Venezuela: Too Big to Fail or Too Broken to Fix?
January 3, 2018
For months now, deteriorating economic conditions, a worsening humanitarian crisis, and social unrest in Venezuela have threatened the ability of the Maduro regime to govern. Lack of revenues has put the nation on the brink of default on several occasions and Venezuela’s oil production and export volumes have markedly declined. The political crisis has been magnified by President Nicolas Maduro’s maneuvering to rewrite the nation’s constitution. Condemnation by regional and global powers has limited Venezuela’s options but Maduro has doubled down and increasingly looks to China and Russia for lifelines while blaming the worsening crisis on foreign critics, especially the United States.
Higher oil prices would provide fleeting help, but deteriorating production and shrinking hard currency exports will likely prove insurmountable. If oil prices weaken, the seemingly inevitable default would come sooner. A persistently cash-strapped Venezuela has no good medium- or long-term options and President Maduro faces growing problems with empty pockets and no obvious white knight in sight.
El Trapo Rojo
Earlier this year, the U.S. Treasury Department imposed financial sanctions on individuals connected to the Venezuelan government, including President Maduro, and the U.S. State Department has promised further “strong and swift actions,” including the possibility of sanctions on additional individuals, bans on oil exports to Venezuela, blocking of oil imports from Venezuela, and bans on U.S. dollar-denominated transactions with Venezuelan entities.
In early November, President Maduro announced that the country was intent on restructuring its debt and named Vice President Tareck El Aissami (already under U.S. sanctions for drug trafficking) to head up the restructuring commission. On November 13, S&P’s Global Ratings downgraded the issue ratings on the government bonds from CC to D.1 The rating agency declared Venezuela to be in “selective default” after failing to pay $200 million in overdue interest payments and Aissami’s meeting with investors produced no concrete proposals to address the country’s financial predicament. Maduro supporters have since attributed the meeting’s failure to sanctions having prevented many of the bondholders and potential lenders from attending the session.
For at least the time being, investors and creditors of the beleaguered nation appear to be holding their fire (in part, unwilling to write off substantial losses), although several banks and creditors have begun to discuss options and next steps. Russia recently agreed to restructure over $3 billion in bilateral government-to-government loans, with minimal principal payments due for the next six years. China, already a substantial creditor, seems leery of further entanglements but has supported Maduro in the past, while Western creditors seem willing to let the saga play out for at least a bit longer. The International Swaps and Derivatives Association (ISDA) has twice postponed decisions on whether the failure of stateowned Petróleos de Venezuela, S.A. (PDVSA) to make scheduled payments constitutes a credit event. Such a determination would require holders of credit default swaps to be paid in full. Failure to do so would precipitate lengthy and costly litigation with an uncertain outcome. Asset seizures, especially in the case of PDVSA-owned Citgo, are also a possibility, but the status and classification of creditor classes makes that route complicated as shares of Citgo Holdings have been previously pledged to bondholders in exchange for earlier loans.
As 2017 closed out, the financial story was appended with a series of political maneuvers with Maduro detaining several senior PDVSA officials as well as Citgo’s acting CEO, José Pereira. The latest round of arrests continues a far-ranging purge at PDVSA that goes back to August. The purge has been characterized as a “trapo rojo” in Venezuela (literally a “red cloth” that signals a diversion intended to mask the real problem), like the red cape used by matadors to provoke and distract the bull. The purge is ostensibly the basis of a corruption investigation but has all the earmarks of similar tactics employed to divert public attention from difficult domestic conditions by shifting blame while championing reform. Not surprisingly, President Maduro recently appointed Gen. Manuel Quevedo, a Chávez loyalist with no energy experience, to oversee the energy operations and root out further PDVSA corruption. Increasingly military supporters of the president have moved into the management ranks of PDVSA, solidifying the government’s control even as production has plummeted.
Reduced national oil production and refining have resulted in product shortages and the need to import diesel and gasoline, including from the United States. Crude exports have also declined dramatically. Shipments to the U.S. gulf coast have markedly decreased over the last year as U.S. refiners have actively sought to replace Venezuelan barrels to meet refinery needs. China too has imported less Venezuelan oil, primarily due to the deteriorating quality of PDVSA’s crude output. PDVSA’s oilfield, refinery workers and contractors have not been paid in months and the company, once the shining star of the Venezuelan economy, now teeters on the brink of collapse with mountains of unpaid debt, loss of skilled workers, and crumbling facilities.
