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Friday, April 04, 2003

What happened to "What happened to profits?" ?

Update: The offending briefing paper by Mark Weisbrot seems to have been taken down from the website. The link to the paper is gone from the CEPR site's main page, and the old URL ( is yielding a 404 ("file not found") error now.

Why? I don't know.

In personal email to me, Weisbrot promised a rebuttal. Oughta be good.

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Tuesday, April 01, 2003

Note to Mark Weisbrot:
Kindly remove head from ass.

José Bové is coming, as well as Ignacio Ramonet of Le Monde diplomatique, and Danielle Mitterand…a virtual who’s who of the most clueless strata of the anti-globalization movement. The occasion is the chavista commemoration of the glorious events of April 11th-14th, and the government sponsored festivity can be expected to dissolve into three days of feverish hero-worship for President Chávez.

Among the lesser known, but perhaps most dangerous, of the featured speakers is one Mark Weisbrot, co-director of the grandiloquently named Center for Economic and Policy Research. A member in good standing of the DC lefty think-tank community, Weisbrot strikes me as the most dangerous kind of chavista apologist, because the propaganda he publishes out of CEPR comes cloaked in the stylistic conventions of academia, and that makes it look to the uninitiated like more or less credible independent analysis. If you’ve followed the issues he covers, though, you can recognize his writing as more or less unadulterated government propaganda. In a sense, what’s most remarkable about his analysis is its failure to go an inch beyond tired old chavista arguments founded on misrepresentation that enjoy near-zero credibility among anyone who knows anything about the issues at hand.

Through What happened to profits?, his latest CEPR Briefing Paper, Weisbrot joins the chavista campaign to sling mud at Venezuela’s state oil company, PDVSA, and specifically at the way it used to be run in the pre-Chávez era. This he does with all the intellectual honesty of, well, a chavista.

At the center of his critique is the claim that PDVSA’s fiscal contributions to the Venezuelan state are significantly lower now than they were immediately following nationalization in 1976, or when compared to other state-owned oil companies in the region. Thus, he concludes, PDVSA’s performance has been very poor and the company was in serious need of a massive overhaul.

Weisbrot is careful not to lie outright, but almost all his arguments are deeply misleading. Take, for instance, this jewel of a sentence: “In fiscal year 2001,” he writes, “the state-owned oil company in Mexico, PEMEX, had sales of $46.5 billion and contributed $28.8 billion to the government budget. By contrast, in 2000 PDVSA took in $53.2 billion and paid only $11.6 billion to the government of Venezuela.” What he’s saying is, strictly speaking, true. It’s also wildly misleading. It’s worth taking a few paragraph to unpack just how many tricks and misrepresentations are packed into this one, harmless-seeming sentence.

To start with terminally silly to compare PDVSA to PEMEX in this way, because the two companies are structured radically differently. While PEMEX produces 3.7 million barrels a day and sells almost exclusively oil produced in Mexico, PDVSA produces (or used to produce) about 2.3 million b/d and, more importantly, sells oil from all over the world. PDVSA is a major player in the intermediation business, meaning that much of what it does is buy oil from third-party producers (Ecuador, say, or Nigeria) and use its huge marketing and distribution network to sell it on in international markets. Indeed, in 2001, over half the oil PDVSA sold ($22 billion out of $43 billion in total sales abroad) was not produced in Venezuela.

Of course, intermediation and production are vastly different businesses, and not surprisingly production is vastly more profitable. Weisbrot and Baribeau’s trick is to conflate the two: they report PDVSA’s combined profit margin for both intermediation and production and then compare that number with a company that’s all production and no intermediation. Apples and oranges. Had Weisbrot excluded the third-party produced oil PDVSA sells from the equation, he would have found that in 2000 PDVSA exported $26.7 billion worth of Venezuelan produced oil and contributed $12.7 billion to the government. That’s 48% of its Venezuelan sales going to the state, and that’s not that far off from PEMEX’s reported 62%.

So that’s trick number one, and it sets the tone of appalling intellectual dishonesty that permeates the briefing paper. However, you could argue that PEMEX still contributes 14 percentage points of its domestic sales more to the state than PDVSA. This, again, is true but misleading.

