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Analysts and pundits alike increasingly admit that when analyzing Venezuela, official public sector statistics “are becoming less reflective of the real performance of the country’s finances.”  For instance despite the 27.5% rise in price per barrel of domestic oil in 2010, state oil company PDVSA’s net profits fell 30.5% as “fiscal contributions” to the leftist government of Hugo Chávez rose 35%, the public sector deficit (as a % of GDP) shrank 1.6 percentage points and total fiscal expansion declined by roughly twice that figure.  Much like the country’s one-time “parallel” exchange rate in 2005, when per The Economist “Chávez pegged the bolívar at 2.15 to the dollar [but] also tolerated a legal parallel market that kept the country supplied with hard currency at a higher rate (providing countless opportunities for arbitrage)”, there now exists an informal public sector in Venezuela that not only systematically siphons money from the oil group (which in turn starves investment and hampers production, underpinning a rising defacto price floor but also arguably stoking domestic inflation pressures) but opaquely spreads it to, per Barclays, “quasi-fiscal” funds such as the “Fund for National Development” (FONDEN, which most critics blast as merely a 2012 campaign support tool) and a “Chinese Fund” that stems from the nations’ 2007 pact in which China gets uber-cheap oil shipments in exchange for an implicit revolving line of rainy-day credit.  Yet ironically while potential bond holders would normally quiver at the egregious lack of accounting inherent to this parallel public finance universe, PDVSA hoovering provides a handy ceiling vis a vis ever-pesky transfers to regional authorities.  Moreover the PDVSA bonds themselves, which most investors tend to link synonymously with the sovereign, are probably safer in comparison.  Analysts noted this spring, for instance, that creditors would likely fare better with PDVSA than the sovereign given the direct claim on offshore assets and USD denominated oil revenues.  The most immediate play on spreads, which widen as crude falls, would involve buying the firm’s 2017 [NY law, 8.5% coupon and ~12% yield] issuance and the 2014 [local law, 4.9% coupon] credit, the price differential of which (between the latter and the former) has actually increased this spring (despite the legal discrepancies between the two) due primarily to supply factors: the central bank, originally owned most of the USD2.6bn, 2017 issue and has been selling USD120m per week for the past three months.  As this selling subsides however, and more importantly as crude investors regroup and find a new trading range for the commodity (against the backdrop of a secular narrowing of the historically large gap between Brent and ‘heavy’ Venezuelan crude due to refining dynamics), look for the aforementioned price divergence to converge considerably.


My November Business Diary Botswana submission:

Italian energy giant Eni S.p.A, which also owns interests in the Republic of Congo, Nigeria and Ghana, announced in late November its acquisition of stakes in six Ugandan oil fields (a 50% interest in Blocks 1 and 3A in the Albert Basin) from Canadian-based Heritage Oil PLC for $1.5 billion–a deal that “underscores the intense interest the world’s major oil companies are showing in Uganda, one of sub-Saharan Africa’s most promising hydrocarbon provinces,” opined the Wall Street Journal. According to Tullow Oil PLC, Heritage’s London-based partner in the sold stakes that wholly owns another block in the same area, in addition to the 700 million barrels of oil that have already been discovered so far in Uganda’s Lake Albert Rift Basin, there are potentially six billion barrels yet to be discovered–a sum that theoretically would make Uganda one of the top 50 oil-producing countries in the world by 2015. Furthermore, Eni’s venture into Uganda is just the beginning of a long-term commitment to renovate the country’s energy infrastructure, points out Thomas Pearmain, African energy analyst at IHS Global Insight. The company is poised to build a pipeline eastwards towards the Kenyan port of Mombasa for exporting, as well as invest “much-needed financial resources and expertise for development of energy infrastructure, such as refineries, terminals and pipelines, in order to fully exploit [the region’s] deposits.” Any sort of vested-foreign interest in Uganda will reverberate strongly in the country’s rapidly maturing capital markets, particularly in bond markets where the success of nascent corporate offerings still depends in large part on further development of the long end of the risk curve by the the country’s central Bank of Uganda, which itself is a function of the country’s fiscal policies and ability to fund borrowing while containing inflation. Moreover, subscription rates may ultimately lag, despite the current uptick in liquidity due to foreign inflows and diaspora remittances, until additional reforms are realized, argues Mary Katarikawe, the Bank’s director of research: “What is needed in developing and deepening Uganda’s financial market is liberalization of the pension sector such that it can pave way for more fund managers, insurance companies and other institutional investors to actively participate in the fixed income market.”

