History of Venezuela's Oil and Rentier Economy

In northern South America, just north of the equator, is the Bolivarian Republic of Venezuela, currently governed by embattled President Hugo Chavez. (1) Bounded on the west, south and east by Colombia, Brazil and Guyana, the northern border of Venezuela meets the Caribbean’s blue waters. Before the discovery of petroleum in Venezuela, most Venezuelans worked as subsistence farmers, cattle ranchers on the llanos, and growers of coffee beans and cacao plants.

Map showing location of Maracaibo Lake in Venezuela. Source: http://www.worldlakes.org/uploads/Maracaibo_index_locat.gif; accessed November 5, 2007

Barroso Number 2, December 14, 1922. Source: http://www.talcualdigital.com/Especiales/images/Petroleo/2.gif; accessed November 5, 2007

Venezuela’s famous oil-bearing Maracaibo Basin in the State of Zulia in the western part of the country includes 1) the freshwater Lake Maracaibo (the largest lake in South America), which drains surrounding rivers and empties into the Caribbean, and 2) the surrounding “torrid, pestiferous jungle” lowlands. (2)

On December 14, 1922, on the eastern aspect of Lake Maracaibo, a startled driller brought in the most productive oil well in the world at the time, thus inaugurating Venezuela’s oil boom years. “Barroso Number 2 oil well blew in a 1,500 feet” and gushed for nine days. (2,3) At first it flowed at 2,000 barrels per day, but then increased rapidly until it flowed wild at 100,000, destroyed the derrick, and blew a column of oil 200 feet into the air”, sprinkling the landscape with a million barrels of crude. (3)

Five years later, with only the United States surpassing her in production of oil, Venezuela rapidly descended into the morass of a rentier economy. A rentier state, as described in detail elsewhere, is a “country that receives substantial amounts of oil revenues from the outside world on a regular basis, tending to make leadership independent of its society, unaccountable to its citizens, and autocratic”. (4) How does a rentier state evolve? Three fine out-of-print books shed light on the process in Venezuela. (5)

Venezuelan Oil before the Twentieth Century

Drilling for petroleum, production in quantity, and refining various products to light, heat and propel machinery are relatively recent phenomena in the history of humankind. The modern oil industry began in Titusville, Pennsylvania in 1859 when drillers discovered the first producing well. Lieuwen explains: “In the oil boom that followed, there arose manifold problems of storage, transportation, overproduction, and cut-throat competition among the numerous operators. In the 1870s, John D. Rockefeller and his Standard Oil Company gradually emerged from the chaos existing in the infant industry and by the 1880s had attained a monopoly position by gaining control of transportation, refining, and marketing facilities”. (6,7) Standard Oil Company in Pennsylvania produced so much oil—30,000,000 of the total world output of 35,000,000 barrels in 1882—it had no real competitors and no need to develop oil-producing areas outside of the United States. (8)

Example of oil seep in New Zealand. Source: http://www.teara.govt.nz/EarthSeaAndSky/MineralResources/OilAndGas/4/ENZ-Resources/Standard/1/en; accessed November 5, 2007

Lake Maracaibo, Venezuela Oil Fields. Source: http://images.jupiterimages.com/common/detail/95/88/22618895.jpg; accessed November 5, 2007

The indigenous peoples in the lowlands around Lake Maracaibo knew about oil seeps where small quantities of petroleum oozed from the earth and solidified into asphalt by the action of sun and air. When the Spaniards arrived at Maracaibo in 1499 A.D., they found the Indians using oil for medicine and torches, and the sticky asphalt for impregnating sails, caulking boats, and trapping wild animals. Caribbean pirates entered the inlet to Lake Maracaibo to treat their weapons with petroleum and to caulk their ships with asphalt. (6)

