As we wrote last August, some governments are watching political developments in Venezuela more closely -- and with more anxiety -- than others. For the past decade, that country's Petrocaribe program has helped 18 Central American and Caribbean leaders avoid the kinds of tough economic choices that sometimes drive angry citizens into the streets -- and helped Hugo Chávez extend his regional influence. Each of these countries has benefited from concessional financing schemes for their imports of Venezuelan crude oil, as well as Venezuelan support for infrastructure projects and social programs. Beneficiaries, especially Cuba, will be watching closely as Venezuelans go to the polls on April 14 to elect Chávez's successor.

They can expect good news and bad news.

The good news for them is that acting-President Nicolas Maduro, Chávez's hand-picked successor, is highly likely to win. Opposition leader Henrique Capriles Radonski is back for another run after losing to Chávez in October, but following a campaign that is likely to prove nasty, brutish, and short, Maduro will benefit from still-strong popular support for Chavismo, public sympathy for those close to Chávez, and fear that the opposition would reverse the late president's most popular policies. Maduro and his allies will also have the resources and political leverage to boost spending and mobilize supporters.

The bad news is that policy is unlikely to improve under a Maduro administration, and political conditions within the country could deteriorate over time as internal dissent becomes more difficult to manage and worsening economic conditions stoke social unrest. Maduro is likely to maintain Petrocaribe, but in the medium term, domestic fiscal constraints may well force him to reduce foreign aid, since among the spending commitments of state-run oil firm and government piggy bank PDVSA, help for foreign governments is the easiest area to cut. Maduro will have to care more about support at home than friends abroad.

Venezuela is currently giving away about one-third of its oil production at below-market prices, including as part of the Petrocaribe program. At today's prices, the volumes that go to Petrocaribe partners amount to more than $6 billion in lost revenue -- about 2 percent of Venezuela's total GDP.

The new president will probably prioritize aid to Cuba, since the Castro brothers are strategic allies and high-profile friends who likely played a role in vetting him for the presidency. Maintaining strong relations with the Castro regime is also a means for Maduro to protect his revolutionary credentials as he works to establish himself as Chávez's legitimate political heir.

But for other Petrocaribe countries, aid reduction will likely be substantial. The Dominican Republic and Nicaragua would likely face the toughest economic challenges, forcing policymakers to make sharp policy adjustments. Reduction or elimination of Petrocaribe financing would put the DR's Danilo Medina in an especially tight spot. Given the size of its economy and its access to international financial markets, the Dominican Republic is better placed than Cuba or Nicaragua to weather the storm, but Medina is already looking for new sources of state revenue.

Cuts to Petrocaribe would also be bad news for Daniel Ortega's government in Nicaragua. Some estimates have Venezuelan support -- in the form of direct loans to Ortega, energy projects, and oil -- at about $500-600 million a year. That's 7-8 percent of Nicaragua's GDP. Petrocaribe has allowed Ortega to subsidize electricity rates and public transportation, boost public sector wages, spend on infrastructure improvements, and enhance food security. A significant cut to Petrocaribe might even persuade Ortega to make new friends in Washington. 

These are a few of the reasons why there will be so much international interest in Venezuela's election -- and in what comes next.

Risa Grais-Targow and Heather Berkman are analysts in Eurasia Group's Latin America practice.

By Daniel Kerner and Risa Grais-Targow

The Bolivarian revolution in Venezuela is rapidly approaching its biggest test yet: The defiant Hugo Chavez, the man who has personified Venezuelan politics for 14 years, has publicly admitted that his days as president may be numbered. His movement has a slight edge in elections that are likely to be called within months, but much will depend on the president's ability to transfer his personal appeal to his chosen successor.

Throughout multiple treatments for what appears to be cancer, Chavez had refused to publicly acknowledge that he may be too weak to lead his country. But on December 8 he announced that he would need a fourth round of surgery in Cuba, and named Vice President Nicolas Maduro as his successor, setting in motion plans for a potentially rapid transition.

