PDVSA bonds

March 24, 2007

PDVSA will issue up to US$ 5 billion in a combo bond which will be sold to local investors for Bolivars, but the bonds themselves will be in US$ and pay interest in US$. The bonds will be issued under the so called Reg S, a regulation for issuing securities outside the US, which does not require a registration and means that US investors can not buy the bonds for the first forty days.

The details of the bonds will be known on Monday morning, all we know is that there will be three of them maturing in ten, twenty and thirty years. Price and coupons will appear on PDVSA’s page on Monday. Rumor has it that the coupons will be in the range of 4-5%.

The issue is strange. First, there is the timing. Orders will be accepted next week, which is just when people start taking off for Easter week, which is a big vacation week here as all kids get off the whole week. Even if only two days are official holidays, it is truly dead time in Venezuela. A second strange factor is that next week is income tax week. In Venezuela you pay income taxes via the banking system. You have to purchase a cashier’s check and then you pay at a bank. Thus, banks are very heavy with traffic that week and they can barely cope. Now they will have people also requesting the bonds which will really push their capabilities. Then, the allocation will be announced on Easter Monday, when most people are not even here. Finally, payment will be made a full eleven days after the allocation, which is unsettling as so much can happen in emerging markets in eleven days.

There is a feeling that the bond was rushed to market for a reason that we can only speculate (PDVSA needs the money, Chavez got impatient after so many announcements, bring the parallel rate down…). A PDVSA bond was being announced since June last year and there were rumors that itw as imminent up to the beginning of this week. Then things cooled off and supposedly the issue had been postponed until after Easter week, which made sense. But then late on Thursday, the Minister of Energy and Oil announced it in an interview in a private radio station (Union Radio). Certainly a weird way to announce what may be the largest bond issue ever in the history of Emerging Markets.

In contrast with the earlier Bono del Sur bond in February, if the rumors of the coupons are right and the price is 100%, buying this bond will not be the easy money that the Bono del Sur was. Recall that in that case, those with money wee able to make a quick return by buying the bonds selling them and turning around and selling the dollars in the swap market to net some Bs. 1,000 per US$ in what was a giveaway by the Government to the well off. The bond will be a roaring success locally, but may not trade where it should in the international markets for quite a while.

This bond will not appear to be such easy pickings. There are a number of reasons for this. First, nobody knows where they will trade, because PDVSA has no outstanding bonds in the international markets. Typically, bonds from a country’s oil company trade above those country’s bonds in yield. In Mexico, for example Pemex bonds yield 0.4% or 40 basis points above the equivalent Sovereign bond. Ideally, this would be where PDVSAs bonds may trade if the issue was registered with the SEC, but it is not. Moreover, the prospectus has no audited financials for 2006. Add to that the huge size of the issue (It represents 23% of the country’s outstanding Sovereign bonds) and initially the large size may cause indigestion in international markets and they may trade 100 to 150 basis points over sovereign. Recall that people will buy these bonds at 100% of their face value (in theory) at the official rate of exchange, but because of their low coupons, they will sell at a discount n the international markets, which means that people will get fewer dollars and thus they wil be paying a higher price for those dollars when they sell the bonds.

If this is true, then the implicit exchange rate of buying the bonds will be something like Bs. 3,400 to Bs 3,500 when you include commissions and the parallel market is trading at Bs. 3,800 and may drop if people start selling the proceeds from the bonds. Thus there is a risk and that is the way it should be.

Unfortunately, many people think it is like the Bono del Sur and they are getting ready for it, borrowing money, registering their family and the like, which may come back to haunt them, particularly because they may get an allocation much larger than they think and they will then need to scramble to come up with the money to pay for it.

What is funny is how the papers are plastered with ads telling people to purchase the bonds, but such ads never say the true reasons behind the bonds. For example, one of the ads asks:Why is PDVSA issuing a bond in Venezuela?

Well, the true reason is because PDVSA needs to borrow money, it is cheaper to do it this way because the coupons can be lower, they be temporarily absorb the excess monetary liquid which pressures the parallel market and many people will buy the bonds, sell them and sell the foreign currency in the parallel market, helping to bring it down and thus hopefully help inflation.

But none of this is mentioned in the ad. The ad says:

-Because PDVSA wants people to participate in the oil industry

Sure, except that 80-90% of those buying the bonds will turn around and sell them.

-Because it wants to strengthen the ability for internal savings by Venezuelans.

Well, the same point as above applies, but what type of signal do you send when you do it in dollars. That is what the “strengthening” is telling people. It is stronger, not because it is PDVSA, but because it is in foreign currency.

-Because it is long term, has good return and security.

Same thing, few people will keep it, the return is good because people are buying dollars they have no access to at a cheaper rate than the parallel market.

-Because PDVSA now finances itself in Venezuela.

Only because it is cheaper to do it this way for PDVSA in the face of exchange controls.

-Because we want our “people” to be able to invest in our most important asset.

Once again, most “people” will sell it, but it was Chavez, when he assumed power in 1998, the one that stopped the “people” from truly investing directly in the assets of our Venezuelan oil industry, when it canceled a project that would have allowed Venezuelans to invest in a now defunct company called SOFIP, which owned 10% of all of the service projects of the oil opening. THAT would have been truly allowing people to invest in the assets of their oil industry.

Thus, as usual, a bunch of half truths and outright lies, but no mention of the real reason why this is being done. Even worse, the President of PDVSA and Minister of Energy and Mines said that PDVSA was going to buy US$ (at the official rate of exchange, of course) with the proceeds. This is somewhat surprising, since PDVSA’s income is mostly in dollars and typically what it has to do is change those dollars to Bolivars to pay taxes, royalties and most of its expenses in Venezuela. I think this was just the official line to make it look as if the bond removes monetary liquidity. It does, but only temporarily, as PDVSA will rapidly spend the Bolivars it received and the effect will be lost. (PDVSA spends US$ 5 billion a month)

Tune in on Monday when we know the details to see how risky (or not) buying these bonds will be.

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