The Fuse

Venezuela’s Crisis Deepens After Default

by Nick Cunningham | November 15, 2017

Venezuela officially defaulted on its debt on Monday, after missing a deadline for a payment of $200 million on sovereign bonds, deepening the country’s economic and political crisis that is the result of decades of mismanagement and low oil prices over the past few years.

The possibility of more output going offline in Venezuela is occurring at the same time OPEC is looking to extend its production cuts and tensions throughout the Middle East are rising.

Venezuela has been determined to meet debt payments throughout the last three years, choosing to divert increasingly scarce cash to creditors even as the average Venezuelan suffered from shortages of food, medicine, and other basic necessities. The logic behind prioritizing foreign bondholders over its own citizens is based on preserving the country’s economic lifeline—its oil production. If PDVSA or the government defaults on its debt, overseas assets are vulnerable to seizure by creditors. If oil exports are jeopardized, the financial situation for the country deteriorates.

As of now, though, the Venezuelan government appears to be out of options, leading to the default.

Against this backdrop, the risk to further oil production losses has intensified as the financial screws on Caracas continue to tighten. The possibility of more output going offline in Venezuela is occurring at the same time OPEC is looking to extend its production cuts and tensions throughout the Middle East are rising. Venezuela’s output is now at 1.9 million barrels per day, down 240,000 barrels per day year-on-year and near a three-decade low.

Debt rollover unlikely

Venezuelan President Nicolas Maduro convened creditors for a meeting in Caracas on Monday, hoping to negotiate a way to restructure its debt. A year ago, Venezuela reached a deal with creditors to stretch out pending debt payments over the next several years, buying some time and breathing space. However, payments this year are much bigger, and Venezuela has even less cash with which to work.

The government, state-owned oil company PDVSA, and other state-controlled entities owe about $90 billion in outstanding debt.

The problem for Venezuela is that the government, state-owned oil company PDVSA, and other state-controlled entities owe about $90 billion in outstanding debt, yet the central bank has less than $10 billion in cash reserves, with much of that in non-liquid assets such as gold. Other analysts believe the country’s debt is much higher—perhaps up to $196 billion.

Analysts questioned the regime’s sincerity at debt negotiations when it appointed Vice President Tareck El Aissami to lead the talks with creditors, an individual specifically targeted by U.S. sanctions for alleged drug trafficking. No U.S. financial institution can legally negotiate with him. That makes rolling over much of Venezuela’s outstanding debt very difficult. The meeting in Caracas on Monday was a “non-event,” according to Siobhan Morden, head of Latin American fixed income strategy at Nomura. The talks did not offer any insight into Venezuela’s plans or next steps, and the meeting reportedly ended quickly with creditors confused.

There are few options left. Venezuela has survived this long through deft financial maneuvering, while also benefitting from loans from China and Russia. China has become impatient with Caracas. Russia still sees advantages in helping Venezuela. Last year, PDVSA gave Russia’s Rosneft a 49.9 percent collateral stake in its U.S.-based subsidiary Citgo, in exchange for a $1.5 billion loan. Russia is now looking to leverage that deal by swapping out the collateral for direct stakes in Venezuela’s oil fields. This would be both more attractive to Moscow while also avoiding any hassle from the U.S. Treasury Department.

Any aid from Russia will be insufficient at wiping away Venezuela’s colossal obligations.

Coming to the rescue of Venezuela would heighten the risk for Rosneft and Russia. Rosneft’s share price plunged 4 percent on Tuesday, following news that S&P declared Venezuela in default, a clear sign that investors are worried about repayment on the billions of dollars in loans made to the South American nation. Today, Russia said that it agreed to restructure $3.15 billion in debt, allowing Venezuela to repay over the next decade, including “minimal repayments” in the first six years. This will grant Venezuela some relief, but any aid from Russia will be insufficient at wiping away Venezuela’s colossal obligations. Russia also said it does not have plans to provide any more financial support at this time.

A long legal battle

Venezuela missed several hundred million dollars’ worth of bond payments in October, and the 30-day grace period on many of them will expire this month.

The FT noted one possible scenario that could see Caracas wiggle out of its predicament. The government could theoretically break off PDVSA more decisively from the state, allowing the country to default but keeping up with payments for the oil company. That could prevent creditors from seizing oil assets. However, this scenario would be hard to pull off, given that the government owns the company.

Most analysts foresee a protracted and disorderly fight for repayment, and the legal haggling could persist for years.

The risk for Venezuela is that creditors could request immediate repayment on the full value of their bonds, sparking a cascading series of demands for repayment. So far, Venezuela has avoided that scenario. At this point, most analysts foresee a protracted and disorderly fight for repayment, and the legal haggling could persist for years.

Oil production at risk

Skipping debt payments leaves the government with more money to spend on its population, with the need for food and other essentials more dire than ever. But there are very few bright spots in this story. The only conceivable turnaround for the Venezuelan economy is for a dramatic increase in oil prices combined with a rebound in oil production.

But Venezuela’s oil production is likely to continue to decline. Output fell by 43,600 b/d in October from a month earlier, according to OPEC’s secondary sources. Venezuela’s oil production is down by 456,000 b/d from its 2015 average.

Venezuela’s oil production is down by 456,000 b/d from its 2015 average.

The losses could accelerate. Some refiners in the U.S., India and China have reportedly rejected oil shipments from Venezuela because quality has deteriorated. Private oilfield services companies have been stiffed on repayment from PDVSA; if they abandon the country, production could fall further. Meanwhile, without cash to import lighter oil for diluent, PDVSA could also lose production from its heavy oil fields. One source with deep knowledge of the Venezuelan oil industry told The Fuse that output could plunge by a staggering 700,000 to 800,000 b/d from current levels.

A sudden loss of a major portion of Venezuela’s output would be “a big shock to the system,” Daniel Yergin, vice chairman of IHS Markit, told CNBC at the Abu Dhabi Petroleum Exhibition and Conference on Tuesday. Venezuela’s oil production has already declined well below its production target as part of the OPEC deal, contributing to a much tighter oil market than would otherwise be the case.

S&P has said that it may upgrade Venezuela’s credit rating if it still makes coupon payments on overdue debt. That would allow it to avoid getting locked out of international credit markets for the time being and ensure that oil shipments are not put at risk of seizure. But with tens of billions of dollars in outstanding debt maturing over the next few years, and no cash to work with, more defaults are likely.

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