According to the Venezuelan constitution, new elections must be held within 30 days should the president be forced to step aside before inauguration day (January 10) or during his first four years in office. Maduro would likely face Miranda Governor Henrique Capriles Radonski, whom Chavez defeated by about 10 percentage points in the October 7 presidential election.

Anointing a successor is a clear admission by Chavez that he is unlikely to complete his six-year term, making an election inevitable. There are three main reasons the government will likely call for a vote as soon as possible.

The future of Chavismo depends on Chavez's ability to transform a movement that is largely based on a cult of personality to one that can survive without him in perpetuity. Chavez remains popular, despite the fact that a majority of the public thinks poorly of the government's ability to solve problems. Chavez therefore needs to aggressively make the case to the Venezuelan people that Maduro has the talent and vision to carry on the revolution. Chavez's ability to campaign for Maduro is uncertain, but it will only lessen with time.

Second, foreign exchange dynamics are untenable for much longer. The country has an unorthodox three-tiered exchange system, with two different official rates for businesses and individuals needing dollars, as well as a parallel (illegal) rate. Black-market rates indicate that the bolivar should be much weaker than it is in the official windows, and dollars are becoming increasingly scarce.

The government would likely prefer to hold fresh elections before a devaluation, which would propel already-high inflation and be politically costly for Maduro's candidacy. In the meantime, the government can rely on domestic and foreign debt issuance to meet fiscal and foreign exchange needs to buttress the political environment in Maduro's favor. 

Finally, Chavismo wants to capitalize on an opposition that remains weak and divided following Capriles Radonski's defeat, by forcing it to compete before an official candidate selection process can take place. Capriles Radonski faces a gubernatorial election on 16 December, which he is likely to win. But if he does not, the opposition will have to scramble to coalesce around a new candidate in a short amount of time.

That said, the opposition is likely to take advantage of its best chance to win since Chavez came to power by uniting around a single candidate. It is far from certain that Chavez will be successful in transferring his personal appeal to Maduro, but Chavismo retains a slight edge in the coming election.

Regardless of who wins, Venezuela faces a very challenging 2013. Maduro would be forced to make difficult economic adjustments and manage divisions within Chavismo. An opposition president would have to make the same adjustments before setting out on a reform course, but would face even more obstruction from Chavismo stakeholders across the state apparatus.

Daniel Kerner is an analyst in Eurasia Group's Latin America practice. Risa Grais-Targow is an associate in the firm's Latin America practice.

By Joao Augusto de Castro Neves

When Brazilian President Dilma Rousseff travels to Washington next week, she won't be looking for a free trade deal or military assistance. Her country, the "B" that begins the "BRICS," primarily wants recognition -- specifically U.S. support for a permanent seat on a revamped U.N. Security Council. But this time around, Rousseff won't even be getting a state dinner.

Washington, due mainly to bureaucratic inertia, isn't ready to give Brazil the recognition it wants. Its reluctance may actually encourage other nations to behave in ways contrary to U.S. interests.

Years of macroeconomic stability, sustainable economic growth, and a cluster of successful social policies gave rise not only to a new and thriving Brazilian middle class, but also to Brazilian multinational companies, the so-called national champions. Externally, these changes translated into greater confidence -- inside and outside official circles -- and a wider scope of international ambitions.

Brazil is beginning to display the characteristics of a regional hegemon -- it has attracted more illegal immigrants from surrounding countries, and helped Colombia's government conduct rescue missions for hostages held by the FARC. And since 2004, Brazil has been leading the U.N. stabilization mission in Haiti. But Brazil's "holy grail" remains a seat at the Security Council table. And it won't get recognition (yet) from the most important member of the Permanent Five, whose support it very much covets.