The reason is two-fold. In the first place, notice that while Weisbrot entitles his paper “What happened to profits?” what he’s actually talking about is not profits but fiscal contributions. PEMEX surely gave the Mexican government a lot of money in 2001, but it also yielded a $3 billion after-tax loss. This suggests strongly that its hefty contribution to the Mexican state was not a function of sterling management or world-beating profitability, but rather it was a function of getting milked by the Mexican government far beyond what is wise. (An appreciation that accords with PEMEX’s reputation as one of the worst managed state oil companies around.) PDVSA, meanwhile, reported a modest after tax profit in 2000.

You won’t learn that from reading Weisbrot and Baribeau’s piece, though.

The second little bait-and-switch is tucked away in a footnote to the paper. Comparing the number of dollars the Venezuelan, Mexican and Brazilian governments perceive per barrel of oil produced, the paper reveals an anomaly. In 1999 and 2000, PEMEX’s fiscal-contribution-per barrel produced was actually higher than the market value of those barrels. A footnote handily explains that this is due to “revenue from downstream operations.” Elsewhere in the paper, Weisbrot and Baribeau slam PDVSA for the disastrous performance of its domestic downstream operations, noting that PDVSA’s losses in that business “have climbed from $75 million in 1998 to $1.35 billion in 2001.”

What’s this about? What are those mysterious “domestic downstream operations?”

From what I can make out, what he’s talking about is basically internal sales, especially gasoline sales. Once you make that connection, then those climbing losses are pretty easy to understand. Gas is absurdly cheap in Venezuela – about 21 cents a gallon (figuring it at the official exchange rate.) Just a couple of days ago, I filled up my old beater, which has a 19-gallon gas tank, for less than 4 bucks. In Mexico, you still get relatively cheap gas, but they at least charge you enough for PEMEX to recoup costs and even make a bit of profit. When you go through the two companies’ statements to the SEC, you find out that PDVSA was selling gasoline domestically at $7/barrel in 2001, while PEMEX was selling it at $35/barrel. The simple fact is that 7 bucks a barrel is far below the cost of production – there’s a huge implied subsidy here, and somebody has to pay for it. In this case, it’s PDVSA.

Now, it’s a bit fresh to blame PDVSA for this situation – it is, after all, the government that sets retail gasoline prices in the Venezuelan market. It’s especially fresh to use a 1998-2001 comparison period since it’s hard not to notice that this was a time when Hugo Chávez was in power. So lets see what’s happening here: Chávez takes power. Chávez refuses to index up the cost of gasoline even in bolívar terms, - the price of gas today is the same Bs.90 per liter as it was in 1998, even though the exchange rate has climbed from Bs.483:$ to Bs.1600:$. So Chávez forces PDVSA to sell gasoline at far, far below its cost of production, making PDVSA to absorb a billion-dollar loss on domestic gas sales. Follow me so far? Good, because here’s where it gets weird: Seeing this situation, philochavista first world economists pounce, but not on the government for subsidizing the ecocidal overuse of fossil fuels, but rather on PDVSA! You read dark mutterings about poor performance, and they wonder how on earth the company could possibly lose all this money on “downstream domestic operations.”

This is just absurd.

In fact, if you factor out the gasoline subsidy forced on PDVSA by the government, the company’s fiscal contribution rises to 53% of Venezuelan barrels exported. And if you factor out PEMEX’s multibillion dollar after-tax loss from its fiscal contribution, (as a way of getting at what PEMEX could actually afford to contribute and still break even) you find that a rationally run PEMEX might have contributed 54% of its domestic oil sales to the government. Funny, huh? When you actually go through the numbers, you realize that the seemingly huge disparity between the two companies’ fiscal contributions are explained almost totally by bad fiscal policymaking in Mexico, an absurd gas subsidy in Venezuela, and, more than anything else, by Mark Weisbrot’s rampant will to deceive.

So just taking apart that one sentence you start to get a feel for the guy’s modus operandi, for his blithe disregard for the basic standards of intellectual honesty one ought to be able to expect from a serious academic.

I have to say I’m especially galled by his cowardly pussyfooting on the gas subsidy: this is, after all, an anti-globalization activist, someone you might reasonably expect to see standing up against a policy as criminally stupid as subsidizing global warming. If he really feels that these domestic market losses are unacceptable, then he should come right out and say so. He should say, straight out, that there are far better ways of spending $1.3 billion a year than subsidizing gas. Who could possibly argue with him if he did?

