The Chavez bubble: The increasing probability of the country’s default

May 17, 2009

A year ago, Venezuela’s finances looked reasonable and the probability of the country defaulting on its external debt seemed remote, despite the lack of transparency of the country’s finances. With no bond maturing until 2010 in the amount of US$ 1.5 billion and then again another one until 2011, it seemed ludicrous to talk about the country’s default.

This is no longer the case.

The Chavez Government continues to act as if oil prices had not dropped and continues to acquire liabilities, despite the fact that it has issued no debt so far in 2009. But its aggressive style is simply to not acknowledge reality and act irresponsibly. In the recent case of the Government taking over the oil service companies, the Government simply decided that it could not pay a good fraction of the US$ 13 billion owed by PDVSA contractors and took them over as if this eliminated the liabilities. But it does the opposite, as the Government now has to pay for them and much of the debt owed to them is owed in return to a long chain of their suppliers.

Thus, on top of the US$ 13 billion, the Government will have to face suits and arbitration processes that one-day will come home to roost. Add to this those processes already in hand, like ConocoPhillips, Cemex and ExxonMobil (Around US$ 12-14 billion) and the numbers add up.

Then there is the increasing debt with local banks and companies, which are owed some US$ 450 million in travel expenditures on credit cards by CADIVI and some 2 billion US$ in letters of credit. It may be in the end that the solution will be the same: take over the banks and nothing is owed in Chavez’ simplistic mind.

And the Government continues to take over institutions like Banco de Venezuela, which are unnecessary and are likely to be driven into the ground much like Banco Industrial has been bankrupted three times in the last ten years.

But this is an increasing house of cards, you pile debt on top of debt, liability on top of liability and one day the whole thing will crash.

Whether the trigger will be lower oil prices or arbitration decisions going against the Government is unclear, but unless oil process rebound dramatically in the next two years, it is likely to all come crashing down to the point that Hugo Chavez will have no recourse but to decide to default on the country’s debt.

Much like the bursting of the housing bubble in the US, the hard part is predicting when this will happen. Besides the oil price uncertainty, there is that of lowering oil production, made worse by the recent decision to take over the service companies and, of course, the fact that the Government has taken few measures to save foreign currency in the face of lower income. This will one day have to be paid.

Imagine, for example, that an arbitration decision goes against the Government, as many are likely to go and a payment of US$ 2 o 3 billion has to be made to either ExxonMobil or ConocoPhillips. It will be easier for Chavez to say forget it and stop making any payments on foreign debt and arbitrations in the name of a revolution.

This will of course create a chain of events, including the seizure of CITGO in the US which will only bring joy to Chavez as he can then say he is doing this as part of his revolutionary process and against the imperialistic and capitalistic forces of the world.

A year ago, I thought the probability of such a scenario was quite low and largely unnecessary for the Government. Even three months ago, it seemed somewhat remote. But adding the new liabilities with the oil service companies, Chavez’ increasing radicalization and the total mismanagement of the country’s economy and liabilities indicate that this probability is not only finite, but increasing day by day.

14 Responses to “The Chavez bubble: The increasing probability of the country’s default”

  1. ed Says:

    You all keep applying academics when analizing Chavez.
    Although academis will catch him sooner or later, it dosen;t lead one to the right conclusion.
    Chavez, through political maneuvers, will easily make it through 2009. Hardship is still 15-18 months away.
    The parallel exchange rate is and will continue to, help him in the months to come.
    Bet the farm on that!!

  2. […] VENEZUELA The Chavez bubble: The increasing probability of the country’s default […]

  3. moctavio Says:

    I think the probability is higher and increasing daily. Right now I would say 30% only because I believe oil prices will move up.

  4. concerned Says:

    The track record for Chavez indicates that he feels he is above the law and not responsible for any past debt. If he were to start over with a clean slate, he would still only honor the contracts of his closest allies. The debt amassed over the last ten years is insurmountable as most requires special terms, rates or all out ‘in exchange for’ future shipments of oil. With PDVSA’s dismal production and spiralling lower each month, it will be impossible to meet these deadlines for payment, past due or coming due. The only way to live for another day are the takeovers of the areas screaming the loudest for payment. This is only temporary as these debts are still there. Any investment in Venezuela would be a crapshoot with a 95% chance of a future defalt. The only people making money now are the ones manipulating the foreign exchange.