Increased participation, moreover, is critical to the development of a secondary market, whose relative absence to date further distorts the type of “information sharing” that increasingly developed yield curves fundamentally supply. Furthermore, say analysts, future economic growth and increased domestic and foreign investment depends on a more varied basket of financial products. Per Andrew Owiny, CEO of East Africa’s Merchant Bank, “Uganda still has room for more institutional investors to develop its bond market while on the equity side there is need for more companies to list their shares,” a testament to the fact that since the country’s capital markets began operating in 1997, only six domestic firms have been listed in addition to five cross-listed ones from Kenya. Could oil be the requisite impetus that accelerates a positive regulatory feedback loop within Uganda’s economy whereby domestic growth is underpinned and reinforced by greater share liquidity through increased institutional participation in the equity market, as well as more flexible debt management strategies via a deepened credit market? Indeed, observed one reporter, “if managed well, petrodollars could transform the economy of the landlocked country, potentially doubling the state’s revenues, create thousands of jobs and help realize President Yoweri Museveni’s dream of industrializing the country.” Mindful of the mistakes made by other resource-rich countries such as Nigeria, where vast reserves did little to alleviate widespread poverty and in fact directly fueled rampant state corruption, a shocking deterioration of environmental standards and an ongoing and vicious struggle waged by domestic “rebel” groups in the Niger Delta region to voice their dismay and to secure Government-funded remuneration, Ugandan officials seemed determined not to repeat them. “Why must people always look at the bad examples and say we will suffer the same curse?” Fred Kabagambe-Kaliisa, permanent secretary in the ministry of energy and mineral development, told the UK’s Guardian paper in August. “Why not mention the good ones, like Norway?” With a per-capita income of $65,509, Norway ranks second only to Luxembourg in global rankings, with much of the wealth derived from North Sea oil and the lion’s share of export revenue reinvested in a fund “to ensure that oil and gas receipts will also benefit future generations.” However, when Norway first began extracting oil in the 1970s, overly-profligate fiscal policy lead to high inflation and an eventual currency collapse when the oil price plummeted in 1986. Politicians quickly passed legislation mandating that future receipts be managed more soundly, ultimately resulting in what’s now labelled the Government Pension Fund, one of the world’s largest sovereign wealth vehicles valued at $350 billion. Yet, cynics mused, is such success and fiscal prudence probable in a country that, unlike Norway at the start of its oil-founded boom, lacks transparent institutions, an educated population and a long history of democracy with little corruption?

Ugandan officials, looking to move down the political, economic and social learning curve as quickly as possible, certainly thought so, and enlisted Norway, which is also subsidizing a feasibility study on whether to build a large refinery near Lake Albert, to advise them through its energy, finance and environmental ministries. Additionally, officials note, to date negotiations with foreign firms, which habitually seek to export the petroleum in order to expediently recoup their fixed investment costs–have all allegedly incorporated a “value addition” philosophy founded on President Museveni’s stated desire to ensure a greater share of profits remains in the country, to help stem reliance on Kenyan ports for imported fuel, and also to help reduce the state’s hitherto over-reliance on foreign aid, which accounts nearly one-third of the government’s annual budget. That said, critics argue, what is to prevent President Museveni, who has been in power since 1986 and will stand for a fourth term in 2011, from holding on to an increasingly precious position at society’s expense? Per Godber Tumushabe, executive director of Advocates Coalition for Development and Environment, a local think tank, oil discoveries historically “encourage political longevity”. Further muddying the analysis, posits Taimour Lay, a journalist and researcher for Platform, a UK-based environment and governance watchdog, is that despite President Museveni’s value-added rhetoric, the [profit sharing] agreements (PSA) in practice are still “dangerously skewed in favor of the international oil companies and represent a significant diminution of this country’s sovereign control over its own natural resource. In particular, the deals fail to capture economic rent–the benefit to be gained from escalating oil prices–for the government.” In a column written for The Monitor in November, Lay showed that the very discounted cash flows explicitly forecasted by the PSAs, assuming “medium-level oil prices for the next 25 years,” would net the oil companies an internal rate of return (IRR) of between 30-40%. As oil prices rise, however, the companies net a greater percentage of profits since the state’s share is ultimately capped at around three-quarters–a clause that allegedly cannot be renegotiated across the duration of the contract. “Compared with comparable deals around the world, from northern Iraq to Libya, Uganda’s government has signed deals that leave it worse off in real cash terms,” Lay concludes. Apparently, even the Norwegians were appalled: a review of Uganda’s PSA model commissioned by the Norwegian Agency for International Corporation (NORAD) and carried out by Arntzen deBesche, a Norwegian law firm, opined that the model “cannot be regarded as being in accordance with the interests of the host country.