According to many foreign policy specialists in Washington, Brazil does not deserve a place in the top echelons of the U.N. because it is not a nuclear power and is unwilling to share the burden of leadership. Another line of reasoning highlights the fact that the U.S. does not endorse Brazil's bid -- as it did with India -- because South America is not a very relevant region in the U.S. strategic chessboard. The remaining argument point to the fact that a potential endorsement could hurt U.S. interests with other key allies in the region, specifically Mexico and Colombia.

Even if some of these considerations may hold elements of truth, at the end of the day they hamper the deepening of relations between the two largest democracies and economies in the Western hemisphere. Brazil could do a better job explaining to the U.S. -- and the world -- how it would behave as a permanent member of the Security Council; but the U.S. could also rethink some of its arguments against Brazil.

The fact that Brazil is not a nuclear power and that South America is not a relevant strategic hotspot should count in favor of Brazil's aspirations, not against. If the region is relatively calm, it is because of the collective effort of Brazil and Argentina to end their economic and military rivalry in the 1980s. As a matter of fact, the rapprochement also defused the nuclear component of the rivalry, something that India and Pakistan were not able to do. The U.S. decision to endorse India's bid and ignore Brazil's sends a perverse message. It awards a country that snubbed every major nonproliferation regime while punishing a country that willingly adhered to these very same regimes.

Although the repercussion of the endorsement of Brazil's bid over U.S. interests with key allies in the region is likely to be negative, its importance is widely overplayed. Even nuclear Pakistan's outright resistance did not factor in U.S. geopolitical calculus when it endorsed India's bid. In addition, for some time now, the U.S.-Latin American agenda is in fact a collage of increasingly specific bilateral relations. Any dissatisfaction, therefore, could be dealt with bilaterally without any relevant repercussion on the regional agenda.

Next week's visit by Rousseff is likely to pass without the words that Brazil wants to hear from President Barack Obama. Those words will eventually come from Obama or a future U.S. president, but their absence in the short term will keep relations between the Western Hemisphere's two most important democracies from reaching their productive potential.

Joao Augusto de Castro Neves is an analyst in Eurasia Group's Latin America practice.  

Today, The Call presents our top risks for 2012. Click HERE for Eurasia Group's complete report.

1. The End of the 9/11 Era -- It was a truism of globalization: economics drives markets, and national security drives geopolitics. No longer. Following the 2008 financial crisis, the killing of Osama bin Laden, the withdrawal of U.S. troops from Iraq, and an end date for the war in Afghanistan, politics and economics will overlap almost entirely in 2012. Political officials around the world will worry mainly over economic risks -- the eurozone crisis, the strength of U.S. recovery, and China's evolving role in the global economy in 2012. Market players, in turn, are anxious mainly about political decisions, especially those that will be made in Europe, America, and China this year, as shortsighted leadership from virtually all the major geopolitical players generates policy stalemate and uncertainty.

2. G-Zero and the Middle East -- The inability/unwillingness of major powers to bolster the region's balance of force will generate greater turbulence across North Africa and the Middle East as unresolved religious, sectarian, and ethnic tensions threaten more unrest. The lack of a viable regional security framework, continuing protests, autocracies at risk, and enormous challenges facing newly democratic regimes will add to the potential turmoil. As this dynamic plays out in Syria, Egypt, Iraq, Libya, Yemen and Bahrain, regional heavyweights -- Saudi Arabia, Iran, and Turkey -- will generate friction as they vie for proxy influence.

3. Eurozone: the rollercoaster ride rolls on -- In Europe, it's not the breakup of the Eurozone we need to fear in 2012 but the "reactive incrementalism" that could spin beyond the control of political officials. The uncertainty and volatility we saw in 2011 has only just begun.

4. United States: right after elections -- Once the votes are counted in November, lawmakers will take up the $5 trillion worth of tax and savings decisions that must be taken in the final nine weeks of the year. Investors face uncertainty about their taxes and government contracts as well as about the broader impact of lawmakers' choices on economic growth.

