China is a long-term player in Venezuela’s energy future

Oil-for-loans deals are opaque but criticisms of China arise from domestic political disputes

China’s continued financial support of Venezuela’s floundering government through oil-backed loan deals has been the subject of fierce criticism from the Venezuelan opposition, which has already taken steps towards a recall referendum to remove President Nicolás Maduro from office.

By providing a lifeline to a regime with scant financing options in order to ensure preferential access to Venezuela’s enormous oil reserves, China has been accused of acting as a neo-colonial power. The opposition has denounced that closer ties have also paved the way for an invasion of cheap, so-called “made in China” manufactured products which have negatively impacted Venezuelan industry.

The uncertainty and lack of available information on the loans-for-oil deals and what they really mean for Venezuela fan the flames of internal political disputes that existed long before China came to town. In such a heated environment, balanced appraisals of the China-Venezuela relationship are hard to come by.

The Venezuelan economy is certainly out of control in many respects. Imports have collapsed, the production of oil and marketable goods has fallen. The fiscal deficit is increasing as monetary financing declines. Inflation has hit three digits, leading to massive price distortions. There is an acute scarcity of products, especially food and medicines. GDP has dropped and the country’s external debt has increased five-fold.

Oil is Venezuela’s main and almost sole export. For almost a century, the US enjoyed a privileged trade relationship with Venezuela. But in the mid-2000s the South American country began to pivot towards China. As with the US, this new relationship has focused on oil. The recent US shale boom, which led to a huge drop in demand for Venezuelan oil (and international prices), confirmed China as a vital export market and political ally.

The future of Venezuelan oil, therefore, lies in the Far East. And this idea is becoming clear among oil experts and political elites. The strengthening of links between China and Venezuela is, then, a question of ‘realpolitik’ where cooler, pragmatic heads are required.

The extent of the debt

A team of Venezuelan economists, led by Ricardo Hausmann, professor of Economic Development at the Kennedy School of Harvard University, recently published a Spanish study which translates as Bases for the design of a national reconstruction programme. The paper offers an overview of the Venezuelan economy in recent years and mentions the country’s US$160 billion total external debt.

The study also refers to Venezuela’s US$25.5 billion debt to China, which is recorded on the balance sheet of Bandes, the development bank created by deceased former president Hugo Chávez. This figure reflects only government to government agreements and not the private debt of local or mixed Chinese-Venezuelan owned companies. Servicing this debt is costing between US$5.5 and US$6 billion dollars annually.

The commitments

Venezuela has two types of financing with China. One is the long-term US$20 billion fund. The second is the so-called Chinese fund, which comprised an initial US$4 billion and is now worth US$5 billion. The Venezuelan government has sole discrepancy over use of this fund.

There are some important critiques of this dual financing scheme. The most frequently articulated is the vulnerability to price fluctuations. At the start of the year, Venezuelan state-owned oil company PDVSA, which repays the loans with oil shipments, sent about 400,000 barrels per day to China. The price was calculated at US$50 per barrel and repaid both funds. But as prices fell in January, so did output. PDVSA was then expected to pump 800,000 barrels per day to make up the revenue shortfall.

“That did not happen,” said Economist Francisco Monaldi, director of the Venezuelan International Centre for Energy and the Environment at the Institute of Advanced Administration Studies (IESA). As such, PDVSA was in de facto default, but China agreed to be more flexible on the repayment terms. “The details of that arrangement are unknown and I doubt that they are going to be revealed,” Monaldi said.

Miguel Perez, vice-president of Venezuela’s economy, told Reuters the deal gave ‘oxygen’ to the economy but did not elaborate on the terms of the repayment.

Another criticism is how the funds are used and the elephant in the room is how much debt China will allow Venezuela to accrue since despite the loans, the country is showing little sign of economic recovery.

Miguel Ángel Santos, the economist who coordinated the Kennedy School study said the terms of the China-Venezuela agreements “are totally opaque” and added that they did not pass through the National Assembly. The finance scheme also funds some apparently unrelated projects.

Santos mentioned the case of the railway to connect Caracas with Venezuela’s main port, in the Puerto Cabello municipality some 200km (125 miles) west of the capital. “It will reap benefits within 30 or 40 years, but the Chinese fund is designed so that Venezuela may repay within a period of four years with oil shipments,” Santos said.

Temir Porras, a former chair of Bandes, says the deals are mutually beneficial: “Somehow both China and Venezuela are guaranteed flows [of oil and finance respectively]. To me, that seems to be quite correct conceptually.”

Although not insisting on specific economic policies as a condition of lending, as Washington-based financial institutions (IFI’s) did with Latin American governments in the 80’s and 90’s, China has sought assurances about how the loans are used.

“The Chinese, on more than one occasion, have asked: How are the funds going to be applied? Are they going to be used to develop technological and industrial capacities? At the same time Venezuelans insist on liquidity, without it being subject to any conditions. These are two legitimate positions,” Porras said.

Yet there are more actors involved in the deals, including private sector contractors. This creates further problems for monitoring how funds are spent. “If you add aggressive Chinese businessmen to disorganised Venezuelan ones thinking only about building themselves a new house in Miami, then you have to apply transparency and verification mechanisms to guarantee results.  Otherwise, you would be opening the doors to corruption,” Porras added.

“Truth be told, neither in the public nor private sector, nor in society in general, are we Venezuelans used to transparency.”

The shadow of political conflict

Following the opposition’s victory in legislative elections on December 6 last year, political conflict has escalated to such a level that it amounts to a “constitutional crisis” according to Jesús María Casal, a preeminent constitutional lawyer.

As part of the sequence of the conflict, on May 16, President Maduro issued the Economic Emergency and Exception Decree that allows him, among other things, to “take charge of operations at the National Treasury”, which opposition spokespeople and legal specialists say must have the approval of Parliament. The state of emergency was extended on July 13 for a further 60 days.

The opposition’s Henry Ramos Allup, president of the National Assembly, warned Venezuela’s creditor countries via a tweet that without parliamentary approval any credit operation could be declared illegal.

“This is a delicate topic that has to be carefully evaluated,” said Monaldi, who added; “among other things, because China will be —it already is — one of the main options for future financing for Venezuela.”

The Harvard report points out that the doors of international financing have been closed to Venezuela since 2014.

Porras assigns Ramos Allup’s declaration to the aggressive climate of domestic politics. “My opinion is that the relationship with China in the mechanism described, is not a sovereign indebtedness of such a nature that it requires the approval of the National Assembly.” He explains why: “For Venezuela, the financial mechanism involves advanced payments in oil. The liability which that operation creates must be transferred to Bandes [as it manages the funds the Chinese banks pay into], which then has equity.” Porras explains that Bandes and PDVSA have an agreement and it is the latter that repays instead of the bank, with oil shipments to China. The equivalent amount (be it denominated in dollars or yuan) the Chinese lender then discounts.

“I’m not saying the mechanism doesn’t need supervision or a transparency framework,” Porras added.