Posted by on October 25, 2016 7:00 am
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Categories: Bond Creditors default Economy fixed Iran Nomura OPEC PDVSA Sovereign Default Wall Street Journal

Submitted by Nick Cunningham of

Venezuela just dodged a bullet, pulling off a last minute bond swap with creditors. The deal only buys Venezuela a little bit of breathing room, and a default at some point next year or the year after is not out of the question. Either way, the South American OPEC nation’s oil production is falling and will only continue on a downward trajectory.

Venezuela’s state-owned PDVSA avoided default at the eleventh hour, getting enough creditors onboard for a debt swap. The oil company had repeatedly offered creditors to exchange debt set to mature this year and in 2017 for payments spread out over the rest of the decade, a proposal that would allow the company – and the sovereign government – to technically avoid default.

But after investors rebuffed at least four offers for a debt swap due to unfavorable terms, they finally agreed to a deal on Monday to swap a portion of the $7.1 billion that PDVSA had due in the coming months. PDVSA had warned a few days ago that a default would come as soon as this week if creditors did not sign on. “Low oil prices will adversely affect the company’s ability to generate cash flow from operations, which will impair the company’s ability to make scheduled payments on its existing debt, including the existing notes,” PDVSA said in a statement last week.


With few options left, it was in both PDVSA’s and the creditors’ interest to make a deal, according to Siobhan Morden, head of Latin America Fixed Income Strategy at Nomura Securities. “It’s logical that this exchange goes forward and PdVSA accepts whatever cashflow relief the market is willing to provide so that muddling through continues.”

But even if it can avoid default this time around, the Venezuelan government only has foreign exchange reserves of $12 billion, a figure that is dwarfed by its debt load.

The fallout from a default would be terrible for Venezuela, but how the situation plays out is unknown. PDVSA’s assets overseas could run into trouble. “I wouldn’t be surprised if you see new precedents in terms of being able to seize oil assets on boats, because the U.S. government is going to be very anti-Venezuela obviously. For sure Citgo refineries get seized,” Eric Fine, bond fund manager for Van Eck Global, told Forbes in an interview. He also warned that a PDVSA default would almost certainly be followed by a sovereign default. Not only are the finances of the two entities intertwined, but once the company defaults, the government would probably lose access to financial markets as well, so paying off debt will merely be a waste of the little bit of cash it has left. For this reason the government has been intent on meeting its obligations even as people go hungry in the streets.

While PDVSA is flirting with insolvency, Venezuelans are much more focused on the country’s political crisis, which is just as bad as the economy. Last week, the government of President Nicolas Maduro cancelled a vote that threatened to remove him from office. For more than a decade, Venezuela, under the late President Hugo Chavez and then Maduro, has seen a steady erosion of its democratic system. But cancelling the recall election is “the most blatant” move yet, says Siobhan Morden of Nomura Securities.

President Maduro, meanwhile, has been undertaking some shuttle diplomacy to oil producing countries in recent days to get them on board for the pending OPEC production cuts. But while he was in Azerbaijan and Iran, Maduro’s problems at home began to bubble over.

On Sunday, the opposition led Congress pressed to put Maduro on trial for violating democracy. The heated session even saw injuries inside the legislature as the two parties broke out into fist fights. The opposition, once fractured but now increasingly united against Maduro’s overreach, is planning a major protest on October 26. The Eurasia Group, a political risk firm, said the cancellation of the recall vote leaves no other avenue for an outraged public than to take to the streets, “increasing the near-term risk of a social eruption amid food shortages and soaring inflation.”

PDVSA may have just avoided default but its poor position likely means that things will continue to deteriorate. The battered state-owned firm is already dealing with declining production and has no cash left to conduct maintenance. Drilling is at a standstill and PDVSA is already in arrears to oilfield services companies like Halliburton and Schlumberger. Output is down 11 percent in the 12 months ending in September, and more declines are expected. In an October 23 article, The Wall Street Journal reported that PDVSA has been reduced to flaring gas and burning oil because it does not have any money left to pay for processing equipment. So not only is production declining, but PDVSA is unable to even sell all of the oil and gas that is coming out of the ground.

It is hard to imagine things getting worse than they already are. PDVSA may have kicked the can just a little bit down the road, but Venezuela’s problems are not going away.

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