Caracas is providing a bad example of how to run a country. Even the region’s populists are paying heed. Latin America remains open for business, says James McKeigue.
You could forgive bondholders who were summoned to Caracas last month for feeling edgy. Venezuela’s socialist regime spends most of its time railing against international capitalist conspiracies; the capital has the world’s highest murder rate. But they needn’t have worried. The government, desperate to keep its creditors onside, feted the visitors, literally rolling out a thick red carpet and providing a ceremonial military guard normally reserved for heads of state.
The emergency summit was called to discuss Venezuela’s worsening financial woes. Between the national oil company Petróleos de Venezuela (PDVSA) and the state itself, Venezuela has $65bn of outstanding dollar-denominated debt. Ever since the oil price crashed in 2014, a Venezuelan default had seemed likely. Yet few emerging-market debt funds felt they could avoid Venezuelan paper – it accounts for nearly 5% of the JP Morgan Emerging Markets Bond Index, a key benchmark. Then, early last month, PDVSA missed a bond payment. Hence the meeting. In the end, investors left Caracas with gifts of luxury chocolate, coffee and vague promises of a “win-win” situation. However, the horrendous state of Venezuela’s economy means that most of its 31 million citizens are already losing out, and investors may be close behind. Ratings agencies have already declared the country in “selective default”.
Venezuela epitomises all the clichés about Latin America – countries run into the ground by corrupt, narco-linked strongmen whose economic incompetence is matched only by their greed. But today, Venezuela is the exception, not the rule. Latin America’s other big economies have long benefited from prudent, orthodox economic management and vibrant, free democracies. This “new Latin America” offers exciting opportunities for investors – but first, let’s look at what went wrong in Venezuela.
The nightmare in Caracas
In 2001, Venezuela was the richest country in South America. Today it is gripped by hyperinflation and food shortages. Ostensibly, it’s all about oil. High oil prices for the first part of the century helped drive growth, but in 2014 oil prices halved, and Venezuela’s economy suffered. Yet other Latin American nations saw huge falls in commodities upon which they were similarly dependent and survived. The real problem was that Venezuelan leader Hugo Chavez squandered the windfall from the oil boom on buying off huge swathes of the electorate, rather than investing in the economy. Local industries were undermined by constant business expropriation, increasing the country’s reliance on oil still further – oil went from accounting for 77% of exports in 1998 to 96% by 2011. Worse still, cronyism was rampant. Managers at PDVSA were picked for political reasons (and still are – last month, an army general with no oil experience was made CEO), while the firm’s status as a piggy bank for corrupt officials starved it of investment. As a result, productivity cratered. Oil production has fallen to 1.9 million barrels per day (bpd), down 36% since 2012, and the oil produced is of poorer quality, and so sells at a discount.
This, along with the oil-price slide, has hammered government revenues. But the regime – headed by President Nicolás Maduro since Chavez’s death in 2013 – borrowed heavily to keep the party going. According to the Financial Times, it owes $64bn to bondholders, more than $20bn to allies China and Russia, $5bn to multilateral lenders such as the InterAmerican Development Bank, and tens of billions to the importers and service companies that “keep the oil industry pumping”. This allowed Maduro to buy the acquiescence of the army and police. But he can no longer afford to pay off voters. Import revenues have fallen by 85% in the past five years, and the economy has shrunk by 30% since 2013 – a fall on the scale of the Great Depression.
For a population accustomed to the giveaways of the Chavez era, the adjustment has been brutal. Hyperinflation – the International Monetary Fund estimates the inflation rate will be 745% in 2017, and 2,300% in 2018 – means that bundles of notes are needed to buy basic foodstuffs, and that’s only when food is actually available. Nearly every household has to devote hours a day to queueing for the daily basics. It’s a tedious, nullifying existence – and a dangerous one. Crime rates have soared. There are 91 murders per 100,000 citizens (the UK rate is 1 in 100,000). You are more likely to be killed in Venezuela than in Iraq. And crime isn’t the only threat. A lack of money, equipment and medicine means that treatable diseases are spreading fast – cases of malaria rose by 76% in 2016, for example. Understandably, those who can are voting with their feet – an estimated 10% of Venezuelans (about three million people) have already fled the country.
