BY WALTER T MOLANO
With one of his closest international allies in the midst of a bloody civil war, Venezuelan Hugo Chavez has lost some of the bounce in his step. It’s true that the problems in the Middle East sent oil prices soaring, which produced an immediate windfall for Caracas. However, years of mismanagement and an endless borrowing binge are taking their toll. The country’s infrastructure is crumbling. Food shortages abound, and international reserves are at their lowest level since 2007. All of this bodes poorly for President Chavez, as he prepares to start yet another re-election campaign. With more than 12 years in office, President Chavez will be seeking a fourth term. Interestingly, his popularity remains slightly above 50 percent. However, a recent poll by Datanalysis found that 28 percent of the electorate would vote for the opposition. Meanwhile, only 26 percent of the respondents said that they would vote for Chavez. The interesting thing is that the opposition still has not decided on who will be the official candidate. The coalition group said that they would hold primaries between the end of November and the beginning of March to decide who would be their representative. The leading contenders are Henrique Capriles, the governor of Miranda, former presidential-candidate Manuel Rosales and Pablo Perez, the governor of Zulia. Although Chavez still holds a high level of popularity, it is nowhere near the 70 percent he commanded on the eve of his last re-election campaign. This is the reason why he is desperately building up his war chest. Although Chavez is successfully tapping the international capital markets, he is also taking out bilateral loans from the Chinese. These loans will be paid back with future oil production—and this is subordinating existing bond holders.
Last year, the Venezuelan government signed more than $40 billion of oil-related loan deals with the Chinese government and institutions. As a result, Venezuela will almost triple its oil exports to China by 2015. Currently, China imports 360,000 bpd and it plans to increase embarkations to 1 million bpd during the next four years. Given that PDVSA is not increasing production at the same rate, the United States is being forced to reduce the oil it receives. Oil exports to the United States are down 16 percent to a rate of 959,000 bpd. The problem for bond holders is that the Chinese are taking possession of the oil inside of Venezuela. Therefore, the oil is Chinese property by the time it hits the high seas, removing any chance of attachment in the case of a sovereign default. Therefore, the loans-for-oil transactions are deeply subordinating bondholders. Given that Venezuela’s oil production is running at 2.3 million bpd, the country is losing almost half of the oil revenue that was being generated to service its external debt obligations. To make matters worse, the Chinese are paying only $3-4 per barrel, allowing them to enjoy the windfall produced by the spike in oil prices. This is occurring at the same time that the Venezuelan government is on an endless borrowing binge, using the currency controls as a mechanism to force Venezuelans to invest in the new bonds as a way to move their money offshore. Thanks to the massive issuance of debentures, Venezuela’s debt to GDP ratio will reach 35 percent in 2011. This does not seem high, when compared to the debt loads recorded across much of the developed world. However, the ratio is much higher when analysed using Purchasing Power Parity (PPP). The Venezuelan bolivar is grossly overvalued, thus overstating the size of the Venezuelan economy. The black market rate for the bolivar is more than 8, and it has been as high as 12. With the official exchange rate at 4.3, the dollar-value of the Venezuelan economy would collapse by more than half in the aftermath of a maxi-devaluation. In such a scenario, Venezuela’s debt to GDP ratio would more than double; thus leaving the country with a precarious debt load.
With Venezuelan bonds providing double-digit yields and oil prices in the triple digits, Venezuela looks like the deal of the century. However, investors need to take a much closer look at the numbers. The subordination of bondholders by the Chinese loans-for-oil deals are making Venezuelan bonds increasingly risky. Recently, some analysts recommended Venezuelan bonds over Belarus bonds, which are also trading at similar levels. The basis of their recommendation is the fact that Venezuela is a major oil producer; meanwhile Belarus is mainly a conduit for gas and oil pipelines that connect Russia with Poland and Germany. However, Venezuela’s oil production may be overstated because much of it has already been pledged to the Chinese. Therefore, investing in Venezuelan bonds may be as desperate as Chavez’s quest for a fourth term in office.
Walter Molano is head of research at BCP Securities