing between the company and the government. Last week, Mandini spoke out against the government's use of PDVSA to finance infrastructure and development projects. PDVSA has already committed 12 billion barrels to financing more than half of the 216 projects included in the president's Plan Bolivar 2000 social agenda, according to Venezuela Online News. Mandini's likely replacement is the vice president of strategic planning, Hector Ciavaldini, reportedly a close friend of Chavez, according to El Universal.

PDVSA's cash flow into state treasury is critical to the president's populist agenda and he is leaving no doubt as to who is in charge. Chavez ran for office on promises to cleanse the government of the gross corruption that squandered the country's oil wealth. He promised to rewrite the constitution, reform the judiciary and purge the Congress. He is dramatically carrying out those promises. The constituent assembly he convened to rewrite the constitution is stripping the Congress and judiciary of most of their powers, recently sparking clashes in the streets between legislators, Chavez loyalists and the national guard.

Chavez is also taking firm and very public -- control of oil policy. The days when PDVSA told the state what it would and would not do are over. Venezuelan state oil policy will be the state oil policy and the state oil company will be the state oil company. Chavez is not waging street battles with government officials who enriched themselves on oil revenues just so PDVSA executives can spend them as they see fit. The president fully intends to redirect the resources to fund his social platform.

But if free market economics suffer under routine graft and corruption, they will last much less under full-scale, populist state intervention. Chavez not only needs to have firm control over PDVSA and Venezuela's oil policy; he needs to have a degree of control over the larger oil market.

For that, he needs OPEC, and he has set out to prove to his cartel members that he is not merely a team player -- he is the team leader. At the conclusion of a recent meeting in Caracas, the Venezuelan, Mexican, and Saudi oil ministers affirmed their commitment to maintaining existing production cuts through March, 2000.

In a joint statement on August 29, the three ministers noted that if they are strictly observed, cuts in production can boost prices. OPEC has cut production by 1.7 million barrels per day (bpd). Accompanied by a 400,000 bpd cut by non-OPEC Mexico, Russia, Oman, and Norway, the initiative has more than doubled crude oil prices. The ministers also insisted that it is too early to lift production ceilings, with stockpiles not yet at normal levels and demand still down because of sluggish economies in Asia.

Largely unnoticed, Chavez has been instrumental in drawing Venezuela, Mexico and Saudi Arabia into closer cooperation in keeping production down. Early in the year, all three competed aggressively for U.S. market share and cheated, producing more oil than they pledged. But on March 1, the new Venezuelan oil minister, Ali Rodriguez, announced that his country would no longer compete for the U.S. market share it had lost to Saudi Arabia in 1998 [ http://www.stratfor.com/services/giu/030499.asp ]. With that announcement, and an upturn in Asian demand, prices began to recover. Crude oil was priced between US$18 and slightly more than US$21 on world markets August 30.

Venezuela is quickly trying to seize a leading role in OPEC. At the weekend meeting, Venezuela proposed that production quotas be guided by a price band. If oil prices drop below a lower limit, the cartel would automatically scale back production. If prices rise above an upper limit, encouraging non-OPEC members to boost production, cartel members would raise their output. This plan and others aimed at maintaining oil prices will reportedly be discussed at the upcoming OPEC meeting, scheduled for September 22.

Venezuela is urging another item for the September meeting: Iraq. Iraq is rapidly nearing its UN-mandated production cap of 3 million barrels per day and could drive prices down. Rodriguez told El Universal that the organization should address Iraq's increasing oil production.

Chavez is also planning to host a summit in March, 2000, for the heads of state of oil-producing countries, including all OPEC members and producers such as Mexico, Russia and Oman. The Financial Times cited Ali Rodriguez as reporting that all the heads of state have agreed to attend. The only previous full summit of OPEC leaders occurred in Algeria in 1975 and the participation of non-OPEC leaders is unprecedented.

OPEC is not what it used to be, controlling only about 35 percent of world production, and the participation of non-OPEC nations is vital to controlling production and price. Chavez and other OPEC members are seeking to strengthen and perhaps formalize cooperation with these countries to make cartelism work.

