Venezuela's trophy oil assets at risk

October will be a critical month for Venezuela – if PDVSA, the state-owned oil giant, defaults on a US$949m principal and interest payments due on its 2020 bonds, creditors could try to seize its crown jewel, Citgo, its US refining and service station subsidiary.

Venezuela – which saw its GDP collapse by 40% during the period 2014 to 2017 – is suffering from the world’s highest inflation rate of between 100% and 120% per month. The International Monetary Fund is forecasting that it could surpass 1,000,000% annually by the end of the year.

Since November last year – when President Nicolas Maduro said he wanted to see a restructuring of Venezuelan sovereign and PDVSA debt – the country has missed US$6.2bn in foreign debt payments. Of those, the sovereign accounted for roughly 40%, PDVSA the remaining 60%.

Since the beginning of the year, Venezuela’s default had been limited to interest payments on multiple bonds; however, on August 15, the sovereign missed a US$1.1bn principal payment on its 2018 note.

Citgo is the only major overseas asset that the country has left. The Houston-based oil refiner that processes Venezuelan crude oil is estimated to be valued at roughly US$4bn. Two years ago, 50.1% of Citgo was pledged as security for more than US$3bn of PDVSA bonds. The other 49.9% was then pledged as collateral against a US$1.5bn loan from Rosneft, the Russian state-owned oil company.

PDVSA must make a US$842m principal and US$107m interest payment on its 2020 bonds on October 27.

“PDVSA’s principal payment due in October is crucial,” said Daniel Osorio, chief executive officer at Andean Capital Management, a New York-and Bogota-based hedge fund. “Whether it makes this payment will be a very tough call for the Venezuelan government. If it does not, the Citgo collateral could be split ‘pro rata’ between the creditors.”

Edward Glossop, a Latin America economist at Capital Economics, a London-based economic consultancy, said: “The Venezuelan government has pledged Citgo to so many different creditors that a massive default in October would be an absolute mess. Maduro does not now seem to have any economic strategy; he is just digging in.”

Venezuelan sovereign bonds have been trading in the range of 23–27 cents on the dollar, while PDVSA’s have been even lower at 19–22, apart from its 2020s, which have been at 80–82.

Ruling and appeal

At the start of August, a federal judge in Delaware, Leonard Stark, ruled that Crystallex International, a defunct Canadian gold miner, could seize Citgo as a way of collecting on a judgement over lost mining rights involving Venezuela’s government. On August 27, US marshals served the US$1.4bn ‘writ of attachment’ on Citgo parent PDV Holding.

Crystallex’s lawyers had successfully argued that PDVSA was an ‘alter ego’ of the Venezuelan state and asked for permission to seize its commercial assets in the US.

However, at the start of September, BlackRock and Contrarian Capital – acting on behalf of 60% of the PDVSA 2020 bondholders – managed to get the case ‘stayed’ on the grounds that Judge Stark’s ruling in favour of Crystallex could harm them. PDVSA is also appealing against the judge’s ruling.

Russ Dallen, managing partner at Caracas Capital Markets, a Caracas and New York-based financial consultancy, said: “We do not think PDVSA will make the October payment. The country just has no money left. However, PDVSA may try to file for bankruptcy protection for Citgo before then. That could stop the assets from being seized, at least for a while.

“The question of whether or not PDVSA is the ‘alter ego’ of Venezuela is likely to go all the way to the US Supreme Court. However, in the final analysis, we believe Venezuela will lose Citgo. The country is very much on the back foot at the moment.”

Next in creditors’ sights following Citgo, would be a seizure of Venezuelan oil cargoes at sea. Elliott Management, a US hedge fund, managed to do this with an Argentine ship in 2012 after it won a US court ruling to collect on unpaid debts. It is understood that Venezuela is moving oil cargoes to safe harbours – including Cuba – to avoid such an eventuality.

Francisco Ghersi, a founding partner at Knossos Funds, a fund manager that has invested in Venezuelan debt, said: “It is a very good question whether PDVSA will make the October payment. It is hard to see the incentive for the government to make it after the Crystallex ruling.

