FACTBOX-Key political risks to watch in Venezuela

By Frank Jack Daniel

CARACAS, May 3 (BestGrowthStock) – A floundering economy, anger
over power and water rationing, elections that may bolster
opposition to President Hugo Chavez, new nationalizations, and
diplomatic tensions with neighbor Colombia are all risks to
watch for in major oil exporter Venezuela this year.

RECESSION AND ENERGY CRISIS

Chavez admitted in April that Venezuela may be mired in
recession for a second year running in 2010, and some
economists forecast the damage could spill over into 2011. A
currency devaluation in January means Chavez has a considerable
war-chest to spend on September legislative elections but the
government has helped the bolivar’s fall to record lows on a
freely-floated market by dragging its feet releasing dollars to
importers and by constantly harassing the private sector
including top private employer, brewer Polar [ID:nN28168594].
Morgan Stanley has warned Venezuela could face a dollar crunch
if it sticks to current policies, with double digit inflation,
falling oil output, a shrinking manufacturing base and rising
imports.

Currency risks are high, with many foreign companies taking
a cash hit this year because of the weaker bolivar.

Electricity rationing is dampening recovery in the private
sector, while hammering output at energy-hungry, state-run
heavy industries, such as steel. Rains have brought hope of an
end to falling water levels in hydro-electric dams, but
structural problems mean the country is likely to suffer an
energy deficit until at least next year.

The devaluation was seen as favorable to Venezuela’s widely
traded foreign bonds, such as the benchmark Global 2027 debt
(VENGLB27=RR: ), because it improves its fiscal situation.
Despite wide spreads over U.S. Treasuries and frequently the
world’s highest sovereign CDS prices (VEGV5YUSAC=MP: ), the risk
of default is low in the short-term because of Venezuela’s
large oil output and history of meeting its debt obligations.
[ID:nN16107974].

Oil prices remain the key variable, with any large,
sustained drop threatening stability and fiscal health. CDS
prices shot up and bonds plunged when oil fell in 2008.

What to watch:

— Further nationalizations, perhaps in food, health care
or mining [ID:nN25163924], along with more regulation of the
finance sector after a series of small bank failures. A
government clampdown on brokerages is driving some of their
trade overseas.

— Growing imbalances in the economy.

— Steel, iron and aluminum industries grinding to a halt
because of power shortages. Already Venezuela is importing
steel from Brazil to feed its own mills. [ID:nN25103314]

LEGISLATIVE ELECTIONS

Elections on Sept 26 will weaken Chavez’s grip on the
National Assembly and give the opposition its first substantial
voice in the legislature since it boycotted the last vote for
lawmakers in 2005. Chavez’s socialist party will likely keep
control of the Assembly but with a reduced majority that could
make it harder to pass major legislation. In the unlikely event
the opposition takes control of the Assembly, it will create
serious headaches for Chavez before the 2012 presidential
election and increase political instability.

Chavez’s popularity has been dented by water and
electricity rationing, the recession combined with high
inflation, and perceptions of government corruption
[ID:nN11174237]. But he has the best organized political party,
a healthy campaign war chest and remains Venezuela’s most
popular politician.

Critics complain Chavez is becoming more authoritarian as
his popularity slips, which could raise political volatility
ahead of the elections. They point to the arrest of opposition
leader Oswaldo Alvarez Paz for “conspiracy” [ID:nN23251241] and
the imprisonment of a judge [ID:nN14178911], among others.

Political risk consultancy Eurasia Group predicts a
fragmented opposition could gain 40 percent of the Assembly
seats because Chavez is increasingly being held responsible by
voters for Venezuela’s problems.

Chavez’s main challenge may be to mobilize his supporters,
who have in the past expressed their dissatisfaction by
abstaining rather than voting for the opposition.

What to watch:

— Increasing rhetoric from both sides but especially
Chavez ahead of the elections. While mostly noise, Chavez’s
campaigns in the past have led to market-shaking threats
against foreign investors and governments. Political
uncertainty is mostly factored in to bond prices – the bolivar
is the main barometer.

— Although unlikely, an opposition majority in the
Assembly would be a game changer. It would likely bring a
short-term boost for financial markets, but that could quickly
reverse if a political crisis ensued.

OIL SECTOR

Venezuela is one of the United States’ top five oil
suppliers but exports are pressured by shutdowns at aging
refineries and rising domestic demand for fuel, partly
triggered by problems at its hydroelectric dams which have
increased reliance on thermoelectric plants [ID:nN17127861].
Venezuela’s largest refinery, Amuay, is closed for maintenance
that could take months. The Carabobo bidding round wrapped up
in February brings billions of dollars from companies such as
Chevron (CVX.N: ), Repsol (REP.MC: ) and a consortium of Russian
companies [ID:nN31225561] to develop new extra heavy oil
fields. The projects are likely to run behind schedule and new
oil output may only replace that lost at older fields. On the
positive side, a flood of money linked to Orinoco investments
including a $20 billion loan from China will boost the
governments and PDVSA’s coffers starting this year.

The devaluation means PDVSA receives more bolivars for
each dollar of income, which company officials says adds up to
an equivalent of 800,000 extra barrels of oil per day. The
company’s finances will still be tight this year, however.
PDVSA finances much of Chavez’s social spending and its
obligations will increase as elections loom. The company is
also in arrears with service companies and must pay down its
debt to them.

What to watch:

— Further outages in refineries and upgraders, such as the
shutdown of the powerless Curacao Isla refinery [ID:nN30142977]
and the latest fire at the Cardon refinery [ID:nN26188799] or
output issues from power shortages in the Lake Maracaibo
region.

— Tension between PDVSA and the oil majors and foreign
state companies who are developing new areas.

— A sharp drop in oil prices hurting PDVSA’s finances.

DIPLOMATIC TENSIONS

A leading voice of the left in Latin America, Chavez could
lose allies after elections in Brazil this year and in
Argentina in 2011. The region is already less friendly toward
him after right-of-center presidents won power in Panama,
Honduras and Chile in recent months [ID:nLDE60H1T7].

Relations with neighboring Colombia are very tense ahead of
May 30 elections there, with barbed comments from either side
on an almost daily basis. A violent border incident cannot be
ruled out, although wider conflict is unlikely.

Things could get worse if Juan Manuel Santos wins the
Colombia presidential election. Santos was the staunchest
critic of Chavez in the Colombian government when he was
defense minister and Chavez calls him a danger for
masterminding a 2008 bombing raid in Ecuadorean territory that
shook the Andean region.

However, polls say Santos has now slipped into second place
or is tied with his main rival Antanas Mockus [ID:nN28162181].
It is less clear how the quirky Mockus would react to Chavez,
who he says he “respects.”.

The U.S. approach to Chavez is often contradictory, with
the Pentagon recently saying Iran’s Qod paramilitaries had a
presence in Venezuela, only to be contradicted by the head of
Southern Command days later [ID:nN27106312]. Chavez has moved
to warm relations, sending his oil minister to a Washington
summit in April.

What to watch:

— Worsening relations with Colombia ahead of May 30
elections and if hard-line favorite Juan Manuel Santos replaces
outgoing President Alvaro Uribe.

— Tensions with the United States ratcheting up as
elections approach. However, now that economic times are
tougher, Chavez may be more cautious than in the past, not
wanting to chase off large investments that foreigners have in
Venezuela [ID:nN15237215].

Stock Market Analysis

(Additional reporting by Patricia Rondon and Marianna Parraga;
Editing by Kieran Murray)

FACTBOX-Key political risks to watch in Venezuela