But Latin America is not Venezuela
Venezuela is now held up by Latin America’s politicians and voters as an example of how not to run a country – Venezuelans escaping across the border are among the most eloquent advocates of the message. As Argentine journalist Andrés Oppenheimer notes in his Miami Herald column, “support for the free market is reaching record highs in Latin America”. According to the Latinobarómetro annual regional survey, says Oppenheimer, a record 69% of respondents agreed with “the premise that ‘the free market is the only path to development’”, compared with 57% in 2003. Governments across the region have opened up their economies to private investors. Nowhere is this more apparent than in the energy sector.
Today, the dangers of having your oil industry dominated by a corrupt, politically compromised oil company seem obvious. But until recently, it was the favoured business model in Latin America. Beyond Venezuela, Pemex in Mexico, Petrobras in Brazil and Ecopetrol in Colombia were the three most obvious examples; in Argentina, the government expropriated oil major Repsol’s portion of state-owned YPF in 2012, to bring its own oil industry fully under state ownership again. In Mexico, private-sector oil firms were forbidden from owning energy assets, and elsewhere they operated at an extreme disadvantage to the national oil company. For example, in Brazil the discovery of a new offshore oil play known as “pre-salt” in 2006 caused auctions to be delayed, while new, far more onerous, rules were created for the private-sector participants.
But even amid the oil boom, the limits of resource nationalism have become clear. Over the past decade, Mexico’s oil production fell by 45% to two million bpd as Pemex (seen as a government piggy bank, similar to PDVSA) failed to invest in new fields. Colombia, meanwhile – traditionally seen as an oil minnow in Latin America – doubled its production to one million bpd between 2007 and 2015, due to its willingness to work with international oil companies. So, in 2013, Mexico enacted a historic reform, opening up its oil and gas sector to international investors. Although the oil price fell just after the reform was passed, it has been a huge success. International and local companies have committed tens of billions of dollars to Mexico’s vast hydrocarbon resources. The US Energy Information Administration reckons Mexico’s long-term oil production could rise by 75% as a result. In Argentina, the new, pro-business administration that came to power in 2015 settled a $6bn claim with Repsol and has been courting private firms to develop its unconventional gas and oil resources, which are the third- and fourth-biggest in the world respectively. Finally, Brazil admitted its new, tough rules were scaring off investors and created more reasonable terms for incoming oil companies, such as dropping the requirement for Petrobras to be the operator on all deep-sea oil projects.
Other factors support long-term private-sector involvement. The drop in the oil price, for example, means the oil majors are cutting investment in big greenfield developments – such as the offshore projects that both Brazil and Mexico are trying to sell – so politicians realise they have to become more competitive to attract investment. But there are growing fears too that the good times can’t last. Some fear Latin America’s oil wealth will never be extracted as the Paris Agreement on climate change persuades a generation of politicians that a global energy transition is under way, for example. And populist politicians continue to campaign against “gringo” companies stealing Latin American oil.
But the worries are overdone. Take Mexico, for example. Its top candidate for the 2018 elections, Andrés Manuel López Obrador, has vowed to derail energy reform. Yet it would be impossible for him to do so – it has been written into the constitution and would require two-thirds of Congress to vote with him, which won’t happen. He is not that popular and constitutional limits prevent one party from having that many seats. As no other party is against the reform, there is no way he can reverse it. He can’t even replace the influential commissioners in charge of regulating the reform as these technocrats are on five-year fixed terms and answer only to Congress. He could slow the reform by investigating specific projects that have already been awarded, but that would be a temporary delay rather than a shutdown.
