El Salvador’s Volcano Bond Will be Issued by a Tiny State-Owned Energy Company, Not the Government

Why is nobody talking about this game-changer?

I wrote about El Salvador’s upcoming bitcoin-backed ‘volcano bond’ sale a few times before. Basically, I argued that it doesn’t make much sense. Using half of the billion-dollar issuance to buy bitcoin is risky and the country can’t afford new infrastructure for the half-baked bitcoin city when on the verge of insolvency. Also, the volcano bond will be governed by El Salvador law, not New York law, which is concerning given that President Bukele just packed his country’s supreme court. Lastly, bond funds and pensioners might be interested in a plain vanilla bond, and speculators might be interested in the bitcoin ‘dividend’ (effectively call options on BTC), but there’s little obvious overlap between the two groups.

In any case, Bukele is selling to crypto diehards on the Bitfinex exchange, not to Wall Street, so his bet is that none of this matters. I also joked that Bukele could use the volcano bond and crypto in general to engineer a huge market selloff and re-purchase the country’s vanilla bonds for cents on the dollar, wiping out up to 10% of GDP in debt. 

The volcano bond is supposed to be issued this week (although it could be pushed back due to market conditions). In anticipation, the FT ran a piece with incredible new information. Apparently, the volcano bond won’t be issued by the government of El Salvador but “by state thermal energy company La Geo” instead. This raises important questions we need to talk about (!!!), starting with –>

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What is LaGeo?

It’s a tiny energy generator. According to their website, LaGeo produces 204MW or about 22% of El Salvador’s electricity with geo-thermal plants. El Salvador has just 6.5 million people, and it consumes about as much electricity as India on a per-capita basis, so the company doesn't do a lot of generation.

According to the 2021 financial statements, its revenues were $136 million last year and it booked a profit of $36 million. LaGeo has $773 million in assets, but around half are (illiquid) long-term loans to electricity distributors in El Salvador. Only $257 million are tangible assets, mostly the Ahuachapán plant near the border with Guatemala (founded 1975, 95MW) and the Berlin plant in the east (founded 1992, 105MW).

LaGeo also has $200 million in long-term debt outstanding from a 2014 deal where they securitized and sold part of their future cashflow. LaGeo isn’t rated by Moody’s or S&P, but local rating agency Zumma says in their June 2021 report that the company had to defer principal and interest payments for 24 and 6 months respectively because of COVID.

Given these numbers –>

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Can LaGeo repay a billion-dollar bond?

Ummm, no.

Basically, the volcano bonds will generate $65 million in annual interest payments (6.5% coupon x $1 billion), which is about half of LaGeo’s total revenue. The company’s annual interest expenses would jump from $15 million per year to $80 million per year (+430%), turning its healthy profit of around $35 million into a loss of $30 million. LaGeo’s long-term debt would also rise from $200 million to $1.2 billion (+500%). 

The company just doesn’t have the size or cashflow – like even remotely – to pay the interest on the volcano bond, never mind the principal in ten years. So the plan must be … for LaGeo to get transfers from the central government every year to fund Volcano bond interest payments (?).

In that case –> 

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Why is LaGeo issuing the volcano bond instead of El Salvador’s government?

Maybe it makes sense on some conceptual level? LaGeo does produce geo-thermal energy, and the marketing for the bond is all about extracting energy from volcanoes to power bitcoin mining, so there’s a link? ¯\_(ツ)_/¯. Jokes aside, there are more realistic explanations.

First, if LaGeo issues the Volcano bond, El Salvador can default on the rest of the sovereign debt without hurting Volcano bondholders. As I wrote recently, Bukele’s ability to pay the country’s $7.7 billion dollars in bond debt in the short and medium run is an open question. Increasingly, Bukele’s willingness to pay is also in doubt. If Bukele stops paying traditional bondholders, he can continue paying the crypto bondholders through LaGeo and crucially, he can continue tapping the crypto community for further financing.

Second, if LaGeo issues the Volcano bond, it’s really easy for El Salvador to just walk away with the money in what would be the first (quasi-) sovereign “rug pull” in crypto. Why? Because if LaGeo goes broke or disappears, then as a bondholder, you would have little recourse, no good ways to recover your investment. You could sue LaGeo in El Salvador and push for a bankruptcy proceeding or debt restructuring, but it would be led by god knows what court and judge, and would get cents on the dollar, if anything. Having LaGeo issue the Volcano bond makes a rug pull even easier.

Anyways, enough speculation. What does the bond prospectus – the document with all the key legal and financial information – say about all this? –>

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Well actually…

There is no prospectus? The bond is supposed to be issued this week but I can’t find any official documentation anywhere. LaGeo’s website, LaGeo’s page on El Salvador’s securities exchange, bitfinex’s webpage and blockstream’s website don’t have any documents. 

None of the press articles I have linked here or read mention any official documents. We still only have the absurd pictures of Bukele standing in front of a powerpoint slide in a leather jacket from last November and scattered statements from government spokespeople and bankers.

Ladies and gentlemen –>

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Welcome to the future of finance

Crypto commentary on reputable sites like CoinDesk sometimes describe the Volcano as “the most truly disruptive and empowering part” of El Salvador’s adoption of bitcoin, which is “the most transformational cryptocurrency landmark in a year full of them.”

“By selling bitcoin-backed bonds through blockchain infrastructure” this CoinDesk author writes, “El Salvador will bypass the Wall Street banks and international institutions that have had a century-long choke hold on loans to developing economies.”

That sounds great, but I still have questions. What infrastructure does bitcoin city need and how will it generate revenue for LaGeo to repay the debt? What happens if LaGeo misses debt repayments? Isn’t this self-described ‘bond’ a security that should be subject to regulation in virtually all jurisdictions, including the U.S.? If Americans are banned from using bitfinex, will there be enough buyers when the volcano bond is issued? Who has the keys to the $500 million bitcoin wallet? What happens if it gets hacked, is there insurance? Is interest payable in USD, USDT or bitcoin? What’s the formula for the bitcoin dividend? 

There aren’t words on PDFs that answer these basic questions, not yet, perhaps not ever. Instead, we are expected to be hyped about this ‘historic opportunity’ even though the legal framework that will govern the instrument still hasn’t gone through El Salvador’s congress and no draft versions of the laws have been made public. We are supposed to be pumped even though we learned the weekend before the issuance that a small state-owned enterprise you’ve never heard of will sell the bond rather than the government, as was widely expected. 

And we’re supposed to believe that this is better than the traditional financial system? It’s a joke…

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