Turmoil in Venezuela

About a year ago, Venezuelan President Hugo Chavez died. Although the political system was ostensibly democratic during his reign in office, Chavez was a charismatic leader that completely dominated the political situation in Venezuela. In the year since his passing, elections were held and Chavez’s handpicked successor, Nicolas Maduro, won in what turned out to be an unexpectedly tight race.

Since the elections, the Venezuelan economy and society have struggled. Inflation remains rampant, running at 56% on a yearly basis. To contain inflation, the regime uses price controls; recently, the government condoned customer raids on retail establishments, forcing retailers to either slash prices or see their wares forcibly removed from stores. There have been anecdotal reports that Venezuelans cannot find airline tickets out of the country if the fare is denominated in Venezuelan bolivars; the airlines are quietly only accepting foreign currency, mostly dollars, to secure a seat. Foreign reserves are falling to dangerously low levels; currently, the country has $20 bn in reserves and has commitments for $17.5 bn in principal and interest payments this year. Two-year government notes yield 16.8% and it costs 1700 bps to insure the debt via the credit default swap market, essentially suggesting that this market is expecting default.

The country uses a two-tiered exchange rate system that is routinely used by the powerful in the regime to import at the preferred rate and sell at the black market rate.[1] Imported goods have become scarce. Because the regime uses the state oil company, Petroleos de Venezuela (PDVSA), as a funding source, the company has not had the funds to maintain investment. Oil production has fallen to 2.4 mbpd from 3.5 mbpd just before Chavez took power. And, of this production, 0.3 mbpd are committed to paying a loan to China, 0.4 mbpd are sold at below market prices to allies, mostly Cuba, and 0.6 mbpd are used domestically. Exacerbating domestic consumption is the policy of heavily subsidizing gasoline prices, currently at 6 cents per gallon. The estimated cost to the government for fuel subsidies is $30 bn per year. Given the claims on Venezuelan crude production, only 1.1 mbpd is available for sale at world prices.

Crime rates are very high and have affected the notable of Venezuelan society. In January, Monica Spear, a former Miss Venezuela and actress, was murdered in a roadside attack. Last week, former WBA super bantamweight and featherweight boxing champion Antonio Cermeno was kidnapped and killed. It is generally believed that Venezuela has the highest murder rate in the world in a nation not at war. In fact, crime rates are so high that the government no longer publishes data; however, it is estimated that a murder is committed every 21 minutes.

In 2009, the homicide rate of 75 per 100,000 people was four times higher than Iraq! The latest report, in 2013, indicated that there are 122 homicides per 100,000 in Caracas.

Although crime was becoming an increasing problem during Chavez’s reign, it never became much of a political issue for him because of his popularity. Essentially, Chavez was able to overcome the problems of the economy and crime due to the force of his personality. Maduro is struggling to replicate that power.

Over the past month, civil unrest has been increasing, with large protests and counter protests developing. Although these protests are substantial, at this point, we would not expect the opposition to gain control from this dissatisfaction. Instead, the protests may lead to new leadership from within the coalition that Chavez created.

In this report, we will examine the underlying structure of Venezuela’s political system, showing the divisions that exist. We will compare and contrast how Chavez was able to manage these divisions and how Maduro is struggling to replicate his success. We believe the opposition is not capable of ousting the Chavez-inspired leadership. Thus, any changes that occur will come from within the coalition. As always, we will conclude with potential market ramifications.

The Coalition

Chavez created an umbrella group of socialists called the United Socialist Party of Venezuela (PSUV). Eleven parties are in the coalition. A dozen other leftist parties declined membership, although they remain ideologically sympathetic to the PSUV. For many of the groups that decided not to join, concerns about corruption and the high crime rate led them to remain independent. In the last election, the coalition did gain a majority of seats but did not capture a two-thirds majority, thus limiting the power of the PSUV.

Like most dictators, Chavez maintained power by manipulating various power centers within the country. Essentially, there are three major groups within the power structure. These are the ideological left, the military and the technocracy.

The Left: There are a number of figures within this group. The most important is Maduro, simply because he was hand-picked by Chavez. However, Maduro didn’t get the nod because he was the most powerful candidate. In fact, it is quite likely he got the nod because he was not a threat to Chavez. Maduro was the foreign minister and spent most of his time in Cuba. It would not be surprising that the Castro brothers encouraged Chavez to select Maduro because he was aligned with their interests. Like most dictators, Chavez eliminated or marginalized any potential replacements and so, with his passing, Venezuela will be run by someone who is probably unsuited for the task.

Other prominent leftists include Chavez’s older brother Adan, who is the current governor of the Venezuelan state of Barinas. Adan is a more doctrinaire leftist and thus less popular. Elias Jaua, the current foreign minister, was a long-serving vice president under Chavez. Jaua supports the pre-Raul Castro model of Cuban socialism which would entail full state control of the economy and little tolerance of dissent. Because Jaua has his own base of support, Chavez eliminated him as a candidate.

