Venezuela: Prospects for Restructuring Sovereign Debt and Rebuilding a National Economy Against the Backdrop of a Failing State
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Venezuela possesses many of the hallmarks of a failing, if not an already failed, state. It is facing a grave humanitarian crisis, with extremely elevated levels of poverty, widespread malnutrition and food insecurity, the troubling spread of disease even before the arrival of COVID-19 in Venezuela, an overstretched healthcare system (with critical shortages of medical supplies and equipment as well as healthcare personnel), and high levels of crime. Moreover, Venezuela is suffering from a collapsing economy, a precarious financial situation, and a political system stalemated between the regime headed by Nicolás Maduro and the forces opposed to the Maduro regime.
In response to the dire situation facing Venezuela, in recent years over five million Venezuelans—representing over fifteen percent or more of the total Venezuelan population—have fled Venezuela and sought refuge in countries in the region such as Colombia, Peru, Ecuador, Chile and Brazil (as well as in countries farther afield such as Argentina, Mexico and the United States), and this large-scale exodus of Venezuelans has created a refugee/humanitarian crisis in some of Venezuela’s neighboring countries.
The economic and financial situation in Venezuela is the central focus of this post (while recognizing, of course, that the acute humanitarian crisis facing Venezuela deserves the international community’s priority and urgent attention). By some estimates, the Venezuelan economy has contracted by approximately seventy-five percent since 2013, and it was estimated to have contracted by approximately thirty-five percent in 2019 (ie, pre-COVID) and twenty percent in 2020 (ie, when the impact of COVID on the economy was felt).
Overall, the huge contraction of the Venezuelan economy over the last decade is virtually without precedent in recent times, particularly for a so-called peacetime economy. The Venezuelan economy has also suffered from hyperinflation, dwindling foreign exchange reserves, high unemployment, and a deeply depreciated national currency.
Venezuela’s oil industry, which has historically been the central pillar of the Venezuelan economy, is in a shambles, and the level of oil production in Venezuela has fallen to historic lows. This sharp deterioration in the health of Venezuela’s oil industry has had profound implications for Venezuela’s overall economic and financial situation, since oil revenues have in the past represented approximately twenty-five percent of Venezuela’s GDP, approximately fifty percent of Venezuelan government revenues, and approximately ninety-five percent of Venezuela’s foreign exchange earnings.
As if the foregoing economic and financial ills were not challenging enough, Venezuela is carrying a staggering debt burden that has been estimated to be approximately $150 billion or more. Unlike the more typical sovereign debt situation where the national government is the primary obligor in question, in the Venezuela case there are two primary obligors that incurred this debt, namely the Republic of Venezuela on the one hand and the state-owned oil company, PDVSA, on the other hand.
Any eventual sovereign debt restructuring promises to be incredibly complex, challenging, and messy. In addition to the sheer size of the debt load that needs to be restructured, there is a huge and widely dispersed creditor body which is likely to make creditor coordination, so critical in restructurings of any scale, a major challenge. There is also a kaleidoscopic array of creditor interests involved, including bondholders, multilateral development institutions, promissory noteholders, trade creditors/suppliers, arbitration award holders, and claimants to blocked foreign exchange payments. The potentially divergent agendas of these various creditors may well give rise to inter-creditor tensions or conflict.
Then there are two very large bilateral creditors to Venezuela, China and Russia, which extended billions of dollars of credit to Venezuela in exchange for Venezuela agreeing to make oil shipments to both countries as Venezuela’s means of repaying the loans. China and Russia could be potential ‘wild cards’ in any eventual sovereign debt restructuring as they may bring certain non-commercial considerations, whether of a geopolitical nature or otherwise, to bear in such a restructuring.
In a new article entitled ‘Venezuela: Prospects for Restructuring Sovereign Debt and Rebuilding a National Economy Against the Backdrop of a Failing State’ published in the AIRA Journal (a publication of the Association of Insolvency & Restructuring Advisors), I explore a wide range of legal and political considerations that Venezuelan policymakers will face in the future if and when they reach the point where it is considered feasible to begin contemplating a restructuring of Venezuela’s sovereign debt and a reconstruction of Venezuela’s national economy. (My new article in the AIRA Journal which is the basis for the current OBLB post covers various topics not discussed in my earlier Venezuelan law review article which was the basis for my prior post on OBLB in August 2020, including topics such as the current political landscape in Venezuela, a pending court challenge to the validity of certain PDVSA debt and a related stock pledge, and the concept of ‘odious debt’ and its potential relevance in any future Venezuelan sovereign debt restructuring.)
