Nightmares Aplenty – The Continuing Saga of PDVSA and Venezuela

19 October 2016


 

Hi everyone,
As we approach Divali and the Christmas season, if ever a reminder was needed that we are living in the most challenging and interesting of times – and that collectively as a nation, T&T has a lot to be grateful for – we take a look at the situation in Venezuela and consider PDVSA’s proposed bond swap.
By the way, how well do you know your country?
Firstline Team

Nightmares Aplenty – The Continuing Saga of PDVSA and Venezuela

 

Petroleos de Venezuela SA (PDVSA)PDVSA is the Venezuelan state owned oil and natural gas company. It undertakes activities in production, refining, and exportation of oil, as well as the exploration and production of natural gas.

Since PDVSA was founded on the 1st January 1976 – when the Venezuelan oil industry was nationalised – PDVSA has dominated the oil industry of Venezuela. As a nation Venezuela is currently the world’s fifth largest exporter of oil and its proven hydro-carbon reserves are the largest in the world.

 

PDVSA and the Venezuelan Government – Running on Empty

The funds generated by PDVSA have traditionally been used by the Venezuelan government to fund its social development projects. Because Venezuela is so heavily reliant on revenue from the oil and gas sector such a reliance has always been fine when prices have been close to or over $100 dollars per barrel.

In June 2014 the price of oil per barrel was $115. At the time of writing of this blog entry, the price of Brent Crude stands at $51.42 per barrel. For most of the intervening period since June 2014, oil prices have been at least 70% lower than the high recorded in June 2014. Of greater importance to both PDVSA and Venezuela, the oil price per barrel has been consistently below or close to PDVSA’s cost of production.

In the most literal of terms – PDVSA has been running out of money and consequently the government has been for some time attempting to “run on empty”.

 

What running on empty really means

The Venezuelan economy and its public finances have been decimated by the collapse in oil prices. The government – starved of cash – has struggled to find sufficient hard currency to pay for the importation of basic necessities including badly needed medicines, and of more importance to bond holders, it now seems it will struggle without action to meet its debt payments

Looking at just the numbers presents a frightening picture. The price of Venezuela’s crude oil fell to a 13 year low of $21.63 in January after a period of four years where it had been close to $100 per barrel. It has since recovered to a price in the vicinity of $44 dollars but $44 is a long way from $100.

Measuring these prices against the average cost to produce a barrel of oil or gas equivalent in Venezuela in 2016 highlights the problem both PDVSA and the government face. Venezuela is a high cost per barrel producer with an average cost of US$27.62 per barrel. With oil prices in the vicinity of $50 that doesn’t leave much profit to build or sustain a socialist economy.

 

The average cost of production of oil or gas equivalents in 2016

Based on the last available comparative data (March 2016) the average cost to produce a barrel of oil or gas equivalent in 2016 can be represented by the following information.

Of the major producers Venezuela sits high up on the table in terms of the cost to produce a barrel with only the United Kingdom, Brazil, and Nigeria having higher costs per barrel. Venezuela’s cost of production is over three times higher than the country with the lowest cost per barrel – Saudi Arabia – who on average extract at an average cost of just under $9 per barrel.

av-cost-of-production-per-barrel

The great PDVSA Bond swapIn September 2016 PDVSA announced the launch of a $7billion bond swap in an attempt to alleviate mounting financial pressure on PDVSA as it stares down the barrel of multi- billion-dollar debt repayments falling due over the next 14 months.

The proposed swap would cover PDVSA notes that are due in April, 2017 and November, 2017, and would allow investors in those notes to trade them in for new notes that mature in 2020 (when PDVSA hope oil prices will have recovered to higher levels than currently seen). Initially the swap was priced at a one to one ratio but an improved offer was made by PDVSA once it became clear that investors did not find a one to one swap attractive. The amended terms offered by PDVSA would have offered an additional $170 in new 2020 bonds for each $1,000 in PDVSA April bonds, and $220 for each $1,000 of PDVSA November bonds if the investor agreed to the swap before the 6th October 2016. After this date the amount an investor would receive for the April bond fell to $120 and the November bond $170. In order to sweeten the pot for investors, the swap is backed by shares in the group’s US based subsidiary Citgo-Petroleum (PDVSA has pledged 50.1% of its stake in the holding company of Citgo-Petroleum as security for the new bonds). One could however conjecture that if there were a default by PDVSA, legal suits and potential seizure of CITGO in the USA will follow thick and fast to secure payment to bondholders.

Under the current terms of issue the PDVSA bond swap offer is only valid if the holders of at least 50% of the existing bonds agree to it. The situation is critical. PDVSA is facing bond repayments totalling $11 billion by the end of 2017, and is therefore seeking to exchange notes that are due in April and November 2017 for new debt with annual payments between now (current) and 2020.

PDVSA have stated that they would like to swap at least half of the existing bonds that mature in 2017.

 

How the market reacted initially – yields fall as bond prices rise

PDVSA’s bonds surged after the announcement amid speculation that the bond swap deal would smooth out a financially challenging debt repayment schedule and allow oil prices sufficient time to continue to recover. The US$3 billion of debt maturing in April 2017 rose to its highest level in more than two years. The effective yield on the April bonds tumbled by over 15% to 64% as the price of the April bonds climbed to 75 cents on the dollar.
PDVSA’s November bonds climbed 4.4 cents on the dollar to trade at close to 79 cents on the dollar.
While most of the rating companies are treating the proposed bond swap as a “distressed exchange” (in other words they view it in a less than favourable light), investors might also consider that the swap would allow PDVSA and Venezuela to keep making payments on what has been (paradoxically) one of the best performing debt securities in the emerging markets category in 2016.

 

Extending the deadline on the deal – is default a possibility?

On the 18th October 2016 PDVSA extended for a third time the deadline for investors to swap as much as US$5.325 of bonds adding a warning that PDVSA will have a hard time avoiding default if the company is unable to complete the transaction.

At the time of writing, PDVSA have pushed the deadline to 21st October 2016 (although there is the possibility it will be further extended), and have announced that they are substantially short of their goal of swapping at least half of the bonds that are due in 2017.

The company’s president and Venezuela’s Oil Minister Mr Eulogio Del Pino has gone on record as stating that the deal is critical for PDVSA moving forward and has raised the spectre of default. According to PDVSA “if the exchange offers are not successful, it could be difficult for the company to make scheduled payments on its existing debt.” In other words, default could easily be around the corner.

 

If ever a reminder was needed

One factor that all should consider is that if the bond swap doesn’t go ahead default becomes more likely. For a government already unpopular with voters that may spell the final kiss of death.

If ever a reminder was needed – we live in the most interesting and challenging of times and we perhaps have a lot to be grateful for.

 

Closing thoughts – time to consider your investing strategies

Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers a number of unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

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