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A Blessing or a Curse? How the Discovery of Oil Changes Growth Outlook

In the 1970s, Venezuela was one of the world’s wealthiest economies with its immense wealth directly attributable to its considerable oil reserves. However, in 2022, it now ranks 176/180 countries in terms of economic freedom [1] and as of 2021, ranked 3rd last in the Global Corruption Index of every country. [2] This fundamental decline in economic strength and governance has been matched by a rise in corruption, hyperinflation, loss of property rights and the collapse of the law. After oil was discovered in the country in the 1920s, there was an influx of international oil companies interested in the relatively easily accessible large oil reserves, good quality crude, close proximity to the major refinery hubs in the US Gulf and the then stable Government. By the 1930s, just three foreign companies—Royal Dutch Shell, Gulf, and Standard Oil—controlled 98% of the Venezuelan oil market. [3]


In 1960, Venezuela joined OPEC [4] and established the country’s state oil company Petroleos de Venezuela SA (PDVSA). One of its first steps was to increase the three international oil companies' revenue tax to 65%. In 1973, a five-month OPEC embargo on countries backing Israel in the Yom Kippur War quadrupled oil prices and made Venezuela the country with the highest per-capita income in Latin America. Over two years the surge added $10 billion to state coffers, which led in turn to rampant corruption and mismanagement. Analysts estimate that as much as $100 billion was embezzled between 1972 and 1997 alone. [5]


When Hugo Chavez was elected as President in 2003, 19,000 employees of PDVSA were fired [6] after they went on strike and were replaced by hard loyalists to Chavez. This coincided with rising oil prices in the market and triggered Chavez’s eagerness to reap some of these profits by removing the power of private oil companies such as BP, Exxon and Shell in order to gain majority control of these projects and by default the largest revenue share. As a direct result of this hollowing out of qualified experienced engineers in PDVSA and the three international oil companies withdrawing key personnel, the country suffered a significant fall in its ability to both extract and refine the oil into motor fuel. This caused the dual effect of not only having less crude oil to sell to generate the much-needed revenue for the state coffers but also simultaneously a decrease in domestically produced road fuel so the country was forced to import more fuel, therefore, increasing its national debt. This exacerbated the existing hyperinflation and resulted in Venezuela essentially becoming a failed Petro state that was unable to repay its government bonds on the international market and led to a mass exodus of its population abroad in search of better lives.


For many reasons, oil has proved to be a curse for Venezuela. On the other hand, Saudi Arabia has consistently been one of the world’s largest producers of crude oil, supplying more than 10% [7] of the world’s output and the country contains a quarter of all proven reserves. [8] The Saudi Arabian Government, backed by the dominant royal family, has successfully protected the country’s economy against the potentially damaging effect of oil price fluctuations by strict management of its oil production through its state Oil Company ARAMCO. [9] ARAMCO carefully matches supply to global demand, therefore doing all it can to help support a high price per barrel [10] on the world markets, and thus maximise the country’s revenue. ARAMCO executes this supply management strategy through the OPEC organization of which Saudi Arabia is the most significant member. Furthermore, ARAMCO always attempts to have the spare production capacity to give the country flexibility to increase capacity in times of a global crisis, such as with the global soaring costs of energy driven by the Ukraine conflict and covid pandemic. This led to a doubling of ARAMCO’s profits in 2021. [11]


The Saudi Arabian Government secured the wealth from oil by slowly buying back the shares of the then part private/part government-owned Saudi Arabian Oil Company (ARAMCO), until in 1980 it was 100% government-owned. [12] Unlike Venezuela, the Government nationalised their oil company but also continued to encourage private companies to operate in the area exploring oil fields. This had the result of strengthening the long-term economic growth that comes from oil, as private companies continued to innovate.


This approach is not foolproof, however, as several events beyond the Saudi Government’s control have caused price shocks, with an associated short-term decline in the country’s economy as global oil markets dip in value. In recent years this has led the Government (under the governance of the royal family) to create and develop a significant sovereign Public Investment Fund (PIF), with the oil revenue being invested to both sustain the economy in times of weak oil prices and further allow it to maintain its generous domestic welfare programme. This in turn increases the living standards of the population and reduces the likelihood of civil unrest leading to the potential ousting of the domineering royal family. The PIF holds an estimated $600 billion worth of assets [13] and, like the Norwegian wealth fund, it preserves the long-term benefit from the oil wealth for future generations.


