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Venezuela-where are we heading?

Chavez is long gone, and Venezuela is in trouble. Photo: Reuters

Chavez is long gone, and Venezuela is in trouble. Photo: Reuters

A few weeks ago I had pointed out that the situation in Venezuela has deteriorated remarkably, primarily in line with the current levels of oil prices, in addition to the current political turmoil. The political situation did worsen further as Venezuelans are rioting and looting amid worsening food shortages. All in all, this is being reflected in the yields of the country’s sovereign debt and in the state owned oil company Petróleos de Venezuela (PDVSA) which over the past months rose notably as uncertainty unfolded.

Undoubtedly the economic situation has worsened further following the crush in oil prices over the past months, mainly in January when oil prices tumbled to circa USD 32.54, despite the some sort of respite following the remarkable gains we’ve experienced over the past two months. According to Bank of America at the USD 25 per barrel, Venezuela’s revenue would be trimmed notably towards the USD 22bn mark in 2016, surely a remarkable decline which increases pressures on the country’s current accounts.

In addition, the latest disclosed data showed that output dropped to 2.37m barrels per day, down from 5 per cent from April and 11 per cent from 2015’s average. Beyond output, Venezuela's refineries and ports have suffered problems due to equipment failures and power cuts. And payment delays led to less diluents for Venezuelan crudes.

The crucial point is how the country will manage to re-finance its existing debt at the current yield levels. Over the past years, China emerged as the country’s salvation as it had loaned over USD50 billion to Venezuela under the financing arrangement created by late socialist leader Hugo Chavez in 2007, in which a portion of its crude and fuel sales to the world's second-biggest economy are used to pay down loans. Here again the country is struggling to meet its obligations and in fact the country is in talks with China to obtain a grace period on the said loans which would improve their capacity to make the upcoming bond payments.

It seems that Venezuela is trying to negotiate the possibility of solely paying interest on loans, while it receives cash payments for the shipments of oil which are currently used to pay principal. The change would improve PDVSA's 2016 cash flow by USD3 billion.

Lately the remarkable increase in oil prices offered bond holders of Venezuelan debt some respite and boosted investor optimism that PDVSA will be able to pay off USD3 billion in bonds that come due in October and November of this year, helping fuel a rally in PDVSA and Venezuela bonds in recent months. Nonetheless Venezuela's debt remains the riskiest of any emerging market paper, with yields currently at elevated levels of circa 28 percentage points more than comparable U.S. Treasuries.

In my view as things stand, Venezuela’s only salvation would be once again China. Any failure in negotiations with the second largest economy might trigger the possibly anticipated default by some analysts which over the past years questioned heavily Venezuela’s sustainability going forward. That said, the question which I pose is whether a positive outcome with China is solely postponing the default at a later stage.

My take is that the smart investor was the one who way back in 2014 when oil prices commenced their descending momentum, opted in dumping their exposure in Venezuela bonds. Surely, going forward the situation is getting critical and one can’t negate the fact that over the past months the probability of default increased drastically. In this regard, investors should not be carried away by the interest coupons being paid, but rather consider the implications of a default.

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

 

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