Hugo’s Gambit

Story Highlights:

• Venezuelan officials are again threatening to cut off US oil supply.
• Venezuela would lose much more than it would gain with such a tactic.
• While probably not credible, the threat underscores today's supply-constrained energy market and how politics are likely to play an increasing role in its trade.

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One of the greatest and most difficult of all chess strategies is the gambit. Gambits are a series of opening moves where a player strategically sacrifices pieces for a better position. It's a big risk and you better know what you're doing or the game will be over very quickly.

Chess has always been the political gentleman's game. It requires strategy, tactics, psychology, knowing one's opponent, and a dollop of chutzpah to make the strategy work. Apparently Venezuelan president Hugo Chavez has been brushing up on his Bobby Fisher of late. They seem to share similar disdain toward the US as well as a penchant for chess strategy. Chavez has threatened to give up his country's revenue from selling oil to the US in order to win a larger political battle. Call it Hugo's oil gambit.

Venezuela's Chavez Threatens Oil Cut-Off
The Associated Press via CNNMoney.com

It's true the US would be hurt economically if Venezuela stopped supplying it with oil, but probably not as much as Chavez hopes. Much of global energy trade is dictated by proximity and ease of transport, and oil is relatively easily transported from Venezuela to the US by pipelines and short shipping routes. It's more costly to get our oil from the Middle East and Asia because it's got further to go. So, there's a mutually beneficial relationship between the US and Venezuela because transport costs can eat into production and end costs.

Time to panic? Probably not. An adept chess player will see Venezuela has too much riding on oil to make the gambit work. The US is their number one customer—they'd be sacrificing far too much to sustain a position they aren't likely to win from anyway. Venezuela is not only currently in poor economic health, but it's extremely dependent on a few key industries. Energy exports are their primary source of revenue. Cut that off and they'd be far more crippled than we would ever be. Purposefully axing its number one revenue stream is a very poor strategy—like giving up the queen for a pawn or two.

Also putting Venezuela at a distinct disadvantage is that oil is fungible. The US can get oil from Venezuela, Russia, the Middle East—wherever—and it's still basically the same oil. While it may be pricier, the US has the option of going anywhere to buy oil, just as Venezuela has the option of selling to anyone. But Venezuela has an additional hurdle. They'd likely be shipping their oil much further—eating into their own oil profits.

Thus, the US has plenty of pieces still on the board and is in good position. The US already gets its oil from a diversified cast of global players, whereas Venezuela would have to strike new contracts to ship oil further than they normally would.

In sum, this episode functions more as a cautionary tale for Emerging Markets investors than a reason for panic. In parts of the world where property rights are iffy, governments can simply seize assets at their whim and that's the end of it. Similar risks are present every day with Gazprom and a very ambitious Russian government.

Oil prices ticked up a bit today after Chavez's rant, but remained well within recent bandwidths. For now, the market isn't taking his threat seriously. Additionally, with energy costs remaining a small component of US economic consumption, this issue probably feels scarier than it really is. Though per-capita energy costs have risen since 2002, they are blown away by much larger gains in disposable income. (And, high oil prices don't spell doom for stocks. See "Hundred Bucks a Barrel," 01/03/2008.)

This characterizes today's continuing environment for high energy demand and crimped supply. Energy prices should remain at heightened levels for the foreseeable future, particularly as the tactic of petro-politics is utilized more often by developing regions to gain power. But Hugo should think twice—gambits backfire more often than not.