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An Analysis of Chinese Investment in Venezuela, Part 1

Written by Jacob Anderson, Master of International Policy Candidate

Introduction

The rise of the People's Republic of China dominates the headlines and conversations amongst leading national security members globally. Its military, political, and economic power has grown from being a country wrecked by violence and instability in the late 1970s to second only to the United States when this report was originally written in April 2016. There is much concern among many of the established powers, especially the United States and its Pacific allies, about both the scope and the speed of China’s rise, and the implications of a suddenly multipolar world. Much of the traditional realist narrative would say that owing to China’s sudden power glut and its opposing ideology to the United States, a conflict between the two would be natural.

Of particular concern has been China’s economic rise and the incredible consumption of natural resources which has both driven and resulted from that. In 2008 alone, the People’s Republic of China (PRC) used 22.6 billion tonnes of total raw materials, including over 5 billion tonnes of fossil fuels, mainly coal and gasoline. In an economy of scarcity, one might assume that China’s consumption of all these resources would exacerbate issues for any other developing or developed economies. In addition, one of the PRC’s primary investment targets has been Venezuela. Since 2002, Venezuela has been led by a leftist government that has explicitly sought to counter U.S. influence. Much public discourse has been directed towards the significance of this, particularly the idea that this represents a facet of the inevitable conflict between the People’s Republic of China and the United States of America.

A closer look challenges this idea, however. Venezuela has lost much of its influence in the last two years thanks in part to cratering oil prices and resultant political instability in the energy export-dependent country. Additionally, despite its tremendous potential, Venezuela is not China’s main energy partner. Yet China still has invested more heavily into Venezuela than any other country in Latin America; as of 2015, Chinese banks had made 17 loans to Venezuela, totaling $65 billion. This paper will examine the question of whether investment by China in Venezuela represents a challenge to U.S. hegemony and security and provide an answer with the available information and literature. First, it will explain the crisis in Venezuela and its causes, then it will examine the potential gains and losses for the China Development Bank and possibly other players in the PRC's political-economic system. Ultimately, this paper will argue that while there is a geopolitical element to Chinese investment in Venezuela, it is driven primarily by business and not ideological or military concerns.

The Challenges Facing Venezuela

Throughout the early 2010s, both crude oil prices and the political and economic clout of the PRC were growing rapidly. The OPEC Basket price for crude oil was at $69.08/barrel, more than double its 2003 trading point of $28.10/barrel. Venezuela’s GDP had accordingly more than doubled as well, from $3,233.96 per capita in 2003 to $8,325.22 in 2007. President Hugo Chavez was popular enough that he could propose a constitutional referendum abolishing term limits, theoretically allowing him to rule indefinitely, and had a fair chance of it passing democratically. Meanwhile, Venezuela was producing over 2.5 million barrels of oil per day, while consuming just over five hundred thousand barrels per day.

At the same time, the People’s Republic of China also found its economic outlook growing rosier. It found itself looking to expand its power and economic base, and perhaps to share its good fortune. Indeed, 2007 to 2009 could arguably be called the period in which China “arrived” in the American public consciousness as not a rising power but a risen power. Its aid, investment, and business in Africa and other parts of the developing world were raising concerns about long-term strategic partnerships with these nations. Furthermore, the PRC’s oil production had been hovering between 3 to 4 million barrels a day for the entire decade, while its oil use had climbed from about 5.5 million barrels per day in 2003 to around 8 million barrels per day in 2007. China’s rapidly growing economy was using tremendous amounts of natural resources, and oil was at the top of China’s economic wishlist. Venezuela was, as a result, a natural investment target, especially considering that its president was causing many developed nations such as the United States and the European Union to turn their backs on Venezuela to a degree. Meanwhile, China’s thirst for oil and its legacy of stated non-interventionism in other nations’ domestic affairs made the Asian nation an appealing business partner for Venezuela.

A decade later, however, the entire arrangement is in dire straits. To begin, the price of oil has cratered lately. OPEC basket prices are sitting at $36.04/barrel, their lowest point since a 2009 crash. However, unlike the 2009 crash, which was caused by price inflation and market over-speculation, and thus quickly recovered from, this price crash looks to continue for the foreseeable future. This is because the crash has been caused by a combination of international politics and simple economics, rather than anything more fine-tuneable or complex. The issue began with the lifting of U.S. and European sanctions on Iran, freeing Iran up to sell its oil legally to these two huge markets, which previously had been primarily OPEC customers. Additionally, the Russian Federation has tied much of its current economic plan to the sale of oil to Europe and Asia. Iran is a long-standing foe of Saudi Arabia and the other Gulf States such as the UAE and Bahrain, who compose a significant portion of OPEC and who also have considerable oil reserves and production. In an effort to drive the Iranians, their constant enemy, and the Russians, who are supporting an opposing faction in the Syrian Civil War, and likely also partially out of economic panic, the Arab members of OPEC have refused to slow or halt production, keeping supply high. Meanwhile, thanks to shale gas, the United States is producing and even exporting much more of its own oil, reducing foreign shares of what was once a key oil market. Meanwhile, oil prices are not expected to fully recover for years, meaning there is no relief in sight for PDVSA, the Venezuelan state oil agency.

