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Considerations for Oil & Gas Expats in Brazil

Several regions in Latin America have been either temporary or longer-term homes for expatriates in the oil and gas industry, for example, Rio de Janeiro, Ciudad del Carmen and Maracaibo.  Given the mobile lifestyle of the typical O&G Expat (let’s abbreviate to OGE), we believe they would reap the benefits of taking independent financial advice.  

Whether a seasoned senior management OGE who has lived in multiple locations or a younger executive on a first overseas assignment, we discuss some of the financial considerations affecting OGEs along their careers. 

1. Currency of package 

Several countries in Latin America have experienced macroeconomic volatility and rapid political change which have affected their exchange rate stability.  Some OGEs earn their salaries and bonuses entirely in hard currency and receive some benefits in local currency e.g. accommodation, health plans and meal allowances.  In some cases, although less common, OGEs receive their salaries in two currencies, which we believe is a ‘safer’ package but it depends on the policy of their employer. 

This graph below shows the British Pound against the Brazilian Real since 2005.  Imagine the case of an OGE who accepted a contract weighted towards GBP at the beginning of 2008. Apart from a few months following the Great Financial Crisis (Q4, 2008), their purchasing power in Brazil would have been significantly weaker over a 3 to 5 year period given that £1 could buy 3.40 BRL in Q1, 2008 and only 2.50 BRL in Q1.2011).  Such a salary contract (in GBP) would have been desirable if it were signed in 2013 until the end of 2015.   

GBP BRL currency chart, 2005-2022

2. Switching from international to local contracts

During the oil price decline from 2014 to 2016, many OGEs were offered an opportunity to retain their employment and location if they switched to a local contract.  A local contract means the employee would receive their salary and bonus in the currency of the country of assignment and may lose some benefits like an accommodation allowance and school fees for children.  

In the case of a middle-aged primary breadwinner and non-working spouse with two or more children, the switch to a local contract would, in most cases, have been too much to absorb. It would depend on other opportunities in the market elsewhere, especially during a recession, but the additional costs of taking out private health insurance, renting an apartment of a similar standard and paying for school fees at an international school would be a game-changer for most families.  Often, the expat benefits package (excluding salary) has a much higher monetary value than the salary itself.

An unmarried employee (with no dependents) would enjoy more flexibility and may choose to accept the switch although as mentioned in point 1, they would be facing higher currency risk if their reference currency were USD, GBP or EUR.   We observed cases of single expats who chose to stay in Brazil purely for social and lifestyle reasons whilst some others were willing to accept a redundancy package and procure a higher paying job in a new country or return to their base country.

Assume the case of switching from a GBP-denominated contract to BRL from 2019 to 2021 or a USD contract to COP (Colombian Peso) in the same period, when several emerging market currencies fell sharply against hard currencies.  In practical terms, the ‘switched OGE’ would still, most likely, enjoy a reasonable income and lifestyle domestically but it would reduce the potential to accumulate wealth in hard currency. 

Any such offer to switch to a local contract should be critically assessed and modelled with all additional costs, the total effect on net income and at least a 20% exchange rate swing.  

USD COP currency chart, 2018-2022

3. Asset consolidation

After several assignments, usually a combination of expat and domestic, we find that many senior managers and directors have been so busy working, travelling and attending to family needs, that their personal financial planning has taken a backseat. 

This brings back memories of meeting financial executives at energy companies who could model an investment payback on a multi-million-dollar oilfield project yet remain distant and disorganised about their personal finances which were scattered in various accounts across countries in which they had worked.  In many cases, they had entrusted their savings to unscrupulous salespeople who abandoned the promise of periodic service; a familiar and unfortunate story on the expat circuit.  

We have discussed consolidation in previous articles and videos. It is important to streamline your personal finances and benefit from lower administrative costs and a more strategic approach to wealth management.  Consider the hurdle rate to generate a real return when inflation and fees are aggregated.  Read about the benefits of consolidation in point 9 here. 

4. Too much dependence on company shares

We should all take a lesson on prioritising our personal long-term financial stability ahead of excessive loyalty to our employers.  Many employees of companies have been hardwired to believe that their companies’ share prices will always follow an upward trajectory.  Employee incentive schemes are usually favourable and it is generally wise to participate in profit-sharing and share option schemes. 