Venezuelans noted with interest the spectacular growth of the oil industry in the United States. Pedro Rafael Rincones, a partner in the only petroleum company active in Venezuela at the time, traveled to Pennsylvania in 1879 to study the oil industry. The following year, he returned with a drilling rig to his group of oil seeps in the state of Tachira on the Andean Mountain border between Venezuela and Colombia. He shipped the rig to Lake Maracaibo, then transported it piece by piece on mules and oxen to the well site in the Andes. When the bit unfortunately caught between rocks and broke, he had to abandon the rig. Instead, he dug three shallow pits with picks and shovels, and as oil seeped in, he scooped it out with buckets. In 1882, he set up a crude teapotlike still and sold refined products (kerosene, gasoline, and gas oil) to people in the surrounding mountain villages until 1934 when his concession to drill oil, obtained from the state, expired. (9)

Venezuelan Asphalt before the Twentieth Century

“Across the country, east of Lake Maracaibo, hidden up rivers and creeks behind huge mangrove forests, lay the famous five mile by three mile natural asphalt Guanoco Lake (also known as Bermudez Lake), which, unlike Maracaibo Basin oil, interested U.S. road builders in the late 1800s. The New York and Bermudez Company, a subsidiary of General Asphalt of Philadelphia exploited the lake beginning in 1887. (10) Astonishingly, “Until about 1900, almost all asphalt used in the U.S. [to build roads] came from the natural sources of Lake Trinidad [on Trinidad Island] and Bermudez Lake in Venezuela”! (11) A Belgian chemist named Edmund J. DeSmedt laid the first true asphalt pavement in front of the City Hall in Newark, New Jersey in 1870, and went on to use sheet asphalt from Trinidad Lake, Venezuela to pave Pennsylvania Avenue in Washington, DC. (12)”

Venezuelan Oil Policy before the Twentieth Century

Unimportant though oil was before the 20th century, two important principles of policy emerged. First, subsoil deposits were the property of the nation, not the surface owner. Second, the president of Venezuela had exclusive power to grant oil leases. The latter policy would later contribute to development of the rentier economy.

Vicennial of Uncertainty (1899-1918)

In 1900, Venezuela was still an agricultural country, whose fortunes lay in her large herds of cattle in the llanos (plains) and on her large coffee and cacao plantations in the Andes and near the coast. The national revenue came from customs duties, especially on coffee, which German firms largely monopolized. (13)

General Cipriano Castro (ruled 1899-1908), who had swept down from the Andes Mountains in the state of Tachira, took Caracas in 1899, thereby initiating a half century of rule by militarists from the state of Tachira, except for a three-year period 1945-1948. Castro was probably the worst of Venezuela’s dictators, argues Lieuwen in 1954. “His corrupt, inefficient, extravagant rule was characterized by foreign intervention, domestic revolt, and financial chaos. In 1903, his refusal to meet debt and damage claims of European creditors resulted in a blockade of the Venezuelan coast by British, German, and Italian warships. Castro expropriated the Guanoco Lake properties of the General Asphalt Company in 1903 because he believed the company was complicit in the domestic rebellion between 1901 and 1903. (14)

Castro, ever in financial difficulty, leased concessions for exploiting hidrocarburos to a handful of his friends in 1907. Exploitation had to start within four years and contracts, which only he could grant, ran for fifty years. Concessionaires had to pay a modest surface tax and an exploitation tax. In return, concessionaries were exempt from import duties on machinery and disputes were subject to domestic courts only. Patriotic Venezuelans criticized Castro’s policy as too liberal for the leaseholder. The chief complaints were that the taxes were too low, the government received nothing for exploration rights, no provision was made for national-reserve lands to safeguard the future, the concessions were far too large for a single contractor to exploit, and the fifty-year titles were excessively long. (15)

Castro’s liberal policy did not draw foreign investors, however, because domestic revolt, Venezuela’s international money troubles, and the expropriation of General Asphalt steered them to Mexico instead.