With so much focus on oil being the nation’s primary source of income, other industries and economic sectors went largely by the wayside. Farming, in particular, has been hard hit, with farmers in Venezuela barely able to feed their own communities, let alone the nation at large. Even if they could, though, government policy forces them to turn over their excess to the government and sell what they have at a loss. These have led to a general meltdown of the Venezuelan socio-economic order. Venezuela’s GDP shrank in 2016, which meant there was a constant economic downturn since 2014. Further, every major indicator of a negative economic environment is running rampant. Inflation is skyrocketing, and the government has found itself committing the response of printing more money to try to compensate, rather than cutting back the money supply to increase value. Furthermore, though it is difficult to measure, corruption in Venezuela is regarded as being among the worst in the world. Certainly, despite all the money poured into the Venezuelan oil market, primarily into PDVSA, there has been a minimal increase in actual oil production. Between 2005 and 2014, there was actually an overall decrease in Venezuelan oil production numbers, which does not indicate effective investment. Overall, Venezuela is rated as one of the world’s worst countries to do business or invest in.

The political and social situation in Venezuela makes this even more difficult. Protests have wracked the country almost unabated since 2014, deepening the political divide between the Chavistas and the political opposition. Furthermore, the Chavista wing of the government and the opposition have fought through the courts and legislative body to try to limit or subsume the power of the other party. President Maduro’s popularity rating is astoundingly low, about 33% by recent polls, with almost 64% of polled Venezuelans saying he should be removed from office or quit before the end of 2016. Also discouraging economic activity in Venezuela is the high prevalence of violence; Caracas has been declared the world’s most dangerous city, with murder rates at over 120 homicides per 100,000 citizens.

Though China’s continued economic development means they will continue to need and use more energy, the smog crisis in its largest cities and other environmental concerns have led China to take measures that will reduce its environmental impact in several ways, including using fewer fossil fuels. The PRC is investing over $2.5 trillion in “green tech,” and is instituting a new tax on fossil fuels. In fact, China is the world’s leading investor in green technology, spending almost twice as much as the United States. One of the key areas of Chinese green-tech investment is in public transportation, where the PRC’s Ministry of Transport says there are already 50,000 alternative energy vehicles on the road and established a goal of 200,000 by 2020. Thus, it is quite likely that the days of extracted crude oil as a fuel source are numbered. Regardless of the economic or environmental impact of crude oil extraction and usage, public opinion in many of the largest oil markets has quickly turned toward green tech and alternative energy sources. Though the timetable can certainly be debated, there is no doubt that at some point it will decrease in value simply due to a decrease in necessity and demand, further increasing troubles for oil-based economies.

Dispelling Common Assumptions

During the height of Chavez’s presidency, western pundits often claimed that China was forging a partnership with Venezuela in order to form a strategic balance against the United States in Latin America. Much of this argument centered around the success of the “Pink Tide”, a shift towards left-wing governments, in Latin America and the natural resources that investment targets such as Venezuela, Brazil, and Peru could provide. However, there was little other than rhetoric to support this idea. Venezuela continues to spout off anti-American rhetoric, but with regards to the region, China has been dead silent. Indeed, the rhetoric China has engaged in has been ocean rights, and even that has been more of a multilateral legal discussion than confrontations or provocations. Military sales by China to Venezuela have been similarly limited to a few transport and counterinsurgency aircraft and some armored cars, hardly the kind of arsenal that would allow Venezuela to challenge U.S. military hegemony. If China’s primary goal had been to directly counter the U.S.’ power and influence in the region, they would have little success with these sales.

What the China Development Bank (CDB) and Others Have to Gain

The CDB would not continue to invest in Venezuela if there were not significant upsides. To begin, Venezuela has a considerable amount of crude oil in reserve, around three hundred billion barrels. Regardless of green tech investments or public desire, crude oil will continue to be a major source of energy for quite some time. Much of the CDB’s loans are “resource-backed” loans, meaning that they’re to be repaid in part in guaranteed oil deliveries, rather than in returned cash. Thus, by continuing to invest in Venezuelan oil, they continue to secure at least some guaranteed crude oil. This means they have at least some guaranteed energy or petroleum product material such as plastic or asphalt.

