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Venezuela living on the edge

Venezuela's national oil company is under pressure from low prices, plummeting output and several self-inflicted wounds

When news broke in May that Goldman Sachs bought up nearly $3bn in Venezuelan state oil company PdV bonds from the country's Central Bank through a London-based broker, the backlash was intense. Protesters gathered outside the bank's headquarters, accusing the company of extending a financial lifeline to an increasingly autocratic and brutish government. Opposition politicians vowed not to repay the bonds if they take power. That prompted a surreal scene in which socialist vice president Tareck El Aissami vowed to sue the opposition leader for threatening the Manhattan megabank. Goldman Sachs defended itself, hinting that it was betting on a regime change. Life in Venezuela "has to get better, and we made the investment in part because we believe it will", the bank said. With billions of dollars in Venezuelan bonds floating around international financial markets, the pressure on investors will continue to grow.

There was also another angle to the story that points to the terrible state of PdV: the price of the bond. The Central Bank reportedly offloaded the debt for just 31 cents on the dollar, around seven cents lower than the bonds' price on the open market, bringing in around $0.8bn. That the government was willing to sell the bonds at such a steep discount isn't exactly a ringing endorsement of the state oil company, which is the country's only significant generator of foreign funds. If it thought anything like a quick turnaround was on the cards, they surely would have held on to the bonds until they could fetch closer to their full value.

But PdV is in dire shape, beset by low oil prices and just as importantly a long list of self-inflicted wounds that have sapped its financial health. This starts with the company's plummeting output. Oil production has been sliding over the past decade, even when prices topped $100 a barrel, due to a lack of investment. The decline has intensified over the past two years. According to figures the country reports to Opec, production is down 20%, or 0.523 barrels a day, since the start of 2015, to 2.194m b/d. Secondary sources track a similar scale of decline, but put output at just 1.956m b/d. The company is on pace to lose at least another 150,000 b/d of output by the end of 2017.

PdV bet big on major new Orinoco belt heavy oil projects to replace falling output from its mature conventional fields. But those Orinoco projects have largely not come through. PdV does not release timely statistics, so the latest breakdown of data is from 2015, when Orinoco output was 1.3m b/d. Given the broader collapse in production, and the dearth of investment, it is unlikely this figure has risen much since then. Unleashing growth from the Orinoco will require billions in spending on new infrastructure to blend the heavy oil output with lighter diluents and to get the oil from the landlocked Orinoco fields to international markets. Eventually, a new crop of multibillion-dollar upgrading plants will be needed to expand production capacity—but that isn't going to happen anytime soon.

As PdV's financial position continues to deteriorate, the company increasingly appears headed for some sort of default

Meanwhile, the decline at PdV's mature fields is accelerating. That is in large part because those fields require complex enhanced-recovery operations, which had been carried out by international service companies like Schlumberger and Halliburton. But those companies have curtailed operations in Venezuela as PdV's debts have mounted and its ability to pay its contractors has diminished. The Venezuelan military set up an oilfield service company called Camimpeg to try to fill the gap, but it is a poor substitute for some of the world's most advanced drillers.

The combination of low prices and collapsing production would be bad enough for PdV on its own. But the company's position is weakened further by other supply commitments that drain cash away from its coffers.

The domestic market is a financial hole for PdV. On top of the tens of billions of dollars the company has put into social programmes over the past decade, it sells fuel products to Venezuelan drivers for pennies a litre. In 2015, domestic consumption was around 0.6m b/d, equivalent to around 30% of today's production. Given the country's deepening economic crisis and sharp slowdown in economic activity, it is likely fuel demand has fallen. From 2014 to 2015, demand contracted around 50,000 b/d, and a similar scale of decline is possible for 2016. But even if demand has dipped as low as 0.5m b/d, it still means PdV is being paid next to nothing for a quarter of the oil it extracts and processes. The increasing strain on the company's domestic refining system has made meeting domestic demand even costlier for PdV because it has had to ramp up fuel imports. It shipped in around 100,000 b/d of fuel products from the US between October 2016 and April this year, a period that saw periodic fuel shortages in Venezuela.

