The Fuse

Venezuela Has Survived Oil Price Downturn—For Now

by Nick Cunningham | January 28, 2016

While headlines about Venezuela nearing a default have appeared for more than a year now, market sentiment regarding Venezuela’s ability to weather the oil price downturn has taken a turn for the worse as of late. The government of President Nicolas Maduro has successfully navigated Venezuela through turbulent waters—thus far. The country is quickly running out of options to pay its mounting debt.

While headlines about Venezuela nearing a default have appeared for more than a year now, market sentiment regarding Venezuela’s ability to weather the oil price downturn has taken a turn for the worse as of late.

Since concerns over Venezuela’s financial situation first cropped up in 2014, the OPEC country has managed to meet all its international debt payments, a top priority for the government. Meeting bond payments has occurred even while Venezuela has failed to pay other entities. For instance, the state is more than $50 billion in arrears to private companies, resulting in some airlines terminating service in the country.

Venezuela has been able to defy repeated predictions of imminent collapse by burning through cash reserves and reducing the amount of hard currency used for imports—a move that has led to shortages of basic goods such as food and medicine.

Venezuela has also finessed its looming debt crisis with some creative ideas. It issued new debt through Citgo, PDVSA’s U.S.-based subsidiary, securitized some oil loans it handed out to allies in the Caribbean, and swapped some of its gold reserves for cash.

Oil bust has hit Venezuela hard

“How many countries of the world can sustain oil production at $22 a barrel? Few, or almost none.”

Oil accounts for over 95 percent of the country’s export earnings. With prices down more than 70 percent since mid-2014, the state is collecting a fraction of what it was a few years ago. On top of that, Venezuela’s heavier crude sells for a discount to international benchmarks. In December, while Brent crude averaged $38 per barrel, Venezuela’s heavy oil marker, Merey, was down to just $24 per barrel. Now with WTI and Brent hovering just above $30 per barrel, Venezuela’s oil price is perilously close to it its breakeven cost of $18 per barrel.

“How many countries of the world can sustain oil production at $22 a barrel? Few, or almost none,” Venezuelan President Nicolas Maduro told a national audience on January 19.

The International Monetary Fund says that Venezuela’s inflation rate will top 720 percent this year, up from 275 percent in 2015. GDP will contract by another 8 percent this year after falling by 10 percent in 2015. The currency has not fared well under such conditions. The official exchange rate still stands at 6.29 bolivars to the dollar, but on the black market, one dollar costs upwards of 800 bolivars, a rate four times higher than a year ago. Simply put, the low oil price is wreaking havoc on the entire economy.

End of the line

Despite Venezuela’s determination to meet debt payments, the South American OPEC member is beginning to run out of options. Venezuela has $120 billion in foreign debt and a shrinking revenue base. It has proven resilient, but there are fewer and fewer assets to liquidate.

Despite Venezuela’s determination to meet debt payments, the South American OPEC member is beginning to run out of options.

Economists and analysts had hoped that the battered economy would force President Maduro to undertake reforms. But little has been changed since oil prices began falling more than 18 months ago. Recently, President Maduro declared an “economic emergency,” a plan that was rather short on details but gives the president more control over the economy. It was simply another inadequate effort to address the economic malaise.

In a January 20 research note, Barclays analyst Alejandro Arreaza issued a stark warning for the country. “The economic emergency decree and any measures that the government could take at this point may be too late,” Arreaza wrote. “After two years of inaction and the recent decline in oil prices, a credit event in 2016 is becoming increasingly difficult to avoid.” Using an oil price of $37 per barrel, Arreaza estimates that debt payments would eat up around 90 percent of Venezuela’s oil revenues this year, a situation that is unsustainable.

“It is practically inevitable to default if the current economic dynamic stays in place,” Henkel García, an economist at Econométrica, told the FT  in a January 22 interview.

But a debt default may not be imminent. Barclays believes that Venezuela will meet the more than $2 billion due in February. The trouble could, however, come later this year. PDVSA has bonds maturing in October, which are currently selling at 57 cents on the dollar, a strong indication that investors think the company will fail to meet its obligation. Long-term bonds do not look much better. Yields on sovereign bonds with maturity dates in 2027 have spiked to more than 29 percent, reflecting sinking confidence in the government’s capacity to meet its obligations.

In a sign that PDVSA is running low on funds, the state-owned oil company recently asked several partners from multiple joint venture projects to pick up the tab for imported naphtha, a light form of crude needed to dilute Venezuela’s heavy oil. Importing naphtha is the responsibility of PDVSA, but Reuters reported that PDVSA sent letters to its partners asking them to begin paying for the imports, a move that does not reflect well on the state of the company’s finances.

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It is all about oil

Whether Venezuela and PDVSA actually default on debt payments largely comes down to oil prices. This backdrop helps explain Venezuela’s repeated pleas to OPEC to reverse its current course and implement oil production cuts. Such a scenario remains remote, but there is a growing buzz surrounding the possibility of coordinated production cuts from OPEC and several non-OPEC members. Oman has already offered to participate in a 5 to 10 percent production cut with OPEC. Several executives from Russian oil companies have also voiced their support for Russia to play a part in stabilizing oil prices.

 Whether Venezuela and PDVSA actually default on debt payments largely comes down to oil prices.

There is a very poor track record of such rumors ever amounting to tangible results, which is not surprising given the conflicting priorities and incentives for all parties involved. Crucially, Saudi Arabia and its Gulf allies in OPEC are keen to let the global market sort itself out, which should force high-cost production offline and lead to more sustainable price levels. OPEC sees the market starting to balance in the latter half of 2016 as non-OPEC supply suffers.

The big question is whether Venezuela can hold out that long.