At last count, over 48 countries have recognized the role of Acting President Juan Guaido of Venezuela, adding further pressure to the flailing regime of President Nicolas Maduro. U.S. sanctions further amplify Venezuela’s loss of market access, for key energy inputs, energy exports and credit for other goods. This piece surveys some of the economic and financial challenges ahead and how they could be affected by ongoing negotiations and potential impacts for asset markets.
Since the U.S. recognition of Juan Guaido as the interim president of Venezuela and the subsequent imposition of tighter sanctions, there has been much speculation about the prospects of reversing the economic and social devastation of the last decade, Given the significant financing needs, deterioration of physical and social capital, there could be some over-optimism about the speed and extent of the revival of the country’s energy sector and outstanding debt, the two areas that constitute the country’s most meaningful links with global financial markets. These two areas are also those in which domestic choices led to “own goals” that have done much to insulate global markets from Venezuela – migration is the one area that is now a meaningful drain on its neighbors.
Market implications:The impact on global oil supply is likely to be modest for the next year – with Venezuelan output uncertainty amplifying some of the lack of clarity on OPEC+ supply (Iran, Russia and Saudi cuts). Oil output volumes will likely be slow to bounce back given underinvestment. The pathway of long-term investment will depend on the terms offered to foreign investors, and key macroeconomic choices including around the exchange rate. Similarly, addressing the debt issues will also be complicated. Sanctions have frozen recent activity in the few bonds that traded freely, and confirmed our view, that rallies would be short-lived. A lengthy restructuring process lies ahead, with competing claims and counterclaims between different creditors.
I’m aware of how difficult it can be to place a timeline on political change – after all, one of my co-written scenario analyses on Venezuela from 2014 would have been surprised that the regime could hang on for this long, liquidate so many assets and contribute to so much pain.
Many research houses have highlighted the many ‘complications’ that lay ahead, particularly relating to the ongoing political standoff, massive humanitarian/migration needs, the debt burden and the potential energy and economic production. All of these issues are interlinked as efforts to force out the Maduro regime contribute to even greater financial strains in the short-term, while excessively optimistic hopes on energy sector bounce back are likely to complicate eventual negotiations on emergency multilateral support and debt restructurings. Any financial support could be complicated by assumptions by creditors that Venezuela’s oil future earnings should allow it to fund itself. Doing so would require significant capital injections to improve infrastucture, attract back human capital and rebuild key institutions. The good news is that there is strong human capital scattered across the Americas and beyond, and the opposition has had time to come up with a key plan, the challenge is that meeting the interests of all the stakeholders locally and internationally will be complicated by the pain of the recent policy regime, even if the current government and military apparatus could be quick.
The upside scenario:The potential for political change seems to open up the possibility of a long-term positive outlook. The focus on need to stabilize the economy, including some moves on the fiscal side and to slowly get on the pathway to lowering inflation expectations. They suggest a possibility for long-term improvement, if sizeable funds are made available to help rebuild the physical and social infrastructure, if significant capital reductions on the debt are negotiated and if any successor government is able to lure back and deploy Venezuela’s human capital.
More likely it will be a long slog, with contentious legal battles. The remainder of the piece looks at some of these incipient challenges.
Humanitarian needs and economic stabilization programs
There are a few small pools of capital available for purely humanitarian needs, mostly from regional peers, though these would be relatively small compared with Venezuela’s needs. At present the Maduro government has been unwilling to accept these funds and they would likely only be turned over to an opposition government (see OFAC’s direct FAQs)
The IMF and multi-lateral development banks have been watching for the end to the political crisis for many years. The lack of direct links with these organizations makes it harder to assess needs, though the IMF and others have long had “shadow” Venezuela country teams doing their best to estimate financing needs and a stabilization program to be available when requested. IMF estimates have pointed to sizeable needs in the neighborhood of $60 billion plus, not to mention sectoral investment needs. Presumably any long-term deal would likely require debt restructuring or reprofiling to massively push down capital repayment terms and maturities (see below). A short-term deal is likely first, but only after political change, a request for financing and the partial or complete lifting of sanctions, would also be necessary for energy and debt restructuring to make much progress.
