Brazil oil and gas sector seeks to shake off Batista break-up
Capital-hungry borrowers seeking to plug the huge infrastructure deficit in Latin America’s largest economy through international capital markets are hoping Eike Batista’s OGX group will avoid default.
Hopes are growing Eike Batista’s OGX group will narrowly avoid becoming Latin America’s biggest outright corporate bond default after both sides of the deal announced they have appointed legal counsel and financial advisers to assist in the restructuring of OGX’s $3.6 billion senior unsecured debt.
Disclosure earlier this year that offshore drilling company OGX would badly miss production targets in three of its key development sites sent Batista’s oil and gas empire into a tail spin over the summer, with OGX corporate bonds collapsing to around 15 cents on the dollar and earning notoriety as the most distressed debt in emerging markets (EMs).
With the company, which had been the lynchpin of Batista’s growth strategy, bleeding cash and seeking fire-sale divestments to keep its creditors at bay, Fitch and Standard & Poor’s both lowered the OGX’s credit rating to triple C, implying a high chance of imminent default.
Against this backdrop, a group of bondholders, including Pacific Investment Management Company, engaged US law firm Cleary Gottlieb Steen & Hamilton to advise on potential recovery strategies, unsure of whether OGX would be able to make the $140 million of coupon payments falling due over the remainder of the year.
Since then, bondholders have appointed Rothschild to advise on investor-recovery options, while OGX has mandated Blackstone Group to help it rethink its capital structure. Given where the bonds are trading, it’s apparent that investors do not expect substantial recoveries from the process.
OGX had become a regular visitor to the international capital markets to fund its aggressive growth plan, looking to foreign investors to support various shipbuilding, logistics and infrastructure projects.
The company’s fall from grace comes at a challenging time for Brazil’s oil and gas sector, which has been suffering from a general sense of underperformance in recent years.
State-owned Petrobras, for example, has lost almost 21% of its market value in 2013, as production has failed to live up to the company’s projections while the costs of extraction have continued to rise.
“Brazil oil and gas has clearly underperformed investor expectations, for example bellwether Petrobras has a clear direction downwards,” says a market source. “It has reduced production, and investors no longer believe it can deliver the volume that it has pre-sold.
“This negative sentiment killed appetite for the QGOG Constellation IPO in February. It has been a rough ride for the sector this year.”
Of course, the EM rout this summer has only made things worse, as the combination of poor sovereign outlook and rising rates led bankers to pull deals they had expected to price before the summer break.
However, the eventual success of one of those, a $1.7 billion secured bond issued by Odebrecht in late July suggested international investors might still have appetite for the sector, albeit at a higher price.
Indeed, while equity market investors punish Petrobras for raising expectations unrealistically high, debt investors took comfort from the company’s role in the Odebrecht secured bond to deliver funding at a relatively attractive price.
“Investors have been herding out of Brazil, and this has been particularly bad for non-investment grade paper,” says Tobias Stirnberg, an attorney with Milbank Tweed Hadley & McCloy in São Paulo, who advises Brazilian oil and gas companies on international capital raisings.
“Odebrecht is the main competitor to Petrobras in the oil and gas sector, and the presence of the state-backed company in the deal structure was the telling factor in why the deal got done,” he says.
Brazil’s government debt has underperformed the EM’s sell-off by around 100%, with the 10-year surging by 2.5% to yield more than 11.8% in recent sessions. Corporate debt is, therefore, only getting more expensive.
The country’s distinct lack of infrastructure, which has exacerbated its industrial underperformance, will require substantial international capital to turnaround.
With the Batista situation apparently under control, and the oil sector finding traction with investors, Brazilian companies can take heart from the lessons of the summer.