The enormous increase in oil prices during the last five years have fully demonstrated the need for production sharing models that adequately protect the interests of the host country by securing the economic rent for the country. The economic rent should be for the benefit of the host nation owning the petroleum resources, and not the oil companies, which should only be secured the fair return on their investments.” That said, what have been the opportunity costs to date of not having an integrated company of Eni’s expertise and capitalization–cash that will build the pipelines, terminals and refining capacity that Uganda’s oil industry has always sorely lacked? The cost of the pipeline to Kenya alone will drastically squeeze Eni’s short-term margins, analysts note, as it will need to be heated since the oil in question is waxy. Additionally, the government also wants a refinery to be constructed to meet increasing domestic demand. Shouldn’t such sunk costs be incentivized? Politics and arguably inequitable revenue splits aside, however, Uganda is undoubtedly in a unique position that could be a boon for not only its domestic production levels, but also for the breadth of its capital markets. The true tragedy would be if the state, perhaps already duped once at the bargaining table, failed to make amends by revamping and liberalizing its financial markets.

Interesting piece from MEED vis a vis Tripoli’s $54bn, 20-year commitment to develop joint ventures with multinational firms in order to transform the Gulf of Sitre–and namely the oil-rich industrial cities of Marsa el-Brega and Ras Lanuf–into energy hubs founded on oil and gas processing and distribution, as well as into a resort destination.  The two cities lack proper downstream investment, but the potential returns on FDI are enormous, gushed a source from the U.S. engineering firm Fluor Corporation, which was commissioned to oversee the project:

“Libya is virgin territory. It is coming out of a long embargo so there are great opportunities. The energy cities have these anchor investments but also provide for secondary industries, which take products from the heavy industries and produce plastics, for example. They also provide work for industrial and construction services. There is a much greater, wider and more open opportunity for investment, from oil and gas to secondary industry and services.”

As with many if not most frontier economies, one primary issue facing investors and companies alike in Libya is the country’s historical lack of ease of doing business:

“Libya has been a notoriously difficult arena for business in the past, and nearly two decades of U.S.-imposed trade embargoes between 1986 and 2004 have helped make it an unknown quantity for many international companies.”

Thus, the relative ease and quickness inwhich capital will begin to flow into Libya is largely a function of the speed and degree of regulatory reform.  Bring on the lobbyists.  In the meantime, the project’s developer–the state-controlled Economic & Social Development Fund (in lieu of the state’s energy firm, NOC), as well as the country’s development agency, the Economic Development Board, will handle coordination efforts of oil and gas, as well as promoting new tax incentives, respectively.

Per Bloomberg, Ghana expects to pump 500,000 barrels of oil a day by 2014 as it seeks to boost supplies to the domestic market and become Africa’s newest crude exporter.  The government recently approved a plan to pump crude from the Jubilee field in the second half of 2010.  Moreover, the various group developing Jubilee have agreed to “donate some of the field’s natural gas to the nation to fund pipeline development and boost the local economy.”

According to Wale Tinubu, CEO of Oando PLC, Nigeria’s foremost indigenous oilfield services company and fuel distributor, the firm’s plan to realize a production target of 100,000 barrels of oil per day within the next four years is already “fully funded.” Oando made headlines in May when it announced the completion of a $150 million, two-year drilling contract with Nigerian Agip Oil Company (NAOC)–the local division of the Italian firm–for its oilfields in the Niger Delta swamps.

As per the ever-volatile oil price, Tinubu predicts $75 by year’s end. He also anticipates an imminent “big shake-up,” in the form of market reforms and deregulation, of the country’s energy industry. The government announced in February that it planned to end subsidies on petroleum products because it could no longer sustain the more than $4.4 billion (one quarter of its original 2008 budget) a year that it spends on subsidies. As it currently stands, Nigeria is the world’s eighth-largest crude oil exporter; yet it imports an appreciable amount of its needed petroleum given the rotten state of its four domestic refineries. Accordingly, state officials would like to deregulate the downstream oil sector and privatise its refineries, which would open the way for investors to restore, and indeed increase, existing capacity.

