Venezuela A glorious revolution, a dependence on oil, a lesson in colossal mismanagement, and misappropriating (sic) Peter to pay Paul.

27 October 2014


As at Monday,27 October 2014

imagesOur closest South American Neighbour

The Bolivarian Republic of Venezuela lies along South America’s Caribbean Coast. It is bordered by Brazil, Colombia and Guyana and separated from the Republic of Trinidad and Tobago by 12 miles of water.

Venezuela’s oil revenues account for close to 95 per cent of export earnings. The oil and gas sector is around 25 per cent of gross domestic product. Apart from petroleum, the country’s natural resources include natural gas, iron ore, gold, bauxite, diamonds and other minerals.

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Why is the Venezuelan economy in a mess?

Put in the simplest terms the economy of Venezuela is totally dependent on the performance of its oil industry. The price of Venezuela’s oil – which accounts for 95% of the nation’s exports and is set on international markets – has tumbled to a four year low. Less income from oil equates to less spending by central government and a general slowing of the Venezuelan economy. While falling oil prices are part of the problem they are not the whole problem.

PDVSA, the state owned oil giant and Venezuelan governments “cash cow” has been ailing for some time. As a result of lack of investment and poor management (fired staff have fled to other countries including neighbouring Colombia), oil exports from PDVSA have fallen by over 40% since 1997. Consequently PDVSA’s operating surplus in 2013 only accounted for 17% of the central governments revenue. Measured against a five year average of 26% this is a significant and sustained fall. Recent falling oil prices have therefore only highlighted a larger problem that has existed for many years.

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Robbing Peter to Pay Paul

Declining oil prices have hit Venezuela very hard with the fall in crude prices this year reducing government revenue by as much as $10 billion a year. The Maduro administration has responded by printing money (the money supply is estimated to have quadrupled in the last 24 months), and adjusting spending downwards. This has resulted in an annualised inflation rate of over 60%. Food prices have nearly doubled in the same period and many critical medicines are in short supply with citizens having to resort to a barter system to trade everyday essentials.

Slowing payments to suppliers (reducing spending) has created significant trade arrears. At the time of writing this blog entry $3.5 billion is owed to pharmaceutical suppliers, and $2.4 billion to food suppliers. It has also damaged the reputation of PDVSA with significant delays on payments to PDVSA’s suppliers, contractors and joint venture partners.

The administration does however remain committed to paying bond holders, inclusive of buying its own bonds on the secondary market at a discount, a savvy strategy. While bond holders may continue to be paid, for the average Venezuelan life must seem extremely harsh with everyday essentials being in as short supply as they are in war torn Syria. We note that for many, life has always been harsh, hence the genesis of the revolution.

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Will OPEC Step In On Oil Prices

Oil prices are falling as a result of a number of factors. First the supply of oil has increased with the introduction of United States shale oil and the increase in production in both Libya and Iraq. Second a slowing of the economies of Germany and China has reduced demand. Third there is no consensus amongst the members of OPEC that supply of oil should be reduced and fourth ISIS has not managed to seize any significant oil assets in Iraq.
For Venezuela there may be no good news on the horizon. Not all of the 12 members necessarily need a price increase (although Iran and Angola almost certainly do) and some of the more significant and powerful producers such as Saudi Arabia (who have significant cash reserves) may prefer to see prices fall further to make life uncomfortable for those producing shale oil in the United States. 

opec-logo-300x225Why Venezuela’s Bonds May Still Be Attractive

Despite there being no good news on the horizon there are a number of reasons why Venezuela’s bonds remain attractive depending on your own risk profile. Consider the following:

  • The government has remained committed to paying back its foreign debt and in this regard paid back $1.5billion of foreign debt on October 8th.
  • Venezuela still has foreign reserves of around $20 billion, although admittedly a large proportion of these reserves are in gold and not therefore immediately liquid.
  • A recent sell-off of Venezuelan bonds by concerned investors has depressed bond prices but increased yields by close to 20%, making Venezuelan bonds attractive (but only if you have an appetite for risk).
  • A significant proportion of Venezuelan bonds are held by wealthy connected Venezuelan citizens making it less likely that the Maduro administration could politically consider the option of default.
  • Oil prices even at current levels are still above PDVSA’s cost of production.
  • Venezuela’s debt to GDP remains comparatively low.
  • Many of Venezuela’s problems could be fixed by adopting sensible exchange rate policies in respect of the United States dollar. On the “black market” one United States dollar equates to 90 bolivars, while officially the rate varies from 6.3 to 50 bolivars depending upon which of the four official rates you use. In short a devaluation of the bolivar may be on the cards.
  • Venezuela could significantly mitigate the problem by reducing the gasoline subsidies it grants to consumers internally and to certain favoured international clients such as Cuba.
  • Even in the worst case scenario of a default Venezuela has significant assets overseas that could be seized to satisfy bond holder’s debt.

Conclusions and a call to action

In the final analysis bond holders may end up getting paid even in the event that OPEC doesn’t come to the assistance of Venezuela by agreeing to constrict the supply of oil and force prices upwards.
For the Maduro administration the price of default may be too high to stomach since it would be an admission on the international stage that the “Venezuelan Revolution” has terminally faltered. For the everyday citizens of Venezuela life – at least in the short term – will surely continue to be a struggle.

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