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Venezuela’s risk of debt default keeps oil, other industries on the edge

July 19, 2011 - Greece may have to move over. While global investors and financial regulators have been transfixed in recent months on a possible European debt crisis, Venezuela, a major oil exporter, ranks just behind the cradle of Western civilization in terms of the risk of defaulting on its debt and roiling global financial markets.

Will its petrodollars be enough to keep it from default?

While analysts say yes for now -- and probably for as long as oil prices stay high -- the long-term odds are not as good. London consultancy CMA Datavision July 7 gave Venezuela a greater than 51.4% chance of defaulting on its sovereign debt within five years. That puts it right behind Greece, which tops CMA’s list with an 80.6% chance. (See related table: Top Five Most and Least Risky Sovereign Debts)

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But oil money is both the cause and the cure of Venezuela's debt risk, along with the idiosyncrasies on regular display by Venezuela's socialist President Hugo Chavez, analysts said.

The idea that Venezuela might default is mostly "just political," said Paula Diosquez-Rice, a senior economist on Latin America for IHS Global Insight. "All of the numbers for cash flow are great, but we have to penalize them for political reasons ... the idea [Chavez] could wake up one day and say, 'We won't pay.'"

This is why Venezuelan bonds rallied after Chavez said earlier this month he was undergoing treatment for cancer -- opening at least the possibility he might not run for reelection.

But for now, analysts expect Venezuela to keep issuing bonds at a steady rate and investors to keep buying them, apparently betting that Venezuela will make enough money from oil to pay its debt.

"Risk is already factored into sovereign and PDVSA bonds," JP Morgan analyst Ben Ramsey said. "Venezuela already trades at very high yields and bonds trade at deep discount." (See related chart: Venezuela vs. Other EM spread)

But a few things could make this unsustainable -- the government taking on excessive debt, or a combination of plunging oil prices and a failure by the country's oil industry to increase its already declining output and exports.

If that happened, seizing Venezuelan oil assets abroad -- as has happened in similar defaults from oil producers -- could be recourse for jilted creditors, Scotia Capital analyst Joe Kogan said in a report.

"Behind much of the decision to buy Venezuelan bonds, we think, is the supposition, or perhaps, just hope, that Venezuela's oil could ultimately become available to satisfy sovereign debts in a default," he wrote. Venezuela's state-owned oil company PDVSA has numerous assets abroad, the most valuable being its Citgo subsidiary in the US, where it owns several refineries.

While there are legal and operational barriers that could possibly stymie attempts to make such seizures, just the threat of it might be enough to keep Venezuela wanting to pay, Kogan said.

A default also would cut off the inflows of outside cash Chavez uses to fund his expansive social programs and keep the taps open in the country's oil fields -- which, in turn, provide even more money for the social programs. With inflation in the country running at above 20%, such funding becomes increasingly complicated. Further, a default would create more pressure for the government to secure cash from somewhere else -- anywhere else, analysts said, including possibly more nationalization of foreign investments.

Although much of the industry has been nationalized, there are still significant international assets. Despite 2007 expropriations, international oil companies BP, Chevron, Total and Statoil continue to operate in Venezuela in joint ventures with the state.

In the meantime, Venezuela's high debt risk rating is already squeezing PDVSA, which also issues its own bonds -- for an total estimated debt of about $32.1 billion, according to Venezuelan consultancy Ecoanalitica.

"The national debt and the perceptions of it in the market very much affects our debt," said Eulogio Del Pino, vice president of exploration and production for the state oil company. "This perception unjustly drags down the debt of PDVSA and forces us to pay interest rates several percentage points higher than what a company that is only being judged by its financial indicators would have to pay."

But outside observers say most of this debt is not going to investment in PDVSA, but rather to the government's social programs, further undermining future production.

PDVSA "essentially has become a government entity used to finance political and social undertakings having nothing to do with oil production," UBS' chief economist for Latin America Javier Kulesz said.

Some analyst also drew links between the oil industry and the country's metals sector, which has been largely nationalized. The country's main aluminum smelter Alcasa has struggled to maintain production levels and has suffered from near-constant labor problems. The steel industry has fared slightly better, other analysts and sources said, partially because it makes pipeline for the oil industry.

For both oil and metals, Venezuela seems to be banking on Chinese investment both to turn the sectors around and stave off the possibility of a default. And Venezuela still has significant dollars underground, especially in its heavy-crude Orinoco belt where it is still trying to ramp up production.

But even onlookers who say a default is not likely put a lot of qualifiers on that statement.

"We suspect that when push comes to shove, he [Chavez] will subordinate policy to meeting debt payments as he did in the past," UBS said in a recent report. "But we admit, we can't really say this with a high degree of conviction."

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Top Five Most and Least Risky Sovereign Debts

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