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The Venezuelan gas deal: Risk versus rewardwill

Thursday, August 30, 2018

The “historic” gas deal signed between T&T and Venezuela on August 25, 2018 is a structural solution to T&T’s gas supply woes experienced by the petrochemical sector over the last few years. This deal, set to flow in 2020 and beyond, coupled with increased local production will provide greater certainty to NGC, Atlantic LNG and many companies operating in the Point Lisas Industrial Estate, and will promote increased business confidence, increasing the likelihood of further business investment.

While much of the details of the deal remain confidential, there are a few considerations that should be explored to assess the risks and rewards to T&T as a country.

Three considerations:

• Counterparty risk

• Forward or market contract pricing

• Geo-political factors

1. Counterparty risk: Who are we dealing with?

“Counterparty risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations. Counterparty risk is a risk to all parties and should be considered when evaluating a contract.”

In this case, the agreement has been signed by Petroleos de Venezuela SA (PDVSA), the Venezuelan state-owned oil company, T&T’s National Gas Company and Shell.

However, in December 2017, “Fitch reduced the Venezuela’s long-term foreign rating to C from CC and called a default “highly probable,” according to a statement. S&P also downgraded the sovereign and state run-oil company PDVSA to CC from CCC, two notches from default.”

More recently in March 2018, Moody’s also downgraded PDVSA’s ratings to C from Ca. Moody’s lowered the company’s baseline credit assessment (BCA) to “C” from “Ca” and the country’s rating to C from Caa3. “C” is the lowest rating possible and is typically attributed to counterparties that are in default.

“The downgrade of the Venezuelan government’s ratings were based on Moody’s expectation that the continuing erosion of Venezuela’s payment capacity will lead to heavy losses to bondholders, with ongoing defaults on interest payments on various bonds compounded by upcoming principal maturities, and the limits on Venezuela’s ability to restructure its debt posed by current US sanctions that prevent US investors from accepting new debt instruments under a potential debt exchange, which will further exacerbate losses.”
Should we be worried?

The good news is that we are not looking for financial payments from PDVSA or the Venezuelan government, we need only to receive a commodity, natural gas from the Dragon gas field. It has been made clear that Shell has the responsibility for transporting the gas to the Hibiscus Platform (jointly owned by NGC and Shell). But who is responsible for extracting the gas in the first place? If it is PDVSA then, we should be concerned about their ability to continue to operate and fulfill their contractual obligations to us, especially considering the country’s current precarious financial situation.

A good way to structure the deal and mitigate this risk, is to ensure T&T and Shell have operational responsibility and associated property rights to take the gas from the ground, in addition to transportation, processing at Atlantic LNG and eventual sale on the global markets.

However, if we are taking some risks, we should be compensated for it, this is where the price of the gas comes in.

2. Forward or market price?

The Government of T&T has stated that “commercial terms of gas sales agreements are subject to the strictest confidentiality clauses” and as such the public will not be privy to this information. However, as reported in the Trinidad Guardian on August 26, 2018, “the Prime Minister took the liberty to say the prices are very competitive and in some cases lower than what we are paying to domestic upstream producers in T&T.”

Given the amount of public disclosure, it is tough to assess the favourability of the deal and the associated risk-reward dynamics. However, the news that prices negotiated are lower than some of those agreed to with domestic upstream suppliers, is most welcome. It says that we are getting a discount (or some compensation) for dealing with a counterparty that has some financial credibility issues (not to mention political and social issues as well).

However, the gas is set to flow from 2020, so have we locked in prices today for gas to be purchased and delivered in the future? If so, then we have entered into a “Forward market contract.” The “Forward price is the predetermined delivery price for an underlying commodity, currency, or financial asset as decided by the buyer and the seller of the forward contract, to be paid at a predetermined date in the future.”

However, if market prices go down by the delivery date, then the seller (in this case Venezuela) usually wins, as they get a higher price for the commodity, when the current market price is lower. The converse is also true, if natural gas prices go up, T&T would have benefited from locking in the lower price.

To neutralise the effect of future commodity price movements, and to eliminate any associated market risk: if the authorities have entered into fixed price contract arrangements on the purchase side (ie T&T buying the gas from Venezuela), then we should immediately start negotiating the fixed price future contracts on the other side with our customers, for when we finish processing the gas and have to sell it on the global market. The key is to lock in the profit margin immediately. This is called hedging.

Another strategy in commodity-based transactions is just to agree to a premium/discount over market rates at the time of delivery. The current gas border deal could also have been set at some generous discounts to final market prices, to compensate both Shell and T&T for the services that are provided to prepare the gas for sale on the global markets. In this case, the profit would be realised once the costs to transport and process are less than the differential between how much we buy and sell the gas for.

3. The geo-political consideration

The tense relations between the US and Venezuela are well known, in May of this year, one day after a Venezuelan election the US government called a “sham,” the Trump administration placed a fresh third round of sanctions on the beleaguered country. Some in T&T have wondered, if we as a country deal with the Maduro regime (who is the real antagonist of the US government, not the people of Venezuela), if we could get backlisted too? However, this is a relatively low probability as the recent “sanctions fall short of direct penalties on the oil sector, which the Trump administration has said would harm the Venezuelan people and American companies. They do not bar United States companies or citizens from selling oil products to or importing them from Venezuela.” As reported by the New York Times on May 21, 2018.

Accordingly, it would be a reach for the US to penalise us, a neighbour, for making this deal. Having said this, any transactions or agreements with the Maduro government, rank as “very high” on the political risk spectrum.

Financial, operational, market and political risks have been identified above, but much can be mitigated by appropriate deal structuring. For the public this will remain a black box for this time. However, it is hopeful that the benefits to T&T which include the bolstering of our natural gas supply and the setting of the frame for sustained increased LNG production, will provide net benefits and the requisite returns to the people of T&T

• Navin Dookeran ([email protected]) is a lecturer and programme director of the Executive MBA at the Lok Jack GSB and was previously the head of credit risk for Manulife Bank and Trust, and worked at the RBC Financial Group, Toronto, Canada.

Navin Dookeran


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