Nowhere is this more evident than in Venezuela, where a newly re-elected Hugo Chávez has made Petróleos de Venezuela S.A. (PDVSA) the epicenter of his power. For Chávez, PDVSA’s oil, its jobs, and the huge revenues it generates are not mere mercantile issues. They are to be used for the benefit of the country and for “future generations.” The issue extends far beyond the economy. How PDVSA is run reflects the philosophy of the country and its government. The results are linked directly with the country’s self-perception. PDVSA’s oil production is indeed the lifeblood of the country.

How did PDVSA end up in this position, and what were its important evolutionary milestones? We address those questions in this article.

The Beginning

Venezuela began producing oil in 1878 from a small field near Lake Maracaibo. But the first commercial production did not start until 1914, when the Zumaque well was discovered at the Mene Grande field on the eastern edge of Lake Maracaibo. In 1922, another big well erupted, the Los Barrosos-2 (near Cabimas, 50 kilometers southeast of Maracaibo), signaling the existence of huge resources in the region.

By World War II the development of the Venezuelan oil industry had evolved to the point that the country was the world’s largest exporter. The country’s oil became a key element of the Allies’ war effort. During the war, Venezuela passed the Hydrocarbons Law of 1943. This guaranteed the government a notably higher participation in the business, including an increase in domestic refining, and a 16.6 percent royalty in exchange for allowing the world’s biggest oil companies access to Venezuela’s vast reserves for an additional 40 years. The golden era of Venezuelan exploration ensued. During 1947-60, some 197 new fields were discovered. Production surged from 800,000 barrels per day in 1944 to 3.2 million barrels by 1960. Five new refineries and a gas pipeline to the country’s capital began operating. Whether democracy or dictatorship ruled the day, the petroleum business was focused on the earnings produced by the subsoil. Profit sharing with the government could be 50-50, or even more.

The application of the new oil policy’s guiding principles began – most prominently, the strengthening of prices and the “Venezolanization” of upper management. In 1960 the state company Corporación Venezolana del Petróleo (CVP) was established. But the company never flourished because it had little support from the government. It could never become the longed-for headquarters of Venezuelan oil and after 18 years it turned into Corpoven.

OPEC and Nationalization

Venezuela solidified its position on the world’s stage by helping to launch the Organization of the Petroleum Exporting Countries. During Gamal Abdel Nasser’s time, Juan Pablo Pérez Alfonso, with the help of Saudi Arabia’s Abdullah Tariki and Abdala Dariguiand, and Iraq’s Mohamed Salman, helped to create OPEC. The debate over whether to continue its membership or exit from the organization has always been discussed within the nation. Regarding OPEC, the most contentious point in Venezuela, as well as within the cartel, has been the portion of the international market sacrificed as a consequence of the member states’ production allocation, established at the 1965 Tripoli Conference. This quota system continues to be the mechanism by which OPEC exerts its influence.

About the same time that OPEC was getting its start, Venezuela became a democracy. In 1958, after decades of political intrigue, the Venezuelan military finally withdrew from national politics. Quality of life improved significantly and the nation flourished. But by the end of the 1970s, a fast, uncontrollable deterioration of the system had begun, and the political-partisan model wore out without any serious attempt to restore the people’s confidence.

The oil industry was nationalized in 1974 with the participation of all sectors, including political parties and universities, with the idea that the industry should be autonomous. The law included strong paybacks for the concessionaries and the possibility of joint ventures with private companies. The original company structure remained the same. All private concessionaries changed their names. They were independent and competed against each other, but PDVSA was the umbrella company.

In the mid 1970s, two key events occurred: the Reserve Act (for the commercialization of hydrocarbons for the state) was passed and PDVSA was created. The Reserve Act defined the amount of indemnity for the expropriation of concessionaries, considering it the net value of their properties, plants, and equipment: the purchase value, less the cumulative amount of depreciation and amortization.

In retrospect what remains clear about the Reserve Act is that, as with the Hydrocarbons Law of 1943, the whole scenario had been decided in advance. The concessionaries were satisfied with the expropriation because the Reserve Act was quite generous, and PDVSA gave them contracts for their help in trading and technological support.

After a difficult beginning, PDVSA grew dramatically. Two and a half decades after it was created, its proven oil reserves had increased by 420 percent and its natural gas reserves by 360 percent. In the Orinoco Belt, contingent reserves and resources totaled some 250 billion barrels of crude oil and 14.3 billion tons of natural bitumen. The company’s equity increased to 8 trillion Bolivars.