The Military: The second major power center in Venezuela is the military. Chavez himself had a military background. In 1992, as a lieutenant colonel, he led a coup against the government of President Carlos Andres Perez. The coup failed; after a short stint in prison, Chavez entered public life and was elected president in a landslide in 1998.

Chavez was leery of the military; as his own history shows, the military can spawn coups that might overthrow the government. In fact, a military coup in 2002 briefly ousted Chavez. After that event, Chavez changed the military from an apolitical professional force to an instrument under state control. He systematically purged high level officers who were thought to be disloyal. He also introduced a rather large contingent of Cuban military figures who have been placed in training and intelligence roles. The Cuban presence has not been popular with many officers; those who oppose the “Cubanization” of the military usually find themselves facing retirement. Venezuela implemented a “two-year or out” promotion program. A soldier that fails to be promoted within two years is forced out. This makes it easy to push out disfavored soldiers and allows loyalty to be rewarded.

Finally, Chavez created a paramilitary group, called the “Bolivarian Circles,” consisting of lightly trained citizens, armed by parts of the military, who stand guard, ready to protect the fatherland. In reality, the circles were created to build a popular bulwark against a military coup. As we will note below, they have been used lately to intimidate political opponents.

The Technocrats: The last power center that supports the socialists is the sympathetic business sector. Although most of the private sector industrialists oppose Chavez on principle, the quasi-public sector companies tend to be aligned with Chavez. The biggest of these is PDVSA. Prior to Chavez taking office, PDVSA was a well-functioning oil company, one of the most professional state-owned oil companies in the world. It was also described as a “state within a state”; in other words, its workers, budget and management operated with little interference from the government of Venezuela. This status ended in 2002. In December of that year, PDVSA management went on strike, opposing Chavez’s attempt to exert control over the company. Chavez fired 19,000 workers, replacing them with soldiers, foreign workers and PDVSA workers sympathetic to his movement. Since this event, PDVSA has been firmly controlled by the government. Ali Rodriguez, the former oil minister and former president of PDVSA, and current PDVSA President Rafael Ramirez best represent this group. Both men are considered loyal to the regime and offered Chavez a degree of professional management of the critical oil industry.

The regime heavily regulates the economy; as seen in all governments, regulation tends to create winners and losers. A politically well-connected businessman can reap huge rewards in a heavily regulated economy. These people receive preferential treatment on foreign exchange, contracts, and, perhaps most importantly, the elimination of competition. Regulation raises the cost of doing business and favored companies usually avoid some of these costs that fall on their competition. Thus, favored companies are seldom efficient but usually quite profitable. The technocrats are benefiting from the current regime and will support it, but they would become a target if a strongman from the left were to emerge.

The Current Crisis

Maduro is a member of the left. He is more ideological than Chavez but clearly not as personable. So far, he has the allegiance of the other two groups. However, there is some evidence to suggest Maduro is facing threats within the coalition.

The head of the National Assembly, Diosdado Cabello, is perhaps the most potent threat. Cabello participated in Chavez’s 1992 coup. A member of the armed forces, Cabello has been part of the Chavez regime from its beginning, holding various positions in government, including Chief of Staff, Vice President, Governor of Miranda State, Interior Minister and Infrastructure Minister. He was instrumental in the creation of the Bolivarian Circles and reports suggest he wields significant influence within these groups.

Last October, Maduro petitioned the National Assembly for an “enabling law” that would allow the president to rule by decree. Chavez had made this request numerous times during his tenure and it was always granted rather quickly. The Assembly made Maduro wait six weeks before the measure was granted; since Cabello runs the legislature, it would appear he purposely delayed the vote. Recently, Cabello traveled to the border state of Zuila and announced the “retirement” of a number of military personnel who allegedly were involved in smuggling.[2] As an analogy, this would be similar to Rep. Boehner or Sen. Reid firing an American general. In addition, Cabello has started a regular television show to talk about national political issues; Chavez had a similar program. Cabello has also met with opposition leaders, including Leopoldo Lopez who was recently arrested by the regime.

Simply put, Cabello’s recent actions look presidential. Firing military members is what a commander-in-chief does; so is presenting a television show that mimics the one Chavez hosted. And, meeting with opposition leaders is usually a role reserved for the nation’s executive, who tries to maintain unity. Cabello initially backed Maduro after Chavez designated him as successor; it appears that Cabello may be concluding that Maduro isn’t up to the job.

Maduro isn’t standing still. He recently replaced the heads of domestic intelligence and military intelligence with members of Maduro’s palace guard. Clearly, he is trying to put loyalists in place in critical intelligence areas. There are rumors that Cuban troops have been deployed to Venezuela; since Cabello is part of the military wing in the coalition, the presence of Cuban troops may indicate Maduro is not sure of the military’s loyalty.

There have been rumors of a military conspiracy to remove Maduro from office. What has been surprising is that there have been few comments from the power centers of the PSUV, which may indicate there is some substance to the reports. The lack of comments probably means that if the coup conspiracy is true, then members of the ruling coalition are behind it.

