Nicolás Maduro, also known as “el bigote” (the moustache), was re-elected (if that is the right word given the rigged system) as president of the Bolivarian Republic last May, allowing Chávismo to run for a bit longer. The outcome was deemed illegitimate by the U.S. and 13 Latin American democracies. Chávismo, named after former president Hugo Chávez, promises to spread Venezuela’s oil wealth more fairly among the poor. However, handing out money rarely translates into a sustainable and buoyant economic model. Venezuela’s economy by now has completely collapsed and, in our view, is beyond repair without substantial external support (e.g. IMF) as well as political change. Economic data are hard to come by but the IMF estimates that GDP contracted by more than 40% since the start of 2015, projecting this year’s real GDP growth at -18%. After the oil price shock in the 2nd half of 2014, economic activity outside the oil sector has come to a complete standstill due to (continuing) disrespect for basic property rights and hyperinflation (the IMF predicts inflation of 1 million percent by year-end!).

Out with the “bigot(e)”…

Venezuela’s economy is singularly based on oil. Oil accounts for nearly all of its exports and a significant part of government revenues. However, the country has not been able to capitalize on its high oil reserves. According to OPEC, crude oil production in Venezuela dropped to 1.34 million barrels per day in June or 0.6 million barrels below the agreed OPEC target. Daily production in 2017 was 1.91 million barrels versus 2.15 million barrels in 2016 (Venezuela itself reports somewhat higher production figures, but these confirm the same declining trend). The loss of oil production is the result of mismanagement (PdVSA, the state oil company, nowadays is run by an incompetent army general, Manuel Quevedo, but maladministration already dates from the early days when Hugo Chávez was president), years of underinvestment (using the cash to build a Bolivarian paradise instead), shortage of qualified engineers and interruption of critical supplies (e.g. diluents) and services (e.g. rigs) due to non-payment. PdVSA also stopped paying its contribution in joint-ventures with other (foreign) oil companies, which led those companies to cut back operations. Indeed, production may collapse further to about 1 million barrels per day by the end of this year, given that the number of active rigs is gradually falling. Many facilities are down because of a lack of spare parts or theft of critical equipment and copper cable. Furthermore, due to deteriorating quality of the oil (as there is no money for blending the heavy and sour crude), some offtakers have negotiated higher discounts or walked away from contracts. Thus, the rebound in oil prices since mid-2017 only provided partial relief. In any case, not all oil exports generate cash as a significant part (about 0.5 million barrels per day) is used to repay Chinese and Russian loans. Finally, ConocoPhillips, an U.S. oil company, laid a legal claim on PdVSA’s Caribbean hubs in response to the nationalization of the company’s assets in Venezuela, further hurting PdVSA’s export business. In response, exports of subsidized oil to countries that form Petrocaribe have been downscaled, although so far exports to Cuba, the leading light when it comes to socialist repression, have been spared. Apart from lower cash revenues from oil sales, a lot of cash ends up in bank accounts owned by Maduro’s cronies and the army thanks to the multiple foreign exchange rate system where subsidized dollars can be obtained for imports of foods and other basic goods (which are subsequently sold at full price). The appointment of Mr. Quevedo as boss of PdVSA is surely orchestrated to ensure that the army can continue to extract the oil rent.

The cash crunch resulted in an inevitable default on international bonds in November of last year after missing USD 200 million of interest payments on two bonds. Thereafter, the government randomly paid interest on some bonds but by now this seems to have halted with the exception of one PdVSA bond. The government continues to make (late) payments on the PdVSA 8.5% 2020 bonds, as these are collateralized by a 50.1% stake in Citgo, the U.S. refinery owned by PdVSA which is a highly valuable asset in that it can handle Venezuela’s heavy crude. These bonds, therefore, still trade in the mid 80s whereas other, unsecured, bonds trade in the low to mid 20s. Strangely enough, in April of this year they also paid interest on the so-called “hunger bonds” that were sold to Goldman Sachs (see our blog “Pot of Gold” of June 2017 for details on Goldman’s questionable deal), angering other bondholders that did not receive this preferential treatment. Restructuring of the defaulted bonds will be near impossible as, in August 2017, the U.S. government imposed sanctions blocking U.S. entities to buy new sovereign and PdVSA bonds. A debt exchange, therefore, is only possible if and when these sanctions are lifted. Amending existing bond terms and conditions theoretically could work but require unanimous consent for certain critical amendments. A restructuring will be complex given the many competing claims (for example, where do JV partners stand vis-à-vis suppliers and could sovereign bondholders claim PdVSA proceeds given that PdVSA is controlled by the state?). In any case, which investor wants to negotiate a deal with an illegitimate regime which can later be struck down (Goldman Sachs maybe?).

It is unlikely that Maduro’s regime can bring about a turn-around of the economy, unless it gets substantial support from China or Russia. Given outstanding debts, the ubiquity of oil exploration projects elsewhere (shale in Argentina, for example), the political cost of supporting a rogue government (Russia might be faced with additional sanctions if it supports the regime in Caracas) and the substantial capex required to upgrade PdVSA infrastructure and reactivate wells, we think it is not likely that China will easily jump in. Russia doesn’t really have the financial resources to provide substantial support and probably only would do some opportunistic deals through Rosneft, probably with little upside for the Venezuelans.

Meanwhile, a humanitarian crisis is evolving. About 60% of the population lives in poverty. Severe food and medicine shortages and rampant crime (including government-backed “colectivos”, armed motorcycle gangs that upholds Chávismo in exchange for being allowed to develop criminal franchises) has resulted in a refugee stream to neighbouring countries. Some 1 million Venezuelans have crossed the borders, most of them settling in Colombia. Hunger has become an effective policy instrument. The army distributes food packages only to those citizens that have a “carnet de la patria”, an ID which also helps to control that votes go Maduro’s way. Dissenters will have to live on an empty stomach. Venezuelans on average lost 11 kilos in weight during 2017, according to a study carried out by 3 local universities. This despite the brilliant Plan Conejo, a scheme where each community receives a cage with baby rabbits to grow them into protein-rich meaty bunnies. Remittances from emigrants might provide some relief but is unlikely to be material as many migrants are unemployed (and often unwelcome) in their new home countries.

Venezuela’s economy has run aground…

Despite Maduro’s jubilant election victory, the government is starting to show cracks. Taking a leaf from Xi Jinping’s book, Maduro is purging political enemies under the pretense of corruption charges (he has a point there; many actually are corrupt!). However, Maduro’s own position becomes more untenable by the day. The debt default allowed him to use funds for imports of basic goods to appease the public but with oil production and exports set to fall further, social tensions may increase in the second half of this year. Reduced oil proceeds and imports also means that less cash can be siphoned off by Maduro’s cronies (some of which, therefore, have diversified into other businesses, like narco trafficking), who may switch alliance if they think another leader can do a better job for them. Some more moderate politicians with Maduro’s party might call for a change as they realize that the economic ship is sinking or the army might step in. Already facing an enormous unpaid debt pile of about US$ 150 billion, Maduro now himself is living on borrowed time…