The Fuse

Venezuela and Ecuador Increasingly Desperate to Restructure Oil for Loans Deals with China

by Paul Ruiz | @pmruiz | June 28, 2016

Low oil prices are casting uncertainty over some of China’s most substantial overseas investments, and nowhere is this uncertainty more apparent than in certain Latin American oil-producing countries, where low export revenues are driving steep economic downturns. Venezuela, which is in the midst of a crippling economic crisis, is underproducing by nearly 200,000 barrels per day (b/d), caused by sporadic power outages, labor unrest, and ongoing refinery and oilfield maintenance disruptions.

Venezuela is hoping to restructure its loan terms with China to free up cash for other creditors. The country, as well as its indebted state-run oil company Petróleos de Venezuela (PdVSA), owe at least $5 billion by the end of the year.

Earlier this month, the Chinese government dispatched envoys to meet with the country’s opposition party to seek a commitment to avoid a default on debt owed to Beijing, out of fears that the regime of current President Nicolas Maduro will be overturned. Venezuela wants a grace period on the repayment of oil-backed securities—equivalent to the revenue from 650,000 b/d at current prices—where it would only pay interest. The Chinese government, however, has expressed wariness of such a deal without an agreement on debt repayment from the country’s opposition-led National Assembly. Venezuela is hoping to restructure its loan terms with China to free up cash for other creditors. The country, as well as its indebted state-run oil company Petróleos de Venezuela (PdVSA), owe at least $5 billion by the end of the year.

The meetings come as Latin American oil producers grapple with the effects of a precipitous drop in the global price of oil, which is half of what it was in mid-2014. Ecuador, which defaulted on two $3.2 billion Western-backed bonds in 2008, similarly turned to Chinese development financing to support economic development when prices were high. Ecuador is working to repay loans, a factor cited by Moody’s Investors Service when it upgraded the country’s credit rating from Caa1 to B3 in late 2014. In April, the IMF projected the country’s real GDP would contract 4.5 percent year-over-year due to the lingering effects of low oil prices on the economy and a strong U.S. dollar.

Growing presence

China’s rising presence in the region—and further commitment of billions of dollars in potentially restructured aid—underpin a strategic desire to strengthen regional partnerships even as its growing energy demand begins to slow pace. Since 2010, its Latin American and Caribbean investments have surpassed $100 billion, more than major multilateral lenders including the World Bank ($46.4 billion) and the Inter-American Development Bank ($73.5 billion). More than half of China’s funds in the region have backed energy projects in oil-producing countries, including OPEC members Venezuela ($41.5 billion) and Ecuador ($6.1 billion). Last year, in a meeting with Latin American leaders in Beijing, President Xi Jinping pledged an additional $250 billion over the next decade.

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Loans from Chinese government-backed institutions generally do not entail the same conditions those from Western multilateral lenders. These include compliance with international environmental laws and regulations, the provision of grievance mechanisms for local authorities, and independent monitoring and review of activities—all common conditions among World Bank loans. “Chinese financing is often the lender of last resort. It is not a cheap one, but due to the concern the international financial community has over Venezuela and Ecuador, and the large risk premiums they would charge, Chinese lending is an attractive option,” Roger Tissot, an energy economist, explained in an interview with the Inter-American Dialogue.

“Chinese financing is often the lender of last resort. It is not a cheap one, but due to the concern the international financial community has over Venezuela and Ecuador, and the large risk premiums they would charge, Chinese lending is an attractive option.”

In the past ten years, China has exchanged development aid for oil as a way of securitizing assistance and ultimately mitigating risk. Its lending agreements contrast with other multilateral lenders in that they offer competitive interest rates backed by the sale of oil shipments to one of China’s national oil companies, typically China National Petroleum Corporation (CNPC) or China Petroleum & Chemical Corporation. Many of China’s loans also require Latin American partners to contract with its businesses, opening new markets for Chinese products but limiting economic development opportunities for producing countries.

In 2011, Brookings scholar Erica Downs noted these loans are not part of a coordinated strategy to secure access to energy supplies but rather are best viewed as a series of favorable business transactions, maximizing the long-term profitability of the Chinese Development Bank (CDB). Based on contract terms, Downs estimated that oil-backed securities would come to represent 1 million b/d of China’s crude oil imports by 2012, 17 percent of the country’s total. Underinvestment in Venezuela’s oil sector resulted in lower-than-forecast production rates that year, exporting 640,000 b/d of oil China that year, the country’s then-Oil Minister Rafael Ramírez said at the time.

