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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management Bi-Weekly Geopolitical report for March 25, 2024. I'm Phil Adler. Ukraine, Gaza, and Taiwan aren't the only hot spots in the world. In South America, oil rich Venezuela is threatening its much smaller neighbor, Guyana, which recently came into major oil reserves of its own. Confluence Chief Market Strategist, Patrick Fearon Hernandez, joins us today to unravel the history of this dispute, what's at stake for the United States, and why investors should pay attention.
Phil Adler:Patrick, this is not a new dispute, but it has flared up recently, certainly. What is the history of this portion of land that both Guyana and Venezuela claim?
Patrick Fearon-Hernandez:Well, hi, Phil. Thanks for having me on the show. And you're certainly right that the Venezuela Guyana dispute goes back a long way. Because of that, I'll only touch on the main points. The story begins with the Spanish conquest of most of the Americas in the 1500.
Patrick Fearon-Hernandez:At the time, Spain considered the Essequibo territory, which makes up much of the western part of today's Guyana, to be a part of its captaincy of Venezuela. In other words, Spain claimed that land as Spanish territory. However, because of the remoteness and difficulty in controlling the territory, it was actually settled by Dutch traders and plantation owners. When Venezuela gained its independence from Spain in 1811, it issues its claim to the Esquivel territory but couldn't enforce it. Soon after, the Dutch sold the territory to the British who rolled it into their colony of British Guyana despite Venezuelan objections.
Patrick Fearon-Hernandez:Now at the end of the 1800, the US promoted an international tribunal to settle the dispute, and that panel awarded most of the territory to British Guiana. Caracas seemed to have no option but to accept the decision, which it formally did. Then, however, new documents came to light in the 1940s that suggested that a tribunal judge had improperly pressured other judges to award Esquibo to the British. Venezuela therefore reissued its claim and has pursued it relatively quietly in the United Nations and other bodies since then, but it has intensified its claims in recent years.
Phil Adler:Well, let's be clear. The the land in dispute does comprise a major portion of Guyana.
Patrick Fearon-Hernandez:Oh, yes. The Essequibo territory that Venezuela claims makes up the western two thirds of Guyana. That's a major proportion, if you ask me.
Phil Adler:It seems like Venezuela might be making a legitimate argument. Is that the case?
Patrick Fearon-Hernandez:Well, I personally think that it's hard to decide for someone who isn't an expert in international law and the specifics of the US led tribunal back in 1899. But in any case, it certainly sounds plausible that Venezuela might have some claim. The problem is that the claim would gobble up so much of Guyana, which because of its past as British Guiana, is a stable democratic, English speaking country that has recently discovered huge reserves of oil.
Phil Adler:Patrick, what exactly was the strategy used by the government in Venezuela to bring this issue to the forefront again?
Patrick Fearon-Hernandez:Well, things really started to intensify late last year when Venezuela's congress, almost certainly at the instigation referendum in which Venezuelans would vote on whether to formally recognize Essequibo as a part of Venezuela and take steps to take control of it. The referendum was held on December 3rd and passed overwhelmingly, albeit with relatively low turnout.
Phil Adler:How has the government of Venezuela proceeded in the wake of this referendum, which may or may not be an accurate reading of citizen sentiment.
Patrick Fearon-Hernandez:Well, in theory, passage of the referendum gave president Maduro the legal basis to attack Guyana or try to seize the Essequibo territory. And in fact, the Venezuelan military has beefed up its military presence along the border. However, the main Venezuelan steps so far have been to pass a series of administrative changes to put the referendum into effect. For example, the Venezuelan legislature has formally designated Essequibo as a Venezuelan state. It's ordered new national maps showing that, and it's named a military commander resources in Essequibo.
Phil Adler:Patrick, Venezuela's attempt to legitimize its goals and carry them out sounds similar to Russia's designs on Ukraine, isn't it?
Patrick Fearon-Hernandez:Well, there is certainly some similarity in the use of a slanted historical narrative to justify the territorial claim, things like that. Whether it's president Putin's claim on Ukraine and other parts of Eastern Europe or president Maduro's claims on Essequibo, these leaders are trying to justify their approach with historical stories. The big difference is that Putin has acted on his claims and actually tried to seize territory by force. Maduro hasn't gone that far, at least not yet.
Phil Adler:Well, Venezuela already has plenty of oil even without annexing these new oil reserves. Is there something we don't understand about Venezuela's apparent appetite for more oil at this time?
Patrick Fearon-Hernandez:Well, you're right that Venezuela already has huge reserves of oil. But under Maduro's socialist economic system, the country hasn't been able to keep up output. Venezuelan oil production isn't anything like what it used to be. So if Maduro can get his hands on Guyana's new reserves, Venezuela might suddenly be able to boost its oil revenues again.