The Opposition

Last April 14th, presidential elections were held, with Maduro running against Henrique Capriles Radonski, the governor of Miranda state.[3] As noted above, the results were remarkably close, with Maduro only winning by a 1.5% point margin (50.6% versus 49.1%). Given that Chavez had beaten Capriles by nearly 11% points in the previous November elections, the result was a shock. It should be noted that Venezuelan elections are far from a fair fight; the state media clearly favors the PSUV candidate. Government workers are given time off to campaign for the coalition candidate and are threatened with job losses if the PSUV candidate loses or if it is determined the worker did not vote “correctly.” In addition, the PSUV conducted a campaign that effectively deified Chavez, with Maduro dressing and speaking like the dead president. Even with these advantages, the personality-challenged Maduro barely won.

Although Capriles protested the results and demanded a recount, a full accounting never occurred. Opposition members of the National Assembly were told they could not address the legislature unless they acknowledged Maduro’s victory.

The April elections basically revealed two key points. First, the coalition Chavez constructed was designed to be managed by Chavez. He was best able to manage the competing groups in the coalition and keep all parties “on board.” We believe Chavez picked Maduro to succeed him in part because he believed that, if by some miracle Chavez survived, Maduro would not be a threat. Unfortunately, Maduro may not have the skills to manage the coalition. Second, Venezuelans are effectively split 50/50 on their support for the government. However, the opposition is hopelessly divided; the only issue that unifies the group is its opposition to the PSUV.[4] Thus, there is a high degree of dissatisfaction, but, so far, the opposition has not been able to harness that unhappiness to win at the ballot box.

This is why the apparent growing divisions within the PSUV are so important. Under Chavez, the PSUV was unified, even with the aforementioned divisions. Chavez mastered the skill of making all three components feel he was “one of them.” At the same time, Chavez was able to successfully characterize any opposition to his rule as “evil imperialists.” He was also able to use the U.S. as a foil; George W. Bush appeared to support the 2002 coup, which allowed Chavez, in a fashion similar to Fidel Castro, to blame Venezuela’s domestic problems on the U.S.

Chavez’s treatment of the opposition is also worth noting. He tended to use belligerent language when referring to the opposition but his actual treatment of the figures and groups opposing him was reasonably even handed. He allowed the opposition to operate and rarely used state power to arrest leaders or thwart protests. To some extent, Chavez’s behavior suggests a high degree of confidence in his position. The same cannot be necessarily said about the current regime. If divisions exist within the coalition, the leadership may be more prone to overreact to civil unrest. In fact, they may use Chavez’s harsh rhetoric to justify their actions. Thus, the odds of violence may be higher than during Chavez’s reign.

Maduro is clearly struggling to keep the coalition together. Although Cabello is emerging as a threat, it isn’t obvious whether he will be any more successful in managing the coalition than Maduro. We doubt the left will support Cabello, and if he tries to oust Maduro a conflict between coalition members is not out of the question.

Unfortunately for Maduro, he appears to be facing an internal threat from within the coalition with deteriorating economic and social conditions. The reaction to the aforementioned coup rumors are telling—if the coup was being engineered by the opposition, we would expect Maduro and the PSUV to be loudly denouncing the plotters and widespread arrests would be undertaken. The lack of comment suggests that the coup rumors, if true, are likely coming from within the PSUV.


Although the unrest in Ukraine is receiving most of the media’s attention, the growing unrest in Venezuela may be as important. As noted above, Venezuelan oil production has been declining for some time and will likely continue to decline until the PDVSA is no longer treated as the funding arm of the government. Still, if the country’s 1.1 mbpd of output were lost, a short-term lift in oil prices would be likely. However, with rising North American oil production and some excess capacity available in Saudi Arabia, the oil price rise should be contained…unless it occurs simultaneously with other outages. Recently, we have seen outages in South Sudan, Nigeria, Iraq, Iran and Libya. Adding Venezuela to the list will lift prices.

If there is a potential upside to the Obama administration’s seemingly turn to neo-isolationism, Maduro’s suggestion that the U.S. is interfering in Venezuela is hardly credible. Thus, Maduro will not have the “U.S. crutch” that Chavez was able to deploy.

For investors, the key issue is oil. The West will prevent a major spike in oil from occurring, simply because there are Strategic Petroleum Reserves that can be released if prices begin to rise sharply. However, it is more difficult to react to a slow, steady increase in prices with reserves. The problems in Venezuela improve Saudi Arabia’s position within OPEC; it also shows the need for increased oil production in the U.S. and Canada.

Bill O’Grady

March 3, 2014

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

[1]There are two official rates, 6.3 and 11.8 bolivars per dollar. The black market rate is estimated at 87.0 bolivars per dollar.

[2]Given the degree of corruption in Venezuela, this charge is highly likely.

[3]Capriles defeated Cabello in the 2008 election for governor.

[4]This became apparent in the 2002 coup attempt against Chavez. Once Chavez had been removed from office, the coup instigators could not agree on a new leader or plan of action.

© Confluence Investment Management

© Confluence Investment Management

Read more commentaries by Confluence Investment Management