5. North Korea: implosion or explosion -- The world's most opaque nuclear-armed state enters a year of uncertainty as the battle for power and influence within the regime gathers force.

6 - Pakistan: turmoil, spillover -- The end of the 9/11 era threatens neglect of other hotspots, and none is more combustible than Pakistan, a terrorism-plagued, nuclear-armed power burdened with an unpopular civilian government, a meddlesome military, politically motivated judges and an increasingly dangerous security environment. The expected withdrawal of thousands of U.S. troops from Afghanistan this year will fuel regional competition for new influence.

7. China: trouble in the neighborhood -- The Obama administration's recent emphasis on Asia will embolden China's neighbors to take more assertive positions with Beijing. Rising nationalism in China, its ongoing political transition, and the leadership's unwillingness -- perhaps inability -- to resolve internal debates about the country's role in the world suggest Beijing is especially likely to meet provocation with provocation in months to come with both naval and economic muscle.

8. Egypt: a transition in trouble -- Egypt faces the risk of political disintegration this year as anger builds between military and civilian political forces, both Islamist and secular. Egypt's base-line stability, its economic recovery, and its broader regional influence will suffer.

9. South Africa: populism ascendant -- The struggle for leadership of the ruling African National Congress will slow the pace of both policy and economic growth at a time when the eurozone crisis already weighs heavily on South Africa's trade and currency.

10. Venezuela: a no-win election -- The country's big political story this year is October's presidential election, which incumbent Hugo Chavez, if healthy enough for a vigorous campaign, is likely to narrowly win. But the outlook for economic and political stability is bad no matter the election result. Should Chavez die or abandon the race, the deep fissures between the Chavista movement and the opposition could stoke violence.   

In addition, Eurasia Group identifies four red herrings, the big stories we don't believe will happen in 2012.

Fallout from the 2012 political transitions -- In 2012, we'll see political transitions in the U.S., China, Russia, and France, countries that together represent nearly half of global GDP and four-fifths of the UN Security Council. But there's surprisingly little at stake in the outcomes for geopolitics and the global economy.

Eurozone breakup -- This is probably the single most overrated risk of 2012. The political will to maintain the eurozone remains strong among all the major political parties in the core Eurozone states, almost across the board in the European periphery and, just as importantly, among eurocrats in the ever-growing European bureaucracy. And there's no effective political mechanism for a Eurozone breakup.

China's hard landing -- There are signs of overheated growth in China, but the state has the tools and resources to manage short-term trouble, and it will pull out every stop to prevent a serious slowdown, especially during a major political transition.

Mayan apocalypse -- Just isn't happening. And if it does, well, sorry.

Over the next three weeks, we'll be posting more ideas and information on each of these risks.

By Daniel Kerner

It's been a busy few weeks in Latin America, with citizens scurrying to the polls in Guatemala, Nicaragua, and Argentina. In Guatemala and Nicaragua, the elections left some uncertainty. Will former army general Otto Perez Molina's tough rhetoric translate into meaningful change in Guatemala, especially where crime and taxation are concerned? And with rampant electoral fraud alleged in Nicaragua, will the United States and the European Union recognize incumbent Daniel Ortega's nearly 32-point win? There are fewer questions in Argentina, where Cristina Fernandez de Kirchner's reelection promises more of the same-and possibly even more of it, if she tries to tweak the constitution to give herself a shot at a third term.

Despite Argentina's staggeringly high inflation (around 25 percent, according to private estimates), worsening fiscal position (spending is up 35 percent so far this year), declining trade surplus (imports have grown 37 percent year-to-date, while exports have gained only 28 percent), and steady capital flight (around $3 billion a month for the past few months), Fernandez de Kirchner swept the Oct. 23 elections. Macroeconomic imbalances notwithstanding, GDP continues to expand, unemployment is low, and wages have kept up with inflation. And this, together with expansive social policies, has improved voters' well-being. Now backed by nearly 54 percent of the vote, as well as comfortable majorities in both the lower house and the senate, Fernandez de Kirchner has little incentive to steer economic policy in a more orthodox direction-including, say, less expansionary fiscal and monetary policies to contain inflation or easing restrictions on foreign trade-especially as Argentine authorities watch the US and Europe struggle under just such a framework.  

