The prize was awarded to the Venezuelan National Assembly, dominated by opposition parties, and to political prisoners.
The award comes after months of protests against the regime of President Nicolas Maduro in Venezuela left 125 people dead and as the oil-rich country teeters on the brink of economic collapse, with the population struggling with shortages of food and such basic necessities as toilet paper and soap.
"There has been a genuine economic and social crisis in Venezuela, the situation has deteriorated, we are facing a genuine humanitarian crisis," European Parliament President Antonio Tajani said.
Maduro's socialist government lashed out later yesterday, accusing MEPs of rewarding terrorism.
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"Violent and terrorist actions by the Venezuelan opposition are rewarded by the institutions of 'civilized' Europe," said Foreign Minister Jorge Arreaza on his Twitter account.
Arreaza said that by awarding Caracas' opponents the European Parliament "removes the mask" of diplomacy and "illegally promotes regime change by force in Venezuela."
"The European Parliament has decided to award a prize to the Venezuelan opposition for burning people alive, for generating violence, for causing death," said Delcy Rodriguez, president of Venezuela's all-powerful Constituent Assembly, in a reference to the violent anti-government protests earlier this year.
Announcing the award, the European Parliament said "more than 130 opponents (of the government) have been murdered and more than 500 have been arbitrarily imprisoned".
Belgian liberal MEP Guy Verhofstadt, whose liberal parliamentary group put the Venezuelans up for the award alongside the centre right EPP, urged international powers to "join us in the fight for freedom" for the country's people.
"This award supports the fight of democratic forces in favour of a democratic Venezuela and against the Maduro regime," he said on Facebook.
The opposition also suffered a heavy defeat in October 15 regional elections by Maduro's socialists who swept the vote in 18 of Venezuela's 23 states, though the Organization of American States declared the elections illegitimate.
Jose Ignacio Salafranca, an EPP MEP from Spain, hailed the Venezuelan opposition as "an example for all".
"They are brave people who, despite being beaten or imprisoned, are not afraid and do not give up, but fight for their freedom and for their dignity," he said in a statement.
Named after the dissident Soviet scientist Andrei Sakharov, who died in 1989, the prize is awarded every year to honour individuals who combat intolerance, fanaticism and oppression, often falling foul of their governments as a result.
The prize worth 50,000 euros will be handed to the winner during an official ceremony in the European Parliament on December 13.
Last year's prize was awarded to Nadia Murad and Lamia Haji Bashar, two Yazidi women activists who escaped the Islamic State group in Iraq.