However, with your additional savings, please focus on diversifying into other sectors and asset classes and be fully aware that your company’s stock market performance could affect a large percentage of your wealth.  

If you are working in the oil and gas or mining sectors, you will be aware of commodity price volatility which inevitably leads to cyclical swings in the share price of your company.  

Let’s take BP (London-listed) which was trading at 586 pence in Jan 2010, 466p in Jan 2013 and 376p in Jan 2016.  On 19 Sept 2022 (date of this article), BP trades at 452p.  Have a look at other companies across all categories of energy and I am sure you will conclude that it is indeed cyclical and that you cannot rely on allocating a large percentage of your wealth to just one sector to provide a retirement income for 20-30 years or to meet other lifestyle goals. 

5. Becoming a contractor

Given the cull of expat jobs across the oil and gas sector in Latam, many consultants and engineers have resorted to becoming contractors.  Contractors generally earn higher daily rates but face the risk of empty unremunerated periods and do not receive the long-term benefits applicable to payroll employees. 

Depending on the jurisdiction and payment currency of their clients, contractors may be required to set up an offshore company and/or a local company in their country of residence which requires specific knowledge and administration time to manage company accounting and periodic filings.  

When choosing an offshore jurisdiction for your invoicing company, it must satisfy several criteria such as being tax-compliant in your country of residence, cost-effective in terms of annual fees and acceptable for your principle clients because some large companies prohibit payments to certain jurisdictions.  

Many company formation agents will happily offer you a cheap offshore company with low set-up and annual fees. Remember, you get what you pay for. We strongly recommend that you make this decision in conjunction with tax advice. You should know how to declare the new entity, the income tax implications and how to structure the company for succession planning.

Disclaimer:  We are providing guidance and personal opinions which should not be interpreted as specific investment advice.  

If you work in the oil and gas sector and would like to discuss any of the above topics, please contact us here.  

Many thanks to Rawpixel.com for the image and cover photo and to Yahoo Finance for the currency charts. 

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Financial Decisions in Times of Coronavirus

 

Let’s discuss how to structure our decision-making during this coronavirus uncertainty.

In our monthly breakfast seminars – Financial Markets Café – we often ask our guests to highlight what they consider to be potential geopolitical risks and triggers of market volatility.  This became increasingly important in 2018/2019 during the late stage of one of the longest bull markets in history.  We discussed the usual suspects such as Brexit, EU fragmentation, North Korea tensions and US-China trade wars.  However, a global pandemic in the foreseeable future was hardly a key talking point!

Disclaimer:  We provide guidance and personal opinions which should not be interpreted as specific investment advice!  Figures quoted up to 30 March 2020.

FINANCIAL MARKETS

March 2020 will be remembered as one of the most turbulent months in the history of global financial markets.  The rapid spread of coronavirus and governments’ actions, such as monetary stimulus and travel bans, have prompted the natural instinct of many investors to reduce their exposure to equities and other risk assets.  The oil price war between Saudi and Russia, resulting in the price per barrel reaching its 18-year low point, was a major factor in the market sell-off.

A lot depends on the strategies of governments and the ability of their health services to cope with the volume of cases.  Investors – individual and institutional – are trying to make decisions based on multiple factors and a plethora of asymmetric information hitting our news channels and social media in real time.  In times of extreme uncertainty, we are observing panic-selling and opportunistic buying which result in high price volatility.

The financial shock is comparable to the 2008 financial crisis although we still have a long way to go before we are able to interpret the ongoing impact of coronavirus and the lockdowns.

The rapid movement of capital has generated extreme currency swings, whereby hard currencies, especially the USD have strengthened against emerging markets.

VOLATILITY

The VIX index measures expectations of volatility 30 days out.  The average daily closing price in 2019 was 15.4.   So far, in 2020, the average is 31.2 and in the second half of March, it fluctuated between 80 and 50.

1 year VIX chart. Source: CNBC

Normally, a daily swing of 4% to 5% would be considered extreme but such swings have been recorded on a near-daily basis over the last month.  The S&P 500 recorded its worst quarter since 1987, down 20% from its peak, and last week, the S&P 500 increased by 20% from its recent low point on Mon (23/03) to Thur (30/03).

