The Devil's Excrement

This weekend President Chávez once again attacked the Central Bank over the amount of “foreign exchange profits” it should turn over to the Government. This continues to be an issue that is not resolved and highly controversial.

Essentially, Central Banks around the world began a few years ago publishing financial statements very much like those of a commercial banks, even if their purpose is not to make a profit but monetary stability. Every time there is devaluation, the foreign currency “purchased” by the Central Bank at the old price is “worth” more in terms of local currency. Thus, the bank “makes” a lot of money every time there is devaluation and it sells this foreign currency purchased at lower prices.

About four years ago, the Venezuelan Government asked the Central Bank to hand over those profits, which it did. This is not a common practice, in fact, it is forbidden by law in many countries. The practice itself is not considered negative by economists as long as handing over the foreign exchange profits fits the purpose of currency and monetary stability which the central bank has. The usual recommendation is that the practice does not become recurrent and that it not be done if it threatens the balance sheet of the Central Bank..

In Venezuela handing over these profits has become recurrent via the annual devaluation that has taken place in the last few years. In the first half of the year alone, the Venezuelan Central Bank transferred Bs. 1.5 trillion in foreign exchange profits, some US$ 781 million at the official exchange rate. A similar payment will be made in the second half. The problem here is that this already represents almost 5% of the funding for the Government’s 2005 budget. Thus, it becomes a vicious circle, as the Government needs to devalue again, even if oil prices are very high, because it has no other source for funding such a large piece of the budget.

The origin of the discussion is that now the Government wants to receive more of these profits and it is arguing that the Central Bank is using for the accounting of these profits LIFO (Last In First Out), rather than using FIFO (First In First Out). The Government wants to use FIFO, because then dollars obtained by the Central Bank last year or the year before at much lower exchange rates would be sold at the current one, thus the profits would be higher. In the Government’s proposal, the Central Bank would have to hand over Bs. 3.1 trillion for the first half of 2004, US$ 1.6 billion or 6% of next year’s budget. The Superintedent of Banks said today that these foreign exchange earnings may reach Bs. 8 to 9 trillion or 15% of next year’s budget which is a huge proprtion. I am not sure where this higher figure comes from, but it sounds too high to me.

Clearly, this would insure that next year there would have to be devaluation, as these profits may reach 10-15% of the national budget, unless oil prices skyrocketed even further. If the Government did not devalue, these profits would evaporate as the Central Bank rotates its inventory this year and fewer profits would be left over for next year. The Government would not have an alternate source of funds for such a large piece of the budget.

Chávez is threatening to go to the Supreme Court on the issue, while Central Bank Directors are calling for arbitration. In either case, the final result will be further devaluations and more inflation because of its recurrent nature. The only unknown is by how much.

This weekend President Chávez once again attacked the Central Bank over the amount of “foreign exchange profits” it should turn over to the Government. This continues to be an issue that is not resolved and highly controversial.

Essentially, Central Banks around the world began a few years ago publishing financial statements very much like those of a commercial banks, even if their purpose is not to make a profit but monetary stability. Every time there is devaluation, the foreign currency “purchased” by the Central Bank at the old price is “worth” more in terms of local currency. Thus, the bank “makes” a lot of money every time there is devaluation and it sells this foreign currency purchased at lower prices.

About four years ago, the Venezuelan Government asked the Central Bank to hand over those profits, which it did. This is not a common practice, in fact, it is forbidden by law in many countries. The practice itself is not considered negative by economists as long as handing over the foreign exchange profits fits the purpose of currency and monetary stability which the central bank has. The usual recommendation is that the practice does not become recurrent and that it not be done if it threatens the balance sheet of the Central Bank..

In Venezuela handing over these profits has become recurrent via the annual devaluation that has taken place in the last few years. In the first half of the year alone, the Venezuelan Central Bank transferred Bs. 1.5 trillion in foreign exchange profits, some US$ 781 million at the official exchange rate. A similar payment will be made in the second half. The problem here is that this already represents almost 5% of the funding for the Government’s 2005 budget. Thus, it becomes a vicious circle, as the Government needs to devalue again, even if oil prices are very high, because it has no other source for funding such a large piece of the budget.

The origin of the discussion is that now the Government wants to receive more of these profits and it is arguing that the Central Bank is using for the accounting of these profits LIFO (Last In First Out), rather than using FIFO (First In First Out). The Government wants to use FIFO, because then dollars obtained by the Central Bank last year or the year before at much lower exchange rates would be sold at the current one, thus the profits would be higher. In the Government’s proposal, the Central Bank would have to hand over Bs. 3.1 trillion for the first half of 2004, US$ 1.6 billion or 6% of next year’s budget. The Superintedent of Banks said today that these foreign exchange earnings may reach Bs. 8 to 9 trillion or 15% of next year’s budget which is a huge proprtion. I am not sure where this higher figure comes from, but it sounds too high to me.

