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Energy bonds of emerging markets now shaky bets

Bond yields of government-linked Petrobras, Pemex and Gazprom spike as oil prices dive
Saturday, December 20, 2014 - 05:50
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OIL WOES: A gas station operated by OAO Gazprom Neft in Moscow, Russia (above), and a protest this week against corruption at the Petrobras headquarters in Sao Paulo, Brazil.
BT_20141220_WORRY20A_1421342.jpg
OIL WOES: A gas station operated by OAO Gazprom Neft in Moscow, Russia, and a protest this week against corruption at the Petrobras headquarters in Sao Paulo, Brazil (above).

THEY were the darlings of global investors.

Petrobras in Brazil. Pemex in Mexico. Gazprom in Russia. The biggest energy companies in some of the biggest emerging markets sold billions of dollars of bonds to investors eager to capitalise on the high interest rates.

As the price of oil plummets and local currencies plunge in value, those bonds are looking shaky.

And concerns are now mounting that their troubles will unleash a new wave of market contagion as big funds unload their stocks, bonds and all manner of investments in these countries.

The precipitous fall in the Russian rouble - and the collapse of the country's bond and stock markets - has already rattled investors, sparking a sell-off in Mexico and Brazil. Like Russia, these countries also relied on cheap money to bankroll their energy investments and fund their growth.

Economists have warned of broader economic ripples if large, state-run companies like Petrobras and Gazprom are cut off from the bond market and lack alternative financing options. Investments will slow, growth will come to a halt, and currencies will weaken - leading to corporate defaults and further investor unease.

With investors selling Gazprom bonds and other Russian securities, emerging-market analysts say that the pressure has already spread to Petrobras, which is enmeshed in a corruption scandal, and to Pemex, where the fear is that the oil-price collapse will lead to a serious slowdown in Mexico.

The bond yields of all three companies, which move in the opposite direction of their underlying price, have spiked in recent days.

The bonds and currencies in non-oil producing countries like Turkey, India and South Africa have also suffered, a sign that investors have broader anxieties about emerging markets. Such countries have been especially dependent on foreign capital flows to fund their growth.

On Tuesday, the Turkish lira hit a record low against the dollar.

The Federal Reserve - and its shift away from stimulus - is only adding to the tension. The Fed is expected to increase interest rates as the US economy continues to gain strength. As a result, the dollar is likely to keep gaining value relative to the Brazilian real, the Mexican peso and the Russian rouble. That doesn't give global investors much incentive to invest in these countries.

"There is a whole feedback loop here," said Daniel Tenengauzer, an emerging markets expert at RBC Capital Markets in New York. "Emerging markets are clearly a problem. The dollar is going higher, and everything else is going lower."

While Gazprom bonds have been popular among bond investors, Mr Tenengauzer pointed out that the bonds of Petrobras and Pemex are even more widely held. As a benchmark, he cited BlackRock's exchange-traded fund that invests in these types of securities. Petrobras and Pemex are the top two holdings in the fund, accounting for 9 per cent of total assets.

"Brazil worries me because it is systemic," Mr Tenengauzer said. "The selling in Petrobras can also lead to selling in Pemex."

The yields of Petrobras 10-year bonds have moved up to 8 per cent, from 6 per cent, this month. Similar Pemex bond yields spiked to 4.8 per cent from 3.8 per cent. For securities that are so broadly held, these are very sharp moves, bond traders say.

A number of regulators around the globe have argued that bonds, by their nature, are harder to sell than stocks. And within the emerging markets, corporate bonds are among the most difficult to sell.

The dynamic can create a domino effect if a selling panic does arise. For example, a mutual fund manager may not find a buyer for his Gazprom bonds, which have been losing value in the face of turmoil in Russia. So instead, the manager may decide to sell more liquid Pemex bonds to meet redemption demands from nervous retail investors. All of which can lead to contagion if such behaviour spreads to other investments and other countries.

The debt issued by Petrobras, Pemex and Gazprom can be found in the portfolios of bond investors worldwide. The rock-bottom interest rate environment of recent years has made high-yielding bonds from Petrobras, Pemex and Gazprom especially attractive. At the same time, these companies, which are largely controlled by their governments, made significant outlays, on the assumption that oil prices would remain fairly high.

In the past, these companies may have turned to global banks to fund their ambitions. But with big banks less willing to make risky bets following the financial crisis, the oil giants turned instead to the likes of BlackRock, Pimco and Franklin Templeton, among others, via a spate of bond offerings.

Since 2009, Petrobras, Pemex and Gazprom (along with its eponymous bank) rank No 1, 2 and 3 in selling emerging market bonds to investors - US$140 billion in total, according the research firm Lipper. During this period, emerging market companies overall sold US$1.7 trillion bonds, a benchmark high.

Petrobras has been the most vivid example of this bond frenzy. It sits on US$170 billion in debt, making it by some estimates the most indebted company in the world. Like its Brazilian counterpart, Pemex, too, came to rely on global bond investors.

And Russia - even with all its political risk - has also been able to steadily tap the global bond market over the years. Lipper calculates that Russian companies such as Gazprom, Rosneft and its major banks, among others, have sold US$244 billion worth of bonds since 2009. By comparison, the Russian government has been fairly prudent, issuing just US$55.6 billion.

Now investors are realising just how risky these bonds are. Some of the issues are specific. Prosecutors in Brazil are cracking down on Petrobras over allegations of corruption. Russian energy giants are dealing with the fallout from Western economic sanctions over the Ukraine crisis.

And they are all dealing with the steady and deep drop in oil prices. Oil, which topped US$100 a barrel this summer, is now less than US$60.

Few mutual funds have rode the ups and downs of the market like Pimco's Emerging Market Corporate Bond Fund. Started in mid-2009, the fund's assets soared to US$1.5 billion in late 2013, making it the largest offering of its kind for retail investors.

But its success was largely driven by dominating positions in Mexico, Brazil and most starkly Russia - which, as of the end of September, accounted for 23 per cent of the portfolio. As performance has sagged, investors have quickly withdrawn their cash, pulling out US$237 million in November alone. Pimco declined to comment.

The fund's assets currently stand at US$496 million, suggesting it can't weather too much more. NYT