Next Up For Venezuela: PDVSA's Inevitable Default

Tyler Durden's picture

Authored by Saxo Bank's head of macro analysis Christopher Dembik via TradingFloor.com,

A Venezuelan default is only a matter of time.

While debt servicing has been a government priority, declining external liquidity and a deteriorating domestic situation (three-digit hyperinflation, shortages, and a political crisis between the government and the National Assembly) make it a daunting task.

By 2020, the country must repay 30% of the external debt due to expire in the next 23 years.

Venezuela can get access to liquidity via three main ways.

The first option is to borrow directly on the financial market which implies that the country must pay an increasingly prohibitive risk premium due to investors’ fear of sovereign default.

The second option, used intensively in recent years, is to borrow from allies, and especially China.

Since 2009, Venezuela has borrowed at least $60 billion from China (through the Venezuelan-China fund) in exchange for selling oil at a discounted price. Loans were used to pay foreign manufacturers and repay external debt, such as in 2015. This exchange of good practices persisted as long as oil prices were quite high and Venezuela’s political situation was fairly stable. Since 2016, China has made a strategic move to reduce exposure to Venezuela which resulted in the repatriation of Chinese oil engineers (who filled local labour shortages), the end of financial aid, and reduced oil imports. 

In this context, it is quite unlikely that Venezuela will be able to count on China for repayment of its loans, which increases the probability of sovereign default in the medium term.

The last option is through the national oil company, PDVSA (Petróleos de Venezuela SA). As the country’s main source of income and access to foreign currency, PDVSA is key for those seeking to gain a real appreciation of Venezuela’s disarray and economic future.

Over the past five years, it has accounted for virtually all of the country’s foreign exchange earnings – about 93%. The financial mechanism is quite simple: PDVSA borrows cash in the US financial market via its local subsidiary Citgo Petroleum Corporation, the sixth-largest US refinery, then the money is transferred to PDVSA and a significant part is allocated to Venezuela’s government budget.

As bonds are issued under US law, which offer a good level of protection to investors, borrowing rates are more affordable than if bonds were issued under Venezuelan law. Until very recently, this has been the least costly way for the country to borrow.

However, access to liquidity and foreign currency is being called into question by PDVSA’s increasing financial difficulties. This dates back to 2003-2004 when then-president Hugo Chavez decided to transfer the majority of PDVSA's revenues to the government budget in order to finance the Bolivarian missions – a series of social programmes – rather than investing in capex to increase the company’s productivity.

The lack of investment did not have an immediate impact on PDVSA’s financial situation as long as oil prices were above $100/barrel. After all, it was enough to cover the cost of producing one barrel of Venezuelan oil (which are among the most expensive barrels in the world to produce at around $23.50 versus $10 in the Arabian Peninsula)... and to balance the government budget.

The fall in oil prices from mid-2014 led to a massive drop in oil production, as well as lower profit margins and tax revenues.

So far, PDVSA continues to pay its bondholders cash on the barrelhead, which explains why 80% of them buy back bonds when they expire. The company tries to maintain the illusion of a good financial situation, but this is misleading.

The company is running out of cash. It keeps repaying bondholders in order not to cut off the Venezuelan government's financing flow but it is already unable to pay the  foreign oil field services companies on which it relies.

Since 2015, PDVSA has made extensive use of various financial instruments (credit notes and commercial papers) to settle outstanding bills with foreign companies such as General Electric in order to delay the consequences of this problem. These instruments are not very liquid and are subject to haircuts, but they have two main immediate advantages.

First, they give PDVSA additional leeway in repaying its creditors, up to six years. Furthermore, they give creditors the possibility of being reimbursed by the confiscation of PDVSA assets upon decision of the International Chamber of Commerce, an independent international organization whose secretariat is in Paris.

In the near term, PDVSA faces a challenging debt repayment schedule since it needs to repay $3.2 billion due mostly in October and November. Based on official reports, the company only has $2 billion in cash to service its debt obligations. Nevertheless, a default is unlikely this year; fighting a political crisis and defaulting at the same time would be too complicated to handle. 

Venezuela still seems willing and able to pay.

In the worst-case scenario, PDVSA might use a grace period of a few weeks, as it did last year, in order to pull coins out of the sofa to pay these bills. The company can still obtain a new loan from Russian oil company Rosneft and propose as collateral its oilfield stakes; it could get funding from Venezuela's public banks (which has already been done recently for about $500 million); or the government can decide to use the central bank’s foreign reserves which are officially estimated at $10 billion, of which $1 billion is in cash and $9 billion in gold bars.

Nonetheless, default seems inevitable in the medium term due to the prolonged period of low oil prices and increased US sanctions. President Trump's executive order of August 24, 2017, strengthened sanctions against PDVSA by prohibiting all transactions related to new debt with a maturity greater than 90 days and by forbidding Citgo from repatriating dividends in Venezuela.

By cutting access to an essential source of funding, the Trump administration is precipitating the default of PDVSA and, given the key economic role of the company, of Venezuela.