“If it does not do so, bondholders will then have to consider ‘acceleration’. But they will ask themselves whether it is worth it: it can be a long and costly exercise. The lawyers’ fees can be very high.”

Until now, the bondholders of defaulted Venezuelan sovereign and PDVSA debt have not triggered ‘acceleration’, the process whereby lenders can require a borrower to repay all of its outstanding debt if certain requirements are not met. This could change if PDVSA misses its principal payment in October.

Venezuela owes a total of around US$32bn of sovereign bonds and around US$30bn of PDVSA bonds. Accrued interest on the bonds this year amounts to an additional US$8bn. Russia and China have also lent it many billions of dollars. It is believed that it has US$23bn of outstanding debt to China alone.

“The Venezuelan situation is unprecedented,” said Ghersi. “This is the first time ever that investors have preferred not to accelerate on defaulted debt. The sovereign and PDVSA are now many months in default. Under US sanctions, American bondholders would not be able to trade in any new bonds arising from a restructuring.”

Osorio said: “The creditors have not accelerated because they have no one to accelerate against; there is no one they can negotiate with since President Trump signed a new executive order that restricts the Venezuelan regime’s ability to liquidate its state assets.”

In May, the US government issued the order that prohibits US citizens from involvement in the purchase of any debt owed to the Venezuelan government, including accounts receivables; debt owed to the government pledged as collateral after May; and the sale, transfer, assignment, or pledging as collateral by the Venezuelan government of any equity interest in any entity in which the government has an ownership interest of 50% or more. It applies to the Venezuelan Central Bank and PDVSA.

Not much in reserve

The Venezuelan regime is currently under intense financial strain. On August 31, the country’s central bank reserves dropped to just US$8.34bn, a level the country first achieved in 1974 (in 2009, they hit a high of US$42.4bn). Experts doubt whether the total is as high as the official figures suggest, and gold – which is not easy to monetise – accounts for around 70% of the reserves.

“The US$842m sinking fund payment in October for the PDVSA 2020 should not represent a make or break for cashflow management,” said Siobhan Morden, head of Latin America fixed income strategy at Nomura. “However, the liquidity and litigation stress is becoming increasingly intense while latest price action suggests taking profits on what has been the best (only) decent trade on the Venezuela/PDVSA complex.

“We still prefer PDVSA relative to the sovereign for the price discount that offers better risk/reward on downside risks and still a beneficiary of upside risks on the increasing risks of regime change as cashflow undermines governability.”

In August, ConocoPhillips, the US oil producer, and PDVSA reached a payment agreement over a US$2bn international arbitration claim. This suspended a dispute that stopped PDVSA from exporting oil from most of its crucial Caribbean facilities. The deal stems from the nationalisation of Conoco assets dating back over a decade ago in Venezuela.

Under the terms of the agreement, PDVSA will make an initial US$500m payment within 90 days, and must pay the balance over the next four and a half years. By the start of September, PDVSA had still not made its first payment and Ryan Lance, ConocoPhillips’s chief executive officer, said: “I’ll count the money when it shows up in the bank.”

Ghersi said: “I understand that ConocoPhillips is still waiting for its first payment. PDVSA just seems to be buying time; it will not really pay.”

The country’s economy is in terrible shape. Oil makes up 95% of total exports but output has dropped below 1.3m barrels per day – back to 1947 levels, according to Caracas Capital.

At the end of August, the regime implemented a package of radical measures. It introduced a new currency called the ‘sovereign’ bolivar that lopped five zeros from the previous set of bank notes. It hiked the minimum wage by up to 5,900%; introduced petrol rationing; increased VAT by 4% on luxury goods; and imposed a tax of up to 2% on big financial transactions.

It also tied the new currency to the ‘petro’, a cryptocurrency set up at the start of the year backed by the country’s oil reserves. Some experts have described the petro as a scam.

However, the central bank’s printing presses seem to be turning at an ever faster pace and the country is facing hyperinflation of the level seen in the Weimar Republic in the 1920s. Venezuelan and PDVSA bonds have become virtually worthless.