Clearly, this would insure that next year there would have to be devaluation, as these profits may reach 10-15% of the national budget, unless oil prices skyrocketed even further. If the Government did not devalue, these profits would evaporate as the Central Bank rotates its inventory this year and fewer profits would be left over for next year. The Government would not have an alternate source of funds for such a large piece of the budget.

Chávez is threatening to go to the Supreme Court on the issue, while Central Bank Directors are calling for arbitration. In either case, the final result will be further devaluations and more inflation because of its recurrent nature. The only unknown is by how much.

This weekend President Chávez once again attacked the Central Bank over the amount of “foreign exchange profits” it should turn over to the Government. This continues to be an issue that is not resolved and highly controversial.

Essentially, Central Banks around the world began a few years ago publishing financial statements very much like those of a commercial banks, even if their purpose is not to make a profit but monetary stability. Every time there is devaluation, the foreign currency “purchased” by the Central Bank at the old price is “worth” more in terms of local currency. Thus, the bank “makes” a lot of money every time there is devaluation and it sells this foreign currency purchased at lower prices.

About four years ago, the Venezuelan Government asked the Central Bank to hand over those profits, which it did. This is not a common practice, in fact, it is forbidden by law in many countries. The practice itself is not considered negative by economists as long as handing over the foreign exchange profits fits the purpose of currency and monetary stability which the central bank has. The usual recommendation is that the practice does not become recurrent and that it not be done if it threatens the balance sheet of the Central Bank..

In Venezuela handing over these profits has become recurrent via the annual devaluation that has taken place in the last few years. In the first half of the year alone, the Venezuelan Central Bank transferred Bs. 1.5 trillion in foreign exchange profits, some US$ 781 million at the official exchange rate. A similar payment will be made in the second half. The problem here is that this already represents almost 5% of the funding for the Government’s 2005 budget. Thus, it becomes a vicious circle, as the Government needs to devalue again, even if oil prices are very high, because it has no other source for funding such a large piece of the budget.

The origin of the discussion is that now the Government wants to receive more of these profits and it is arguing that the Central Bank is using for the accounting of these profits LIFO (Last In First Out), rather than using FIFO (First In First Out). The Government wants to use FIFO, because then dollars obtained by the Central Bank last year or the year before at much lower exchange rates would be sold at the current one, thus the profits would be higher. In the Government’s proposal, the Central Bank would have to hand over Bs. 3.1 trillion for the first half of 2004, US$ 1.6 billion or 6% of next year’s budget. The Superintedent of Banks said today that these foreign exchange earnings may reach Bs. 8 to 9 trillion or 15% of next year’s budget which is a huge proprtion. I am not sure where this higher figure comes from, but it sounds too high to me.

Clearly, this would insure that next year there would have to be devaluation, as these profits may reach 10-15% of the national budget, unless oil prices skyrocketed even further. If the Government did not devalue, these profits would evaporate as the Central Bank rotates its inventory this year and fewer profits would be left over for next year. The Government would not have an alternate source of funds for such a large piece of the budget.

Chávez is threatening to go to the Supreme Court on the issue, while Central Bank Directors are calling for arbitration. In either case, the final result will be further devaluations and more inflation because of its recurrent nature. The only unknown is by how much.

To his credit Alcalde Bernal criticized what happened today with the Columbus statue and reported five people were detained. Hope something happen to them in the end, but I doubt it. I bet they do nothing about aporrea.org which the Government funds and was clearly behind the action. This was not anarchy, this was premeditated. .

Today a bunch of Chavista thugs ended up in Plaza Venezuela their celebration (or protest) of Columbus Day for some, or the day of indigenous resistance for others and they ended tearing down the old statue of Columbus in Plaza Venezuela, as shown in the following pictures:

Now, I don’t want you to think that this was a spontaneous act of celebration in which some people got carried away. Chavista website aporrea.org has been calling for this for a few days, they even had the truck ready to take the pieces away and probably sell them. There is always profit somewhere down the line around this sorry revolution:

The bottom part says: continue the fight against the devil, Bush and Columbus are the same, old and new imperialism! Talk about uncivilized and hateful behavior and that is new! This is promoted by websites well financed by the so called revolution: Hate, destruction, stupidity and savage behavior.