REVIEW YOUR PORTFOLIOS AND DO NOT PANIC-SELL

Higher risk, equity-heavy portfolios will have felt the full brunt of the recent crash.  Even low and medium risk portfolios will have felt the impact as they hold a variety of ‘risk assets’ such which were affected by the sell off.

Financial loss (and gain) often create emotional reactions.  Imagine how first-time stock market investors in Brazil would be feeling after entering the stock market for the first time in 2018/2019. The interest rate (Selic) has fallen steadily from 14% (2016) to 3.75% (March 2020) whilst the hope of reforms (pension, taxation etc) encouraged many individuals to move away from fixed income and into equities.  After reaching a record high on Bovespa, Brazil being the top emerging market equity performer in 2019, investors subsequently endured a sharp decline with Brazil falling by a much greater percentage than the global average.

Ask yourself whether you really need to withdraw money from your investments in the short-term if this means crystallising losses.  Preferably, draw cash from your bank account or a near-cash source such as a money market fund.

Ensure you set aside an emergency fund.  This applies even more to self-employed individuals and those facing less job security.

Review your portfolio, line by line, preferably with an experienced professional, and decide how to rebalance strategically.  If you are approaching retirement or in pension drawdown, then your advisor will need to rebalance your portfolio and recalculate your cash flow – and potentially, recommend adjustments to your personal spending, at least in the short term.

Some investors may prefer to wait for a recovery outright without adjusting their portfolios.  Others may decide that it is worth crystallising certain losses and using the available cash to purchase other funds which they believe have a higher upside.  After the 2008 crash, many banks share prices declined and flatlined for years while many large tech companies grew above the market average over a decade long bull market.

Global equities and corporate bonds. Source: Quilter

The above graph shows the benefit of having a greater share of equities in your portfolio if you are investing for the long-term.  In theory, you should de-risk the portfolio accordingly as you approach retirement or another target date such as paying for children’s education costs.

We have all read the disclaimers about past performance being no guide to the future . However, financial markets are always volatile in the short term and have grown in a more steady manner over longer periods despite geopolitical shocks e.g. surprise election results and regional conflicts.

IS THIS A BUYING OPPORTUNITY?

Theoretically, yes, if you have the appetite for more fluctuations over the coming weeks and months.  You may have heard analysts discussing V, U and L shaped recoveries:

V – sharp fall followed by a rapid recovery

U – a period of market plateau followed by eventual recovery

L – not really a recovery, just a long-term plateau or slow growth

Some analysts believe that markets have undershot reality, due to mass panic-selling, whilst others believe there is more downside on the horizon.  As per the introduction, with so much information flying around, we are bound to hear conflicting opinions (even in periods of stability!) and many ‘expert commentators’ are basing their views on their own emotions or their biases to certain fund managers or investment banks.  A US equity fund manager making an appearance on CNN is hardly going to discuss the potential of  emerging market bonds, right?  And I wonder what asset class a property fund manager will tell you is the best investment whether we’re in the middle of a credit crunch or a boom…

A common and safer strategy is to phase your money into equities and other risk assets over time; buying a selection of funds at regular intervals at different price points and taking a long-term view.

FTSE 100 chart

The FTSE 100 is truly a global index with some of the world’s largest banking, energy,  mining and pharmaceutical multinationals.  It reached 7,778 points, its record high on 18 May 2018 and suffered a sharp fall to reach 5,563 on 30 March, partly due to panic-selling.  Step back from the numbers and consider the operations and scale of the constituent companies like  BHP, HSBC, Shell and Unilever.

Demand will eventually return and stabilise slowly once lockdowns come to an end. We expect many companies to undertake restructuring having learnt valuable lessons from this crisis. Only time will tell how effective the stimulus packages are on consumer demand and company balance sheets.

There may be a lot more bad news to come and indeed, it could fall below 5,000 again (it did temporarily in the 3rd week of March) but consider the strategy of phasing money into the market over time – whether you buy ETF trackers, investment funds or direct shares.