Cash-strapped

Then there are the oil-for-loans deals. Around 400,000 b/d to 0.5m b/d of crude goes to China to repay around $30bn in outstanding debt, generating no fresh cash flow for the company. PdV is now adding to the burden, by agreeing new oil-for-loans deals with Russia. In May, Venezuela's oil minister Nelson Martinez said the country would be sending Rosneft 70,000 b/d of crude this year to pay off a $1.5bn loan—a deal in which PdV also put up a 49% stake in its American refinery business Citgo as collateral. That loan, which valued the Citgo stake at a steep discount to PdV's previous claims, was agreed when PdV needed cash ahead of steep bond payments due in October and November last year. Another 100,000 b/d or so are sold to Cuba and around the Caribbean under the PetroCaribe programme at a steep discount, and often bartered for goods rather than cash.

Put it all together it means around 1m b/d, or roughly half of PdV's crude output, is committed to sources that don't generate cash flow. A report from Harvard University's Growth Lab by Francisco Monaldi and Igor Hernandez estimated that in 2015 alone, the last year reliable data is available, the combined non-cash sales and fuel imports from the US cost PdV around $25bn.

The US is by far the most important export market for PdV to bring in funds. Exports to America are running at around 0.7m b/d, down about 6% from the same period in 2016, and down around 20% from 2012—a worrying trend and clear sign that exports are under pressure.

As PdV's financial position continues to deteriorate, the company increasingly appears headed for some sort of default on its debt obligations. So far, PdV and the Venezuelan government have shown an ironclad commitment to meet its international loan payments, even as the country has had to drastically reduce imports of food and medicine to preserve cash to pay. That is because an unmanaged default would be catastrophic for PdV. Its oil shipments could be detained for payment, its assets abroad seized and vital sources of international financing would dry up.

$3bn - Debt payments due in October and November

In February, PdV defied widespread scepticism and met nearly $2.5bn in bond payments, pushing off the immediate risk of default. However, the company will face another test soon. It has $1.275bn in bond payments due in October and $1.708bn in November—nearly $3bn in total.

With China no longer apparently willing to extend financial largesse to Venezuela, PdV is turning to Russia to shore up its finances. A controversial Supreme Court decision in March gave president Nicolás Maduro broad power to execute oil deals, an authority that had rested with the opposition National Assembly. He hopes to use that authority to strike a deal with Moscow, which has remained a staunch backer of the increasingly isolated Maduro administration. During a trip to Russia in June, oil minister Martinez said PdV was in talks over five new projects with Rosneft, including the Petropiar heavy oil venture, which PdV operates alongside its American partner Chevron.

The talks, however, have been held up and there is no guarantee Russia will want to go through with new deals. For one, the outcry around the Supreme Court decision, which was widely seen as an attempt to clear the way for the Petropiar deal, has made any such agreement politically toxic in Caracas. Opposition lawmakers vowed to axe the deal if they return to power. Rosneft could choose to forge ahead, but it is a far riskier proposition now. Russia is also already struggling to recoup its loans to Venezuela. Reuters reported in June that the Russian government had cut its revenue projections by $1bn on expectations that Venezuela wouldn't be able to repay a bilateral loan. While ally Russia isn't likely to push PdV into a messy default, the news does not augur well for October and November's round of payments.

If PdV can make it through 2017, there is some relief on the debt payment front in sight. After more than $6bn in bond payments this year, PdV faces around $3bn in payments next year and just under $4bn in 2019.

Still, Venezuela's deepening crisis and lurch towards economic pariah status will keep the pressure on the country and PdV, which has become increasingly political in recent months. Donald Trump's administration has taken a hard line against Venezuela and has started discussing sanctions on the energy sector. Given the US' reliance on Venezuelan oil imports that seems unlikely, but Washington DC is unpredictable these days. Moreover, the outcry around Goldman Sachs's deal has spurred on the "Hunger Bonds" protest movement, a reference to the country's widespread food shortages, which hopes to cut off the flow of cash to Caracas by naming and shaming its financiers. Venezuela looks headed to a breaking point soon. PdV won't be spared.

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