Catalysts to watch: Statements on Guaido proxies or PDVSA on JV projects, terms for foreign investments, assessments of quality of wells. OPEC+ quota. OFAC implementation (if Maduro clings to power)
Energy (especially production) likely to lead any economic rebound, but one needs need to distinguish between near-term revival potential (low given investment needs) and long-term potential (good, albeit with high production costs for much of Venezuela’s reserves). Guaido proxies have said a lot of the things that International oil companies (IOCs) want to hear including the plans to reduce restrictions on foreign joint ventures, pay back arrears and the like. However, it remains to be seen what the local political consensus will be on contract terms, tariffs and investment. Capital account restrictions, to allow reinvestment of measures and repatriation of profits into projects may also be necessary.
Unlike countries like Libya or Iran where oil either went offline briefly or there was time to plan for shut-ins, Venezuela’s output decline was long standing and reflected in part a lack of funds for maintenance. This plus the likely drop off in production already on course, questions how quickly it can be revived. The example of Iran’s limited oil output gains may also be instructive. While the sanctions sword of Damocles remained a concern for investors, the relatively unattractive terms offered to foreign companies by Iran’s parliament was a contributing factor. Expect them to look closely at terms offered by Venezuela especially for any new plays in the relatively costly Orinoco Valley.
Still, the most promising parts of the energy sector are likely the joint ventures that PDVSA sharred with certain foreign partners. These accounted for most of the production in the last few years, and temporarily staved off/dampened the decline in output, at least until the Venezuelan government stopped them from repatriating the profits or reinvesting them. Allowing access to these financing (only possible after some sanctions adjustment and assuming a government change. This could still take some time to get back on track.
Over the long-term, political and energy sector policy change suggests Venezuela could be one of the few countries that meaningfully increases oil output. This has led to some analysis that Venezuelan oil output might lead to significant increases in OPEC+ oversupply, putting pressure on its partners. This doesn’t seem to be a near-term risk, for the reasons above, but will likely put pressure on some OPEC+ countries who have benefited from Venezuela’s own goal. Venezuelan projects likely have a mid-range production costs.
Catalysts to watch: statements from Guaido proxies on debt, OFAC implementation, adjustment made to sanctions implementation, details re China and Russia debts. Divergence among creditors some of which will step up efforts to attach early assets.
It may seem premature to be talking about debt restructuring given that most of the traded bonds are frozen and subject to sanctions for U.S. persons as part of the U.S. efforts to cut off the cash flow for the Maduro regime. Sanctions were the last straw for a government that was near default for years, scraping together sufficient funds to repay creditors by liquidating or leveraging any state assets, thus prioritizing repayments over the needs of local business and population. This liquidation of assets (FX and gold reserves, PetroCaribe debts) and other creative financing structures has left the Venezuelan government with very limited savings to invest or repay its creditors. It also contributed to the massive contraction in imports that helped Venezuela partly close its external deficit for a time. This was painful and unsustainable, especially as planned investment and revival will likely need meaningful imports of material, and reviving consumption will require financing for other imports. As with most energy production increases, these import needs will likely outpace the export increases, thus limiting improvements in the external financing outlook (current account).
This suggests that Venezuelan debt is not sustainable, especially when the bilateral debt to China and Russia is added to the mix. Of course calculating debt sustainability is complicated by lack of clarity on the volume and terms of the loans from these bilateral lenders. Nonetheless all of these lenders will seek to be made whole, something that does not seem consistent with economic stability and revival.
In short, a tough restructuring is probably ahead given the likely cash flow and financing needs. needs. Venezuela sharply and painfully reduced its imports some years ago to limit the new debt financing requirements. Repeating this is not consistent with economic revival.
2019 set to be a tougher year…
Growth momentum has weakened in the second half of 2018, particularly in European and Asian exporters, who are responding to the end of above potential growth of the last few years, which has moderated final demand growth. Tariffs, restrictions and tighter financing costs have reinforced this trend, making final harder to forecast and encouraging caution on new investment decisions, Meanwhile Fed tightening, exit from quantitative tightening and boost in available US Treasurys, have begun to increase debt service costs across a range of sectors and geographies.
