(Ft.com, Gideon Long, 25.Oct.2018) — In a month in which emerging market government bonds have been hammered by the prospect of US rate increases, geopolitical risk and fears of a US-China trade spat, one bond — in crisis-racked Venezuela of all places — has rallied to record highs.
The 2020 bond issued by the state oil company PDVSA has rallied 14 per cent in six weeks to trade at over 91 cents, up from a year low of 80 cents in early September. By contrast, most PDVSA bonds trade at around 20 cents.
The reason for this unusual outperformance is that investors are increasingly convinced that the cash-strapped oil company will come up with an $842m principal payment due this weekend to avoid default and potentially lose a key asset, US-based refiner Citgo.
“I believe that they [Venezuela and PDVSA] are willing to pay,” said Siobhan Morden, head of Latin America fixed income strategy at Nomura. “Their track record suggests willingness to pay to protect strategic assets.”
Payment in itself would be remarkable: Venezuela and PDVSA have defaulted on all their other commitments to bondholders over the past year and are now $7bn in arrears on their combined traded debt of about $60bn.
But this bond is different. If PDVSA fails to service it, the company risks losing its prized US asset Citgo, a Houston-based group with three refineries in the Gulf of Mexico and the Midwest that process about a third of Venezuela’s oil exports to the US.
PDVSA has pledged half of Citgo as collateral on the $2.5bn 2020 bond, and the other half as security on a loan from the Russian oil company Rosneft. If it fails to pay, bondholders could in theory go after their half. There is no grace period on the amortisation payment, although the company has an additional 30 days to make an interest payment of $107m, also due this weekend.
Even so, 2020 bondholders would have a fight on their hands because everyone, it seems, wants a bit of Citgo. Having largely given up on ever being paid by Venezuela or PDVSA, creditors are increasingly going after their assets abroad, Citgo being the jewel in the crown.
The Canadian mining company Crystallex is trying to seize Citgo to compensate it for $1.4bn owed by the Venezuelan state. The US oil company ConocoPhillips is in a similar position, seeking payback for money owed by PDVSA. It has previously seized assets in the Caribbean, where PDVSA processes much of its oil exports.
As for bondholders, in what has become a complex multi-directional legal battle, the world’s largest asset manager BlackRock and New York-based Contrarian Capital Management have waded in on behalf of US and UK investment managers who hold some 60 per cent of the 2020 bonds.
For now, Rosneft is watching from the sidelines but if PDVSA were to default on its separate loan from the Russian company, it too would be eligible to claim almost half of Citgo. In theory, that could leave the Russians in the novel position of having a major holding in a US refiner, something US President Donald Trump would want to avoid.
Even if PDVSA makes this payment, Venezuela faces a daunting debt mountain. The sovereign must pay a final $1bn on its 2018 bonds in December, and alongside PDVSA must find $9.3bn for bondholders in 2019 and more than $10bn in 2020, although no one expects it to do so.
Faced with these desultory figures, Venezuela is rumoured to be considering a complete overhaul of PDVSA. This week the specialist energy reporting agency Argus said Caracas was thinking of replacing PDVSA with a new national energy company that would inherit PDVSA’S physical assets, including Citgo, but not its debts. That could pave the way for PDVSA to be formally declared bankrupt.
In addition to its traded debt, Venezuela owes billions of dollars to China and Russia. Meanwhile, oil production has plummeted to its lowest level since the 1940s, the economy has halved in size in five years and inflation is running at almost 500,000 per cent. Central bank reserves stand at $8.8bn, close to their lowest level for 30 years.