In a recently published book on the topic, regional finance expert Kevin Gallagher explains that contrary to popular belief, China’s contracts require its state-owned oil companies to purchase shipments on the day orders are received. Oil-for-loans agreements are linked to current market prices, he says, and generally provision more oil than is necessary to pay back the loan. Since prices are currently low, Venezuela is only contributing to the balance of its loans, leaving little to cover operational costs. The country now faces $130 billion in sovereign debt, one half of its GDP. Venezuelan Oil Minister Eulogio Antonio Del Pino Diaz says $50 per barrel will be enough to avoid a default.

As prices hover around $50 per barrel, several Latin American countries are jostling for breathing room in what they hope is a short-term market rebalancing. Under a series of recently revised deals, the CDB extended loan maturation periods, in some cases allowing Venezuela to pay its development account in bolivars instead of foreign currency. Venezuela may now only meet minimum shipment requirements, allowing it to sell barrels elsewhere on the global oil market to raise additional revenues.

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In February, China’s central bank cut the amount of money its lending institutions were required to hold in reserve, the fifth time it did so since the start of 2015, to support recently slumping economic growth. These policies helped the country prop up oil demand, IEA said in its May 2016 Oil Market Report, supporting the shipment of 700,000 b/d from Venezuela.

“China was directly the cause of the economic growth in the region from 2003 to 2013,” said Gallagher, director of the Global Economic Governance Initiative at Boston University, in an interview late last year. “But in the long run, it sort of locks the region back into its growth model of the 19th century, which it spent 100 years trying to get out of.” That overdependence on natural resources has not necessarily been the intention of China, he argues, but rather the byproduct of countries failing to diversify their economies and adequately provision oil incomes into sovereign wealth funds in the face of China’s energy-based financing.

Many projects have benefited exporters. Around the world, Chinese oil companies have worked with national governments to improve oil refining capacity, boosting the overall trade value of product exports. In a 2011 joint venture with Petrobras, for example, PdVSA received $1.5 billion in Chinese investment to construct the Abreu e Lima refinery in Brazil, a heavy processing facility capable of producing more than 230,000 b/d. Venezuela’s state-owned oil company owns almost 40 percent of the refinery. In another 2013 project, CDB lent $4 billion to fund production in the Orinoco Belt by Sinovensa, a 60-40 venture between PdVSA and CNPC. Investment there helped grow production to 168,000 b/d in 2015, PdVSA says.

Last week, Ecuador approved an 181-million-barrel agreement with CNPC that will expire in 2024. The deal, which was reported in the country’s center-right newspaper El Comercio, represents the second agreement reached between China and Ecuador in 2016. This year alone, Ecuador committed 257 million barrels to China in exchange for two CDB loans. Under China’s contract terms, export partners are not required to actually deliver oil to China, so many Chinese companies resell oil on the open market. China’s oil-for-loans agreements cover as much as 90 percent of Ecuador’s oil exports.

Little recourse

China’s interest in the region—and deployment of oil-backed securities there—ensures steady access to oil supplies. While loans have been a net economic benefit for China, the adverse economic consequences are much more severe for oil exporting countries when global oil prices fall. Ecuador’s imports from China, for instance, are diversified between telecommunications equipment, bicycles, civil engineering equipment, and rubber tires. More than four out of five exports to China, however, are petroleum resources, revealing structural dependency issues within the balance of trade when global commodity prices fall. The country’s oil dependence has only grown in the past two decades, from 28 percent of all exports in 1993 to 50 percent in 2012. The situation is worse in Venezuela where the country relies on oil for 95 percent of export earnings.

Ecuador and Venezuela are part of OPEC, which means they theoretically have some recourse in the form of a seat at the negotiating table when low prices begin to drain government revenues.

Ecuador and Venezuela are part of OPEC, which means they theoretically have some recourse in the form of a seat at the negotiating table when low prices begin to drain government revenues. In advance of this summer’s Vienna meeting, several of the region’s largest petroleum producers, including Venezuela, Ecuador, Mexico, and Colombia convened in Quito to discuss strategy. The group of nations called on the global oil cartel to set a ceiling for production, but its advocacy did not work as its price hawks—those who wanted country-specific production quotas—were unsuccessful in garnering agreement among the now 14-member group.

In the absence of being able to materially affect global oil prices, this means that some producers will have to reexamine the structure of their bilateral trade relationships, which are increasingly dependent on China’s cooperation.

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