The government's moves since the elections support this more-of-the-same outlook. Three days after Fernandez de Kirchner's win, her administration decreed that it would force energy and mining companies to repatriate all of their export revenue (previously, they'd been allowed to keep 70 percent and 100 percent of it abroad). This about-face was likely an attempt to reduce downward pressure on the currency, a result of the deteriorating trade balance and rising demand for dollars. The government also limited access to foreign currency to stem capital flight. The central bank has already spent more than $4 billion of its reserves trying to prop the peso up, and while the administration is loath to let the currency fall, it's likely to keep proffering ad hoc fixes like forcing companies to repatriate revenue or imposing foreign exchange controls rather than making any serious adjustments. Likewise, while the government announced earlier this month that it would reduce subsidies to the energy and transportation sectors, thereby curtailing spending, the proposed $140 million reduction is miniscule compared with the roughly $17 billion that the government spends on subsidies. And most of that $17 billion will probably come in the form of higher taxes rather than higher energy prices (which would stimulate investment).  So no game changer there.

As a result, Argentina's economic distortions are unlikely to improve much, and could worsen if the world economy languishes further. Fernandez de Kirchner will have to be careful, though. Her popularity depends in part on the country's economic conditions, and her chance of securing a third term depends on her popularity. She'll need support from two-thirds of both chambers to make the necessary constitutional adjustment -- a challenge, but not an impossibility. It remains to be seen whether she'll test the waters this year. 

Daniel Kerner is an analyst in Eurasia Group's Latin America practice.

By Christopher Garman and Jefferson Finch

At first glance it would appear that Brazilian President Dilma Rousseff has successfully weathered her administration's first political crisis: a scandal that led to the resignation of her chief of staff, Antonio Palocci (his second departure from a Workers' Party government due to accusations of shady dealings). Indeed, it'd be easy to think that it might be smooth sailing for the rest of the year. The president substituted Palocci with Gleisi Hoffman, a senator whom she knows well and who is loyal to her; the market's trepidation about inflation appears to be receding for the moment; and the latest unemployment data, released yesterday, reveal that seasonally adjusted unemployment has reached an all-time low of 5.9 percent. What's more, a public opinion survey conducted by Datafolha in June found that Brazilians' impression of the Rousseff administration had improved a little since March, with 49 percent of respondents saying her government was "good" or "great," compared with 47 percent before.

But Rousseff's political future might not be as rosy. If you dig a little deeper, a different, more challenging picture emerges. The same Datafolha poll found that the share of respondents who think inflation will stay high jumped from 41 percent in March to 51 percent in June. Likewise, the portion of respondents who think their purchasing power will increase dropped from 43 to 33 percent. Meanwhile, the National Confederation of Industry found that 71 percent of the people they spoke to expect inflation to increase over the next year, the highest percent in roughly a decade.

To make matters worse, consumer confidence is starting to drop. Datafolha discovered that 17 percent of respondents think the economy will worsen, almost double the number (9 percent) who felt that way in March. These shifts in popular sentiment may not be dramatic enough to change the political calculus of Rousseff's advisors, some who think her popularity might even rise later this year. But they do hint that the economic foundation of Rousseff's popularity is splintering. As Brazilians feel their purchasing power sapped, the rosy halo around Rousseff will likely start to fade. That said, the president's downhill slide will probably be gradual. After all, we're talking about higher inflation, not runaway inflation, and slower growth (just under 4 percent for 2011), not recession.

Christopher Garman is head of Eurasia Group's Latin America practice. Jefferson Finch is an associate in the practice.