Phil Adler:Patrick, just how big are these new oil reserves?
Patrick Fearon-Hernandez:Well, the latest estimates suggest that Guyana has about 11,000,000,000 barrels of recoverable oil, which is more than Norway's reserves and roughly equal to Brazil's reserves today. The figures I've seen suggest that when those reserves are fully exploited in the coming years, Guyana's oil production could rise from roughly 400,000 barrels a day right now to 1,200,000 barrels per day as early as 2028. For comparison, that level of output would be similar to that of today's Algeria or Angola.
Phil Adler:That is a lot of oil. What other reasons might be behind Venezuela's decision to raise the pressure on Guyana at this time?
Patrick Fearon-Hernandez:Well, part of it is that president Maduro recently agreed to a US demand to hold free and fair elections in return for lifting some US economic sanctions. Now assuming that he's going to follow through on that commitment, Maduro may want to stoke nationalist sentiment to make sure he can win those elections. And finally, Maduro may be gambling that the US is too distracted by the wars in Ukraine and Gaza to push back against a Venezuelan grab for Essequibo.
Phil Adler:How might US interests be threatened?
Patrick Fearon-Hernandez:Well, for the US, allowing Venezuela to actually seize part of Guyana would call into question our credibility in terms of controlling what happens to our friends in our very own region. After years of enmity between Venezuela's socialist government, it would also make the US look like it had been humbled by Maduro. More broadly, it would make the US look like it couldn't ensure global energy supplies and the rule of law. For all these reasons, the US has strong interest in defending Guyana and making sure Venezuela doesn't seize any of its territory.
Phil Adler:Are there good reasons, Patrick, to suspect Venezuela might not actually follow through with its threats?
Patrick Fearon-Hernandez:Yes. Indeed. The biggest consideration is that Guyana has friends that would likely come to its aid. The US and the UK have already held emergency joint military exercises with the tiny Guyanese Armed Forces and otherwise signaled that they would help push back the Venezuelans. In addition, because of the dense, largely roadless forest on the Venezuela Guiana border, any Venezuelan effort to invade Guiana might have to go through Brazil.
Patrick Fearon-Hernandez:And so the Brazilian armed forces have already moved troops to the border region to make sure that doesn't happen. And more broadly, Venezuela would likely be criticized at the UN and on the world stage for such an action. For all these military and political reasons, Venezuela might not actually follow through on its threats, although we can't be sure.
Phil Adler:You mentioned the United States has eased trade sanctions on Venezuela in what appeared to be an effort to bolster the availability of oil and and keep inflation in check. Do you see a reestablishment of sanctions?
Patrick Fearon-Hernandez:Yes. That agreement is actually set to expire in about a month. If Venezuela were to invade Guyana to seize the Essequibo region, the US would almost certainly allow those sanctions to snap back. In fact, the US and other countries would likely impose additional sanctions on Venezuela.
Phil Adler:Patrick, what do you think is the most likely outcome of all this?
Patrick Fearon-Hernandez:Well, to sum it all up, we think the most likely scenario is for Venezuela to refrain from actually following through with an invasion or other attack on Guyana. It really looks like Caracas is aiming for potential economic concessions and trying to play the nationalism card to ensure Maduro wins the elections, which are now scheduled for late July. But, of course, we can't be sure. The concentration of Venezuelan, Brazilian, and Guyanese troops on the border sets the stage for a potential accident or miscalculation in which military activity swings out of control.
Patrick Fearon-Hernandez:And perhaps Maduro is just unrealistically confident risk situation is a risk for global oil supplies.
Phil Adler:Patrick, where does this event fit in the broader geopolitical landscape?
Patrick Fearon-Hernandez:We think the situation is a good example of how authoritarian leaders around the world have become emboldened by the increased power of China and Russia and the perception that the US has grown tired of its role as the global hegemon or global policeman. To the extent that authoritarian leaders around the world perceive the US to be reluctant to act, those leaders are more likely to grab what they can. So the Venezuela Guyana situation is probably a harbinger of the kinds of territorial disputes and threats that we're likely to see more often in the future.
Phil Adler:And finally, how does this dispute reinforce views on investment strategy that Confluence Investment Management has expressed in recent months?
Patrick Fearon-Hernandez:The situation reinforces our view that in a world of increased geopolitical conflict and chaos, energy supplies and the supply of other key commodities are more at risk. In addition, national security is becoming more of an imperative for countries, so defense spending is rising around the world. And finally, in economic terms, conflicts like this will likely prompt further efforts by companies and countries to shorten their supply chains As they work to bring production back home or at least to more friendly countries, the result will likely be higher costs, higher inflation, and higher interest rates than we all got used to over the last 3 decades.
Phil Adler:Thank you, Patrick. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stoll. I'm Phil Adler.