Archive for October 5th, 2013

Venezuelan Bonds Drop. More to come?

October 5, 2013

Venezuelan and PDVSA bonds have not done well lately. While there was a nice rally in September, up to the US Federal Reserve announcing that it was not ready to reduce tapering, after that, they did not well, with a bounce on Friday due mostly to JP Morgan reiterating  its overweight rating on the bonds,in a report entitled something something like “Venezuela: Bending, but not Breaking.

The graph for PDVSA 2022 is shown below:

That was quite a drop, almost 10 points since September 20th., except for Friday’s bounce.

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Why has this happened? Essentially all news coming out of Caracas is negative. There is nothing positive happening and Maduro has been in power almost six months and very little has been done on economic policy. In fact, there has been total policy paralysis on economic matters since April.

In April, I suggested that investors reduce their position in Venezuela and PDVSA for the simple fact that bonds had gone up because “change” was expected, but as long as Giordani remained in the Cabinet, it was difficult to envision this change.

But for foreign investors signs are even worse, everything coming out of Caracas seems to be negative:

-There is total policy paralysis

-Sidetur bonds defaulted, the first time in 14 years the Chavista Government has allowed this to happen.

-Liquid international reserves are low. There is money in parallel funds,but people don’t know how much. Is Maduro willing or commited to pay as much as Chávez?

-PDVSA has failed to increase oil production significantly. Even more ominous, Lukoil and Petronas have decide to leave the partnerships they joined recently in thePetrocarabobo and Junin 6 fields.

-A new foreign exchange system, called Sicad was set up, but has failed to deliver foreign currency. No auctions have been held in four weeks in what was supposed to be a system that would regularly offer foreign currency to companies.

-The ICSID Court ruled against Venezuela in the ConocoPhillips case, which will eventually have a financial obligation attached. Given the uncertainty over the full amount, this implies an additional financial commitment in the future for the country.

-President Maduro went to China and while he failed to obtain a US$ 5 billion loan in cash, he did extend the Heavy Chinese Venezuela fund with a US$ 5 billion loan. This loan is an extension, which will allow Venezuela to buy Chinese goods in exchange for oil, constraining PDVSA’s cash flow from oil sales.

-The non-payment for the delivery of three oil tankers raises questions as to why PDVSA is holding back payment when the amounts involved are not significant.

-Investors are increasingly concerned that the Government will have to resort to issuance in the near future, if it wants to create any form of new foreign exchange market as resources to supply this market are limited at this time.

-The Government intervened paper product maker Manpa, sending another negative signal to markets. While the intervention is supposedly temporary, President Maduro has suggested a number of irregularities were found and the intervention will be extended.

-Meanwhile, President Maduro continues to blame the private sector for inflation and shortages.

-And oil could drop further now than Iran is talking to the US Government.

But in our opinion, all that is happening is that Venezuelan bonds are sort of resetting their expectations. While I do not expect the government or PDVSA to default or restructure in the next two years, one has to think back to what happened in 2011 when Hugo Chavez got sick. At that time, bonds were trading at a spread of 1,000 to 1,200 basis points to US treasuries, as shown in the curve below:

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This is a plot of the country risk since 2011, expressed in basis points. As you can see, right before Chávez got sick, the price to insure Venezuela bonds for 5 years was oscillating between 1,000 basis points (19%) and 1,200 basis points (12%). The country risk (the price paid by people to insure Venezuela against default, dropped as low as 600 basis points, as people were betting that once Hugo was gone, there would be change in the way the country was run. However, since Maduro took over over five months ago, little has happened and people are getting concerned. The spread r country risk reached 1,030 on Friday.

Some people are so concerned that they think Venezuela or PDVSA will default soon. I don’t think this is the case. However, looking at the plot above, you can see that the credit risk spread can easily (or should?) go back to 1,200 basis points. Thus, this resetting of the curve is not something I am willing to ride out. Bonds will likely have further to drop.

Thus, I am telling people to simply lighten up on their Venezuela positions. Bonds could easily drop 10 more points, something most investors would have a hard time riding out.

In fact, just as Chávez was sick because of his health, I think Cristina is politically sick in Argentina and investors will bet that things will change down there and bonds from that country will rally sharply in the next couple of years. Even if nothing changes in the end in Argentina, just like in Venezuela.

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