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Venezuela Hits Oil Slick

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Country may face inflation, budget shortfalls on falling price of crude.

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The falling price of oil is about to hand Venezuela's president a jolt of reality.

Oil accounts for 94% of Venezuela's exports and about half of President Hugo Chavez's national budget.

The price of a barrel of oil on the New York Mercantile exchange recently fetched $63.22, down about 57% from the high of $147.27 reached in July.

At the same time, Chavez plans to boost state spending by about 22% next year to $79 billion, after nearly tripling Venezuela's budget since 2004.

Venezuela's state oil company has added about 11,000 workers this year, boosting the payroll to 70,400 as production declines. This will increase the drag on a sagging economy.

The government plans to cut the workday to 6 hours from 8, a move sure to hurt the private sector.

Chavez appears to have little room to maneuver, because it would be difficult to cut social programs, including subsidies for food and free education. Overall, the government payroll has grown to 2 million, or about 1 in every 14 citizens.

Chavez's handling of the economy could lead to future food shortages, especially if oil production continues to fall and the price per barrel continues to drop during the worldwide economic slowdown.

Venezuela is a net importer of food and durable goods, a situation made more difficult by the nation's current inflation rate of about 36%. There's no apparent effort to check inflation, which is likely to get worse.

However, Chavez's government appears to have about $100 billion in reserves, or enough to last 18 to 24 months. And then?

Gasoline now costs about $0.12 per gallon, and the government may soon raise the price, a move sure to be unpopular. Chavez may also reduce the Petrocaribe program, which allows Caribbean and Central American countries to buy oil below market rates. Venezuela has made over $2 billion in sales since 2005 to 18 member nations.

At $100 a barrel, Petrocaribe members paid 40% of the bill on delivery and cancel the balance over 25 years at 1% interest. If the price falls below $80 a barrel, the initial payment increases to 50%; it jumps to 60% if the price hits $50 a barrel.

Analysts say Venezuela needs to export oil at about $94 a barrel to offset current imports of goods and services. A drop below that price also means the country will take a bigger hit on the Petrocaribe program.

Despite the looming budget crunch, Chavez announced earlier this month that he plans to buy dozens of Russian tanks and armored vehicles, adding to more than $US4 billion in arms purchases from Moscow.

Chavez may gloat over Wall Street's troubles, but his revolutionary ways are about to confront Economics 101. This will create hard times for the people of Venezuela, but don't bet on the crunch changing Chavez's view of the world one bit.

After all, economics is just a club wielded by rapacious capitalists, right?

No positions in stocks mentioned.
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