Slowing final demand growth globally is not a surprise, and has been a part of our themes for the last year, but the trade disputes and restrictions have reinforced some caution from buyers and supply chains. The drivers of this slowing of growth include a) the disconnect between policy stance in the U.S,. and other major economies across fiscal and monetary policy b) the lack of structural measures to boost final demand growth, c) removal of the “sugar rush” of monetary policy support as quantitative tightening takes hold. The U.S. and Chinese central banks have been particularly focused on continuing with business as usual, with overall policy stances only partly supportive. In both cases, a relative disconnect between fiscal and monetary policy complicates the messaging, and exacerbates some of the FX pressure.
This post shares a few takeaways from my discussions last week in London with policymakers, investors and analysts on MENA and energy. Overall, sentiment was upbeat.There were two big elephants in the room: Saudi Arabia economic and foreign policy activism and the Iran nuclear deal. There remains significant uncertainty around the implementation around those issues, which offsets what is generally a more upbeat outlook in the face of $65-70/barrel crude.
One broader question pervaded my discussions. How much do higher oil prices help? Brent around $70 (or even in the mid 60s) gives significant more room for maneuver and likely will reinforce government driven growth across the GCC as it likely implies less fiscal austerity. It clearly buys time and room for maneuver and spread compression. However, we see only Kuwait and possibly the UAE having scope to resume saving, meaning that regional sovereign funds are likely to receive little new capital as more of the funds are used to support domestic spending. These trends will reinforce the ongoing acceleration of local growth from the 2016-17 pace, much private sector is likely to drag behind as the desire for quick growth brings government actors more into play.
Institutional investors remain constructive on GCC bonds on valuation grounds especially vs Asian alternates and even some of the more liquid CEEMEA names in the USD space. Oman and Egypt seemed to be top picks given that macro environment seemed to be better than feared, allowing some yield compression. $70 brent provides a lot of space for regional external balances and pegs, even if it won’t help fiscal balances much. Expect the GCC to continue to dominate global USD issuance among EM and Frontiers again in 2018, with Qatar joining peers. Going forward, concern may rise about Bahrain, and whether any regional support may not help bond investors.
Oil price and fundamentals: there’s a general consensus that the market is rebalancing and the OPEC + (Vienna agreement) has “worked” and the excess inventories in the U.S. will continue to be drawn down this year, but there is less consensus about the price forecast, which has a wide band around 55-80 this year. This reflects a difference of opinion about the growth in global demand (between 1.1 and 1.7mbd) and the persistence of the production freeze if prices remain high and incentive to cheat rises. On the demand side a key question is whether rising costs will dampen consumption growth (MENA oil producers are one place to watch, as is U.S. and Asian consumers) while shale production is a key place to watch on the supply side.
Global oil majors and many in GCC seem to be looking for $65 Brent this year, seeing some increase in shale output, some drawdown in inventories and the risk of a speculative correction. Others especially on the sellside seem to be sharply scaling up their forecasts, with Goldman Sachs pointing to the possibility of $85 by mid-year. In this price environment, expect oil companies revenues to move up but new investment is unlikely to outstrip plans.
Saudi Policy consternation: The Saudi anti-corruption detentions seem to be coming to an end, with reports that $100 billion in assets have been raised, likely a combination of stakes in companies and cash. This turns attention to the many key questions about the new anti-corruption regime, new institutions and the broader economic reform. Will Saudi authorities continue to hike public wages, even if that places a greater burden on the public sector? What will the new legal process be for corruption cases? Where will the new funds be managed? Will these funds be incorporated into the Public Investment Fund (PIF) which is already managing much domestic investment funds and waiting for new foreign issuance. Interest in the Aramco IPO seemed to have died down despite the improved oil valuation with many investors waiting to believe when they see terms. Meanwhile, the general view was that economic growth would accelerate and
The PIF itself is a matter of much interest, with many investors and regional watchers wondering how its asset allocation will evolve, how it will balance the foreign versus domestic investments and how it will balance competing mandates. It is rapidly staffing up and cares about a professional structure, but like many areas of Saudi policy, it is being asked to do a lot at once, with mixed goals.