Late last week, Ecuadorean President Rafael Correa, having tried to pass a new public servant law that would have significantly cut police wages, found himself roughed up, tear-gassed, and barricaded inside a Quito hospital by rebellious cops for several hours before loyal officers finally shot their way inside and freed him. It was all the result of Correa's attempt to roll back spending in one of South America's most challenged economies, in a context where he has precious few financing options (having defaulted on his country's debt in 2008, Correa's finding it a little hard to get loans these days).

Because Ecuador's military and its top police commanders remained loyal, the coup quickly fizzled and the plotters were soon jailed. Order, for the time being, has been restored. But last week's unpleasantness in the Andes reflects a broader story with potentially more worrisome implications: how the extended economic downturn is dramatically exacerbating popular discontent with regimes where political instability had already been percolating -- and how, in some cases, that discontent can quickly and without warning spiral out of control.

This isn't much of a concern for the world's key emerging markets -- think China, India, Turkey, or Brazil -- since they've all performed well over the past year. Nor is it an issue for most of the underperforming developed states, since even the worst of these laggards have enough built-in social and political stability to weather the slow, painful recovery to come (think Japan). Even Greece, basket case that it is, should be able to soldier on, thanks to all the funding and outside support it has received from Europe and multilateral bodies such as the IMF.

But the dangers are out there. In Latin America, the worst fat tail risks -- that is, countries where serious unrest is still a relatively low probability but would be massively destabilizing if it erupted -- are in Cuba and Venezuela. That's because both countries are in disastrous economic shape, and are going to need to make some serious, painful cuts to stay afloat; yet in both countries, the regimes face major problems with popular legitimacy, which will make these cuts hard to sell to regular folks. Further afield, Ukraine, with its economic woes, deeply divided population, and perpetually dysfunctional political culture, also deserves to be added to the mix. (Indeed, the new president, Viktor Yanukovych, probably knows this, which is why he's recently tacked his foreign policy toward Europe, in order to connect to the broader electorate.) And while the developed states are generally well insulated, it's probably worth keeping half an eye on Spain -- which faces one of Europe's worst economic situations but must contest national and regional elections in the next twelve months. Portugal is also worth watching. This isn't to suggest that Iberia is about to erupt in flames. But if protests do occur and the Spanish and Portuguese take to the streets in real numbers, the narrow political consensus around the belt-tightening necessary to get through the economic crisis could crumble.

As for literal collapse, that's a real risk in a few places. Exhibit one is Pakistan, where this summer's massive floods worsened an already shaky political situation. The one saving grace so far has been that the military has little interest in intervening, since that would force the generals to assuming responsibility for governing the troubled country themselves. That said, don't rule out the chance of some sort of a sudden power transition. And then there's North Korea, which is trying to negotiate a leadership succession (from a coddled dipsomaniac to an overweight, untested 28-year-old, no less under disastrous economic circumstances; never an easy move).

The overall prognosis? Stay tuned. Place brittle regimes under great stress, and the one thing you're almost guaranteed to get is a larger number than usual of "unexpected" regime changes.

Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? 

By Daniel Kerner and Willis Sparks

Remember when Britain and Argentina went to war over a handful of hard-scrabble islands with little to recommend them but two thousand windblown people and a few million penguins? In 1833, Britain seized and begun occupying what it called the Falklands, a set of islands just 350 miles off Argentina's coast and about 8,000 miles from London. Argentines, who refer to them as Islas Malvinas, have demanded their return ever since.

In April 1982, General Leopoldo Galtieri's military government announced that Argentina had finally claimed ownership of the islands. Prime Minister Margaret Thatcher insisted that they still belonged to Britain. To rally the Argentine people to a military junta blamed for large-scale human right abuses and a floundering domestic economy-and convinced that Thatcher would let the islands go rather than fight for them, Galtieri ordered an amphibious invasion. The British navy arrived and quickly forced an Argentine surrender.