Meanwhile in another part of the city, Diosdado Cabello, MVR candidate to Governor of Miranda was promoting other values as seen in this picture. Certainly the equality and emancipation of women were not among them. Machismo promotion may have been one though. That’s one group the revolution has done little for, in fact, it is remarkable in a country accustomed to women in positions of leadership what a set back women have suffered in the last five years under this “revolution”

Absolutely disgusting use of women in political campaining!

(Thanks Ed for the heads up!)

Today a bunch of Chavista thugs ended up in Plaza Venezuela their celebration (or protest) of Columbus Day for some, or the day of indigenous resistance for others and they ended tearing down the old statue of Columbus in Plaza Venezuela, as shown in the following pictures:

Now, I don’t want you to think that this was a spontaneous act of celebration in which some people got carried away. Chavista website aporrea.org has been calling for this for a few days, they even had the truck ready to take the pieces away and probably sell them. There is always profit somewhere down the line around this sorry revolution:

The bottom part says: continue the fight against the devil, Bush and Columbus are the same, old and new imperialism! Talk about uncivilized and hateful behavior and that is new! This is promoted by websites well financed by the so called revolution: Hate, destruction, stupidity and savage behavior.

Meanwhile in another part of the city, Diosdado Cabello, MVR candidate to Governor of Miranda was promoting other values as seen in this picture. Certainly the equality and emancipation of women were not among them. Machismo promotion may have been one though. That’s one group the revolution has done little for, in fact, it is remarkable in a country accustomed to women in positions of leadership what a set back women have suffered in the last five years under this “revolution”

Absolutely disgusting use of women in political campaining!

(Thanks Ed for the heads up!)

General Francisco Usón became another political prisoner of the Chávez administration when he was sentenced to five years and six months in prison for insulting the Venezuelan Armed Forces. Usón’s crime was to say on TV that the Fort Mara soldiers were burnt by a flame thrower and not by an accidental fire.  This charge was made by Usón in a TV program where he was being interviewed.

What is remarkable about the case is that to this day, the military has not shed light on exactly what happened that day in Fort Mara. The case was turned over to a civilian Court, but the witnesses were never presented by the military. Initially, the military said the soldiers had died when a fire caused by a cigarette butt ignited a mattress. The press made a big deal out of it and Chavez laughed on his Sunday TV program about much ado about nothing, only to have the first of the soldiers die that night. Later that week one of the soldiers that was getting better taped a video in which he said a big flash came into the jail cell through the door which led to the flamethrower theory. That soldier died of a heart attack that same night, before it was known that the video existed.

Maracaibo fireman, the National Guard and experts from the Armed Forces have all backed the theory that the fire in the cells that killed three soldiers was induced from the outside by either using a flamethrower or some form of chemical. This evidence was taken into account by the military court.

Usón was Chavez´ Minister of Finance until the events of April 2002. He said then that he saw from his office how the trap was set for the opposition march and converted the parking lot of his Ministry of Finance into an improvised hospital. He now will be able to appeal, while in jail, but becomes another political prisoner of this vengeful and intolerant Government.

All of a sudden the genius and all powerful CNE Director Jorge Rodriguez realizes that the voting process may take too much time: “We have time problems, due to the difficulty of the process, this is due to the difficulty in the process”….”this is much more complex than that of the presidential recall vote”.

You mean to tell me they did not consider this when they bought the machines? Could it possibly be that they were thinking only of the recall vote when they bought them and considered their design? So, they spent a zillion dollars on machines that were ideal for a Yes/No vote that did not even require electronic voting? What is going to happen when next summer those same voters will have to vote, not for one Mayor and one Governor, but for dozens of choices for Deputies of the National Assembly?  They did not think of that? Bunch of amateurs!

In fact, when I went to the practice run of the voting system on Jul.18^th. I said: “Simple enough for a single vote, I thought the screen might be too small for a multiple election.” Now, this was based on a thirty second test of the machine by a non-expert, but it seems nobody thought of this when they spent more than US$ 100 million in voting machines that most of the time will be used for multiple elections rather than a simple “Yes” and “No” vote. These are the arrogant and “revolutionary” administrators of our “democracy”.

While Venezuelan officials in the local media tried to downplay the possible effects of yesterday’s announcement that Venezuela will change the 1% royalty tax to 16.6%, the reality is different. Obviously, the fear is not as the President of PDVSA said today, that foreign oil companies may leave, but that they may not find the country attractive.

Minister of Energy and Mines Ramirez said that these companies “would not protest”  and that the Venezuelan Government had “excellent” relations with foreign oil companies.

The truth is that the main problem with the increased royalty is not how it will affect the operating companies, but the precedent of unilaterally changing conditions on established contracts is not something that will encourage companies looking to invest in Venezuela. In fact, the new Hydrocarbon law says that the royalty should be between 20% and 30% on new projects, which the Chavez Government itself has been bypassing, so what is to stop it on the future from increasing the royalties even further?

