Debt market for Brazilian oil and gas thaws, but outlook icy

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Brazilian capital markets are showing signs of life again after a particularly torrid summer as industrial conglomerate Odebrecht priced a $1.7 billion nine-year bond. But investor wariness towards Latin America’s largest economy persists.

With weak economic growth and increasing concern about the political leadership of president Dilma Rouseff’s government, Brazilian capital markets have taken a battering this year. Brazilian bearishness has been a particular problem for the country’s emerging oil and gas sector, which has seen the QGOG Constellation IPO pulled from its planned NYSE listing and bond financings abandoned as investors have shunned the sector.

But, in a glimmer of hope for commodity issuance in the country’s debt markets, Odebrecht, backed by oil-drill-ship charter and service agreements with state-owned Petrobras, launched a bond at the end of July after abandoning its first attempt to launch the deal in May.

Although the company raised about $200 million less than it had originally hoped for, the deal was two times oversubscribed, allowing the underwriters to print the bond in line with revised guidance at 6.75%, according to sources familiar with the deal.

At the heart of investor wariness towards Brazil over the past year is the country’s apparent failure to deliver on its promise to become one of the world’s leading producers of oil from coastal fields. "Brazilian oil and gas companies have underperformed in general, and the risks in the sector are clearly skewed to the downside. Most oil extraction companies have reduced production, and the market in general does not believe that the drilling companies can deliver the volume that it has pre-sold," says a São Paolo-based attorney who works with international investors to identify investment opportunities in the Brazilian energy sector.

The implosion of Eike Batista’s EBX Group over the summer provides a stark illustration of the kind of economic and governance problems wreaking havoc on investor confidence. Ranked as Brazil’s richest man only last year, Batista saw about two-thirds wiped off the value of his energy empire as share prices plummeted across five of his six publicly traded holdings. OGX Petroleo & Gas Participações, his oil and gas drilling subsidiary, has been particularly badly hit after investors dumped the company’s corporate debt as prices fell as low as 15 cents on the dollar.

Credit rating agencies seized on poor operational performance and increasing concerns about Batista’s governance standards, lowering OGX’s credit ratings to triple C, driving a mass exodus out of the corporate debt by the world’s largest emerging market bond investors, BlackRock and Pimco, regulatory filings show.

"According to our criteria, we assess OGX’s management and governance as ‘weak’, due to negative assessment of the company’s strategic positioning and risk management," Standard & Poors’ analyst Renata Lotfi said in the rating action published on July 2. "Management’s ability to convert strategic decisions into constructive actions significantly lags those of its peers, in our view, and OGX has frequently revised downward, sometimes very abruptly, its production plans."

With the remaining OGX bondholders taking steps to prepare for a potential restructuring event, questions about the enforceability of security and the Brazilian judicial system are being raised. Indeed, if OGX misses the September payment and defaults on its $2.65 billion bonds due in 2018, it will rank as the largest emerging market default in history, taking that dubious honour from the Banco de Galicia y Buenos Aires $1.9 billion default of 2002, according to Moody’s

In view of the headline risk around Brazilian energy company Odebrecht, its successful launch seems all the more remarkable. However, market participants are not ready to declare the Brazilian capital markets reopened just yet. Rather, the deal represents acceptance of Petrobras’s status as national champion. The same observation applies to recent deals from Banco do Brasil and the State of Maranhão.

"With markets like Colombia, Mexico and Peru offering better economic growth, investors are herding out of the market. Odebrecht got its deal away because it was a refinancing of one of the two lead energy operators, not because investors were hot on Odebrecht risk," one source says.

Although the latest approval surveys suggest that confidence in the Rouseff government might have bottomed out over the summer, the fundamental issues confronting Brazilian infrastructure industries, and the country’s economic fortunes in general, are rather more intractable. "A major obstacle for Brazilian industry and the economy is the lack of real infrastructure. You have energy and electricity companies going bust amid a general lack of confidence in the government, which hasn’t given the market clear guidance on how economic policy will develop," the São Paolo-based attorney says.

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