The Daily Update - Venezuela nearing tipping point

As Venezuela experiences its worst economic and political crisis, and state-owned oil giant Petroleos de Venezuela (PDVSA), which is on the brink of collapse is to cover a substantial interest and coupon obligation tomorrow, the pressure on the country is mounting. Having failed to deliver relatively small coupon payments on sovereign paper over the weekend (due to ‘technical difficulties’- there is a 30-day grace period in place), Venezuela appears to be prioritising PDVSA obligations: Ecoanalitica (a consultancy firm based in Caracas) tweeted, ‘The funds regarding the PDVSA 20 (capital + interests) is already approved, so it should become effective by friday’ [sic]. At time of writing, we have yet to see an official statement substantiating this claim from either the government or PDVSA.

This is great news if correct, however, PDVSA will have to contend with a further $1.2bn payment on a bond maturing next week, and will have to find ~$26m to cover missed payments to NuStar Energy so that PDVSA can regain access to the Statia oil terminal; let alone the USD50bn owed to China and Russia. Debt restructuring could be an option to get around the first issue going forward, however, US sanctions could make accessing international markets more tenuous. Meanwhile, rumours suggest that Russia’s quasi-sovereign oil and gas giant Rosneft is in talks with PDVSA to lend a hand; in an attempt to avoid a sovereign default.

Venezuela has been fortunate in the past to drum up payment obligations at the last minute, however, with roughly $13bn in debt payments due by the end of next year (combined for both the government and PDVSA) and less than $10bn in FX reserves and only $1bn in central bank reserves, the risk of default is rapidly increasing. Despite the country owning the world’s largest oil reserves, there appears to be little respite from the turmoil Venezuela faces, at least in the medium-term; in fact a very grave concern is that creditors could in fact go for the jugular and choke off its crude reserves, to be used as collateral.

Relentlessly low oil prices since June 2014 continue to plague the economy, particularly painful as crude accounts for 95% of total export revenue. Despite Venezuela looking to China to price oil contracts in renminbi in a bid to shun the US dollar and attract China business, it doesn't appear as if China’s extra demand will significantly impact oil exports. Venezuela also has to contend with escalating US sanctions, hyperinflation at ~128% (according to sources), a potential humanitarian crisis due to a severe shortage in medical supplies, healthcare, food and everyday goods, meanwhile, political turmoil and militarisation appear to be deepening. Some have claimed that the situation is so dire that the economy is ‘at the point of no return’. So concerning that the IMF, which broke ties with Venezuela back in 2007, has recently dusted off its calculator to try plan out possible bailout scenarios.

Venezuela was actually considered a wealthy economy a few years ago, however, as there have been no reliable official figures on the economy it is very difficult to gauge just what situation the country is faced with, let alone its current account data. The one thing that has prevented us from ever investing in Venezuela, aside from its shaky economic fundamentals is its junk ratings; the sovereign is currently rated Caa3/CCC-/CC by Moody’s, S&P and Fitch, respectively.

We would much rather invest in high-grade Abu Dhabi and state-owned investment vehicle, International Petroleum Investment Corporation (IPIC); both rated Aa2/AA. Although Abu Dhabi's export revenues are predominantly generated from its hydrocarbon sector, its non-oil related sectors have been growing; and the drive for diversification continues. The wealthy Emirate also has huge hydrocarbon reserves, a very strong government balance sheet and one of the highest levels of GDP per capita globally. We recently added the sovereign’s 4.125% 2047 new issue across our portfolios, the bond remains attractive, offering an expected return and yield of ~16% and 4 notches of credit cushion. Meanwhile, IPIC 6.875% 2041’s, which are up +90% (in total return terms) since issue in 2011, remain attractive. Trading at a spread of 146bps over USTs, while similarly rated bonds with a duration of 13.3 years trade at ~50bps, we calculate that the bond is still over 5 notches cheap and offers ~17% return and yield.