This is the view in today’s Wall Street Journal (by subscription):

“The government hopes to attract billions of dollars in investment for new projects in the Orinoco area, but by changing the rules, industry watchers say, Mr. Chavez has raised doubts about Venezuela‘s willingness to honor contracts with private oil companies.”

“The latest wrinkle could send some companies back to the drawing board. An executive with a major oil company that is a partner in one of the projects said it is “too early to say” if the tax increase would derail plans for new projects in the area.”

To me, this is the bigger problem; Chavez and his administration seem to act as if they were the only choice in the world. If Canada has a 1% royalty, what could be the attraction to doing a heavy oil plant in Venezuela and not in Canada?

A better way would have been to negotiate with the companies that partner up with PDVSA in these projects. Each of these projects produces or is scheduled to produce roughly 200,000 barrels of the combination of heavy cruders and of synthetic fuels per day. They were supposed to break even at US$ 12-15 per barrel for the Venezuelan oil basket, thus with the oil basket at, let’s say US$ 30 per barrel (this may be a little high), each of the projects is generating an additional US$ 1.05 billion in profit per year!. Thus, it would have seemed reasonable for the Government to negotiate the increase in the royalty in exchange for increased production or new areas and I am sure international oil companies would have been amenable to negotiate them.

In the end, the net result on collection by the Government is smaller than the 15.6% difference in royalties. PDVSA owns roughly 42% of each of the projects, so that the new royalties in some sense represent a transfer from PDVSA profit to Government royalty. Moreover, there will also be lower taxes. My back of the envelope calculation is that the Government will receive US$ 400 million more in royalties, but will lose about US$ 150 million in taxes and PDVSA will receive US$ 150 million less in profits. Of course, the Government will now receive the royalties directly and regularly rather than via PDVSA dividends. Unfortunately, this difference may not be compensated by future dividends if one takes into account new projects that go elsewhere in the world.

While Venezuelan officials in the local media tried to downplay the possible effects of yesterday’s announcement that Venezuela will change the 1% royalty tax to 16.6%, the reality is different. Obviously, the fear is not as the President of PDVSA said today, that foreign oil companies may leave, but that they may not find the country attractive.

Minister of Energy and Mines Ramirez said that these companies “would not protest”  and that the Venezuelan Government had “excellent” relations with foreign oil companies.

The truth is that the main problem with the increased royalty is not how it will affect the operating companies, but the precedent of unilaterally changing conditions on established contracts is not something that will encourage companies looking to invest in Venezuela. In fact, the new Hydrocarbon law says that the royalty should be between 20% and 30% on new projects, which the Chavez Government itself has been bypassing, so what is to stop it on the future from increasing the royalties even further?

This is the view in today’s Wall Street Journal (by subscription):

“The government hopes to attract billions of dollars in investment for new projects in the Orinoco area, but by changing the rules, industry watchers say, Mr. Chavez has raised doubts about Venezuela‘s willingness to honor contracts with private oil companies.”

“The latest wrinkle could send some companies back to the drawing board. An executive with a major oil company that is a partner in one of the projects said it is “too early to say” if the tax increase would derail plans for new projects in the area.”

To me, this is the bigger problem; Chavez and his administration seem to act as if they were the only choice in the world. If Canada has a 1% royalty, what could be the attraction to doing a heavy oil plant in Venezuela and not in Canada?

A better way would have been to negotiate with the companies that partner up with PDVSA in these projects. Each of these projects produces or is scheduled to produce roughly 200,000 barrels of the combination of heavy cruders and of synthetic fuels per day. They were supposed to break even at US$ 12-15 per barrel for the Venezuelan oil basket, thus with the oil basket at, let’s say US$ 30 per barrel (this may be a little high), each of the projects is generating an additional US$ 1.05 billion in profit per year!. Thus, it would have seemed reasonable for the Government to negotiate the increase in the royalty in exchange for increased production or new areas and I am sure international oil companies would have been amenable to negotiate them.

In the end, the net result on collection by the Government is smaller than the 15.6% difference in royalties. PDVSA owns roughly 42% of each of the projects, so that the new royalties in some sense represent a transfer from PDVSA profit to Government royalty. Moreover, there will also be lower taxes. My back of the envelope calculation is that the Government will receive US$ 400 million more in royalties, but will lose about US$ 150 million in taxes and PDVSA will receive US$ 150 million less in profits. Of course, the Government will now receive the royalties directly and regularly rather than via PDVSA dividends. Unfortunately, this difference may not be compensated by future dividends if one takes into account new projects that go elsewhere in the world.