As the war of attrition between Venezuelan president Hugo Chavez and workers on a national strike drones on, a once untouchable giant has begun to totter. Oil production at Petroleos de Venezuela has dried up, imperiling the company's heavily used SPV, PDVSA Finance.

With its $3.6 billion and E200 million in outstanding cross-border debt, a default by the vehicle could bruise many emerging market bond portfolios in the US. Already, rating downgrades are forcing investors into damage-control mode.

"Future investments in riskier assets might suffer," said a manager at a large US insurance company that has a sizable investment in PDVSA Finance notes. "It certainly affects our cost of capital."

While no one sees an imminent default, the picture is certainly grim. Since PDVSA workers went on strike Dec. 2, both the volume of exports and the resulting generation of receivables have nearly evaporated. Most analysts estimate current output to be in the ballpark of 500,000 barrels per day, about 70% off regular levels, while exports are understood to be 60% of that. The company typically pulls in between $600 million and $800 million in export revenue per month.

According to Fitch Ratings, foreign sales hit $125 million in December, barely rising to an expected $200 million in January.

As a result, one of PDVSA's former strengths, a broad receivable base, has vanished, analysts said. The lion's share of exports is now going to Lyondell and Citgo in the US, the latter being a PDVSA subsidiary.

And to add insult to injury, a glitch in processing invoices has held back payments. "About $400 million in receivables in November weren't billed," said Greg Kabance, senior director at Fitch. He estimated that the backlog could run as high as $600 million.

The company needs cash to keep running. According to one estimate, PDVSA needs $2 billion of capital expenditures a year just to maintain production levels. Alas, raising that kind of money this year looks improbable.

The ballooning risk has led the rating agencies to cut PDVSA Finance down to size.

On Dec. 18, Moody's Investors Service stripped the company of its investment grade status, dunking it to Ba1 from Baa2. But the real action came on Jan. 9, when the agency yanked the bonds down five notches to B3. On Jan. 21, PDVSA Finance was cut further to Caa3.

On Jan. 10, Standard & Poor's slammed the bonds down to B- from BB, while Fitch Ratings - the least pessimistic of the three - took them down to BB- from BBB.

PDVSA Finance's next bond payments, on the order of $154 million, are due Feb. 16. However, past debt coverage ratios of 12x to 18x have given the company a good deal of breathing room for the present, and there are indications that the collection account could cover debt service for at least two quarters, analysts said. A liquidity account also holds enough for one payment.

"By our estimates, there would be a technical default [in March] only if there were no exports between now and then," said Ignacio Ponce de Leon, managing director at JP Morgan Securities.

The bank believes there is still time for things to improve before either a technical or payment default takes place, he said.

PDVSA Finance is required to keep the ratio of eligible receivables cash flow to aggregate debt service at no less than 4x on a rolling three-month basis. It is that covenant violation that would most likely trigger a technical default, analysts say.

If Chavez capitulates to demands of an imminent referendum or if the strike dissolves for other reasons, PDVSA Finance will probably emerge from this rough patch. Less bearish analysts note that the opposition is not unified and that all parties involved would be loath to see the company go under.

But the bigger question is whether PDVSA Finance will return safely to investment grade territory and recover the faith of investors, and the signs thus far are not encouraging.

"The risk that the government will stick in its hand has increased," said a source who has worked on PDVSA transactions. Indeed, the Venezuelan government has more incentive now to tamper with PDVSA flows as its revenues go up in smoke, and the overall economy remains in free fall.

The recent imposition of capital controls is yet another potential flashpoint. "We're waiting to see if that requires the repatriation of profits," said Nancy Chu, director at S&P. If that is the case, she added, "the structure will truly be tested."

Finally, other Latin American exporters eyeing the capital markets may feel the repercussions, particularly in those countries with a tempestuous political stage. The possibility of crippling work stoppages "is definitely going to be a risk people will consider now," said one source. That will further throw into question the distance of export structures from sovereign risk, despite the sector's commendable performance in the aftermath of the Argentine default.

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