Nobody’s Default But Mine
The cascading economic crisis in Venezuela has reached a point of virtual insolvency. For several months, the bonds issued from national oil company PDVSA have been in an effective “default limbo.”
Technically, the failure to pay interest on time late last year should have triggered a default, one that would also impact the status of sovereign debt (given the collateralized cross-holdings of the paper). But the market has refrained from calling it what it was.
PDVSA has not paid interest amounting to at least $1.2 billion in what amounts to a selective non-payment on its eight bond issuances. At least one of the issues – the bond maturing in 2022 – is past-due 50 days. Those bonds and the crude oil upon which they are based had been a major underpinning of the paper issued by the central government in Caracas.
In other words, the decline in PDVSA finances is dragging the country down with it.
It’s not as if the matter would have been salvageable otherwise. Venezuela is a text book case of a failed state, a central government that cannot administer within its own borders, has lost the ability to support a domestic currency (the bolivar is in virtual free fall), and is suffering monetary, fiscal, and fiduciary meltdown.
If the PDVSA mess cannot be improved, the “hard” default resulting will trigger a range of cross-default provisions extending to Venezuelan sovereign debt. Now some of that debt has been in an effective default since last November. But the cross holdings between PDVSA and sovereign bonds make the unravelling environment even more insecure.
Cross defaults occur when the default on one debt instrument causes the default on others. Some Venezuelan sovereign debt has used PDVSA bonds as collateral. Declaring a hard default on one would unleash a default on the other.
This is already a major monetary problem in itself. The PDVSA interest arrearage on PDVSA debt alone comprises over 12% of the reserves available for the country’s central bank. Default of connected sovereign bonds would exhaust central bank ability to support currency exchanges.
Oil, Oil Everywhere…
At the foundation of both debt crises is the ability of PDVSA to sell crude oil at sustainable prices. Oil sales are the only major vehicle for export-driven hard revenues. That means there are four primary needs fueled by the same income source: (1) servicing the company’s debt; (2) servicing the sovereign debt; (3) meeting PDVSA operating requirements; and (4) providing an essential under-girder to the country’s economy as a whole.
Unfortunately, the prospects for oil production upon which to attend all these objectives has emerged as the most acute shortcoming of them all.
Venezuela holds (on the books at least) more extractable oil reserves than anybody on earth. That includes the Saudis. However, virtually all of this is very heavy oil located in the Orinoco River basin. This is expensive to lift and requires technology still not under direct domestic control by PDVSA. Previously, the volume of exports at a competitive price allowed for the acquisition of such expertise.
Problems began years ago when the populist President Hugo Chavez threw out Western majors from the Orinoco, replacing them with a combination of Russian and Chinese companies augmented by Iranian finance.
This was supposed to be facilitated by a petroleum finance bank established in Caracas involving all four countries. The idea was to replace ExxonMobil and others with a consortium comprised of the five largest Russian oil companies, supplemented by CNPC and Sinopec on the Chinese side.
In addition to the operational side, plans were for the Caracas bank to finance oil swaps. This would have allowed PDVSA crude to be exchanged for Iranian and Russian oil consignments, thereby allowing a broader global market without requiring the actual transport of Venezuelan crude to Asia or Europe.
There had been an early example of how these swaps would work. PDVSA and Russian private major LUKoil entered into such contracts. On paper it looked promising. The two companies would swap similar grades of export crude. LUKoil would expand its end-user market in South America with Venezuelan sourced crude, while PDVSA would be able to establish a European base for new clients and sales using LUKoil export volumes released from that company’s huge terminal in Rotterdam.
The agreement was never operationalized. In addition, the Russian consortium of companies committed to working in Venezuela began to collapse. When the three largest opted out, the approach was essentially over. The Chinese companies had an interest in continuing, but they did not have the technical expertise to extract the heavy oil of the Orinoco.
Beijing would continue to offer loans to PDVSA and the Venezuelan central government. But the ability to make payments was dependent upon increasingly suspect foreign sales of Venezuelan crude. For their part, Russian companies began acquiring domestic oil assets inside Venezuela for what became increasingly discounted prices.
…While Venezuela Sinks
By mid-2017, the government of current President Nicolas Maduro faced losing control over an increasing portion of its declining crude export revenue flow (to pay back the Chinese loans to both company and state), while simultaneously losing ownership over assets inside the country (to the Russians).
The Chinese approach had already been successfully implemented in Ecuador, Peru, and Brazil. Unlike earlier initiatives abroad focused on acquiring crude for transport back to a thirsty China, this new development allowed loan recipient countries to export their oil anywhere but now centered around Beijing controlling large amounts of the proceeds for those sales.
The crisis has been compounded by a series of PDVSA failures in retaining contracts to terminal crude in Caribbean locations. Once again, this has resulted from the company’s inability to keep payments current to partners owning the facilities. The replacement contracts – when even available – were at unfavorable terms, further cutting into PDVSA export profits.
Matters have become so desperate that Maduro seriously proposed basing PDVSA valuation on a national cryptocurrency (the petro). The proposal was rejected by his own hand-picked and politically stacked national legislature.
It is against the backdrop of such an avalanche of miscalculations and flat out disasters that the present condition of PDVSA is considered. The company cannot maintain even the semblance of adequate working capital. Field equipment is failing and cannot be replaced. What can be is more frequently acquired at what amounts to barter of future oil production. That, of course, simply further deflates the essential national proceeds from sales.
For any chance of salvaging the situation, PDVSA must dramatically increase both production and exports. That is not happening.
Estimates now put daily PDVSA production by the end of 2018 at little more than 1.35 million barrels. Placing that in stark perspective, the figure is some 30% below production levels from barely two years ago.
PDVSA and Venezuela as we have known them will not survive the year.