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Fall in oil prices can accentuate the Venezuelan crisis

Fall in oil prices can accentuate the Venezuelan crisis

Posted by Dubraswka Aguilar on October 17, 2014

When Venezuela last week demanded an emergency Opec meeting to try to stop the fall in energy prices, it was not the socialist country’s peers in the oil-producing cartel that paid attention but rather its increasingly worried bond investors on Wall St.

“It is the question that I am being constantly asked; at what oil price can Venezuela no longer pay [its debts]?” said Francisco Rodríguez, senior economist at Bank of America Merrill Lynch.

Although Venezuela has the largest energy reserves in the world, its deteriorating economy has forced Nicolás Maduro, the president, to slash imports to cover foreign debt payments amid a severe hard currency crunch that has already produced shortages of almost everything, from toilet paper to medical supplies.

“It is hard to believe, but there are worse shortages in Venezuela than there are in Syria,” said Moisés Naím, senior associate at the Carnegie Endowment for International Peace in Washington.

But this week’s fall in the oil price has further fomented worries of a possible default, pushing up Venezuelan bond yields to more than 18 per cent and boosted credit default swaps to over 2,230 basis points. Oil accounts for about 95 per cent of Venezuelan export revenues.

“We believe that Opec has to co-ordinate action to arrest the fall in oil prices,” said Rafael Ramírez, Venezuela’s foreign minister and the former head of state oil company PDVSA. That is “even more [so] when we are convinced this is not due to market fundamentals, but to price manipulation to create economic problems among major oil producing countries”.

The fall in world oil prices has highlighted how slowing energy demand combined with increased shale gas production in the US has changed the balance of global energy production and the geopolitical forces that come with them.

But so far, Opec – which is due to meet on November 27 – has not heeded Venezuela’s calls for an emergency meeting. Indeed, Saudi Arabia, Iran and Iraq, which account for half of Opec’s output, are currently selling crude to Asian buyers at a discount in order to maintain market share. On Tuesday, benchmark Brent Crude fell to $85 a barrel, its lowest level since 2010.

Four years ago, Venezuela responded to the hard currency shortfall of the oil price drop by issuing $51bn of dollar-denominated debt. It also borrowed $50bn from China, which is being repaid with 450,000 barrels per day of exports.

The problem now is that Venezuela’s escalating bond yields make borrowing on international markets again prohibitively expensive. Investor appetite for risky assets has also taken a beating with the general market sell-of.

The problem now is that Venezuela’s escalating bond yields make borrowing on international markets again prohibitively expensive. Investor appetite for risky assets has also taken a beating with the general market sell-off.

The country also faces other demands on its dwindling foreign reserves, including a $1.6bn payment due to ExxonMobil after Caracas nationalised its operations in the country seven years ago.

Venezuela has continued to insist that it will meet its international bond obligations, despite international reserves falling to an 11-year low of $20bn, and on October 8 it also repaid $1.5bn of maturing debt. Yet, although the country also has low debt-to-GDP ratios, this has not calmed default fears.

This week, Harvard University economists Carmen Reinhart and Kenneth Rogoff said there was an almost “100 per cent probability” the South American country would default on its foreign debt. Last month, when fellow Harvard University professor Ricardo Hausmann also suggested that Venezuela would likely default, President Maduro called him a “financial hit man”.

The cost to Venezuela of a default would be very high as it has ample assets abroad that could be seized to repay defaulted debt, such as oil cargos. Nonetheless, analysts are dusting off their spreadsheets to see at what energy price a default by Venezuela might be inevitable.

Bank of America’s Mr Rodriguez believes the country could continue to service its debt at oil prices as low as $60 a barrel – but only if Caracas also takes a series of politically difficult moves, such as slashing domestic gasoline subsidies and its subsidised oil programme to Cuba.

“There are things the government could do, although they have not yet, that could make $60 oil sustainable,” he said.

Others believe the crunch could come at a higher oil price. Russ Dallen, of Caracas Capital Markets, estimates that PDVSA’S cost of production is around $66 a barrel for its heavy oil mix, which in turn is trading at a $7 discount to global oil price benchmarks.

“As Saudi Arabia has said it sees $75 a barrel as a fair target price . . . we could soon be at PDVSA’S breakeven cost,” he said. However, after taking into account the extra revenues that the country needs to finance imports rather than just oil production, Mr Dallen estimates Venezuela’s “sovereign break-even oil price” is above $100 a barrel, significantly higher than current oil prices.

 

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