The same advice applies to Brazil and the potential buying opportunities of shares and funds.  Current accounts and CDBs are paying less interest than ever and therefore you would benefit from a diversified portfolio and phasing some of your cash into the market with a long-term view.  There are other interesting asset classes in the fixed income and multiasset categories.  On a final note, I mentioned the concept of portabilidade for private pensions (previdência privada).  Now would be a good time to review your previdênciaprivada and potentially migrate to another provider whilst adjusting the asset allocation.

WHAT ABOUT CURRENCY?

Two questions which I’m hearing more frequently:

  • “Is it a good time to send money to Brazil?”
  • “Shall we get our cash out of Brazil as the Real (BRL) is tanking?”

Answer in most cases:  “It depends on your needs, the urgency and purpose of the transfer”.

If you have cash in USD and want to build up cash in BRL or buy a property – yes, absolutely transfer money into Brazil.  Could USD/BRL go from 5,2 to 6,0?  Possibly, who knows?  It depends on many factors like interest rates, government policy, speculation, coronavirus data etc.  Trying to time the exact moment is a risky game.   The property you want to purchase in Brazil has became at least 25% cheaper over the last year in USD terms.  You would have gladly taken 5,2 when it was 4,0 last year, right?

USD/BRL chart. Source:  Bloomberg

Fact – the Real is a volatile currency.  As per the graph, USD/BRL was 3,1 in 2017 with less volatility then 2019/2020.  In times of crisis, emerging market currencies tend to weaken given the flight of capital to safety, notably US treasuries.

A client decided to transfer his BRL to Sterling (GBP), taking a painful hit on the exchange rate.  In the last 12 months, BRL has fallen 20% against GBP – but he wanted to invest in a pension and start a business in the UK.  There was urgency and purpose.  If BRL were to flatline or weaken over the next 12 months, he would simply be waiting without putting the capital to use.

TALK ABOUT TAX.  PREPARE YOUR TAXES!

What could be more exciting than using quarantine to bring your tax admin up to date?  In Brazil, key deadlines have been extended, namely:

  • Tax return (IRPF-2020).  Deadline moved from 30 April to 30 June
  • Central Bank overseas asset declaration (DCBE). Deadline moved from 5 April to 1 June.

For US persons – the IRS filing date has been extended to 15 July.  Remember to declare foreign accounts on your FBAR form.

Now that many families are under one roof, it may be an appropriate time to enjoy a detailed discussion about family finances.  How about starting with the potentially not-so-comfortable topic of inheritance and succession planning? How much money would families save in tax if they didn’t perceive it as being taboo and confronted reality well in advance of the inevitable?

Inheritance tax planning in the UK and Brazil requires careful professional guidance especially if families and assets are divided between both countries. In Brazil, death taxes are applied at state level and vary significantly between different states.  Double taxation is an undesirable outcome which can be mitigated by taking action in advance.  I reiterate, seek independent advice rather than a tied product-salesperson otherwise, you may end up paying high annual fees and eventually, more than 40% tax on assets which you inherit.

Consider which tax-efficient savings vehicles you wish to increase, hold or surrender and whether the tax benefits are recognised by the tax authorities in your country of residence e.g. ISAs and private pensions (UK), previdência privada (BR) and 401K (US).

For example, if a US person, resident in Brazil, were to sell her primary residence, Brazilian capital gains tax of 15% is waived if the proprietor purchases a new property within 180 days of the original sale.  However, this Brazilian exemption is not recognised by the US and the individual would be taxed on the gain. Uncle Sam… c’est la vie!

COULD YOUR RESIDENCY STATUS BE AFFECTED BY LOCKDOWN?

Many expats and geographically-mobile executives manage the number of days spent in certain jurisdictions to optimise their tax position.  Travel restrictions and lockdowns may create undesirable residency scenarios with harsh tax implications including double taxation on income and gains.

The UK taxman allows 60 additional days for extraordinary circumstances.  There is no precedent of a global epidemic of this nature with quarantines and international border closures.  Will HMRC extend the day count if lockdowns last longer than expected?  Check in advance whether you need to file more than one declaration.