PDVSA’s subsidiary Intevep became a first-class research center with hundreds of patents for instruments, substances, and equipment developed or transformed in its laboratories, and used domestically and worldwide.

Internationalization began in 1983 and grew quickly. In 1991 at the request of the Ministry of Energy and Mines, PDVSA launched the Apertura (the opening), which allowed the company to form operating agreements for the reactivation of marginal fields. It also allowed the creation of petrochemical ventures: since 1987 that has resulted in the construction of 13 new plants. Other deals include the operation of modern tankers such as Lakemax, the extraction of Paso Diablo bituminous coal in the state of Zulia, the issuance of petroleum bonds, and a number of strategic associations to develop the huge reserves of heavy oil in the Orinoco Belt. Orimulsion, an exclusively Venezuelan fluid using an upgrade of Orinoco heavy oil, was developed in 1986 and export of the new fuel began five years later.

By 1999, PDVSA held ownership stakes in refineries in Germany, Belgium, the United Kingdom, Sweden, and the United States. And those overseas refineries were processing as much crude as the company’s domestic plants. The 13,000 gas stations belonging to Citgo’s network in the U.S. represented more than 10 percent of that domestic market. Asphalt refined in Venezuela controlled European and North American markets.

The Chávez Era

The Organic Law of Hydrocarbons of 2001 widened the possibility for the private sector to participate in all oil industry activities, but allowed only some minor reductions in the royalty (fixed at 30 percent) and refused to change the requirement that the government control more than 50 percent of stock capital in newly formed joint ventures.

By its third year, the Chávez government had lost a large part of its initial spontaneous popular support. On December 2, 2002, a strike broke out in opposition to the government. Chávez took advantage of the situation to begin preconceived, programmatic government actions in order to obtain total control over PDVSA, which was to be managed “by the people and for the people.”

Chávez granted his hand-picked company president extraordinary powers through which he alone could manage the company. The same day, a mass layoff of upper and middle staff managers and workers began. The government fired more than 20,000 PDVSA employees, a move that led to a drastic decrease in production. The Venezuelan military tried to help stem losses by moving the oil tankers, but the use of uncertified crews resulted in loss of international insurance coverage. Intesa, the company in charge of technological services, joined the strike and stopped supporting the contingency plan. Exports dropped to just 12 percent of their normal volume.

For the first time in 80 years, the Venezuelan oil industry invoked force majeure to justify noncompliance with contracts. Two months after the strike began, there were still no indications that a reasonable, fair, and balanced solution would appear in the near future. The losses due to the cessation of activities for the 10 largest transnational companies operating in the country were estimated at $300 million.

PDVSA’s contractors were told that they were prohibited from hiring former PDVSA employees, who were classified by the government as saboteurs and coupsters. As part of a series of actions that the government undertook against the ex-PDVSA employees, many were evicted from their homes and their children were barred from attending school.

The Integral Cooperation Agreement with Cuba caused more controversy. The crude oil and products supply delivered to Cuban ports under preposterously low sale conditions amount to 25 million cubic meters per year. By the end of 2003, Cuba owed Venezuela almost $1 billion for received crude shipments.

Chávez expected PDVSA to finance a large part of the Bolivarian government agenda and the new social plans called “missions.” In January 2004, the Central Bank authorized PDVSA’s request to form a trust, in the range of $1 or $2 billion, for infrastructure, the agricultural sector, and the missions. Thirty percent of the budget for the state oil company’s investments was destined to fulfill the ideal of democratizing the oil riches.

While Chávez talks about using Venezuela’s wealth to help the poor, he’s made PDVSA’s production and financial information the equivalent of state secrets. Indeed, there is virtually no transparency. For instance, on November 17, 2006, the company finally filed its annual report with the Securities and Exchange Commission (SEC) – for the year 2004. The company claims high production numbers, but allows no audits.

Independent analysts in Venezuela put PDVSA’s production at 2.57 million barrels per day while PDVSA claims it produces 3.2 million. Worse yet, the company’s financials don’t add up. In 2005, according to estimates compiled by the former director of the Central Bank of Venezuela, economist José Guerra, the company’s earnings totaled $32.5 billion and expenditures were $29 billion. But there are no explanations for the missing $3.5 billion.

Nevertheless, amid all the questions about Venezuela’s most important company, on December 3, 2006, Chávez was re-elected by a landslide for a new six-year term.