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When Hugo Chàvez was inaugurated as president of Venezuela in January 1999, there was a general view among pundits that his autonomy would be severely limited by low international oil prices. In 1998, the Economist had even pondered on a world economy in which the oil price might fall to $5 a barrel. Because Venezuelan oil is more expensive to extract than most middle-eastern oil, questions were even being asked locally whether there would be any oil revenue left over for the Venezuelan government once the ample costs of the state oil company, Petroleos de Venezuela SA (PdVSA), had been paid.

Just over seven years later, the Venezuelan economy is booming and Chàvez has enough oil income left over from domestic demands to offer quite large amounts of money to such beneficiaries as poor people in the United States and political allies in Latin America. In the meantime, the actual amount of oil being produced in Venezuela has decreased, and the growth of (highly subsidised) domestic oil consumption means that exports have contracted at an even greater rate.

These past few years in Venezuela offer an extreme example of a theme that recurs in many countries in Latin America. With the important exception of Mexico, most of the region still depends substantially on the export of commodities whose prices fluctuate dramatically and unpredictably.

Capital markets reinforce these fluctuations. The president of a country whose export prices are going up is a hero to international lenders. When export prices go down, he is a villain – or at least an inadequate manager who needs to run a tighter ship. Domestic electorates, too, show a marked preference for big-spending governments over those having to manage scarcity. Exporter countries can no doubt do something to ease the resulting instability – but usually they don't do very much, at least not in Latin America. They certainly cannot plan or forecast with any degree of reliability. Future price trends are always unknowable.

There is of course more involved in Venezuela than the commodity lottery – or else Chàvez would not be so controversial a figure – but it is a key underlying issue. In key respects, Chàvez is a beneficiary, who knows whether temporary or not, of the bungled invasion of Iraq and the fallout from hurricane Katrina (it might be expected that he would have been more appreciative of the help that he has unintentionally received from George W Bush).

The key to understanding the Chàvez administration is as much its situation as its policies. True, happy economies are not always happy in the same way, but there are real resonances with other countries enjoying commodity booms, not least with Venezuela itself in the high oil-price days of the 1970s.

At that time a reforming president called Carlos Andrés Pérez (1974-79) nationalised the Venezuelan oil industry, supported sharp increases in international oil prices, backed the Sandinista insurgency in Nicaragua, denounced the United States administration, and called for a "new international economic order". In a second term (1989-93), a re-elected Pérez became a stern economic liberal, and the very man that Chàvez tried to overthrow by force in his coup attempt in 1992. Plus ça change…

There is another noteworthy but often overlooked characteristic of the Chàvez administration. His principal adversary, at least until very recently, has not been major international oil corporations but PdVSA, the state oil company itself. Venezuela nationalised its oil industry in 1976. Admittedly the nationalisation was significantly relaxed in the 1990s to permit the entry of foreign companies in a variety of guises, but when Chàvez took office PdVSA was the dominating influence in the Venezuelan oil industry and a hugely important influence over the entire Venezuelan economy. Under Chàvez's predecessor, Rafael Caldera, PdVSA was a major actor in the making of national economic policy, as well as dominating pretty much the entire energy industry.

The problem from Chàvez's viewpoint (and he was not alone), is that PdVSA had become a state within a state – or even a state above a state. It was nominally answerable to the Venezuelan government but it paid international salaries, played on an international stage, engaged in tax avoidance as ruthlessly as any private oil company, and was actively planning its own gradual privatisation.

PdVSA was respected by many Venezuelans, but a number of senior politicians – by no means only those on the left – resented its wealth and power. However, when Chàvez tried to bring PdVSA under political control, many of its managers lined up openly with the opposition. During 2002-03 PdVSA operatives struck twice against the government. On the first occasion, a settlement was negotiated. On the second, the oil workers went on strike with the avowed aim of weakening the economy in order to bring down the Chàvez government. They did so in open defiance of the supreme court as well as the elected government.

Chàvez responded to this strike in a way not unlike Margaret Thatcher's tactics during the coal miners' strike in Britain in 1984-85. He patiently withstood the disruption, waited for the return to work, then dismissed a large number of strikers (though he relented by allowing some of them at least to return to their positions).

PdVSA has now resumed its operations. It is more cheaply and austerely run than before, but also less efficient and less proud: in short, a much weaker organisation. It has become better as an instrument of wealth redistribution but worse as an instrument of wealth creation. While capable of maintaining its existing operations, it seems to have lost some of its ability to develop new and more difficult aspects of the industry.

Venezuela's oil industry is at present basically stagnating. As a result, the Venezuelan government will find that it needs to deal with the private capital that it dislikes if it is even to maintain, let alone (as it hopes) increase, national oil output. Rising international prices have so far enabled it to negotiate toughly with private companies without driving them away altogether. However oil prices will not go on rising forever and Venezuela's need for investment will tend to increase. Venezuela may hope to play a Chinese or some other wild card, but there are few philanthropic organisations in the oil world. Whoever goes to Venezuela to invest will expect to make a profit and will be sensitive to the political outlook.

Overall, Hugo Chàvez has engaged in large-scale public spending in the way that previous Venezuelan governments have done at a time of high oil prices – though he has shown more interest than most of his predecessors in redistributing, rather than just recycling, oil wealth. Whatever the effectiveness of his policies, he is making a genuine effort to help poorer Venezuelans and this is appreciated by the majority of the electorate.

Nevertheless, Venezuelan dependency on high oil prices remains. Venezuela does have enough financial reserves to cope with a short downward blip in oil prices, but a sustained weakening would cause the country great difficulties. Meanwhile, the question of how Venezuela can maintain or increase oil production with a weakened state oil company and an acquired reputation for high-handedness in dealing with private oil companies remains unanswered.

George Philip is professor and reader in Latin American politics at the London School of Economics. Among his books is Democracy in Latin America: Surviving Conflict and Crisis? (Polity, 2003). Petroleumworld not necessarily share these views.

Editor's note: This commentary was originally published by Open Democracy, on May 24, 2006. Petroleumworld reprint this article in the interest of our readers. Petroleumworld not necessarily share these views.

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