The war lasted 74 days and killed 255 British and 649 Argentine troops -- along with three local residents. The Argentine government was soon forced from power, and Thatcher rode a surge of patriotic pride to a landslide re-election the following year.

Though Argentina withdrew, it has never surrendered its legal claim on the islands; ownership is enshrined in the country's constitution. The Falklands have experienced an economic boom in recent years, thanks to the revenue generated by increased exports of squid. But for most people outside Argentina and Britain, the war represents little more than a curious footnote of naval history. 

Until last weekend.

On Sunday, a British-based oil company, Desire Petroleum, began drilling for oil in the northern basin of the islands. The news has provoked sharply rising tensions between a lame duck government in Britain, where the 1982 war remains a point of pride, and a struggling government in Argentina, where hard feelings over the conflict remain alive and well. Both governments face critical elections -- Britain later this year and Argentina in 2011.

Faced with few real options, the Argentine government tried to pre-empt the British exploration with a decree on February 16 that all ships moving to and from the islands that use Argentine ports or pass through Argentine waters must have a permit. Cristina Fernandez de Kirchner's government is now tightening the diplomatic screws on Britain, mainly by working to win broad support for its position from across Latin America. Other British oil companies are expected to explore the area soon.

Exploration will continue for the next few months. Local officials in the Falklands government claim there could be as many as 60 billion barrels in reserves beneath the basin, but some experts are skeptical. It's not yet clear that oil deposits near the islands contain enough accessible oil to make further investment worthwhile. Tensions will likely subside in coming weeks, and no one envisions a sequel to a war that killed nearly 1000 people. The Argentine government has said publicly that armed conflict is not an option, and the Argentina public is highly unlikely to support one.

But what if local officials are right about size of the oil reserves? What if there is much more oil there than some experts think? If two governments fighting for their political lives at home will go to war over islands famous only for their penguins, what might they do to secure billions of barrels of oil?

Daniel Kerner is a Latin America analyst at Eurasia Group, and Willis Sparks is an analyst in the firm's Global Macro practice.

By Ian Bremmer

Brazil's emergence as an investor-friendly, free market democracy has been one of the world's most encouraging stories of the past several years. As Venezuela's Hugo Chavez perfects his Castro impersonation, Ecuador and Bolivia follow Chavez's example, and Argentina's economy flounders, Brazil's President Luiz Inacio Lula da Silva has maintained responsible macroeconomic policies -- while redistributing wealth to narrow the still-considerable gap between the country's rich and poor. But as he begins his final year in office, a huge off-shore oil find has emboldened his government to deepen state control of the energy sector, clouding the investment picture.

Lula now looks likely to win a legislative battle over the future of Brazil's oil sector. State-owned oil company Petrobras will then hold exclusive rights to operate all new exploration and production in off-shore fields that are believed to contain one of the world's largest deposits of crude oil discovered in recent years. Brazil's government will then control all activity in the new fields, making the big decisions on project operation and management. Over time, Petrobras will become a much larger but less profitable and less efficiently run enterprise.

No surprise then that multinational oil companies resolutely oppose this plan. Despite the tremendous potential in the offshore fields, many of them may simply opt not to work with Petrobras under the terms the Brazilian government has proposed. That's why there's a real risk that Brazil will have to turn to Chinese and other state-owned energy companies for the resources they'll need to bring this oil to market. That will be bad news for those who import oil because, though Petrobras has the technical expertise for the job, the company is already approaching overstretch on development of existing projects. The fact that Petrobras can do the job doesn't mean it should. Partnership with oil multinationals with much more experience managing projects to recover maximum quantities of deep sea oil deposits would bring more oil to consumers -- and do it more quickly and efficiently.

Brazil's opposition isn't happy with Lula's plan either, but his popularity (near 80 percent) has kept the opposition quiet. Even Sao Paolo Governor Jose Serra, the candidate most likely to defeat Lula's preferred successor (Chief of Staff Dilma Rousseff) next October is keeping most of his reservations to himself. Lawmakers who would normally oppose a government-managed plan are eager to remain in Lula's good graces as elections approach.

