Petroleum of Venezuela (PDVSA, Financial) is one of the biggest oil companies in the world and the key to sustainability of Venezuelan social and economic plans. PDVSA has a strong implicit government support due to the company's economic (oil represents 90% of exports) and strategic importance. The company has considerable oil and gas reserves as well as low development costs. Additionally, it has extensive ownership of Citgo, which is a key foreign asset. When I analyze PDVSA I consider it a must to differentiate between fundamentals and emotions. There is a big gap between those when you evaluate PDVSA credit metrics and the political scenario in Venezuela.
As I will explain in some of the points below, PDVSA has very low debt (even considering that the government takes a considerable amount of EBITDA generated by the business), an impressive interest coverage ratio (a key metric to evaluate default risk) and one of the biggest oil reserves in the world. “PDVSA is the main pillar in the Venezuelan economy. Chavez can hate American people but he knows that PDVSA must service the debt in order to keep financing social plans and maintain economic order in the country” said Pilar Ramos, credit analyst at Barclays.
PDVSA debt is trading at default risk prices even when PDVSA has the one of the lowest Debt/EBITDA ratios of national oil companies in the world (NOCs) and one of the biggest interest coverage ratios. From fundamental reasons, a default can't happen with those metrics. Also, nobody in Venezuela will take PDVSA to default when the company can comfortably pay the debt in the near and medium term. Almost all retirement accounts from Venezuelan citizens are invested in PDVSA fixed income, so no government will default for political reasons or hate to Americans. “Chavez is a dictator but he knows that if he does not service the debt, the country will collapse as Argentina did in 2001, and he has ample solvency to service it. Oil reserves are huge,” explained Ms. Ramos.
One month ago, I heard a presentation of Michael Hassenstab, portfolio manager of Templeton Global Bond Fund in Buenos Aires. He explained that in PDVSA's investment case and sees that yields in PDVSA's bonds compensates the risk taken. Templeton is one of the biggest institutional holders of PDVSA credit and an expert in emerging markets fixed income.
I recommend to buy PDVSA 2037 bonds, that are currently trading at 45 cents over the dollar, were issued by New York legislation and offers an annual pay of 12.5% in dollars. There are some scenarios and fundamentals that I made in my thesis to invest in PDVSA:
1. I am comfortable with the public sector’s willingness and ability to service debt in the near term. Of course, there is some apprehension about Venezuela’s sensitivity to lower oil prices in the current global context. However, PDVSA does not have any external amortization payments scheduled in 2012, while the government has only $0.8 billion. In addition, the sum of the central bank’s FX reserves and the public sector’s other liquid assets rose to $64 billiob in second-quarter 2011 from $51 billion in the previous quarter. I think that if oil prices fell for a sustained period of time, the government would keep borrowing and, following next year’s presidential elections, reduce spending and/or devalue the bolivar, while continuing to prioritize external debt payments.
2.The government’s over-reliance on PDVSA as a fiscal and monetary agent at the expense of the company’s investment needs and balance sheet. This point is not well seen by the markets. PDVSA transferred about 80% of its cash flow generation (EBITDA before government take) in the last five years to the Venezuelan government through fiscal and social contributions, dividends and balance sheet transfers. This put a strain on investments (about 38 cents invested for each dollar transferred to the government). It also caused the company to increase net debt from $0.5 billion in 2005 to $19 billion in 2010 and accrue about $10 billion of payables to suppliers over the last three years through (sometimes severe) payment delays. PDVSA invested $13.6 billion on average over the last five years (or about $12 per barrel of crude oil produced), with crude production increasing by 0.5% annually over that period (to 2.975 million bpd in 2010). PDVSA’s high government transfers and underinvestment should continue to weigh on the company’s leverage metrics and production sustainability under the current administration. While the future of the company remains uncertain beyond 2012 presidential elections in Venezuela, I remain comfortable with the Venezuelan public sector’s willingness and ability to service its external debt in the near term — PDVSA’s debt to EBITDA before government take should increase but remain below oil peers in the medium term.
3. These charts explain the current fundamentals and picture the credit metrics of PDVSA:
a) Here we can see that PDVSA has almost double public sector liquid FX holdings as public sector external bond debt. PDVSA has no solvency problems.
b) PDVSA has the biggest Proved Reserve to Production Ratio compared to all national oil companies in Latin America.
c) Considerable production, revenue and EBITDA compared to other oil peers.
d) Due to PDVSA's low production costs, its E&P realization price is much lower than other companies.
e) The market doesn't like the amount of government takes from PDVSA's EBITDA but compared to other National Oil peers, the government take does not appear to be abnormally high.
f) PDVSA has better hard currency revenues than peers.
g) Debt/EBITDA is low (too much lower than Petrobras or Pemex), even Debt to Proven Reserves. EBITDA/Interest Expense at 23.8 seems too much big for the default risks the bond prices are implying.
4. There is a near-term issue coming from the International Center for Settlement of Investment Disputes (ICSID) decision on the Exxon Mobil arbitration claim, which could be announced any day now. There are at least 16 arbitration cases against Venezuela before the ICSID with a potential value of $55 billion in claims. The largest of the claims were brought by Exxon Mobil (originally $15 billion, later reduced to $7 billion) and Conoco Phillips ($31 billion). The claims are on the government, but I think PDVSA will likely be responsible for a significant share of their payment. PDVSA expects a decision on the Exxon Mobil claim by the end of September and has set aside $3 billion in preparation; a decision on Conoco Phillips’ case is expected next year.