Conditions changed suddenly in 1908 when General Juan Vicente Gomez seized power when Castro went to Europe to have an operation. Gomez ran Venezuela for the next 27 years. He needed revenues to meet administrative expenses and the accumulated obligations of the Castro regime. “Hoping that new revenue might be raised through taxes and royalties, he officially invited foreign investors to come in to develop his nation’s resources. Significantly, one of his first acts was to restore General Asphalt’s Guanoco Lake properties and grant them a new fifty-year contract.” (16)

Royal Dutch-Shell

The oil industry around 1900 began to change as the recently invented internal combustion engine increased demanded for refined petroleum products. “Standard’s monopoly was broken as the Royal Dutch Oil Company, founded in 1890, invaded the former’s foreign markets. In 1907, Sir Henri Deterding [1866-1939], the dynamic head of the Dutch firm, succeeded in effecting a merger with his leading European competitor, the Shell Transport and Training Company of England, thus forming the Royal Dutch-Shell combine. Between these two powerful companies, Shell and Standard, a rivalry began which spread over the entire globe and continued unabated till 1929”. (17) Beginning around 1912, the Royal Dutch-Shell combine and Standard began nosing their way into Venezuela. Drillers placed the first well in 1912—Batui no. I--in Sucre State.

The foreign operators in early 20th century Venezuela faced many problems developing the virgin areas of Venezuela. First, the government of Gomez offered no assistance. Second, operators had to build roads, build power plants, construct camps, build health facilities, and import machinery and food. Locating skilled labor was a major problem, which the operators solved by importing skilled workers, mostly West Indian blacks. Some unskilled Venezuelan workers obtained jobs and received better wages than prevailing agricultural wages, thereby initiating the transformation of the country from an agrarian economy to a rentier economy.

Lieuwen describes the hurdles faced by foreigner operators. “The greatest difficulty was transportation. Getting the machinery to the well site and the oil to an ocean port were the principal problems. The entire communications system had to be built from scratch. A sand bar at the entrance of Lake Maracaibo, which prevented entry of large ships, necessitated transfer and reshipment of supplies on shallow-draft vessels. Also, Venezuelan oil development started just about the time World War I began. Transportation shortages and export restrictions imposed by the warring countries made it impossible for the companies to obtain machinery and other supplies.” (18) Some companies suspended drilling until after the war was over.

Refineries on Curacao, Not Venezuela

Gomez allowed the refining industry to leave Venezuela. Shell took advantage of the 50% tax reduction on petroleum products made and sold in Venezuela by setting up a refinery at San Lorenzo to supply the domestic market. But to supply the world market, it built a refinery in 1917 on the nearby Dutch island of Curacao where it processed the vast bulk of the crude oil it withdrew from Venezuela. Gomez did not figure out the advantages of refineries built on Venezuelan native soil, either along the shores of Lake Maracaibo or, by first dredging the sand bar, on the Paraguana Peninsula. Some people believed he did not encourage industrialization of the isolated Maracaibo Basin for fear it might become too powerful economically and difficult to control politically. Oilmen readily justified their decisions to refine the crude on Curacao because its harbors were superior and there was a ready labor supply. (19)

Effects of World War I on the Oil Industry

The demand for oil was a serious consequence of World War I (1914-1918). “Modern warfare had transformed petroleum into a vital strategic material essential for fueling trucks, tanks, warships and planes”, noted Lieuwen. (20) The Commissioner General for Oil Products, France, World War I, Henri Berenger said, presciently,

The U.S. government, which had more than enough domestic supplies of oil in 1915, was aware of the covert movement by Shell to take over Venezuela’s entire output, but saw the move as competition between companies and not between countries. Standard of New Jersey, which inherited most of the foreign interests of the Standard Oil trust after the latter’s dissolution in 1911, was indifferent about the Venezuelan leases at this time in Venezuela’s history.

Great Britain, however, was keen to acquire petroleum during World War I for her navy, whose ships ran on foreign oil rather than domestic coal. She accomplished this feat by aggressively purchasing control of the Anglo-Persian Oil Company, as described elsewhere. (4,21) During the war Britain sent troops to occupy the Near East, and when hostilities ceased, the oil lands were in her hands.” (22)

As World War I dragged on, the U.S. drained her domestic supplies and fear of a shortage resulted. Additional alarm ensued when Britain appeared to corner the market on foreign supplies. “American oilmen, squeezed both at home and abroad, sought diplomatic aid, and by August 1919, the Wilson administration had adopted an aggressive policy. It vigorously protested the [British deal] to control Near East oil, then sent all its embassy and consular officers the following instructions:

In 1919, U.S. oil companies received their first opportunity to secure concessions for unleased areas in the Maracaibo Basin (Zulia state). Gomez granted 65 concessions to his favorites, indicating to the U.S. oilmen that they would need to buy the leases from Venezuelan nationals.

