Oil, former Venezuelan oil minister Juan Pablo Perez Alfonzo famously noted, is “the devil’s excrement.” Ironically, his own country has ignored this prophetic warning most of all. In Venezuela and many other Latin American countries, huge nationalized petroleum companies have firmly entrenched themselves as the means to national wealth and power even though corruption, inefficiency, and innovative stagnation often characterize such industries. Finding a way to reshape their industries in order to reap the benefits of oil resources in an efficient manner poses a significant challenge for these countries, especially because sudden abandonment of nationalized industry often fails politically in the face of popular resistance to international capitalism. However, a middle path exists: Latin-American petro-states can avoid the problems of petroleum politicization by embracing economically-focused, state-owned multinationals. If Latin America gradually shifts from a political focus to an economic focus, it may not need to throw the baby out with the ideological bathwater.

Energy nationalization, which stems largely from the strong tradition of Latin American populism, often provides a sense of national identity: to this day Mexicans celebrate their country’s 1938 petroleum nationalization. The idea that a nation is rich, fertile, or otherwise uniquely endowed with petroleum stirs a “resource nationalism” that, say, wheat production simply cannot muster. Free-market states frequently criticize such energy nationalization as undermining the benefits of private enterprise. Yet integration of a somewhat competitive, quasi-private system can nudge these national energy giants toward the advantages of the free market more effectively than rapid liberalization.

Consider Brazil’s Petroleo Brasileiro (Petrobras). Brazil has been a net exporter of the resource for the last two years, but fifty years ago the country produced only three percent of its oil. Its consistent success contrasts with other, far less stable state-run oil companies. Petrobras is weathering the global financial crisis and consequent slump in world oil demand far better than many of its counterparts, having secured US$1 billion in loans in December 2008 to develop the giant off-shore Tupi oil field, which would remain profitable to recover as long as oil prices stay in the US$50 per barrel range. While virtually every other state-owned oil company faces declining profit forecasts, losses in credit access, and shrinking investment, Petrobras is growing wildly. It is now considering new natural gas fields as well as projects that would increase Brazil’s domestic production by one million barrels of oil per day by 2015.

Though Brazil does have certain natural resource advantages, its success is largely due to smart policy. Brazil offers a true lesson to the rest of Latin America: the region need not choose between full nationalization and immediate, complete privatization.

Brazil has successfully developed Petrobas by gradually introducing free market mechanisms. Petrobas has cultivated a long-term competitive edge by focusing on technological innovation; for example, during the oil shocks of the 1970s, Petrobras invested heavily in extraction technology rather than pursue quick-and-easy oil fields. More important, Petrobras offers a new organizational model for the nationalized industry: the state-controlled oil multinational. In 1997 Brazil permitted outsiders to bid on some developing leases, and though the Brazilian government still owns a majority stake in the company, it has been publicly traded on the New York Stock Exchange since 2000.

This is not the familiar Latin American model. As oil prices soared, the so-called ”petro-politics” or “oil diplomacy” of Hugo Chavez’s Venezuela garnered the international spotlight and won allies and economic partners such as Nicaragua, Cuba, and Ecuador. But this apparent prestige masked dangerous instability. The steep drop in oil prices—which were between $40 and $50 a barrel in early 2009 after peaking near US$148 earlier in 2008—has forced Petrуleos de Venezuela SA (PDVSA), Venezuela’s state-owned energy corporation, to reevaluate tens of billions of dollars worth of refinery investment projects in Nicaragua, Cuba, and Ecuador. This economic downturn has cast doubt on Chavez’s political future, as opposition parties made significant gains in the November 2008 provincial elections.

By pegging the oil industry’s economic viability to the government’s political fortunes, politicization directs the oil-industry’s priorities toward the fleeting, short-sighted goals of politicians and precludes the long-term strength of an accountable, economically-focused business model. PDVSA cannot provide Venezuela with long-term wealth or stability if decisions are driven by the whims of Caracas.

If Latin America avoids the glamorous but unsustainable oil diplomacy of Chavez’s politicized model, nationalized energy companies may be able to adopt a model that focuses on economics over politics. State oil companies that face the choice between Brazil’s model and Venezuela’s model, such as Mexico’s Pemex, should analyze the results of this natural experiment. It is on this choice—whether to leverage the state-run giants as a political tool or as an economic tool—that all questions of profitability, sustainability, growth, and true power rest.