Oil slump raises Venezuela default risk

By:
Rob Dwyer
Published on:

Sovereign highly exposed to oil price drop; default still not fully priced into bonds.

The collapse in the oil price has dramatically increased the chances of a Venezuelan sovereign default in 2016. The financial position of the oil exporter has been precarious for years, say analysts, but the sub-$30 price-per-barrel of oil will raise the country’s financing gap to an estimated $30 billion. At this level the likelihood of a government default increases materially.

Edward Glossop, emerging markets economist at Capital Economics, predicts that the Venezuelan economy will shrink by 8% in 2016, having fallen by 7.1% year-on-year in Q3 2015. Inflation is spiking – already at 141.5% and climbing – and the currency has collapsed by 90% on the black market in the past 18 months. The country faces a shortage of basic goods as imports fall in line with the value of oil exports.

"Before oil prices started to fall we said there was a good chance [of sovereign default]," says Glossop. " If oil prices remain at about $30 there is a very good chance. If oil rebounds to about $45, as our commodity team is expecting, there is still probably a pretty good chance."

Estimates

Others estimate an even higher likelihood of default. Assuming the market’s future curve for oil prices at an average $40.7 is correct, Venezuela would generate $9.3 billion less in revenues than the $39 billion in 2015. Even with government import cuts, Barclays predicts a financing gap of $27 billion. Some of this shortfall could be covered by further loans from China, with potentially some repayment of Petrocaribe debt and up to $3 billion in debt liability management but it is likely the government would need to raise around $20 billion from asset sales. 

Barclays believes the government has just $7 billion in liquid assets. Sales of gold reserves and some of the bonds that the country holds on its balance sheet could raise some dollars, although buyers for the latter might be hard to find. Alejandro Arreaza, analyst for Barclays in New York, concludes: "A credit event in 2016 is becoming increasingly hard to avoid."

Stuart Culverhouse
Stuart Culverhouse,
Exotix

However, others are less pessimistic: "I don’t think there will be a default, although the risks are increasing," says Stuart Culverhouse, head of research at Exotix. "As there still hasn’t been any economic adjustment the low oil price means that the chances of default are higher than last year but I think they will be able to muddle through like they did last year."

Casey Reckman, analyst at Credit Suisse, sees a strong possibility of default later in the year but thinks the payment of $1.5 billion in bonds due in February should be met "without incident". 

"We think they have the money, especially if they are willing to sell more gold reserves," she argues. "Furthermore, President Nicolas Maduro reiterated the government’s willingness to pay in his annual address [on January 15]."

Given the socialist politics of Maduro, and Chavez before him, it is perhaps surprising that investors have never focused on the country’s willingness to pay. The appointment of Luis Salas, as head of the country’s economics team, has led to questions beyond the country’s ability to pay. Salas, an academic radical who has argued for "economic war", claimed that inflation does not exist as an independent phenomenon and that "high prices are a reflection of a class struggle". He is also a close collaborator with Centro Estrategico Latinoamericano de Geopolitica (CELAG), a leftist think tank that praised Ecuador’s 2008 default.

not enough assets graph

"The economy is in absolute meltdown but the government has shown a very high willingness to pay – essentially defaulting on its citizens rather than the financial markets," says Glossop. "Salas’s appointment is interesting but Maduro still calls the shots and I don’t see any change to his approach although we will carefully follow any changes to the rhetoric."

Arreaza says discussion about a political shift with Salas’ appointment is misleading. "The authorities keep reiterating their willingness to pay," he says. "However, their position seems to indicate a lack of appreciation of the magnitude and roots of the critical situation that the Venezuelan economy is facing, which may increase the risk of a disorderly credit event."

Year end

Most expect Venezuela to meet the year’s first repayment test in February but the default question focuses on amortizations towards the end of the year. 

There is a suggestion that default would bring about market-friendly reforms and those bonds would ultimately generate a very high rate of return.

However, even if this sequence of events were to happen there are downsides. "That’s a really long-term move," says Glossop. "You only need to look at Argentina, which is still suffering from its 2002 default 15 years later. It’s not an easy road, defaulting and restructuring is a very long path."

Daniel Chodos, research strategist for Credit Suisse in New York, thinks it is too early to enter into such a long-term trade: "It’s hard to see value in a default situation," he says. "In this environment of high risk of default, even with the bond prices trading in the low 30s it is hard to see a high recovery in the near term. The situation on the ground is so convoluted that it will take time for the country to restructure its debt. In a default scenario I would think the bond prices will go closer to 20 before rebounding."