Cutting the Venezuelan debt knot

National Assembly leader Juan Guaido, who declared himself Venezuela's interim president, told the country's creditors in January that he would seek renegotiation of the nation's mounting foreign debt if he were recognized as Venezuela's rightful head of state. Immediately after his announcement, Venezuela's sovereign bonds gained amid speculation that the Latin American nation's myriad of creditors would finally get their money back.

Boasting what is believed to be the world's biggest oil reserves as well as underground reserves of gold, iron ore and other resources, Venezuela could easily obtain financing and cut a deal with its creditors, the 35-year-old Guaido said.

"With a new government, the debt will not only be repaid, but we could refinance with the trust of a government that can pay," Guaido announced.

Venezuela's outstanding debt is estimated to be around $140 billion (€123.7 billion) at the end of 2018. A major problem for the petrostate is that it owes so much money to so many different parties.

More than $65 billion is due to international bondholders, while China and Russia have outstanding claims of $40 billion under their respective loan-for-oil deals. Moreover, there are companies that have been granted arbitration awards, like Canadian mining company Crystallex and oil giant ConocoPhillips. And finally, unpaid suppliers have claims, too.

Bondholders

International debt investors are already closing in on the government in Caracas demanding in January more than $9 billion in overdue bond payments. The urgency increased after ConocoPhillips and Crystallex managed to wring $1 billion out of the government by threatening to lay claim to Venezuela's assets abroad.

Until then, the government of President Nicolas Maduro favored servicing debt borrowed from Russia and China, which is unsurprising given that the two countries are among the few supporting the authoritarian ruler.

Large holders of Venezuelan bonds, including Fidelity, Pimco, BlackRock, AllianceBernstein, T. Rowe Price and Goldman Sachs Asset Management have been left hanging. But there seems to be a willingness on the part of Guaido to repay when the time comes.

On February 4, Venezuela's envoy to Washington, Carlos Vecchio, said that a successor government would honor debts that were "legal" and "financial," but left unresolved the question of whether it would honor loan-for-oil deals.

So if Guaido wrests control of the government, there won't be widespread defaults. But nobody is going to get paid immediately, and many bond traders believe that untangling Venezuelan debt will become the biggest mess in the sovereign debt space ever.

Cash-for-oil deals

China now finds itself in a very different position than it would have imagined a decade ago when its oil-backed loans to Venezuela seemed like an efficient path to securing supplies while also quietly building a political foothold in America's backyard.

Now, lenders from the Asian powerhouse, including the China Development Bank, have been forewarned that their $50 billion in loans — about $20 billion of which are currently outstanding — could be on a precarious foundation. Already in 2016, Beijing granted the Maduro government a grace period until 2018, in which Caracas only had to pay interest so that it could redirect funds to shore up its collapsing economy.

Venezuela's massive oil resources would, theoretically, offer ample support for the loans. But China may be coming to realize that oil is not formally collateral for the debt, but rather a means of generating cash for repayment. If a new government viewed China's oil-backed loans as an illegal impediment to selling a significant portion of Venezuela's oil, China would face a predicament.

"They're worried the opposition will come in and not necessarily want to honor their contracts, or find loopholes," Russ Dallen, a specialist for Venezuelan bonds at Caracas Capital Markets, said in a note to investors recently.

Other analysts, however, believe that a new government will honor Venezuela's debt to Beijing, because failing to repay China would erode Guaido's credibility.

Kathryn Rooney Vera, chief investment strategist at Bulltick Capital Markets, says that any loan default would hurt him. "It would also hurt their future capacity to issue debt in terms of their credit. So I don't think that's going to happen."

Gabriel Collins from the US-based Baker Institute for Public Policy and cofounder of the China SignPost analysis portal, thinks that the upcoming restructuring, including possibly a debt haircut, is a classical example of Chinese "geo-economics gone wrong."

"The sting will offer a painful reminder of the risks inherent in lending to unstable sovereigns lacking the rule of law," he wrote in a recent analysis.

Moscow's pawn

While Guaido has signaled he wants to honor Venezuela's obligations to China, he has made no such overtures to Russia. Moscow is considered crucial to Maduro's survival and has repeatedly come to his and his predecessor's rescue, handing Venezuela at least $17 billion in loans and credit lines since 2006.

If Russian President Vladimir Putin gave another financial lifeline or even continued to buy gold at a discounted rate, the situation could become a protracted crisis.

Helima Croft, global head of commodity strategy at RBC Capital Markets, says the question now is whether Putin believes "a couple of billion dollars more will preserve a type of regime that remains loosely or closely aligned to Moscow."

"Not only are they getting oil, but they've also gained access to pretty good acreage in Venezuela," said Croft.

Ironically, if Moscow lets Venezuela default on its debts, then Russia would actually be able to exercise its lien on Venezuela's most valuable asset: US-based oil giant Citgo.

In 2016, Maduro secured a fresh loan by giving Russian oil giant Rosneft a 49.9-percent stake in Citgo as collateral. In addition, the remaining 50.1 percent — held by Venezuela's state-owned oil company PDVSA — are also collateralized under a bond issue owned by Russia.

"It would not be unusual for the Russians to try and exercise the lien, just because it would be very disruptive and chaotic to the United States," said Dallen of Caracas Capital.

At the end of January, however, matters became more complicated for Moscow after Washington imposed sanctions on PDSVA's oil exports to the US. Moscow described the ban as illegal, with Deputy Finance Minister Sergei Storchak saying he now expects problems for Maduro.

"Everything now depends on the army, on the soldiers and how faithful they will be to their duty and oath. It is difficult, impossible to give a different assessment," he told reporters.

But if the Russians want to get their money back, they should remember their own situation when they defaulted on $40 billion of old Soviet-era loans in 2000. Back then, Putin and Russia's creditors agreed to restructure the bonds, and three years later the oil-rich nation's debt was back to investment grade.