There are further tips in our two articles about organising your financial planning in 2020.  All 10 points are important and relevant, regardless of the current scenario:

Tips 1-5   Budgeting – Saving – Private pensions – Banking costs – Money transfers

Tips 6-10  Tax return – Central Bank declaration – Fund platforms – International asset consolidation – Insurance

For specific queries, please contact us here.

Stay safe and please look after yourselves and your families!

Amit

Photos:   Many thanks to rawpixel.com for offering a wide selection of timely images for this article.  We strongly recommend rawpixel.com to content producers and web designers.

 

 

 

warner-ptudKzrajps-unsplash

Oil company executive: Deciding between pension options

A client was recently offered pension options by his former employer, a US energy multinational.

He had worked in the company for over a decade whilst contributing into the pension scheme.  Currently 57, he would start receiving income in 8 years, when he is 65.  The options were:

  • Keep in existing employer scheme until 65th birthday and receive an inflation-adjusted pension income starting at $33K p.a. gross.
  • Migrate the employer pension to an IRA (US Individual Retirement Account) with a transfer value of $390K.
  • Cash out completely with a 30% penalty (against the transfer value), receiving $273K today.

Keeping the calculations simple, I used www.mycalculators.com for the withdrawal schedule and impact of inflation.   The withdrawal schedules are attached below for options 2 and 3.

Assumptions
  • Safe withdrawal rate = 4%
  • Inflation = 3%
  • Net annual return (equity-bond 50-50) = 3%
  • Pension income taken from 65 to 90

 

Option 1:  Keep in existing scheme

For a long-serving employee of a multinational, 65 is a realistic retirement age and it’s reassuring to have a core source of stable income from the pension scheme of an international company.

To obtain this income stream as a private investor, one would require $825K of capital which would generate $33K in the first year, assuming a 4% withdrawal rate.   At 3% inflation, his income at 70 would be $38,256 and at 80, $51,412, before the capital is fully depleted when the client turns 90.

Option 2:  Migrate to IRA

 An IRA would allow the client more control of his asset allocation.  Assuming a 3% net growth rate over 8 years, the migrated $390K would grow to $494K.

Assuming a 4% withdrawal rate, the pension income in the first year (at 65) would be $19,760. With inflation at 3%, the income at 70 would be $22,240 and at 80, $29,889. The capital would be depleted by his 90th birthday in which the final income payment would be $40,168.  These figures are well-below option 1 and with much less stability.

Option2. 494K capital

Option 3:  Take the cash

 If the client opted to take the cash and place it into an investment, let’s assume a net growth rate of 3% on $273K, holding for 8 years until his 65th birthday.

1.038  x 273K = $346K

Assuming a 4% withdrawal rate, income in the first year would be $13,840 hence we can see that there is no point comparing this to options 1 and 2.

Option3. 346K capital

The required growth rate to reach the IRA’s future projected value, as per option 2 (at 65th birthday), of $494K is an unrealistic 7.85% *

* This is even less likely with a 50-50 equity-bond portfolio and let’s consider that we are in the latter stages of a long bull cycle at the time of writing this article.

This would only be worth considering if the client had a specific business opportunity or the were desperate to place a deposit on his dream home.   Even in such scenarios, this would only be recommendable if he had another sufficient and stable source of pension income.

 

Conclusion

We chose Option 1:  To remain in the scheme and receive benefits at the likely retirement age.  This is by far, the most secure option.

Given the above scenario, the company pension scheme may be underfunded in the long-term and they are trying to reduce the liabilities by incentivising early cash pay-outs and migrations – at the expense of the financial well-being of some of their employees. Just because some are engineers and PhD holders, it does not infer they are experienced in making financial planning decisions especially when the employer is encouraging Option 3.

Some employees may be tempted to take a cash pay-out to cover current needs or because they believe they can obtain a better return elsewhere.  The decision to take the cash is irreversible and may result in financial hardship later in life when other income sources are unavailable.

When a large lump sum of cash is available and the company are trying to steer employees towards this decision, we encourage them to seek financial advice to and ensure they protect the long-term financial security of their family.

 

Image credits:

Oil Platform by Warner at Unsplash

Bull & Bear Market by Jack Moreh at Unsplash