Energy

Return to Article

Chavez Setback May Pinch Oil Prices

Simon Constable

Democracy caught a break in Venezuela over the weekend, but will the oil market?

It's hard to tell so far, but the answer seems to depend on the time frame in question and who's asked.

Venezuela, the fifth-largest oil-producing member of the OPEC cartel, provides the U.S with about 12% of its daily oil needs, a fact that the country's loudmouth president, Hugo Chavez, has long exploited politically with vocal threats to cut off supply of the black gold to America.

But Sunday, Venezuelans went to the polls and narrowly rejected Chavez's latest plans to cement his power even further and remove term limits for the presidential job. It would have taken the country another step closer to a Soviet-style dictatorship and could have left Chavez in the role for life.

The stunning referendum defeat was the biggest setback for Chavez during his presidency, and it may have some implications for the oil market and the U.S. economy.

With oil prices recently resting at around a $88 a barrel -- high, but below the all-time intraday record of $99.29 reached last month -- and the wider economy starting to show signs of weakness, the last thing the U.S. needs is a supply shock that could send energy costs into the stratosphere.

The first impact of the referendum is likely to be positive compared to what could have happened had the vote gone through, says Joe Brusuelas, chief economist at IDEAglobal in New York.

"In a geopolitical sense he's been weakened, so it basically delegitimizes the regime," says Brusuelas. "He may now find his colleagues urging him to de-escalate the rhetoric."

OPEC's Arab country members like Saudi Arabia are becoming increasingly concerned that oil prices near $100 a barrel are not sustainable. Continued high energy costs would likely dramatically slow the U.S. economy and so eventually crimp demand, perhaps starting a downward spiral.

Chavez's flamboyant threats aimed at the U.S., although seen by many as hollow, have been at least part of the story in pushing oil up from around $55 a barrel at the beginning of the year.

So in the shorter term, there will likely be a toned-down Chavez, perhaps greasing the skids for a pullback in oil prices, says Brusuelas.

But Brusuelas is careful to note that Chavez is still very much in charge of the country, firmly in office and has the backing of the army. That means he will likely continue to be something of an irritant, albeit a potentially less vocal one.

Another problem for Venezuela has been consumer inflation, which is currently running at around 17% a year, largely driven by massive spending on public health care and education programs. That's part of the reason Chavez has been able to garner such solid support among the poor.

Had the vote gone in his favor, Chavez also would have given unfettered access to the country's foreign-exchange reserves to fund yet more social spending. But here's the rub: If he did that, it would likely spark even higher inflation, possibly igniting civil unrest among the working poor as food prices spiraled out of control.

The truth is that snowballing inflation may break out anyway with the same results, but perhaps at a later date.

Looking longer term, some see the vote as an encouraging signal to members of the opposition parties in Venezuela.

"The election result reduced Chavez's aura of invincibility," says Max Pyziur, an energy analyst at New York-based specialty commodity firm CPM Group. "The opposition has been a weak force. This at least gives them hope to organize."

It might be a long shot, but a meaningful opposition might one day reverse the expropriation of foreign-owned oil assets, such as those taken from Exxon Mobil(XOM Quote) and ConocoPhillips(COP Quote). With the eventual return of foreign companies, more efficient extraction of the oil may actually increase supply for the country and help ease the supply and demand balance on the world market.