The delivery of five cargoes of gasoline from Iran to Venezuela is certainly a major act in the theater of the absurd (or perhaps macabre) that is the government of Venezuela. The two countries have formed an alliance partly based on the shared circumstances of being subject to U.S. sanctions, as well as the mutual antagonism between them and the U.S. But that the country with hundreds of billions of barrels of oil reserves must import a million barrels of gasoline demonstrates just how badly managed the country, and especially the national oil company, Petroleos de Venezuela, have been.

The dominant driver of the fall of Venezuela can be found in the country’s politics and the split between the educated elites and the leftist opposition. President Hugo Chavez waged war on the established elites, including inside Petroleos de Venezuela, treating a vast class of technocrats as political enemies to be expunged, replaced by loyalists (often from the military). This ignored one of the greatest leadership maxims: loyalty is no substitute for competence.

He also tragically failed to learn from his predecessors’ failings (and successes), including those of presidents Carlos Andres Perez and Rafael Caldera. The former had the advantage of ruling during the first oil price boom of the 1970s, but his administration blundered as described in Terry Lynn Karl’s The Paradox of Plenty. CAP, as he was known, wanted to vault the country into the league of industrialized nations and ignored the advice of the technocrats that he was too ambitious, labeling them ‘dinosaurs’ and circumventing them by gathering power inside his office. When the oil price collapsed, the country was burdened with massive projects that were inoperative due to poor planning and lack of funds.

Hugo Chavez repeated those mistakes very precisely, convinced that any disagreement with his plans had its origins in political opposition and insisting that his ideology was so superior that it could overcome all technical problems. (This is common with ideologues and populists; Mussolini always sent underequipped soldiers into battle claiming fascism would provide victory.) Chavez’ firing of the senior management of Petroleos de Venezuela, which triggered a strike and mass dismissal of most managers and skilled professionals, crippled the company. Oil production is now about 20% of the level when he took office.

Oil production and refinery output have suffered spectacularly because of lack of maintenance. Refining began in the 1860s with equipment similar to that of moonshiners—cooking the oil and condensing out the desirable light products, namely kerosene. (There was no market for gasoline: Grant marched on Richmond, he didn’t lead a convoy of SUVs). Modern refineries still perform this basic function, but with instrumentation and chemicals that optimize production. Neglect those and output will decline, both absolutely and relative to inputs, the plants ultimately becoming not just inefficient but inoperable.

A little history can point to a way out. Rafael Caldera, as president in the 1990s, initially implemented socialist economic policies, including trying to tame inflation with price police. Unlike his successor Chavez, he learned his lesson and began a series of reforms, including what was called the apertura or opening which enlisted the private sector to boost oil production. This was a great success, with production soaring by a million barrels a day in a few years, before Chavez came to power. Much of this increase was not due to Orinoco oil projects but just allowing entrepreneurs to take over so-called ‘marginal fields,’ redevelop them and boost production.

So, the Maduro regime could repeat this, but hopefully with one change: perform the most basic maintenance and refurbishing of refineries, but give priority to oil production. Historically, the refining sector has been much less profitable than oil production, especially in resource-rich countries like Venezuela. Unfortunately, governments often emphasize investment in refineries as if they were strategic businesses, which has not been true for a long time.

After the 1951 nationalization of BP’s holdings in Iran, the shutdown of Asia’s largest refinery at Abadan created product shortages and encouraged a move towards ‘refining on the consumer’s doorstep.” Later, in the 1980s, many OPEC countries wanted to have their own downstream sector to provide them with ‘value-added’ for their raw materials and ‘demand security.’

Both rationales have some validity, but in periods when the downstream sector is depressed (as with the current situation), it is much more profitable to sell crude, buy products, and invest the savings elsewhere. As the figure below shows, refinery capacity utilization has rarely been close to the 90% range, even for OECD nations, that result in profitable operations. The demand downturn this year will send utilization plummeting by 10% globally, from 83% in 2018 to below 75%. For those looking to invest in refineries, it is a buyers’ market but far better to purchase a unit being sold by a financially distressed operator than to build anew into a very bearish market.

Unfortunately, this basic lesson in microeconomics is often lost on politicians with the most recent example being Mexican president Andres Manuel Lopez Labrador, who is planning to sink $8 billion into a new refinery, basically to avoid the unpleasant optics of importing gasoline. He would be better off importing the gasoline and paying spin doctors to explain the benefits then spending much needed cash on what could prove a very costly white elephant.

Source » forbes