Venezuela and Boom Time in World Oil Production 1923-1929

The period 1923-1929 was a boom time in the world’s petroleum industry as production doubled in supply of gasoline and lubricants for cars and fuel for factories and homes. The U.S. consumed about 65% of the world’s petroleum during this period and kept pace by doubling her own output. Venezuela, a tiny producer in 1922, exploded into the number two producer after the U.S. by 1928.

Venezuela exported nearly all of her petroleum and, like all rentier economies, was thus extremely sensitive to external price shocks and upturns in demand in the world market. After the short-term recession of 1921, for example, petroleum prices rose and demand increased. The drilling of an abandoned well near Lake Maracaibo on December 13, 1922, which produced the Barroso Number 2 gusher, put Venezuela on every oilman’s map. “The Barroso well, only a mile and a half form the lake shore on Shell’s Aranguren concession, fired the imagination of the American companies holding adjacent properties, because if the underground pool [La Rosa reservoir] extended below their leases, they too could tap it”, wrote Lieuwen. “The pattern of production on the eastern shore of Lake Maracaibo soon found Shell on the land, Gulf in the shallow water along shore, and Standard of Indiana in the lake. Operating side-by-side, this trio carried on competitive offset drilling along their common boundaries, all extracting crude from a common underground reservoir”. (24)

Venezuela’s oil production doubled every year from 1922 to 1928; it would have increased more except for the limiting constraint of transportation. Ocean tankers still could pass over the twelve-foot bar at Maracaibo. Oil companies finally decided to dredge the sand bar, but Gomez nixed the idea, again, it is generally believed, because he wanted to suppress political power in the Maracaibo Basin. Standard of Indiana and Gulf had not alternative but to order lake tankers from England to carry their crude to ocean piers at Aruba and Punta Piedras. More than a thousand trips per month of some 30 vessels traversed the narrow shifting one-way channel between the Gulf of Maracaibo and Lake Maracaibo the lake. Incredibly, Maracaibo pilot station became the busiest in the world. Channel traffic became so congested by 1929 companies put in a system of lighted buoys and lighthouses to permit around-the-clock navigation. Shell refined most of its crude at Curacao, then shipped it to European markets. Gulf and Standard of Indiana hauled to U.S. refineries. (25)

Standard of Indiana, which ran into problems marketing crude in the U.S. in 1927 because of f U.S. market saturation, made the decision to build a refinery near the Venezuelan source of supply. Again, President Gomez missed an opportunity for refining oil in Venezuela as Standard of Indiana constructed its refineries on Aruba. Thus, the Dutch colonies adjacent to Venezuela “enjoyed the fruits of an industrial boom fed by Venezuela’s crude”. Lieuwen wrote, “Curacao and Aruba were—and are—economic parasites that thrived on the black blood of a benevolent Venezuelan host. The companies preferred keeping the nation’s petroleum a purely extractive industry, and Gomez acquiesced.” (26)

Labor

As companies sprayed mosquito-infested swamps with crude, purified water supplies, and built sewage systems, malaria and dysentery subsided, and Venezuelans from all parts of the nation began to migrate to the oil fields in search of work. Half of the workers came from neighboring Falcon and Trujillo. Companies preferred them because they were already acclimated to the climate. These Venezuelans were unfamiliar with petroleum work. As a result, technical tasks went to foreigners. Four to five thousand foreign workers (including their families) lived in the Maracaibo Basin in 1929. British and American companies brought their administrative personnel from their respective homelands, but most drillers and other skilled field workers came from the U.S. Native Venezuelans resented the West Indian day laborer brought in by companies because the West Indians were “better disciplined” (or more submissive, Lieuwen suggests). Only 10% of the labor force was West Indian. Anglo-Saxons occupied nearly all the administrative and technical jobs. Of the total 1929 labor force, 23% were foreigners. Five thousand men were employed in 1923, 20,000 in 1927. (27)

Native Venezuelans Begin to React to Foreigners

Venezuelans not employed by the oil companies were rankled by the Anglo-Saxon affair in their midst where petroleros got the oil out and sent it to their homelands, and lived and worked in isolation in camps surrounded by high fences with armed guards at the gates. The foreign petroleum workers imported their food, houses, furniture, automobiles, and set up special schools for their children.