Hugo Chávez, that’s who!

Advocating gas-price hikes is the ultimate political no-no here. Ever since a gas-price increase set off mass looting throughout the country on February 27th, 1989, the issue has been a kind of third-rail in Venezuelan politics - especially in irresponsible lefty/populist circles. So arguing against the gas subsidy openly would put Weisbrot and Baribeau at odds with the idiotic Chávez administration policy of wasting billions of dollars in scarce resources to subsidize a toxic chemical that benefits middle-class car drivers disproportionately. They couldn’t do that, clearly! The solution? Hide behind a sterile sounding euphemism - “downstream operations in Venezuela” – and blame it on PDVSA, to boot!

But there’s more. Weisbrot devotes half the paper to a searing critique of the pre-Chávez drive to open up the Venezuelan oil industry to foreign capital, alleging that the higher operating costs and lower tax rates on these deals has taken a major bite out of PDVSA’s profitability. Again, his critique is so bizarrely warped, it’s impossible to understand it aside from an ulterior political motive.

First, you need a bit of background. In 1996, PDVSA found itself with a dilemma. While the country had gigantic oil reserves, most of the yet-to-be-exploited oil here was extra-heavy crude in the east of the country. This is not commercially attractive oil. Basically, it’s gunk, a semi-solid black sludge rather than the flowing syrupy black liquid you probably picture when you picture crude petroleum. Eastern crudes here are so thick and laden with impurities, geologists don’t even call it oil but rather “bitumen” – not-quite-oil.

Meanwhile, much of the “good oil” in the country comes from wells in the West of the country that have been in operation, in some cases, since the 1930s. These are the highly depleted deposits known as “marginal fields,” or “squeezed-out oranges” as an oil exec once put it to me. The wells still have some exploitable oil in them, but not very much. Understandably, it takes far more effort, expertise, technology and investment to get oil out of these marginal fields than out of a brand spanking new oil field.

In 1996, PDVSA decided that it wanted to expand its production, to boost it all the way to 6.7 million b/d by 2007. Had the plan been carried out, Venezuela would have become the world’s second leading exporter after Saudi Arabia, and PDVSA would have been able to take advantage of the huge marketing and distribution networks it’s currently using to market third-party crudes. (In fact, much of the reason those extensive marketing and distribution networks were set-up in the first place was the expectation that, in time, Venezuelan production would expand enough that they could be devoted to selling high-margin Venezuelan oil rather than low-margin third-party oil.) However, without much in the way of fresh deposits of light or medium crudes to exploit, PDVSA had to expand domestic production through marginal fields, and through Eastern bitumen. That’s just the geological hand the country was dealt.

But PDVSA had neither the technology, the expertise, nor the financing needed to put these expensive-to-start-up projects into operation. The Eastern bitumen projects required building “upgrading facilities,” a new(ish) technology that amounts to pre-refining bitumen from a semi-solid gunk to something closer to standard crude oil (which receives the somewhat paradoxical name of “synthetic crude.”) PDVSA didn’t have the money or the technology to do this, but the foreign majors did, so PDVSA asked the big foreign companies to come in and build the upgraders. The cost of a barrel of synthetic crude would be significantly higher than that of nice, naturally light crude, but at around $9-10 a barrel it was still a pretty good deal.

However, these upgrader facilities would cost billions of dollars to build. The capital costs were so large that the pre-Chávez government realized it would need to sweeten the deal for the foreign companies to attract them. And the way they chose to do this was by dropping the royalty rate on these projects from the usual 16.67% to just 1%.

This decision comes in for particular scorn in Weisbrot’s piece, which seems to have no idea why the royalty rate was cut in the first place. He produces a handy chart showing how much more money PDVSA would have gotten had it taxed these projects at the previous rate, or at the Petrobras or Pemex rates. It’s a fun bit of mental-masturbation, but meaningless – these projects wouldn’t have been built if the government hadn’t dropped the royalty rates, because they would not be profitable at that higher rate. There would have been nothing to tax.