  5. Mr Danger Says:

    CDS spreads tell the story – even though Venezuela’s spreads have fallen sharply, they remain very high at around 1,500 for the 5 year contract, implying a 12% annual probability of default. That’s only a little lower than Ukraine, and multiples of Brazil (2.8% PD) and Mexico (3.2%).

    Astonishing numbers for a country which basically won oil lotto and squandered the lot of it, and then some.

    Personally, I think it should be trading wider – i think the chance of default is more than 20%.

  6. revbob22 Says:

    I seriously doubt the US is going to hammer Iran. Obama has enough on his plate, and it’s not his style either. Unless Iran is doing something so horrific that the entire world would ask the US to intervene ipso facto.

    Nor do I think a blockade is in the cards either, just say Cuba.

  7. HalfEmpty Says:

    an act of war in itself which could be met with air and sea blockade of Venezuela’s northern, western and eastern flanks basically cuttting it off from the world

    While I hugely respect the US Navy, short of nuclear weapons they cannot hold a candle to Hugo’s destruction of Vz.

  8. Casper the friendly spook Says:

    there is another angle which will bring oil prices back up and that is war with Iran. The pieces are being put into place for such a contingency: Israel accepting Palestinian statehood and Obama’s upcoming trip to Russia. Iran is going to get hammered and the U.S. will likely go along for Israel cannot permanently stop Iran’s military nuclear ambitions unless they pre-emptively use tactical nuclear weapons.

    What will Chavez do when this happens? Oil will spike but will the U.S. be a recipient? That depends on what Chavez does. There will be plenty of surplus this year and there’s also the strategic reserves. How Chavez sides with Iran will determine the U.S. response. A symbolic gesture will elicit little if no response but anything beyond that could be considered aiding and abetting an enemy in a time of war, an act of war in itself which could be met with air and sea blockade of Venezuela’s northern, western and eastern flanks basically cuttting it off from the world.

    Thus I think that many of the events currently happening in Venezuela are with an eye towards this future when Chavez will need to be in firm control of the country as his hold on power will be certainly challenged with Iran is bombed.

  9. KA Says:

    What is the likelihood some of the these take overs, particularly the oil services can be offset by awarding them to China? Brazil? or some other state oil company? In other words you nationalize then resell the rights to a more favorable partner. Wouldn’t this greatly diminish the liability of nationalization?

  10. Gringo Says:

    Chavez’s spending of past, present and future petrodollars brings forth the crack that Washington Redskins owner Edward Bennett Williams made about George Allen, his coach. Williams joked that he had given Allen an unlimited budget, but Allen had exceeded it.

  11. HalfEmpty Says:

    Imagine, for example, that an arbitration decision goes against the Government, as many are likely to go and a payment of US$ 2 o 3 billion has to be made to either ExxonMobil or ConocoPhillips. It will be easier for Chavez to say forget it and stop making any payments on foreign debt

    While I understand that the hit on the credit worthiness would be huge, isn’t a selective default possible?

  12. geha714 Says:

    Beside what all of you wrote, which is accurate; Chavez is also playing the “scorched earth” card.

    Remember Zimbabwe…

  13. Robert Says:

    Great recap.

    The question is simple. If you can’t pay what you owe the service companies, how can you pay what you owe the service plus the cost of taking over the service? (buy out cost). It’s insane!

    And you have not gone into what will happen with the GM, Toyota and other international companies that still have interest in Venezuela. GM has dollar debts over a billion US, some near 300 days old. Where’s those dollars coming from?

    Chavez is bankrupt and no oil price increase can bail him out of this one.

  14. concerned Says:

    It would be easy to blame the failure to pay debts owed on the lowered oil prices, but most of these debts are owed for 12 months or more when the price of crude was at record prices. Throw in the fact that PDVSA sells it’s dollars on the parallel market for up to three times the B value at the official rate and last year PDVSA was raking in the equivalent in B value of $200 plus / barrel of crude. Today, trading in the $40’s still reaps the equivalent of $100 plus / barrel.

    Last year, there was speculation as to what price / barrel would bring about Chavez’s demise. $70’s to $80’s come to mind but that would imply that the money from Venezuela’s resources was actually going directly to the people and the social programs as this bullshit revolution claims. With crude prices at record prices, I challenge you to show me one aspect of a Venezuelan’s life where it was improved or anyone is better off today (not counting the short term payments for elections). The truth is that due to the unbridled corruption within this government and PDVSA, the Venezuelan citizen is worse off today than last year, and the year before that, and so on. The government doles out just enough to keep the voting public from starving while every other quality of daily life has deteriated.

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