U.S. Counsel Alexander Sloan wrote from Maracaibo about the messiness of the industry with its derricks, pipe lines, storage tanks, and laker tankers. Oil was everywhere:

Venezuelans accustomed to using the waters of Lake Maracaibo for drinking and washing clothes watched in horror. The oil industry drew workers away from agriculture even though it could not hire all the farmers who arrived for jobs. “Both plantation agriculture (principally coffee, sugar and cacao) and subsistence farming suffered. Producers and merchants took advantage of the food scarcity, and food prices rose rapidly. As farmers poured off the land, the food shortage worsened and Venezuela had to import more and more food. In addition to the transport costs, the food had to come in over one of the highest tariff walls in the world.

Peculation in Gomez’s Administration and Creep of Rentierism

Venezuela’s foreign trade increased dramatically during the boom years. However, in 1925, petroleum surpassed coffee as Venezuela’s leading export and by 1929 comprised 76% of all exports. (29) Government oil revenues grew from almost nothing in 1921 to over 50 million Bolivars in fiscal year 1929-1930. The petroleum industry counted for half the government’s revenues in 1929. The new revenues went to public works, a vast government bureaucracy, and payment of foreign debt, which Gomez erased in 1930.

The problem was that the revenue stream created by taxes paid by the oil companies to Gomez’s administration did not increase domestic productivity. The great oil industry blossoming in Venezuela did not cost the government a single Bolivar. The oil companies built roads, mapped large areas of the territory, and hired Venezuelans, improving their health, education , and living conditions. Only a small percentage of the Venezuelan population enjoyed employment by the oil companies, however, and the foreigners were draining Venezuela of her natural resources. Furthermore, the foreigners were making massive profits. Finally, the oil companies drew farmers and ranchers away from vital agriculture, creating a population dependent on foreign food imports. “The increasing dominance of petroleum, they said, actually sapped the country’s productive capacity.” People wondered whether petroleum was a blessing or a curse.

“Worst of all”, noted Lieuwen, “the critics stated [that] oil contributed to the maintenance of a corrupt and brutal dictatorship”. An official document of the time just after Gomez’s death shows that from July 1919 to June 1936, the Treasury obtained from the oil companies 612,000,000 bolivars. The companies themselves sold the Venezuelan oil for about 8,644,000,000 bolivars. The firms had thus paid about 7% of their gross takings into the Venezuelan national revenue. (30)

Gomez spent the petroleum dollar to increase the size of the army and to purchase official sycophants. The Gomez family and their friends made great profits while in power, continuing the custom of peculation , which in Venezuela and other Spanish American countries has not yet been eradicated. Gomez’s fortune at the end of his rule was some 200,000,000 bolivares.

“Public works were not for the nation but for the dictator, for the new roads ran from the capital to regions where revolutions might begin [think Maracaibo] and Gomez might need to brutally suppress them. Gomez ignored “the real problems of Venezuela, such as improvement of education and health and development of domestic industry and agriculture. Meanwhile the country became dangerously dependent on a single foreign-owned industry that responded only to the unstable demands of a capricious world market”. (29)

Venezuela’s Rentier Economy 1930-1965

A raging rentierism characterized the economic structure of Venezuela after the dramatic transformation in the 1920s from agriculture to oil. In 1952, for example, oilfields in production numbered 172,000 hectares, there were 10,616 wells, and 75,000 people working in oil. A powerful amount of capital was concentrated in a handful of foreigners and very few Venezuelans. This capitalism permitted the growth of the economy through but one export, oil, and promoted importation of luxury goods. Oil caused the abandonment of agriculture for a single source of income, which resulted in the concentration of wealth in the hands of a few. The small laboring middle class cried out for diversification of industry in town and country. More than a half of Venezuela’s five million inhabitants in 1956 were illiterate and living in poverty. (30)

Can Rentier Economies Change?