In conclusion, Venezuela is an extreme example of a country that has suffered from the resource curse. Dictatorships and poor independent legal enforcement have led to short-term populist policies that have essentially bankrupted the country. The myopic policies of the Government have led to the demise of long-term economic growth as the economy has not diversified, and therefore remains primarily dependent upon the fluctuating price of oil. This has all led to mass unemployment, significant population emigration and hyperinflation leading to extraordinarily high costs of living.


In contrast Saudi Arabia, whilst being dominated by a royal family akin to a dictatorship, has managed to navigate successfully the risks associated with its significant oil reserves. It has not only established a significant sovereign wealth fund but has managed to maintain a significantly high standard of living for its population despite the country coming 52nd in the global corruption league (for comparison, Norway places 4th in the same league [14]). Despite this level of corruption, oil has still proved overall to be a blessing to the county and its population.

 
References:

[1] https://www.fraserinstitute.org/economic-freedom/graph?geozone=world&min-year=1970&max-year=2019&countries=BWA,COD,VEN&page=graph&area1=1&area2=1&area3=1&area4=1&area5=1&type=line


[2] https://www.transparency.org/en/cpi/2021


[3] https://www.cfr.org/backgrounder/venezuela-crisis


[4] https://www.opec.org/opec_web/en/about_us/25.htm#:~:text=The%20Organization%20of%20the%20Petroleum,Founder%20Members%20of%20the%20Organization


[5] https://www.cfr.org/backgrounder/venezuela-crisis


[6] https://www.cfr.org/backgrounder/venezuela-crisis


[7] https://www.jstor.org/stable/42919278?searchText=how+saudi+arabia+transformed+economy+through+oil&searchUri=%2Faction%2FdoBasicSearch%3FQuery%3Dhow%2Bsaudi%2Barabia%2Btransformed%2Beconomy%2Bthrough%2Boil%26so%3Drel&ab_segments=0%2FSYC-6294%2Ftest_segment_1&refreqid=fastly-default%3A8b9a398ff9fa3011afd83a7b4ffe0e29&seq=1


[8] https://www.jstor.org/stable/42919278?searchText=how+saudi+arabia+transformed+economy+through+oil&searchUri=%2Faction%2FdoBasicSearch%3FQuery%3Dhow%2Bsaudi%2Barabia%2Btransformed%2Beconomy%2Bthrough%2Boil%26so%3Drel&ab_segments=0%2FSYC-6294%2Ftest_segment_1&refreqid=fastly-default%3A8b9a398ff9fa3011afd83a7b4ffe0e29&seq=1


[9] https://www.aramco.com/?utm_source=googleads&utm_medium=ppc&utm_campaign=GO_GB_Brand_EX&gclid=CjwKCAjwgr6TBhAGEiwA3aVuIdLfuLWrlvcAPN2NMOU0qhFeZFWAs7ZuCrp5cl5I29aGOoYO62FplhoCy2kQAvD_BwE


[10] https://www.aramco.com/?utm_source=googleads&utm_medium=ppc&utm_campaign=GO_GB_Brand_EX&gclid=CjwKCAjwgr6TBhAGEiwA3aVuIdLfuLWrlvcAPN2NMOU0qhFeZFWAs7ZuCrp5cl5I29aGOoYO62FplhoCy2kQAvD_BwE


[11] https://www.aljazeera.com/news/2022/3/20/saudi-aramco-says-annual-profit-more-than-doubled-in-2021#:~:text=Saudi%20giant%20says%20its%20net,with%20%2449bn%20in%202020.&text=Energy%20giant%20Saudi%20Aramco%20says,from%20a%20pandemic%20induced%20downturn


[12] https://www.aramco.com/?utm_source=googleads&utm_medium=ppc&utm_campaign=GO_GB_Brand_EX&gclid=CjwKCAjwgr6TBhAGEiwA3aVuIdLfuLWrlvcAPN2NMOU0qhFeZFWAs7ZuCrp5cl5I29aGOoYO62FplhoCy2kQAvD_BwE


[13] https://www.pif.gov.sa/en/Pages/AboutPIF.aspx


[14] https://tradingeconomics.com/country-list/corruption-index

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