On Christmas Day, protesters took to the streets decrying the shortage of pork, a condition President Maduro quickly ascribed to Portuguese complicity with U.S.-backed sanctions. Even Cuba, a long-time Venezuelan ally, has become so disenchanted with Maduro’s chronic failure to pay outstanding bills that in mid-December they claimed title to PDVSA’s 49 percent share in Cuba’s 65,000 b/d Cienfuegos refinery southeast of Havana.
What happens next?
When a country defaults, investors typically are faced with a limited number of options—many of which are unsatisfying and complicated. They can choose to sit back and wait, hoping that the defaults are somehow resolved or “cured” and that eventually they will be repaid. They can push for repayment utilizing a limited number of avenues, including efforts to accelerate bond payments or resort to asset seizure, trigger credit default swaps (based on an ISDA determination), or litigate. They can also opt to negotiate to restructure the debt. The Venezuelan government has indicated that some 70 percent of its bondholders are North American and the U.S. Treasury, for example, has indicated that it could alter its sanctions policy under certain conditions, including the restoration of power (in the case of debt restructuring) to the National Assembly.
That said, however, the path forward remains formidable. Venezuela contends that it has paid the bulk of the $1 billion-plus PDVSA debt that matured at the beginning of November, although some bondholders have reported delays in receiving those funds. Outstanding payments due this year reportedly run in the hundreds of millions but not billions, so “surviving” into the second quarter of 2018 is plausible. Though estimates vary, somewhere between 20 and 30 percent of the total outstanding debt is believed to be held in the public domain. This is the portion that holds near-term litigation risk. The balance, as indicated above, is held by the Russians and Chinese in various forms.
President Maduro, who is rapidly running out of friends and options, recently announced plans to create a cryptocurrency (the “Petro") to defeat the financial blockade imposed by U.S. sanctions. However, Maduro’s real problem is mismanagement, not sanctions, and the currency move looks like just one more “trapo rojo” in the president’s suit of lights.
In the meantime, Venezuela’s humanitarian crisis continues to worsen, with starvation and a decided lack of medical supplies increasing the death toll. Yet specter of being “too big to fail” still seems to prevail. Public and private investor reluctance to accept the precipitation of widespread default has so far continued to provide President Maduro with an economic lifeline even as his political fortunes continue to deteriorate. And while the IMF reportedly estimates that the cost to rescue Venezuela in the event of a default is about $30 billion dollars per year, other experts caution that this figure could be far greater. The complexity and magnitude of the bailout would undoubtedly be daunting and, at present, it is unclear that the international community is either inclined or prepared to mount such an effort.
Which brings the discussion full circle, back to the notion of “too broken to fix”. Just yesterday (January 2), Standard & Poor’s reported that Venezuela had failed to repay yet another tranche of bond debt. It remains to be seen for how much longer investors will still prefer irregular and late payments to the formal, but messy and uncertain, process of restructuring. At some point, we suspect that bondholders will find a way to coordinate a response and steer around U.S. sanctions- perhaps by selling their holdings to a non-U.S. third party who can negotiate a restructuring agreement with the Maduro government. To the extent the next steps involve greater involvement of Russia and China, the United States will be confronted with addressing the geopolitical implications of their growing presence in the Western hemisphere.
 The CC rating is used when a default has not yet occurred even though the obligation is considered highly vulnerable to nonpayment; the D rating is S&P’s lowest and is used to signal default or a breach of an imputed promise.
Frank Verrastro is senior vice president and trustee fellow at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Adam Sieminski holds the CSIS Schlesinger Chair for Energy and Geopolitics. Sarah Ladislaw is director and senior fellow of the CSIS Energy and National Security Program. Andrew Stanley is a research associate with the CSIS Energy and National Security Program. Albert Helmig is CEO of Grey House LLC, a global financial consulting firm.
This Commentary has been updated from a previous version published on January 3rd.
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