Trinidad and Tobago: Challenges Ahead
The government has announced an external bond issuance for Q1 2011. We think it’s an appropriate time to review the main credit issues in Trinidad & Tobago; its creditworthiness is closely linked, in the medium term, to the fortunes of its oil and gas sector.
Politics: Growing Pains
After a sweeping victory last May, the People’s Partnership (PP), a coalition government made up of three parties (UNC, COP and TOP) succeeded the PNM in office. The PP government has a comfortable position in parliament, holding 30 out of the 42 seats (Figure 1). As such, it can easily approve bills submitted to parliament. However, as a coalition government, most initiatives have to go through internal discussions which somewhat delay policymaking. For example, after six months in office, the appointments of several boards to several statutory authorities and state enterprises, which are in charge of a significant part of the public sector’s capital expenditure, are facing delays.
The PP’s first few months in office have been complicated by several “skeletons in the closet” left by the previous PNM administration. Chief among those are arrears in VAT refunds and to contractors, the “hot potato” of finding a solution to the Clico saga and the need to adjust wages to public sector unions for the previous three years (2008-2010). We will examine these issues in more detail in the fiscal section. Dealing with these “skeletons in the closet” has distracted the incoming administration from taking on more urgent matters. However, we also suspect that the government is slow not only in making decisions, but also in following up after major policy announcements.
T&T: An Oil & Gas Play, After All
The recent performance of oil & gas production has been mixed. Oil production and exports have been falling for four years running (Figure 2), whereas natural gas production has been steadily rising. Coupled with a relative price increase of oil versus gas, this has paradoxically meant that the gas participation in the tax take is diminishing.
Despite representing almost 90% of the energy complex production, gas only provides 60% of the sector’s taxation. This means that the “marginal buck”, in terms of increased taxation, is likely to actually come from increases in oil production.
Authorities understood this logic, and have announced several changes to the fiscal regime for oil & gas. In a nutshell, the tax changes are likely to promote deep water oil exploration. Industry experts expect higher oil production in a two to three year timeframe; this development would be supportive of T&T’s creditworthiness.
However, the market is concerned with T&T’s declining natural gas reserves, particularly given strong production (Figure 3). As 2011 is set to start, the proven reserves-to-production ratio stands at 8 years, down from 19 years in 2004.
According to industry experts, a proven reserves-to-production ratio between 8 and 12 years is healthy, and can be maintained with “exploration and appraisal drilling with resource pull-through generally offsetting production” (Energy Committee, Trinidad & Tobago Chamber of Industry and Commerce).
We remain bullish on the outlook for the natural gas sector in T&T. While there is oversupply now, the country is a low-cost producer, as infrastructure (pipelines and downstream) is already built and paid for. The regulatory framework is appropriate and the “rules of the game” are respected. We expect industry players to begin replenishing reserves a few years before they need to renew their long-term delivery contracts; the major renewals are due in 2018-19. Starting to replenish reserves now would be uneconomical and actually won’t constitute optimal reserves management.
Despite the recent positive performance of the energy sector, non-oil output remains in the doldrums; it has now contracted for six quarters running (Figure 4). Unemployment remains high, domestic credit is just turning positive (led by strong mortgage lending) and local confidence remains low. As such, we expect GDP growth of 0.6% this year and a further recovery to 2.5% next year; the government expects GDP growth of 2.5% and 2% in 2010 and 2011, respectively.
Authorities typically build some cushions in the budget at the time of its formulation and are usually achieved by using conservative estimates for oil & gas prices. For example, in the 2009/2010 fiscal year (which ended last September), at the time of the budget exercise a year ago the authorities projected a deficit of 5.4% of GDP. However, as per the most recent projections included in the FY 2011 budget, they revised down last year’s deficit to 3.5% of GDP, as energy-related revenues came in stronger than budgeted. We estimate an even lower deficit of 2% of GDP, as the new authorities reined in fast expenditure by the outgoing administration (Figure 5).
Something similar is likely to happen in the current fiscal year. Not only is the oil price likely to come in higher than budgeted (WTI at $65/barrel), but we also expect authorities to keep primary expenditure under control, running a neutral fiscal stance. Authorities have publicly complained about the previous administration’s lack of fiscal discipline and, as such, are intent on building their own credibility. At the Central Government level, authorities tabled a budget with a 5.5% of GDP deficit. However, we project the shortfall at 1.9% of GDP, led by higher energy revenues and under-execution of public spending. As such, we expect another contribution to the Heritage and Stabilization Fund, which we estimate stands at $3.3 bn (16% of GDP) at the end of 2010.
We expect the Republic to have no problem filling its financing gap for the current fiscal year (Figure 6). The local market is flush with liquidity, as deposit growth stays strong and local credit is just turning the corner. But still the sovereign seems intent on returning to international capital markets, from which it has been absent since 2007, reportedly with USD 500 mn.
After significant deterioration in its debt-to-GDP ratio in 2009-2010, we envision the sovereign returning to more normal debt levels (Figure 7). Authorities are making a major effort to bring under control the capital expenditure by statutory authorities and state enterprises, the main culprits of the fiscal deterioration witnessed since 2009.
Several “skeletons in the closet” inherited from the PNM administration are likely to show up in increased government indebtedness down the road. The settlement of arrears in VAT refunds and to contractors, which amount to 5% of GDP, are likely to put pressure on fiscal accounts in the short term. But the continuing Clico saga is likely to strain accounts further in the medium term: The government is including in the current budget a cash payment of TTD1.5bn, while issuing TTD10.5bn (7.6% of GDP) in zero-interest 20-year bonds as compensation to Clico’s depositors. And the Central Bank had already extended a loan of TTD 5 bn (2.6% of GDP) to Clico when this fiasco came into the open back in January 2009. The Cabinet would send a signal of fiscal rectitude if it can stick to Finance Minister Dookeran’s proposed solution. Another “hot potato” relates to the wage negotiations with public sector unions, relating to the previous three years.
T&T is now trading comfortably inside Costar, having traded flat to it only six weeks ago. And it is currently trading just wide to Panama. Despite a higher rating, small issue sizes justify a liquidity discount versus Panama. As such, we view T&T as being fairly priced to slightly cheap.
We are of the view that investors should get involved in the upcoming issuance, particularly if, as expected, authorities launch a benchmark-size transaction and pricing is attractive. T&T is the only commodity play in Central America and the Caribbean, and is an interesting diversification play in a global/EM bond portfolio.