To be sure, any eventual sovereign debt restructuring and any future national economic rebuilding agenda may need to await a new Venezuelan government since the current Venezuelan regime headed by Nicolás Maduro is generally not viewed as being inclined to take the steps necessary to execute a sovereign debt restructuring or a program of reconstruction of the Venezuelan economy. But even if the Maduro regime were so inclined, it is not considered likely that the Maduro regime would be able to easily attract the types and (massive) amounts of international support that would be necessary to successfully implement those twin tasks of debt restructuring and economic reconstruction.
Restructuring Venezuela’s sovereign debt will likely involve a broad range of restructuring tools being employed, from the more conventional to the less conventional. For example, it may be necessary to employ some mix of traditional sovereign debt restructuring techniques such as adjusting coupons or interest rates, rescheduling (or reprofiling) debt service payment dates, and/or forgiving a certain amount of outstanding principal. Yet less standard restructuring approaches may also feature in any eventual Venezuelan debt restructuring.
Such potential approaches might encompass, for instance, debt-for-equity swaps involving an exchange of a certain amount of outstanding Venezuelan debt for shares in Venezuelan enterprises or, perhaps even more innovatively, an exchange of Venezuelan debt for development rights in Venezuelan oil reserves (reputed to be the largest in the world) or development rights in Venezuela’s other mineral reserves. (To be sure, any Venezuelan creditor that is considering swapping its Venezuelan debt for oil development rights will need to consider whether global concerns about climate change will affect its time horizon for developing such reserves as well as the overall desirability of developing such reserves in the first place.) In addition, as some commentators have noted, a future Venezuelan debt restructuring might well involve the issuance by Venezuela of ‘oil warrants’ where restructuring creditors would receive an additional payout in the case the price of oil exceeds a certain pre-established benchmark.
Rebuilding Venezuela’s economy will likely involve the Venezuelan government pursuing a multifaceted approach. First, given the centrality of oil to Venezuela’s economy, there will need to be a concerted effort to rebuild Venezuela’s oil industry, and that may require substantial investment—perhaps tens of billions of dollars—from the private sector as well as from international financial/development institutions. To the extent Venezuelan policymakers are hoping to attract foreign private investment, they might wish to consider having Venezuela rejoin the ICSID Convention since this might give foreign investors some much-needed comfort in making their investments in Venezuela, particularly in light of the spate of expropriations that took place in the mid-2000s under the Venezuelan government then headed by Hugo Chavez.
Of course, in considering the prospects for the Venezuelan oil industry and what can be done to revive it, Venezuelan policymakers will need to consider how global concerns about climate change will affect future demand for fossil fuels produced by oil-producing countries such as Venezuela and what the timeline might be for the eventual phasing out of fossil fuels under global climate accords and otherwise.
Second, future Venezuelan policymakers might well consider the need to diversify the Venezuelan economy so that the economy is not overly reliant on a single sector, namely the Venezuelan oil industry. In the past, Venezuela had a much more diversified economy, and the future diversification of the Venezuelan economy might make sense for Venezuela as a hedge against the vagaries of the oil price cycle as well as against the potential for diminished demand for fossil fuels in the future as discussed above. Again, there will most likely be a need for substantial investment to make this vision of a diversified economy a reality.
Third, Venezuelan policymakers might consider strategies for recovering the billions and billions of dollars that have been improperly diverted from Venezuela’s national coffers (including any funds misappropriated from PDVSA).
Needless to say, in effectuating any future debt restructuring and economic reconstruction strategies, Venezuelan policymakers will want to be very mindful of public opinion and the interests of the Venezuelan people. Moreover, Venezuelan policymakers will need to consider carefully the full range of concerns that may be associated with pursuing particular approaches.
For example, if a future Venezuelan government decides that major foreign investment is necessary to redevelop the Venezuelan oil industry (or if it decides to exchange oil/mineral development rights for its sovereign debt as part of a debt-for-equity swap), it will need to ensure that the government would receive an appropriate or fair price for whatever interests it is offering to foreign investors. Otherwise, it might open itself to public criticism that it would be ‘giving away’ the national patrimony at terms that are unfavorable for the Venezuelan government and ultimately for the Venezuelan people.
Similarly, if a future Venezuelan government decides to change limitations on foreign ownership in oil and gas-related joint ventures so that foreign investors are no longer restricted to holding a stake of below fifty percent in such joint ventures or if it decides to change the royalty rates for oil produced by foreign companies, it will presumably want to ensure that it has the support of the Venezuelan public before making any such fundamental changes in existing Venezuelan law and policy.
The article, which can be found here, originally appeared in AIRA Journal published by the Association of Insolvency & Restructuring Advisors (AIRA) and is linked here with permission of the publisher. Shorter versions of this post previously appeared in Columbia Law School’s CLS Blue Sky Blog (May 18, 2021) and the Harvard Law School Bankruptcy Roundtable (July 20, 2021).
Steven T. Kargman, a leading expert on international restructurings, is the Founder and President of KARGMAN ASSOCIATES, New York City.
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