Multinational oil companies are moving cautiously, as well. They've aired their criticisms through Brazil's Petroleum Industry Association, but have avoided direct involvement in Brazil's election dynamic. 

Without determined opposition, the legislation will probably pass. If Serra wins next fall's presidential election, he will probably try to reverse the legislation. But that would be a long process. If Dilma wins, international oil companies can only hope for an eventual victory in court on the reform plan's constitutionality. Either way, Brazil's energy sector will be much less investor friendly for the next several years.  

Ian Bremmer is president of Eurasia Group.

ANTONIO SCORZA/AFP/Getty Images

by Eurasia Group analyst Erasto Almeida

Brazil has navigated the global financial crisis relatively well, and is well positioned to resume economic growth in 2010 and beyond. Responsible macroeconomic policies are probably here to stay, even when a new president takes office in January 2011. New vast oil discoveries will further reduce the country's vulnerability to external shocks and offer a number of new investment opportunities. So what's at stake for the markets in the 2010 elections? It will be important to watch the role of the state and national champions in key sectors such as oil, power, and mining.

No matter who wins the presidential election, it is highly unlikely that Brazil will return to the kind of irresponsible macroeconomic policies it had in the past. The country's largest leftist party, the ruling Worker's Party (PT), has not only embraced responsible macroeconomic policies but, very importantly, benefited politically from its decision, as shown by President Luiz Inacio Lula da Silva's reelection in 2006 and 80 percent approval ratings.

Lula's chosen candidate to succeed him, Chief of Staff Dilma Rousseff, is unlikely to change course. Jose Serra, the governor of Sao Paulo from the opposition Brazilian Social Democracy Party (PSDB), who will probably be her main adversary, is even more market friendly. Rousseff and Serra might differ on how to calibrate policies, but neither one will significantly alter the status quo. The 2010 electoral cycle may contribute to some fiscal slippage and generate noise on monetary policy with the likely departure of central bank governor Henrique Meirelles, who wants to run for office. Yet even if a less predictable candidate emerges and wins the election, a shift away from voters' preferences for low inflation is unlikely. Brazil remains overall a sound long-term bet for investors.

With macroeconomic stability here to stay, what differentiates the two main candidates is their view on industrial policy and the state's role in key sectors of the economy. Rousseff has a much more state-centered view than Serra, perhaps even more than Lula. Her view is already present in the current government, where she is the key policy decision-maker, but it would probably become more salient in a new PT administration. Investment from state-controlled energy company Petrobras, for instance, has been a key component of the government's counter-cyclical policy. More recently, the government seems to have decided to propose that Petrobras be the sole operator of the new deep-sea oil province. There may be similar moves, if on a smaller scale, in the power sector, for example, with a greater role for state-owned utility Eletrobras. Brazil's National Development Banks (BNDES) will play an increasingly important role in providing financing for companies and projects. Rousseff wants greater private investment as well, but as Brazil's economy and state revenues grow, she will have more room to push for industrial policies and national champions. If Jose Serra and the PSDB win, however, the state and national champions would have much less involvement.

The big question that remains open, of course, is who will the election. While the presidential race is expected to be tight and it's still early to make concrete predictions, the odds seem to be in Rousseff's favor. Although she is behind Serra in current polls, has never run for office, and lacks Lula's charisma, she signifies continuity -- which is likely to be the popular trend. Brazilians are happy with the economy and recent improvements in their lives. Studies show a steady expansion of the lower-middle class, which grew from 42 percent of the population to 52 percent in the past seven years. This progress helps explain Lula's record high approval ratings, which will also be Rousseff's main asset. If she wins, she won't put economic stability at risk, but Brazil will most likely see the state take a heavier hand.

EVARISTO SA/AFP/Getty Images