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Venezuela going for broke

The Maduro government wants a new deal on its debt. Things are going to get messy

The inevitable has come to pass. During a 2 November national broadcast, Venezuela's President Nicolás Maduro said the country could no longer pay its debts and he was setting up a commission to negotiate a restructuring with holders of sovereign and state oil company PdV bonds. Maduro blamed an "economic war" waged by the Trump administration, saying recent sanctions had given his government no choice but to seek a new debt deal. In truth, the sanctions are a useful scapegoat. Venezuela's economy has been crushed by economic mismanagement, the fall in the oil price and the heavy debt burden accumulated when prices were high.

The government has only been able to keep up with the payments by slashing imports of vital medicines and foods, and entering into a series of increasingly unconventional and costly financial arrangements. Some involve deferring principal payments on debt in a way that increases total payments; or selling off oilfields and other assets at fire-sale prices to raise cash quickly. Ultimately the government hoped an oil price recovery would bail it out. But the recovery hasn't come and rather than continue digging deeper into an economic hole, the government is finally looking for an exit.

The negotiations will start an extraordinarily complex process of resetting the terms of Venezuela's debt, with no guarantee that the talks won't breakdown into a disorderly default.

The Maduro government insists it's entering the talks in good faith. The president pointed out that the government and PdV have paid $71bn servicing debt over the past four years, including more than $2bn in the weeks spanning late October and early November, as proof. Nelson Martinez, the head of PdV, said in a statement, "we are guaranteeing an honest dialogue between the Bolivarian Government and holders to look for debt renegotiating formulas".

However, bondholders have reason to be doubtful. The head of Maduro's negotiating team is executive vice president Tareck El Aissami. If that name sounds familiar, it's probably because the US Treasury Department has accused El Aissami of, among other things, leading a massive transnational drug smuggling operation. Those taking part included notorious Colombian drug lord, Daniel Barrera Barrera, known as El Loco, and the ultraviolent Mexican cartel Los Zetas. El Aissami is under US sanctions, making it illegal for US citizens to deal with him. Needless to say, El Aissami won't be travelling to Manhattan to work out a deal with New York's financial elite.

Looming payments

So, what lies ahead? A recent paper by Mark Walker, a managing director at the Millstein & Co, a financial services firm, and Richard Cooper, a debt restructuring specialist at the law firm Cleary Gottlieb Stein & Hamilton, released prior to Maduro's November announcement, offers some clues. Their prognosis is glib: "No other patient in the sovereign restructuring ward has presented an array of symptoms as challenging as Venezuela."

At the centre of the problem is the sheer scale of debt owed and the diversity of creditors. PdV owes $26.5bn in unsecured bonds. The Venezuelan Republic another $36.1bn. PdV issued $3.4bn in new bonds last year backed by its US subsidiary Citgo, 49.9% of which is held by Russia's Rosneft. PdV, Walker and Cooper estimate, still owes around $28bn to China as part of the oil-for-loan deals the country signed, and another $9.1bn to Rosneft under similarly structured financing.

Then there are the tens of billions of dollars in outstanding payments to suppliers and oilfield service companies, some of which was repackaged as financial debt and issued to companies like Halliburton. Walker and Cooper estimate there are also still outstanding claims in international arbitration courts worth around $16bn from companies like ConocoPhillips and ExxonMobil that had their assets nationalised in Venezuela. Billions more are owed to regional financial institutions and private banks—bringing the total to close to $200bn.

Sorting through these debts and deciding who should receive priority will be devilishly difficult. "Policy makers in Venezuela will have to grapple with what may be the most complex and challenging sovereign restructuring ever," Walker and Cooper write.

High on the priority list for Venezuela will be protecting PdV's assets abroad from default. PdV's oil sales and Citgo, the company's US refining subsidiary, are the only significant sources of foreign income for Venezuela and potential hold-out bondholders will be gunning for them. If those bondholders were successful in seizing PdV's oil sales as payment, the company would find it difficult to carry out its daily operations. Venezuela would see its foreign currency earnings collapse even further, with virtually no savings as a backstop. The oil market could be faced with the sudden collapse of as much as 2m barrels a day of output, which would ironically deliver just the price recovery Venezuela needs.

PdV has a couple of options to protect its oil sales, though none of them are foolproof. The most viable option, argue Walker and Cooper, would be to make the initial sale of crude destined for export to a third-party company which creditors couldn't go after, and have that firm sell the oil on to a final customer. It would be costly, and would likely be challenged in court, but it's a strategy that has been used in the past. Venezuela formed Camimpeg last year, an oil company run by the country's military. Venezuela watchers have speculated since its creation that Camimpeg could be used to shield PdV, by taking over oil sales or the company's assets altogether, in case of default.

Protecting Citgo

Keeping control over Citgo, PdV's most valuable asset abroad, would be much more difficult, given last year's deal to securitise the PDVSA 2020 bond with Citgo equity. Any default larger than $100m would trigger a cross-default clause in the PDVSA 2020 bond, putting control of Citgo at risk. PdV, through its US subsidiary, could seek bankruptcy protection in the US, which would at least put a stay on any creditor attempts to seize Citgo equity. But the strategy would only provide temporary reprieve and would bring with it other risks. Adding to the complexity surrounding Citgo is that Rosneft is in line to take over a 49.9% stake in the event of a default. Given that Russia is toxic in Washington DC, there is little chance such a transaction would get through congress, which has the authority to review foreign takeovers on security grounds.

The broader restructuring talks will bring on a complex battle over jurisdiction, the size of haircut debt holders will have to take, competing claims over who would get first dibs on PdV and Venezuela's limited financial resources, and broader economic reforms.

Walker and Cooper suggest Venezuela draft a new bankruptcy law that would stand up in US and other foreign courts, so negotiations can run through Caracas, but rightly doubt that any such law could be passed under the current fractured state of Venezuelan politics. Maduro would pass a law through the recently-elected National Constituent Assembly, a rubber stamp body Maduro created to bypass the opposition-controlled National Assembly. The Constituent Assembly lacks legitimacy both in Venezuela and with the international community.

Then there's the question of the International Monetary Fund. Unless Russia or China plan to step in with a massive cash injection, the IMF is the only international financial institution capable of mobilising the scale of resources Venezuela will need to keep bondholders on side while starting to right the economy. Venezuela would need tens of billions of dollars in assistance over the coming years. In exchange, however, the IMF and other lenders would demand sweeping economic reforms that would hit at the heart of Chavista's economic model, and which Maduro has shown no interest in implementing. Nor is Maduro likely to welcome the IMF, having all but cut ties with it since taking power. It was notable that the day after Maduro's announcement, the IMF threatened to censure Venezuela for failing to supply it with regular economic data.

In short, a restructuring negotiation would be extremely difficult and costly, even under the best of circumstances. But the conditions in Venezuela will make it all but impossible. Markets need to gird themselves for a messy Venezuela default.

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