In addition to massive reserves of crude oil, Venezuela also possesses among the world’s largest reserves of natural gas. OPEC assesses the nations’ reserves of natural gas to be at over five trillion cubic meters, an amount which might have allowed it to corner the market were it not for the United States’s equally prodigious reserves. Projections based on current production ratios put Venezuelan gas reserves lasting 100 years, long past the point where fossil fuels are expected to be the primary source of energy for most of the world.

China in particular is a growing market for natural gas. Much of China’s smog issues are being blamed on its heavy use of coal for power, and as such, the government is attempting to encourage the switchover to cleaner-burning natural gas by closing coal mines and cutting the price for natural gas. As China tries to further cut down on its carbon emissions, further investment in sources of cleaner-burning natural gas in Venezuela is probable. As the CDB has historically been the primary Chinese investor in Venezuela, they are likely to take the lead on investing in Venezuelan natural gas.

Another key benefit of sourcing energy imports from Venezuela is comparative resource security. Venezuela has proven reserves, but so do Iran and Russia, both of whom are also close business partners with the People’s Republic of China. However, in terms of security of source and transit, Venezuela has a few distinct advantages. The region best known and most sourced for oil, both crude and refined, is of course the Middle East and North Africa. However, security in the region has always been a factor in the supply and price volatility of oil. Compared to this, Venezuela could seem fairly attractive if the political and economic sphere stabilizes.

What the CDB and Others Have to Lose With Investments in Venezuela

There are several potential downsides for the China Development Bank and the PRC as a whole if the bank were to completely pull out of its investments in Venezuela. First and foremost, the CDB has put an incredible amount of money into Venezuela almost singlehandedly. As of June 2015, Venezuela had received $65 billion in loans by the China Development Bank. Of those 15 loans by the CDB, the China-Latin America Finance Database lists eleven as being for the purpose of “energy,” a catchall term referring to any investment in the Venezuelan energy sector. The key here is that many of these loans are resource-backed loans. A famous strategy by Chinese investment banks, resource-backed loans involve a Chinese bank loaning money to a country, usually to a specific industry or sector, with guarantees that the loan will be paid back at least partially in resources, rather than in money. This means that continued loans to the Venezuelan energy sector mean continued guaranteed oil imports, regardless of price fluctuation, politics, or currency devaluations. For a nation with extensively documented energy and petroleum distillate needs, the loss of such a guaranteed source could pose risks to energy security.

Beyond this, there is the fact that increased U.S. sanctions on Venezuela leave relations between the two on the verge of collapse. Though much has been made of Chinese investment and business deals in Venezuela and elsewhere in Latin America, the United States remains Venezuela’s largest trading partner. In 2013, when Venezuela’s economic crisis began, 20% of Venezuelan exports went to the United States alone, and 23% of imports to Venezuela were sourced from the U.S. Comparatively, China’s share in these areas at the same time was 7.9% and 14%, respectively. Venezuela has little to offer the U.S. other than oil, it is unlikely that the U.S. will feel the economic need to reopen business with Venezuela any time soon. At this point, U.S. relations with Venezuela continue to sour.

Conclusion

There is no doubt that Chinese investment in Venezuela is an issue that will continue to raise questions around financial and political circles until it is finally resolved. Whether that is through the CDB abandoning its investment in Venezuela, the Venezuelan economy slowly recovering, debt restructuring or some other path has yet to be seen. There is no doubt, however, that the result of this period will have significant effects on the Chinese and Venezuelan economies. What should be evident from this paper, however, is that Chinese investment in Venezuela should not be seen as an attempt to directly challenge U.S. security interests in its’ own backyard, but rather as an attempt by China to take advantage of a strategic business partnership in a region not historically open to investment by great powers other than the United States.

Epilogue

This paper was written during the first five months of 2016. At that time, the situation in Venezuela was concerning, but not the humanitarian crisis it has become by this point. Since then, Venezuela has spiraled into totalitarianism in Caracas and staggering violence and poverty across the country. The pink wave that helped Venezuela and China build business and partnerships in the region has reversed, with center-right to right-wing governments now controlling several of the countries which once had aided the Bolivarian ideals of Hugo Chavez. Countries around the world are becoming more aware of the risks of development loans from the CDB and other Chinese lenders, and are more averse to them. In fact, there have been no new loans from any Chinese institution since 2016 to Venezuela. Venezuela itself has functionally collapsed, and even if democracy and business were to return to the country overnight, the nation would need to be rebuilt from the ground up. The United States remains the overwhelming power in the region with no peer competitors militarily and a tremendous political, cultural, and economic influence throughout the region. We are left with more questions, then: If China was willing to put so much money into Venezuela, why were they so willing to cut and run? Perhaps more important, what happens now?

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