Meanwhile, there is a much more important political factor shielding the reform. On a recent trip to Mexico, I spoke to then-Pemex CEO José Antonio González (now Mexico’s finance secretary). Clearly he is not unbiased – he’ll probably be sacked the day after Obrador wins power – but he was sanguine about the future. “Pemex hasn’t got the money to develop these fields on its own. If we reneged on our deals with private-sector partners, we’d face all sorts of law suits. At the same time we’d be trying to raise incredible amounts of international capital to fund these projects on our own – it’s just not going to happen.” As Mexico’s energy secretary, Pedro Joaquín Coldwell, told me: “Populist politicians need money – if he cancels the energy reform he won’t have it.” PDVSA’s woes in Venezeula ensure that all of the region’s populists would grudgingly agree.
The world’s most exciting oil plays
In short, Latin America’s oil fields are open for business. That matters, because it’s the world’s most exciting region for new oil plays. Geologists believe that Mexico has more than 100 billion barrels up for grabs onshore and offshore. Brazil’s offshore pre-salt is home to an estimated 50 billion barrels, which can be extracted – according to Royal Dutch Shell – at just $40 a barrel. Meanwhile, there are many mature onshore fields that have been abandoned by the national oil companies, but that can be profitably reworked by smaller firms with newer technology. Last but not least, the region is also home to the world’s best unconventional oil and gas resources outside of the US. We run our eye over some of the most promising investment options in the box below.
The best stocks to buy now
In August, a new pan-Latin-American oil company was created when Vista Oil and Gas (Mexico City: VISTAA) listed. Backed by private-equity energy specialist Riverstone, and led by former YPF boss Miguel Galuccio, the firm targets onshore and shallow-water oil and gas in Brazil, Mexico, Argentina and Colombia. Clearly it’s risky to invest in a company without any producing assets as yet, but the top team assembled bodes well for the future. As Galuccio tells the FT, the four countries he is targeting “have never been open for business at the same time before: the opportunity for establishing a pan-regional exploration company is now”. Reports suggest that Vista’s first move could be to buy Argentine oil and gas fields from Chinese state-owned producer Sinopec, which would be a good fit with Galuccio’s experience. UK-based investors can buy via Interactive Brokers (InteractiveBrokers.com), although note that the firm’s shares are not very liquid.
If that’s too risky for you, a safer bet is GeoPark (NYSE: GPRK). Founder James Park had the idea for a pan-Latin-American oil company before it became popular. He did it the hard way, focusing on cheap onshore assets across Chile, Colombia, Brazil, Argentina and Peru. I interviewed him last year in Argentina and it was fascinating to speak to a genuine, old-school oil man who’s been building oil businesses there for decades. He certainly knows Latin America and that’s reflected in GeoPark’s numbers. Since it was founded in 2006, GeoPark has built up to producing 29,000 bpd, 80% of which is oil. That might not sound a lot, but because he started from scratch, it represents a steady 36% compound annual growth rate over the past decade. There is plenty of growth potential – GeoPark holds the rights to concessions with 235 million barrels of reserves, yet the firm trades on a price/earnings ratio of just 11.
As for UK-listed companies – oil majors BP and Shell have plenty of assets in Latin America, but they are also present in every other corner of the globe, so they are hardly pure plays. There are some smaller British firms with direct Latin American oil exposure, but they tend to focus on just one or two countries. If you are interested in Argentina, then take a closer look at Phoenix Global Resources (Aim: PGR). Amerisur (Aim: AMER) has carved out a lot of success in Colombia and has exciting development projects in Paraguay. President Energy (Aim: PPC) has production assets in Argentina and development projects in Paraguay. Premier Oil (Aim: PMO) isn’t a pure play as it has assets around the world, but it recently made a huge discovery in Mexico that could transform the company. Likewise Chariot Oil and Gas (Aim: CHAR) isn’t just focused on Latin America, but success in its Brazilian assets would be a gamechanger.
James McKeigue is the managing editor of LatAm Investor (Latam-Investor.com), the UK’s only Latin America-focused finance magazine.