  1. Behold the “negative basis trade,” per John Dizard: “You can own a corporate bond, or emerging market sovereign bond, buy default protection on the paper with CDS, and collect interest payments for taking no risk. That’s right: because CDS prices are depressed, relative to the comparable bonds, you can collect money for taking no risk.”
  2. Per Riccardo Barbieri of BofA-Merrill Lynch, “as long as [oil] prices rise only moderately from here – say, revisiting the $80 a barrel level by year-end, this would not pose severe risks for the advanced economies, while the emerging ones would be able to tolerate even higher levels, say, $100, in due course.”
  3. David Pilling notes that “Vietnamese exports have been fairly resilient. While economies such as Singapore and Taiwan have seen declines of 30 or 40 per cent in shipments, Vietnam was down a modest 3.7 per cent in the first four months of this year against the same period in 2008.  Economists think Vietnam might be benefiting from a new Wal-Mart effect by which western consumers switch from expensive branded products to cheaper goods in which countries such as Vietnam excel.  Last month, the port at Ho Chi Minh City was so busy it was backed up with ships. ‘They’re not producing i-Pods and laptops; they’re producing T-shirts and shoes,’ says Jonathan Pinkus of Harvard University’s Kennedy School of Government.”

According to a recent survey conducted by the Society of Petroleum Engineers, nearly 90% of senior human resources executives at top global oil and gas companies feel that their industry faces a major talent shortage and that the workforce issue was one of the most critical challenges facing their companies.  The two primary reasons cited for the shortage of skilled manpower are the aging workforce and a lack of interested graduates, creating an experience gap known as the “great crew change”.

“In recent years, the supply-demand equation for talent has become imbalanced,” noted one background paper.  Speaking on behalf of the government of Qatar, Deputy Premier and Minister of Energy and Industry HE Abdullah bin Hamad al-Attiyah told the International Energy Forum (IEF) symposium recently that an exodus of skilled workers from the energy sector poses a significant threat to national and international expansion plans.

The International Energy Agency (IEA) cut its 2009 demand forecast by another one million barrels per day, bringing total revisions for the year to three million bpd.  Total demand for 2009 is thus forecasted at 83.4 million bpd, some 2.4 million bpd less than in 2008, and the lowest level since 2004.  According to reports, while the prospects for lower demand have muted concerns about a “supply crunch,” the IEA warned that resulting low oil prices could undercut investment in future production. Most experts in the industry, for instance, “envisage oil supply levels in the next five years seriously constrained by today’s lower prices and lower investment.”

Richard Savage, Head of Energy Research for Mirabaud & Cie, a private Swiss banking firm, noted over the weekend at a conference held in Oman that oil’s $147/barrel peak last July was driven not by fundamentals but by “the same surfeit of liquidity that drove other asset classes to unsustainable highs.”  The withdrawal of said liquidity, he stated, means that “the market is once again being driven by fundamentals, and with inventories at near record levels and OPEC sitting on 5 million barrels of spare capacity, we do not expect a recovery anytime soon.”

Savaged continued that in his estimation, once the price of oil does eventually rally, “we do not see a return to a $100+ per barrel world.  We believe a $75 per barrel oil price is high enough to incentivise all but the most expensive producers; it is high enough to encourage investment in alternative energy sources; and it is high enough to put a break on the explosive demand growth that was the catalyst for the last oil price rally.”

The current account surplus of $400 billion among the Middle Eastern and North African oil-exporting states will turn into a deficit of $30 billion this year, according to the latest IMF report, which classifies said exporters as Algeria, Bahrain, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Sudan, the U.A.E. and Yemen.

That said, according to IMF Middle East and Central Asia Department Director Masood Ahmed, “for most countries, this deterioration is from a position of significant strength, and thus can comfortably be sustained by the large stock of reserves that these economies have built up.”  Riyadh-based investment bank Jadwa Investment, for example, stated that Saudi Arabia’s net foreign assets of roughly 433 billion dollars gives the Arab world’s largest economy “an advantage over most other countries in alleviating the impact of the extreme financing pressures.  It can push ahead with strategic projects such as key infrastructure, oil, power and water, and support the private sector where necessary.”

But this is not to suggest the collective regions are in the clear.  Risks to the outlook for the countries in the region include the following, said Ahmed:

“First, if oil exporters cut their long-term oil price expectations and, consequently, their spending, growth prospects would be weaker for the entire region. Second, a more prolonged global recession would imply even weaker exports, tourism, and remittances for most emerging markets and developing countries. Finally, if asset price corrections deepen and the impact of asset price corrections feed through to corporate and, ultimately, bank balance sheets, some financial institutions in the region may be under stress.”


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