His international strategy is closely tied to his nationalist domestic strategy. He needs increased oil revenues to pay for his domestic agenda; for that he must firmly control state oil policy and the state oil company. But none of this is of any value unless OPEC and other producing nations can enforce greater discipline on production and on price.

Chavez must act quickly, though. Oil prices are leading off of expectations of renewed growth in Asia. But there are indications that growth in that region is just a temporary uptick, not a prolonged upswing. And Iraq is poised to increase supply.

On March 15, former Lt. Col. Francisco Arias Cardenas entered the presidential race in Venezuela. A former comrade of President Hugo Chavez, Arias is hoping that his own revolutionary credentials will help him defeat the president. Arias claims that Chavez - who has depicted himself as a populist - has become a tool of corrupt civilian advisors, betraying his anti-corruption campaign of 1998. The former governor of Zulia state, Arias is backed by the Democratic Action Party (AD) and the Social Christian Party (COPEI), as well as by former military officers.

The contrast is striking. In 1998, Chavez shocked much of the Western hemisphere by running a campaign steeped in revolutionary rhetoric and promises of an anti-corruption campaign. A former paratrooper who helped lead an unsuccessful coup attempt in 1992, Chavez played on his image of honesty and claimed to be incorruptible. Instead, he charged the dominant political parties with failing to invigorate a stagnant economy. Chavez was aided, as well, by the low price of oil, which made Venezuela's oil-dependent economy and politicians easy targets.

Two years later, the economic situation has hardly improved. The rise in oil prices that began in spring of 1999 brought a boom in Venezuela's oil revenues, but little trickled into the country's economy. Natural disaster, in the form of last December's mudslides, has brought more of the country's poor into the cities. A resultant rise in unemployment and inflation has caused the crime rate in the Caracas, the capital, to soar.

Both Chavez and Arias share an important set of experiences, but have taken divergent paths. Both were military officers; each participated in a failed 1992 coup attempt. Chavez went to jail. Arias went on to become governor of Zulia state, an important oil- producing region. Arias worked with foreign oil companies, the environmental movement and Venezuela's Indian population. Chavez carved a rhetorically revolutionary place for himself in the country's politics and implied that he would cut ties with U.S. oil companies. Only recently, Chavez has toyed with relations with Cuba, refused U.S. troops the right to come ashore during flood relief efforts and re-kindled a territorial dispute with neighboring Guyana.

Today, the coalition that brought Chavez to power has started to splinter. Last week, the Fatherland for All Party (PPT) and the Movement toward Socialism (MAS) party split from Chavez, nominating their own candidates for office. On Feb. 4, the eighth anniversary of the aborted coup, three former co-conspirators accused him and his advisors of corruption, publicly breaking with the president. The three said the president had lost sight of the objectives of the "Bolivarian Revolution" and become as corrupt as the political elites he once campaigned against. In reality, the break was due to the growing influence of Chavez's civilian advisors.

In order to defeat Chavez, the AD and COPEI have turned to the only candidate who can viably challenge Chavez. AD and COPEI have already come out in support of Arias. Caracas Mayor Antonio Ledezma, a former member of the Democratic Action Party, has announced that he will withdraw from the presidential race in order to help consolidate support behind Arias.

The prospect of replacing Chavez with Arias would have strong appeal to foreign oil companies, which have feared all along that Chavez might nationalize their holdings. Washington would also look favorably on his defeat; the president has challenged U.S. influence in the region. In May 1999, Venezuela refused to allow U.S. counter-narcotics flights over Venezuelan territory. Arias appears less prone to upset U.S.-Venezuelan relations.

Still, Arias faces two hurdles in winning the presidency. One, by associating himself too closely with establishment parties, Arias leaves himself vulnerable to the charge that he is a candidate of Venezuela's elite. In addition, Chavez has been a popular president. Polls conducted in late February found that Chavez held an approval rating of 71 percent.

To oust the president, the opposition is offering up the same formula that Chavez used to oust the establishment: campaigning against corruption and dressing it up with revolutionary rhetoric. The country's political establishment is fighting fire with fire. As the race heats up and the election draws near, neither candidate will be, according to the other, revolutionary enough.