PDVSA debt: an [opaque] play on crude, Venezuela

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.

Is there arbitrage in Venezuelan paper?

Earlier this month news that Venezuela’s state oil company was behind on billions in payments to private oil contractors made bond investors squeamish, sending the average yield on Venezuelan bonds (which had fallen 7% since Jan. 9th), to an average yield of 17.4 percentage points more than U.S. Treasuries.

But have the markets overshot? President (for life?) Huge Chávez’s comment recently that Venezuela was well-equipped to weather the global economic storm, despite falling oil prices (oil accounts for 94% of Venezuela’s exports and funds nearly half the government’s budget), was based at least in part on the fact that the country saved at least some of its past oil revenues, and that the Central Bank still has reserves of some $29 billion.

However, a tidbit in this week’s Economist (“Chávez for ever?) suggests there may be more to the story, namely the voraciousness of the country’s private banks for government debt:

[Chávez’s] bravado is based partly on the hope that the oil price will rise next year, and the conviction that Venezuela’s private banks will be happy to finance this year’s deficit, albeit at a price. They may well do so. According to one banker, the banks have a “gigantic appetite” for government paper because other lending is even more unattractive. The government caps interest rates, but inflation is running at over 30%.

Credit Suisse seems to agree. The Swiss bank announced last week that Venezuelan bonds would “outperform” after Chavez won a referendum to scrap term limits that would have forced him from office in 2013, noting that the victory gave the government “more room to pursue a set of measures to ameliorate the impact of the decline in oil prices on the fiscal accounts.” Said measures are likely to include the devaluation of the currency to 3.1 bolivars per dollar and a move to keep spending increases below inflation, they said. Chavez pegs the bolivar at an official exchange rate of 2.15 per dollar under restrictions he imposed in 2003.