The impending ICSID headline will likely be negative for Venezuela and PDVSA assets regardless of the size of the award. I believe Venezuela will eventually pay this claim, though. Venezuela has paid arbitration decisions in the past, though the previous awards have been less than $1 billion. In my view, the government is aware that it requires access to markets to maintain the current FX policy regime at least through next year’s elections as well as to fund political, infrastructure and investment spending. Still, I think that once the decision is announced, the government and PDVSA will try to negotiate with Exxon Mobil on the composition of the payment.
As I will explain in some of the points below, PDVSA has very low debt (even considering that the government takes a considerable amount of EBITDA generated by the business), an impressive interest coverage ratio (a key metric to evaluate default risk) and one of the biggest oil reserves in the world. “PDVSA is the main pillar in the Venezuelan economy. Chavez can hate American people but he knows that PDVSA must service the debt in order to keep financing social plans and maintain economic order in the country” said Pilar Ramos, credit analyst at Barclays.
PDVSA debt is trading at default risk prices even when PDVSA has the one of the lowest Debt/EBITDA ratios of national oil companies in the world (NOCs) and one of the biggest interest coverage ratios. From fundamental reasons, a default can't happen with those metrics. Also, nobody in Venezuela will take PDVSA to default when the company can comfortably pay the debt in the near and medium term. Almost all retirement accounts from Venezuelan citizens are invested in PDVSA fixed income, so no government will default for political reasons or hate to Americans. “Chavez is a dictator but he knows that if he does not service the debt, the country will collapse as Argentina did in 2001, and he has ample solvency to service it. Oil reserves are huge,” explained Ms. Ramos.
One month ago, I heard a presentation of Michael Hassenstab, portfolio manager of Templeton Global Bond Fund in Buenos Aires. He explained that in PDVSA's investment case and sees that yields in PDVSA's bonds compensates the risk taken. Templeton is one of the biggest institutional holders of PDVSA credit and an expert in emerging markets fixed income.
I recommend to buy PDVSA 2037 bonds, that are currently trading at 45 cents over the dollar, were issued by New York legislation and offers an annual pay of 12.5% in dollars. There are some scenarios and fundamentals that I made in my thesis to invest in PDVSA:
1. I am comfortable with the public sector’s willingness and ability to service debt in the near term. Of course, there is some apprehension about Venezuela’s sensitivity to lower oil prices in the current global context. However, PDVSA does not have any external amortization payments scheduled in 2012, while the government has only $0.8 billion. In addition, the sum of the central bank’s FX reserves and the public sector’s other liquid assets rose to $64 billiob in second-quarter 2011 from $51 billion in the previous quarter. I think that if oil prices fell for a sustained period of time, the government would keep borrowing and, following next year’s presidential elections, reduce spending and/or devalue the bolivar, while continuing to prioritize external debt payments.
2.The government’s over-reliance on PDVSA as a fiscal and monetary agent at the expense of the company’s investment needs and balance sheet. This point is not well seen by the markets. PDVSA transferred about 80% of its cash flow generation (EBITDA before government take) in the last five years to the Venezuelan government through fiscal and social contributions, dividends and balance sheet transfers. This put a strain on investments (about 38 cents invested for each dollar transferred to the government). It also caused the company to increase net debt from $0.5 billion in 2005 to $19 billion in 2010 and accrue about $10 billion of payables to suppliers over the last three years through (sometimes severe) payment delays. PDVSA invested $13.6 billion on average over the last five years (or about $12 per barrel of crude oil produced), with crude production increasing by 0.5% annually over that period (to 2.975 million bpd in 2010). PDVSA’s high government transfers and underinvestment should continue to weigh on the company’s leverage metrics and production sustainability under the current administration. While the future of the company remains uncertain beyond 2012 presidential elections in Venezuela, I remain comfortable with the Venezuelan public sector’s willingness and ability to service its external debt in the near term — PDVSA’s debt to EBITDA before government take should increase but remain below oil peers in the medium term.
3. These charts explain the current fundamentals and picture the credit metrics of PDVSA:
a) Here we can see that PDVSA has almost double public sector liquid FX holdings as public sector external bond debt. PDVSA has no solvency problems.
b) PDVSA has the biggest Proved Reserve to Production Ratio compared to all national oil companies in Latin America.
c) Considerable production, revenue and EBITDA compared to other oil peers.
d) Due to PDVSA's low production costs, its E&P realization price is much lower than other companies.
e) The market doesn't like the amount of government takes from PDVSA's EBITDA but compared to other National Oil peers, the government take does not appear to be abnormally high.
f) PDVSA has better hard currency revenues than peers.
g) Debt/EBITDA is low (too much lower than Petrobras or Pemex), even Debt to Proven Reserves. EBITDA/Interest Expense at 23.8 seems too much big for the default risks the bond prices are implying.
4. There is a near-term issue coming from the International Center for Settlement of Investment Disputes (ICSID) decision on the Exxon Mobil arbitration claim, which could be announced any day now. There are at least 16 arbitration cases against Venezuela before the ICSID with a potential value of $55 billion in claims. The largest of the claims were brought by Exxon Mobil (originally $15 billion, later reduced to $7 billion) and Conoco Phillips ($31 billion). The claims are on the government, but I think PDVSA will likely be responsible for a significant share of their payment. PDVSA expects a decision on the Exxon Mobil claim by the end of September and has set aside $3 billion in preparation; a decision on Conoco Phillips’ case is expected next year.
The impending ICSID headline will likely be negative for Venezuela and PDVSA assets regardless of the size of the award. I believe Venezuela will eventually pay this claim, though. Venezuela has paid arbitration decisions in the past, though the previous awards have been less than $1 billion. In my view, the government is aware that it requires access to markets to maintain the current FX policy regime at least through next year’s elections as well as to fund political, infrastructure and investment spending. Still, I think that once the decision is announced, the government and PDVSA will try to negotiate with Exxon Mobil on the composition of the payment.
