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Venezuela's debt crisis deepens

It's crunch time in Caracas after the country defaulted on two bond payments and oil output continued its freefall

Venezuela's debt problem is quickly spiraling out of control. On Monday, the government blew through a 30-day grace period on $200m in coupon payments due for its 2019 and 2024 bonds without paying, leading the credit ratings agency S&P to declare the country in default on those bonds and in selective default on its long-term debt. The Luxembourg Stock Exchange suspended trading of the bonds, totaling nearly $5bn. Another $420m in coupon payments on four more bonds are also late, but still within their grace periods. Defaulting on those would raise the risk of a cascading and chaotic sovereign default.

The timing could hardly have been worse. The first default came on the same day President Nicolas Maduro's government had summoned bondholders to Caracas to kick off negotiations over a restructuring of $60bn in sovereign and state oil company PdV bonds. It was a bust for those that made the trek to the Venezuelan capital, according to those that attended. Investors hoping for a roadmap out of the crisis instead got vague assurances that Venezuela would keep paying its debt, no concrete proposals for the restructuring and political screeds against the sanctions imposed by the US and European Union. To make matters worse the meeting was led by Vice President Tareck el Aissami, who the US has accused of leading a massive international drug operation and has placed under sanctions, making it illegal for American citizens to meet with him.

All of this has left investors and market watchers in a state of total confusion, which may well be part of the government's strategy. Although Venezuela is now in default, it is so far fairly contained. S&P, in fact, offered a blueprint for Venezuela to quickly get out of selective default. If the government can meet the $200m in outstanding coupon payments and stay current on the other debt, the agency said it would lift its rating from selective default to "CC", indicating a vulnerability to default. That would at least put the country on firmer ground for restructuring negotiations. It is also worth noting that PdV has so far stayed current on its bond payments, though not without delays and uncertainty.

But the backdrop looks perilous. Start with the country's fractured domestic politics. Any restructuring deal and new debt issuances, which would be necessary to replace the renegotiated bonds, would have to be signed off by the opposition-controlled National Assembly to have any sort of credibility with international debtholders and courts. However, Maduro has sought to sideline the National Assembly by creating a rubberstamp legislative body called the Constituent Assembly, which was established through rigged elections in July and whose legitimacy has been explicitly rejected by the US, EU and most of Venezuela's neighbours. Any negotiations that went through the Constituent Assembly would be a non-starter, making the opposition a vital player in the restructuring negotiations.

However, the government and opposition are barely even on speaking terms. The sides were scheduled to hold talks in the Dominican Republic this week over next year's elections, foreign aid, political prisoners and a litany of other grievances. But the opposition pulled out at the last minute because it said foreign ministers from regional neighbours weren't able to attend. The talks are further complicated by the fact the opposition coalition splintered following last month's gubernatorial elections, where apparent widespread fraud helped the government to a sweeping victory. It's not clear who, if anyone, is able to speak on behalf of the opposition's diverse factions.

Then there's the question of a potential bailout from Maduro's primary allies, Russia and China, which could at least provide Caracas with some breathing room to carry out the negotiations with private bondholders. Beijing has shown a willingness to ease the terms of its existing oil-for-loans deals, but hasn't been willing to pump more money into Maduro's government in recent years.

Crude loans

Russia, on the other hand, has extended around $10bn in new oil-backed loans to Caracas over the past couple of years. Moscow says it has reached a deal with the Maduro government on $3bn of that debt, which will likely see the bulk of payments pushed back. However, Rosneft, Russia's state oil company, says it doesn't plan to add to the billions of dollars in oil prepayments it has already made to PdV, which had provided the company with badly needed liquidity ahead of previous payment due dates.

Without a financial lifeline from Beijing or Moscow, Venezuela's cash position will only worsen. On top of the $60bn owed to private bondholders, the country owes another $140bn or so to Russia and China, suppliers like Schlumberger and Halliburton and companies like ConocoPhillips that have won judgements for previously seized assets.

Then there is the continued deterioration in the oil industry, the only cash generator left in the country. Opec's November monthly report showed another significant drop in Venezuela's oil output in October. Production fell by 130,000 barrels a day in the month, according to figures PdV reports to Opec, to 1.955m b/dits lowest level since the 2002 oil strikes. Output is down by 295,000 b/d, or 13%, in the the first 10 months of 2017. Since mid-2015 production has dropped by 0.8m b/dnearly 30%. The decline has blunted any potential benefit from the recent increase in crude prices. The rig count fell to 35 in Octoberhalf its level in mid-2015, in a further sign that investment and drilling activity is seizing up as the financial crisis deepens.

Things would get even worse if there is a chaotic default. PdV has managed to expand heavy oil output from the Orinoco Belt beyond the exiting upgrader capacity by simply blending heavy oil with imports of light oil to create a marketable crude grade. If it isn't able to bring that light oil into the country, between 100,000 and 150,000 b/d of output could be immediately at risk, argues Facts Global Energy, a consultancy. International bondholders will also likely move aggressively to seize oil shipments and PdV's other international assets, like ships and refineries, in lieu of bond payments.

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