Any exit from the crisis will necessarily involve an increase in oil production. Since 2005, the country has been aiming to produce five million barrels per day but this target has never been reached and has been pushed back from year to year. In the first seven months of 2017, average oil production was 1.9 million barrels/day. The objective of multiplying oil production by 2.5 is achievable provided that the government lets the local private sector step in and signs agreements with foreign companies.

In this respect, it can draw inspiration from the US which has increased oil production from 4.3 million to 9.5 million barrels per day over the past five years by relying on numerous small-scale private shale oil companies. However, this also implies full respect of private property, protection of minority investors, and political stability.

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serotonindumptruck's picture

Is there any doubt that Maduro is going to seek alliances with Russia and China?

Doesn't Russia already control 51% of PDVSA?

Shemp 4 Victory's picture

 

By cutting access to an essential source of funding, the Trump administration is precipitating the default of PDVSA and, given the key economic role of the company, of Venezuela.

...because the US is genuinely concerned about the people of Venezuela and will rescue them from Oppressive Dictatorship® regardless of the cost in Venezuelan lives.

In this respect, it can draw inspiration from the US which has increased oil production from 4.3 million to 9.5 million barrels per day over the past five years by relying on numerous small-scale private shale oil companies. However, this also implies full respect of private property, protection of minority investors, and political stability.

But the US doesn't have full respect of private property, protection of minority investors, or political stability, so I don't understand the implication.

BennyBoy's picture

 

US GOV oil cronies want to turn Ven into Nigeria on the Caribean.

 

a Smudge by any other name's picture

That's the irony here. Venezuela signed the contracts that give creditors access to assets. They already signed the fowl documents. I didn't know this before. It was over the second they did the deal. It's over.

Yeah, Trump will be blamed for the outcome but the Chavistas did it themselves.

downwiththebanks's picture

While the fascitarian fanboys at ZeroHedge whine about Maduro, the Constituent Assembly will piss oil over those documents.

Take your dollars, and shove them up your do-nothing ass.

Uncle Sam's little baby-raping hedge funders won't do shit about it but whine.

sodbuster's picture

>However, this also implies full respect of private property, protection of minority investors, and political stability.<

Yeah, well that ain't gonna happen.

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

WhackoWarner's picture

ECONOMIC HITMAN Been done many times before.

 

Frig off USA USA. At this point the desperate flailing is so visible and the idiocy so transperent.  Economic hitman until it no longer has impact.

 

Sorry guys and gals but the petro-dollar and all the BS that goes with it is fading fast.

USA USA USA has not one friend left on this planet.

MoreFreedom's picture

What's to stop Maduro from selling the oil fields to Russia, then reneging on the deal?  Will Russia invade to take them?

Escrava Isaura's picture

Can’t say that Trump didn’t get plenty of warning from people that know what they’re talking about it.

WASHINGTON (Reuters) - Four U.S. Senate Republicans from oil refining states urged the Trump administration on Thursday to not block oil shipments from Venezuela as part of U.S. sanctions against the country, saying it could raise costs for U.S. fuel consumers.

https://www.reuters.com/article/us-venezuela-politics-usa/senators-urge-trump-to-avoid-blockade-of-venezuela-oil-shipments-idUSKBN1AR00Z

 

 

SmittyinLA's picture

Inevitable Default

Of course it's inevitable, there's no point in nationalizing assets without a default and transfer of stolen assets to their proper owners, Goldman Sachs and Hillary.

serotonindumptruck's picture

What's the current market value of CTGO?

At roughly 13% of petroleum imports to the USSA,, what would happen if this flow were interrupted?

Can the frackers in North Dakota take up the slack?

are we there yet's picture

Maduro could go back to driving a buss

downwiththebanks's picture

Maduro has withstood your beloved CIA ratfuckers for a long, long time.

ReturnOfDaMac's picture

Citgo, whats wrong with using RMB, Euros, Rubles or even (gasp) gold? 

Whats all this fuss about dollas, man ...

Nick Jihad's picture

They borrowed in dollars, so they need dollars to repay.

downwiththebanks's picture

Venezuela will tell the US banks to fuck themselves, and pay back their real lenders.

I can't wait to watch the little do-nothing button pushers in their little hedge funds throw a shitfit when it happens!

2banana's picture

That should work out well.

Venezuela will lose its US based Citgo Operations.

Then any flagged ships in US waters.

Defaulting on sovereign debt is serious business.

The communist USSR did eventually pay off Russian Czar era government bonds.

That is how serious the rest of the world takes sovereign bonds.

downwiththebanks's picture

How serious does the US take its soverign bond payback?   It's an absurd joke.

Uncle Sam will turn those same Citgos into weed collection zones that look like empty slabs of concrete.  That will work out well as well.

There won't be a default:  the illegal sanctions placed upon Venezuela mean that the US banker-gangster vampires get paid last.

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

Don in Odessa's picture

The History of the Next 70 Years

We are seeing the unveiling of the "New World Order" led not by the US, rather by China and Russia. Venezuela will be pulled into what will become the "Global State" and and "world citizens" will absorb the financial loss. The US will go to war, lose and join Venezuela's fate. A new economic system will evolve to belay and pacify  the rock throwing, pitchfork jabbing hordes, displaced by war and robotics. Hope will reign again ... for a season.