Diversification and privatization of the economy are the main answers to dig out of a rentier economy. Above all, the solution to the economic problems of a rentier state is not more, but less government expenditure. The elites previously preoccupied with consuming the national wealth must find ways of creating it. This is not a likely scenario, which is why rentier economies are so difficult to eradicate once they begin. (4)

Sources:

1. SEMP Biot Report #476: “Hugo Chavez: Venezuela’s Master of Mimesis” (October 16, 2007). Available at http://www.semp.us/publications/biot_reader.php?BiotID=469; accessed November 4, 2007.
2. Morris Gilbert: “Bolivar’s Great State Broken a century ago: Venezuela’s celebration marks the end of the liberator’s dream and the beginning of the repugca as it is today—Oil and a hundred Years of History. The New York Times, December 15. 1929. Available online at http://select.nytimes.com/mem/archive/pdf?res=FB0617FC3E5D117A93C7A81789D95F4D8285F9; accessed November 4, 2007.
3. Edwin Lieuwen: Petroleum in Venezuela: A History. University of California Press, 1954, p. 39.
4. SEMP Biot Report #227: “What is a Rentier State?” (June 23, 2005). Available at http://www.semp.us/publications/biot_reader.php?BiotID=227; accessed November 4, 2007.
5. The three books are Walter H. Bucher’s Geologic Structure and Orogenic History of Venezuela (1952), Edwin Lieuwen’s Petroleum in Venezuela (1954) and Guillermo Moron’s A History of Venezuela (1964).
6. Edwin Lieuwen: Petroleum in Venezuela. University of California Press, 1952, p. 4.
7. An excellent book about this period in American history is Ron Chernow’s Titan: The Life of John D. Rockefeller, Sr. Random House, 1998.
8. The only other countries producing oil in the 1880s, around 5 million barrels per year, were Rumania and Russia.
9. Rincones related this story to O’Shaughnessy in 1926 who recorded it in his O’Shaughnessy’s South American Oil Reports (July 1926), which Lieuwen then documented in his 1954 book Petroleum in Venezuela.
10. “The Asphalt Lake in Venezuela: Deposit of Pitch Inexhaustible and Should Last for Ages: Huge Black Sea of Wealth: It Value Almost Incalculable”. The New York Times, February 17, 1901. This is a fine article about this strange lake. Available online at http://query.nytimes.com/mem/archive-free/pdf?_r=1&res=9B05E3D61039E733A25754C1A9649C946097D6CF&oref=slogin; accessed November 5, 2007.
11. http://www.hotmix.org/history.php
12. “History of Asphalt”. National Asphalt Pavement Association. Available online at http://www.hotmix.org/history.php; accessed November 5, 2007.
13. Guillermo Moron: A History of Venezuela. Edited and translated from the Spanish by John Street. George Allen and Unwin Ltd, London, 1964, p. 189.
14. Edwin Lieuwen: Petroleum in Venezuela. University of California Press, 1952, pp. 8-9.
15. Ibid, p. 11.
16. Ibid, p. 12. See also Moron’s A History of Venezuela, p. 188.
17. Ibid, p. 8. See also Moron’s A History of Venezuela, p. 196.
18. Ibid, p. 15.
19. Ibid, p. 17.
20. Ibid, p. 18.
21. SEMP Biot Report #137: “Fall of the Shah of Iran” (November 11, 2004). Available online at http://www.semp.us/publications/biot_reader.php?BiotID=137; accessed November 5, 2007.
22. Edwin Lieuwen: Petroleum in Venezuela. University of California Press, 1952, p. 19.
23. Ibid, p. 20.
24. Ibid, pp. 38-39.
25. Ibid, p. 48.
26. Ibid, p. 49.
27. Ibid, p. 51.
28. Ibid, p. 52.
29. Ibid, p. 54.
30. Guillermo Moron: A History of Venezuela. Edited and translated from the Spanish by John Street. George Allen and Unwin Ltd, London, 1964, pp. 197-199.
31. “Crude Oil and Total Petroleum Imports Top 15 Countries: August 2007 Import Highlights: Released on October 17, 2007”. Energy Information Administration: Official Energy Statistics from the U.S. Government. Available online at http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/company_level_imports/current/import.html; accessed October 16, 2007.