Venezuela’s deteriorating crisis is “going to be the biggest geopolitical story to watch in the oil markets," according to Helima Croft of RBC Capital Markets.
The economic, political and security situation in Venezuela has been frightening for quite a while, but things continue to grow worse. The new “constituent assembly,” put together to rewrite the constitution, is seen by most as an attempt to erode the nation’s democracy and consolidate power in the hands of the president.
In an ominous sign, more than a dozen soldiers reportedly attacked a Venezuelan military base on Sunday, and although the assault was put down, it highlights the increasing fragility of the state. "The significance lies in whether this suggests that Maduro is losing his grip on the military and whether we can expect to see more mutinies to come, or if this is just an isolated incident,” said Stuart Culverhouse, Global Head of Macro & Fixed Income Research at Exotix Capital in London. "Details are sparse and it’s probably too early to say either way at this stage.”
But even if Venezuelan President Nicolas Maduro manages to maintain power and push through a new constitution that defangs any restraints on his grip, he won’t be able to outrun the spiraling economic crisis. Perhaps the most visible economic issue is the debt payments that fall due this year. Venezuela has $5 billion in debt maturing before the year is out – both in sovereign bonds and in debt payments by state-owned oil company PDVSA.
That is an alarming figure given that the government has an estimated $3 billion in cash reserves, according to S&P Global Ratings, a paltry sum that means a default in the next few months is more likely than not. Venezuela has to pay $725 million in debt payments this month, although the problem gets really serious in October and November, when a combined $3.6 billion in debt must be paid to bondholders. The value of PDVSA’s bonds has plunged in recent weeks.
Any measures from the U.S. government would likely push Venezuela over the edge, one reason why the Trump administration has held back for now. But the U.S. Treasury Department has not taken some sort of embargo or sanctions policy targeting Venezuela’s oil sector off of the table. Venezuela exports just under 800,000 bpd to the U.S., which accounts for about half of the country’s exports. That source of revenue is the only thing keeping the government going right now.
“There’s a huge dependency on exports to the United States at a time of profound economic turbulence. It would be basically cutting off the single most important source of revenue. It would significantly raise the risks of default,” Roberto Simon, lead analyst for Latin America at FTI Consulting, told the WSJ.
The probability of default within 12 months, based on the value of credit-default swaps on Venezuelan debt, has an implied rate of 70 percent, according to the WSJ.
In a sign that the situation for PDVSA is growing worse, Reuters reports that the oil company is sending fewer barrels to its U.S.-based refiner, Citgo. The lower exports come as PVDSA has to send more oil to Russia’s Rosneft as repayment for a prior loan the Russian company made. But because those barrels sent to Rosneft are used as repayment, and aren’t sales, PDVSA will take in less revenue by reducing shipments to the U.S.
It is hard to see how Venezuela avoids a credit event in the next half-year or so. A Venezuelan default might not lead to contagion in the bond market, even if the value of missed payments is large – the WSJ says it could be one of the largest in history – because the Venezuelan economy has grown more isolated in recent years.
However, the effect on the oil price could be significant. Venezuela produces about 1.9 million barrels of oil per day, a volume that is nearly as large as the global surplus was at its maximum point during the market downturn in the past three years. If some significant portion of that goes offline, it would certainly send oil prices sharply up.
"The question is how fast does Venezuela fail?" Helima Croft of RBC Capital Markets said on CNBC last week. "The thing is Venezuela has no capacity to overproduce at this point. Their oil production is going in one direction and that is down," she said.
"The national oil company owes $3.5 billion due in October-November. They are unlikely to make those payments," Croft said. “We really do think a disorderly default is on the cards for Venezuela."
A default might then put some of Venezuela’s oil assets in the sights of bondholders, who could try to seize oil cargoes in lieu of repayment. The end result, one way or another, is likely a decline of oil exports from Venezuela, sending a jolt through the oil market.
Ultimately, that could push oil prices up to $70 to $80 per barrel later this year, Croft predicts.