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ANALYSIS-Venezuelan bond drop shows investor resolve cracked, not broken

Daniel Bases
Tuesday, 18 Feb 2014 | 6:34 PM ET

NEW YORK, Feb 18 (Reuters) - Venezuela's oil reserves, the world's largest, are giving debt investors comfort they will be repaid, even as anti-government protests send bond prices to levels akin to a nation in default.

The sell-off in Venezuelan credit has pushed the yields on some of the OPEC nation's debt above 20 percent and raised the cost to insure a portfolio of bonds against default to its highest levels in nearly five years.

This scenario tests the one constant cited by government officials and fund managers on Wall Street alike, that Venezuela has had both the willingness and ability to pay back its debts.

Venezuelan debt prices have fallen to 63 cents on the dollar for some issues, levels often associated with a nation at or near default.

That may be shaking investor resolve, but oil remains the key element for the nation going forward.

"Right now I would keep my hands in my pockets," Russ Dallen, managing partner at Caracas Capital Markets said, indicating he would not advise buying debt right now as "prices still have more to fall but ultimately there is still a good story here because Venezuela has more oil than Saudi Arabia."

Economic policies implemented by former leader Hugo Chavez and continued by his less charismatic successor Nicolas Maduro have resulted in shortages for things as basic as toilet paper and led to rampant inflation.

Student-led protests against Maduro have spread across the nation of 29 million, killing four people. There is no end in sight to the turmoil.

Adding to economic strains have been state takeovers of large swaths of the nation's non-energy related industries. Exacerbating problems is stagnant oil production under state-owned Petroleos de Venezuela (PDVSA), subsidization of fuel that makes filling a tank of gas a matter of pennies rather than dollars and discounted fuel for economic partners Cuba and China.

Oil has become both Venezuela's biggest strength and weakness, forcing it to issue tens of billions in debt to help balance its books and pay for social programs that have lifted millions out of poverty.

A failure to reform the economy is bringing the resource-rich nation closer to a tipping point.

"The ability to pay may be damaged as a function of a deterioration of the economy. As you look forward you don't see them changing the economics," said Tony Volpon, head of emerging markets research at Nomura Securities in New York.

"This is the paradox: you have a very strong regime and therefore it is difficult to say the opposition is going to take over anytime soon. Now you have a leader who is very weak within a regime and cannot push forward economic changes to stabilize the system. That is why you are stuck within the worst of all possible worlds," Volpon said.

DEBT VALUATION

According to Caracas Capital Markets, Venezuela has issued $48 billion in new debt, either through PDVSA or the sovereign itself since 2008. In February it has debt payments of $732.5 million, roughly equivalent to a week's worth of cash from oil exports.

However, as Dallen points out, Venezuela uses much of its production for domestic consumption in the form of cheap gasoline or diesel power for inefficient electricity generators to stop power outages that sometimes plague the nation.

Right now, the benchmark 2017 PDVSA U.S. dollar-denominated bond is yielding nearly 23 percent, with bid prices down 1.737 points on Tuesday.

For an investor theoretically looking to insure a portfolio of $10 million worth of these bonds against a default, they could buy CDS protection that would cost them 17 percent, or $1.7 million annually for five years.

They would still take home, even with protection, a 5-6 percent gain on the investment.

Extend your maturity out to the benchmark Venezuelan 2027 global bond, with a yield of nearly 16 percent and the hedged trade with CDS becomes unprofitable from the start.

The ability to pay given its oil reserves is not in question. Rather, as Dallen says, "what's happening is they don't have the capacity given falling oil production."

Oil production in Venezuela is about 2.4 million barrels per day versus Saudi Arabia which pumped 9.7 million barrels, according to the latest Reuters survey.

"Venezuela is either going to break or bounce. If it bounces you win. If it breaks you also might win because if a democratic capitalist-based government takes over... Venezuela has a chance to become Saudi Arabia and yields go to 2 percent," said Dallen.

(Reporting By Daniel Bases; editing by Andrew Hay)