Pushing absurdity and intellectual bad faith to the limit, the paper then turns around and slams PDVSA for its rising capital costs during that period – precisely the time when the costly high-tech upgrader facilities were being built. “Capital expenditures on domestic downstream operations soared to $2.517 billion in 2001,” they argue, adding that “rom the viewpoint of standard financial accounting these investments do not make sense if they produce a low return for the shareholders.”

Now, perhaps Weisbrot and Baribeau aren’t quite clear on the concept of investment, but the word usually denotes a one-time expenditure meant to generate profits over a long period of time – some 30 years, for these projects. So looked at in context, their argument dissolves into utter meaninglessness, something like: it costs a lot of money to build expensive things meant to pay off in the long run. Gotcha…why is that bad again?

(Weisbrot and Baribeau also criticize a tax-reform effort carried out in 1992 that’s too boring to go into here, but on that score too their critique is highly misleading.)

The authors then segue into a critique of the marginal field operating contracts, where foreign companies were hired to squeeze out the last few remaining drops from old, worn out fields. Here, as far as I can tell, their argument boils down to an impassioned denunciation of the fact that more-expensive-to-operate oil fields are less profitable than less-expensive-to-operate oil fields. It’s a “well, duh!” moment, though that doesn’t stop them from regaling us with all kinds of facts, figures and charts detailing the scale of this outrage.

The argument is so silly, even Weisbrot seems to realize it, admitting that these marginal fields are still profitable, but arguing that “it is questionable if it is worth it for PDVSA to produce such high-cost oil, since it presumably counts as part of the country’s OPEC quota and displaces other oil that could be produced at much lower cost.” But this rejoinder only makes sense if a-you think staying within OPEC makes any sense (which I don’t) and b-you have some kind of spare capacity in low-cost, high-margin fields which you could substitute for the marginal field production, which Venezuela doesn’t. And why doesn’t it? Due to under-investment and dropping capacity figures in the Chávez era, as a result of Chávez’s policy from squeezing every last dollar from PDVSA until the company could not afford to even maintain production capacity at previous levels.

Weisbrot and Baribeau then complain about the rise in overall production costs – saying from 1997 to 2001 the cost of producing a barrel of oil or equivalent increased by 35.6%, from $2.33 to $3.16. This is the one part of his argument that is not total bunk: PDVSA’s costs have indeed been rising way too fast, and part of this is due to PDVSA mismanagement, particularly to the company’s bloated payroll.

However, even when they get it right, they get it wrong – this time by omitting key parts of the reason for this cost-increase. They casually paper over “details” like the fact that the Chávez administration’s mismanagement of collective bargaining negotiations with oil sector workers in 2001 is a major contributor to PDVSA’s rising cost structure over the past few years, as a Fedepetrol strike backed the government into having to offer a much higher than usual pay rise and setting the industry minimum wage at over three times the legal minimum wage (but that’s Chávez’s fault, not PDVSA management’s, so shhhhh!)

They also fail to mention the way the government’s broader macroeconomic mismanagement made the bolívar more and more overvalued from 1997 to 2001, making the cost of everything you did in Venezuela increased alarmingly…in dollar terms! (Note to the macroeconomically challenged: that’s what it means for a currency to be overvalued.)

(It’s also fun to note that if you go back to the much vaunted PEMEX - which elsewhere in the paper the authors treat as the model of a highly profitable state oil company – their 2001 per-barrel production costs were $3.34 – 18 cents more than PDVSA’s.)

I could keep going, picking apart other, similarly warped aspects of this dreadful paper, but why bother? It’s very hard for me to believe that anyone as bright as Mark Weisbrot who sets out to analyze PDVSA’s performance in good faith, freed from the drive to blacken the company’s reputation for ideological reasons, could have gotten it so, so wrong. Weisbrot and Baribeau are the very worst sorts of pseudo-intellectuals – using the stylistic conventions of academia to produce political propaganda that has the look-and-feel of a serious, respectable policy-paper.

So if you find the tone of this critique somewhat over the top, all I can say is that people like Weisbrot and Baribeau, who refuse to play by even the most stripped down rules of honest academic discourse, forfeit their claim to civility from those who criticize them. They treat reality with disrespect, and deserve nothing but disrespect in return. They are propaganda-mongers masquerading as analysts, and they have become accomplices in the unbelievably misguided drive to dismantle the one institution in the Venezuelan state that, for all its undeniable faults, used to work more or less properly.

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