Iran deal and economic policy: Coming only a few weeks after President Trump’s ultimatum on the nuclear deal and demand that European allies improve the deal, there was a lot of uncertainty on investment outlook. The view from Europe (especially France and Italy) is that the deal is working, and the burden high for changes, and the Iranians seem to be woking had to make sure that they are not blamed for the deal falling apart. This suggests major changes might be a hard task. Some European countries have already chosen to backstop local companies doing business in Iran, though oil companies concede that Iranian domestic policy uncertainty and term preferences pose as much concern as U.S. sanctions. Banks remain very concerned about sanctions and regulatory risk, which may explain the direct support of European firms. Meanwhile local macro issues including the vulnerabilities of the non-bank credit and the battle between government and IRGC suggest that Iran may struggle to benefit from some of the higher energy prices. The recent protests have triggered a less restrictive fiscal policy, with more subsidies remaining in place, and greater domestic leverage from the government.
Qatar: The general view is that the blockade is here to stay for some time and I've written extensively about Qatari resilience to the blockade due to its deployment of past savings. The economy has bounced back, the continued energy trade has provided solace to investors, and support from the U.S. and EU has limited the approach to secondary sanctions by the Saudis/Emiratis. Indeed, the new supply chains with Iran and Turkey look likely to stay. The recent U.S.-Qatar meeting likely increases Qatari leverage. Still, there are losers at home and the public sector is driving economic activity and absorbing more of the loans. These trends are likely to continue, as local rates remain high. The broader costs to GCC coordination and institutional strength are significant. Regional competition is likely to outstrip coordination resulting in lower domestic liquidity.
Finally, natural gas: If anything there was an even wider divide on natural gas fundamentals and price, with energy market representatives differing on whether there is an LNG supply glut, whether new entrants are taking advantage of cheap supplies sufficiently, and whether new supplies will offset. Policy mandates from China and other growing demand suggest that supply may be absorbed, and the market is gradually becoming less regional. I did field a lot of questions about U.S. energy policy and in particular support/demand for coal, which had some gas producers concerned. The pressure on higher cost natural gas producers is likely to remain.
Saudi Arabia released its 2018 budget with great fanfare today, including a meaningful increase in spending directly and via off-balance sheet funds such the public investment fund (PIF). With the oil sector no longer a drag and the non-oil sector benefiting from government pump-priming, economic growth should accelerate, from near-recessionary levels, part of a broader trend among oil producing nations. Still, private sector contribution is likely to lag as credit demand struggles, government funds dominate and questions remain about the rules of the game after the anti-corruption crackdown. Changes to energy policy are unlikely.
The budget included the largest planned spending (figure 1) of any budget, 978 billion riyal ($260 billion) and an additional 150 billion riyal in spending from various development funds. It comes close to the actual spending peaks of the early 2010s boom years. Given the spending increase in Q4, and a tendency to overspend budgets, actual spending in 2018 may again outstretch plans and in the longer 5 year plan. Adding in the spending from the PIF, there's likely to top that. This will reinforce the bounceback in growth after several years of moderate recession and austerity. It may be less effective in generating private sector activity, which is likely to lag consumption and government investment.
Figure 1: Actual and Government Spending (USD billion)
Source: Saudi Arabian Ministry of finance, Author's Calculations
The more expansive stance is not unique to Saudi Arabia. Most of its GCC and energy producing peers will also have more expansive or at least less austere budgets in 2018, helped by stronger oil and gas prices and still relatively easy global credit conditions that make it easier to issue debt. In Nigeria and Russia as well as Bahrain and Oman, less austerity is likely rather than stimulus. Still these decisions reinforce several trends for 2018 including a belated recovery for many commodity producing nations (catching up to the broader expansion seen in 2017), a bottoming out/improvement in EM investment and some pickup in inflation. All of these generally support EM and local equity over bonds.
With OPEC members and friends (and the ever growing energy journalist cohort) meeting in Vienna, it seems apt to look at the economic adjustment of some of the participating oil producers. While most would gain from rising prices. Russia, and Iran, smaller GCC countries (Kuwait, UAE and even Qatar) as well as some U.S. producers would look to be the relative winners. The slowbleed of capital outflows, external and fiscal deficits are likely to moderate across most of the other producers including Saudi Arabia, Oman, let along more vulnerable countries like Nigeria, Angola which are still struggling with the aftermath of their FX policies. With U.S. and global interest rates edging up, expect continued rate and sovereign risk divergence.
Rachel's musings on macroeconomic issues, policy and more.