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The risk profile of Venezuela is set to deteriorate, particularly for private companies looking to operate in the country. But there are deals to be done for those armed with tightly structured contracts and nerves of steel. Eleanor Wragg reports.

Venezuela, with its vast oil reserves, large domestic market and rich natural resources, should, by rights, be an enticing destination for international trade and investment. However, political and economic risks including an increasingly interventionist government, expropriations of assets and a shortage of foreign currency, have turned the country into one of the most daunting places in the world to do business.

As one Latin American insurer puts it: “We see Venezuela continuing to deteriorate. We have taken some risk and we’re very nervous because everywhere we look there are issues. Venezuela is a big claim waiting to happen.”

Despite, or perhaps because of, the high risk, trade with Venezuela continues to prosper for certain companies and sectors, although some are having to use increasingly more creative mitigation strategies to deal with a raft of threats.

Since 2007, the Venezuelan government has been on something of an expropriation spree, nationalising assets in the petroleum, tourism, agribusiness and banking industries. In August 2011, the gold industry became the latest part of the economy to be put under state control. Last year alone, a total of 537 properties or businesses were nationalised, topping 2009’s figure by 34%. Although the Venezuelan government maintains that it will compensate for nationalisations, this seldom occurs.

“Venezuela is the only country in South America that is red on Aon’s political risk map, and it’s red for a reason,” says Keith Martin, director of trade and international investment at Aon risk solutions.

“But one of the things that international investors can do is insist on including international arbitration clauses.”

Today, there are 23 cases against Venezuela before the World Bank International Centre for Investment Disputes (ICSID). Another pitfall facing potential investors is the Foreign Exchange Administration Commission (CADIVI)’s exchange rate control.

“The most striking feature regarding President Hugo Chavez’s policymaking is that he has just tried to turn the clock back. Venezuela today in a nutshell is Latin America in the 1960s, when exchange rate control was the norm,” says Carlos Caicedo, head of Latin American forecasting for Exclusive Analysis.

The controls were introduced in 2003 after a major strike hit Petróleos de Venezuela (PDVSA), resulting in serious capital flight. “A savvy policy maker, once the crisis had passed and oil prices are about US$100 a barrel, would lift the exchange rate controls and allow the economy to go back to the normal environment, but Chavez never did that,” says Caicedo.

“Even at the peak of the oil boom, when PDVSA was earning record oil revenue, they never considered lifting exchange rate controls. I think they realised very quickly that by having exchange rate controls you have an additional tool to punish any company that doesn’t follow government policies.”

In 2007, lengthy dollar approval delays at the controlled rate by CADIVI meant that Venezuela’s banks ran up against their credit limits, and stopped issuing letters of credit. Today, many banks will confirm new letters of credit obligations only as others are liquidated, and some have reduced or terminated their credit lines for confirmations. Many payments for non-essential products can be delayed by eight months to over a year.

To overcome this, companies have begun to structure their contracts differently. “The main risk mitigation these days is innovative structuring, because there is very little political risk insurance available in the market. This covers two aspects. The first is to either have a large portion of the contract prepaid or to split the project or sale into small sub-parts, only beginning work on the next part when payment in dollars has been received off-shore,” says Aon’s Martin.

“The second is to use official Brazilian sources for financing, particularly BNDES, Brazil’s development finance bank, which continues to be open for Venezuela. The sense is that Brazil continues to have a close relationship with Venezuela. This is reflected on the business side, where Brazilian companies, generally speaking, enjoy a somewhat more privileged, safer environment than some of their counterparts from other countries.”

Another alternative that has emerged is bartering goods and services for oil, which is encouraged by President Chavez as an alternative to capitalism. This avoids currency issues, but potentially exposes companies to the vagaries of oil prices.

“China has been happy to lend Venezuela as much as US$32bn so far in the knowledge that Venezuela will pay back with oil. Russia would also be happy to do that because they are after contracts in the Orinoco belt, so the situation is not as desperate for Venezuela as many people think,” says Caicedo at Exclusive Analysis.

Evidently, the risks involved put trade with Venezuela out of reach for many private companies, although country-backed and parastatal deals are increasing. “We are seeing an increase in the kind of bilateral agreements in which businesses push their governments to talk to Chavez directly. For example, it appears that the Colombian central bank and the Venezuelan central bank are dealing with debts for trade. The same is happening with Ecuador and Argentina. I believe that it’s going to be more and more a question of bilateral agreements, government to government, trying to support their own businesses to get the payments done,” says Caicedo.

“It’s still profitable to be in Venezuela even though there are high risks of the rules changing. The risk for the oil sector is lower compared to construction or food because the rules have already changed, and it’s less risky that it will change in the future, so that’s why you see companies like Italy’s Eni coming back,” says Paula Diosquez- Rice, senior economist at IHS Global Insight.

For companies with a large enough risk appetite, the opportunities for trade are numerous, as the country’s limited manufacturing capacity means it also relies heavily on imports to satisfy customer demand.

“Venezuela is interesting because the flip side to Chavez’s social programmes is he’s enabled a new class of people to consume more products. Some clients have told me that one of the most successful markets for consumer goods for them is Venezuela,” says Corina Monaghan, vice-president of political risk services at Aon.

Other promising sectors include power generation, infrastructure, telecommunications, education and training and healthcare. Despite these available opportunities, the country still relies heavily on the oil sector, which accounts for 95% of its export earnings.

These earnings took a hit earlier this year when the US imposed sanctions on PDVSA for violating the Iran embargo.

“The PDVSA sanctions issue has been quite a shock for the market, because PDVSA was one of the best risks,” says Monaghan. “There was no doubt that Venezuela infringed the Iran embargo. There was a lot of noise in Congress and Hilary Clinton had to do something, so the US took symbolic measures,” says Caicedo.

“The reason the US will not go beyond that is because there are US companies operating in Venezuela, so to go into an economic war and to tighten the sanctions will damage the interests of a good number of US companies. Nonetheless, PDVSA is looking to diversify.”

As well as intensifying intraregional trade, the company is looking to strengthen its ties with Asia. But this diversification comes at a price. “While it takes a week for a tanker to go to Houston, it takes three weeks to go all the way to China or Japan, and I would be surprised if Venezuela wasn’t paying part of that cost.

On some of those deals you might see that Venezuela is accepting a slightly smaller profit. It’s a great deal for China, Japan and Italy to get in on the action,” says Daniel Linsker, senior manager of global services in the Andean region for Control Risks.

It seems unlikely that Venezuela will change any time soon. Despite his illness, President Chavez has insisted that he is well enough to run for re-election, and so far is off to a good start in his bid to secure another six-year term. With approval ratings over 50%, a Moody’s country report says: “He will also be helped by the opposition’s decision to wait until February of next year to organise a primary to select a presidential candidate, which coupled with President Chavez’s likely decision to bring forward the election as he has been prone to do before, will give the eventual opposition candidate too little time to generate enough visibility to effectively challenge Chavez.”

“President Chavez is a certain risk, in the sense that he’s already, for the most part, clearly demonstrated what he will and will not do. He is somewhat pragmatic and also has been consistent in moving, wherever possible, away from Venezuela’s traditional trade and investment partners in Europe and the US towards those from the BRICs, especially Brazil and China,” says Aon’s Martin.

“As an outlook, we see more state backed trade and finance going in, as well as some private companies still trading if they get around the payments issue,” adds Linsker.

As such, although trade with the country is certainly not for the faint-hearted, Venezuela and its petrodollars still offer an enticing return to those who are creative enough to work around the risks. GTR