the case of petrozuata

7/29/2019 The Case of Petrozuata

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Petrozuatas Use of Debt Financing

International Financial Management

Ricky Chen

Anna PakmanJames TobinJanie Wang


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Agenda

Timeline

Introduction to international debt and debt ratings

Description of the PDVSA and Conoco joint venture

Petrozuatas debt rating Debt financing: 144A Bonds

Project financing: advantages and disadvantages

Three types of project financing risks

The aftermath: Duponts sale of Conoco and state ofPetrozuata today


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Timeline

1976 1997 1998 1999

Venezuelangovernmentnationalizes

interests of oilcompaniesand formsPDVSA

Petrozuata was

formed

Dupont soldConocoand first set

of costoverruns

Secondcostoverruns


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The Case of Petrozuata

PetroleraZuata

ConocoIncorporated

(USA)

Petrleos deVenezuela(PDVSA)

(50.1%

Interest)

(49.9%

Interest)


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The Partners - PDVSA

Currently 4th largest oil company in theworld

State-owned and formed through thenationalization of other companiesassets (Mobil, Exxon, etc)

Despite government instabilities, PDVSAhas a strong track record


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The Partners - Conoco

Subsidiary of Dupont (USA)

Has operations in over 200 countries

Known for expertise in technology andextraction processes


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The Joint Venture

Petrozuata was formed in 1997 byPDVSA and Conoco

Three key components Production of heavy oil from a new field in

Venezuelas interior

Transportation of the oil to coast via pipeline

Transportation of oil to refineries along theUS Gulf Coast


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The Joint Venture (contd)

Estimated $2.425 billion in costs

Conoco (50.1%) and PDVSA (49.9%)

together invest $975 million Remainder $1.450 billion to be financed

through debt


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Why International Debt?

In liquid markets, greater availability ofcapital

Diversification effects similar to that ofdiversifying portfolios

But there are risks -

Illiquid markets Foreign Exchange Risk


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Debt Ratings

An evaluation of the possibility of defaultby a bond issuer

It is based on an analysis of the issuer'sfinancial condition and profit potential

Main providers: S&P, Moodys, Fitch


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Debt Ratings (contd)

AAA highestpossible rating

D Default


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Petrozuatas debt rating

Conoco was rated single A

PDVSA was rated single B

Junk Bond (it is state-owned company) Its target is to get a BBB rating

How?


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Crude Oil Price


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Petrozuatas debt rating (Contd)

Conoco guaranteed to buy all the output thatPetrozuata would produce for the next 35 yrs (priced in$)

All costs (ie: water, electricity and gas) are also under

long-term contracts, except labor (but it onlyrepresented a small fraction of total cost)

Conoco & PDVSA guaranteed to pay projectexpenses, including any unexpected cost overruns

The project passed six completion tests (to make surethat the project can produce syncrude at pre-determined quantities and qualities)

stable revenue + stable cost + no extra costs BBB


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Debt Financing

High leverage ratio (60%) Bank debt, the traditional source of debt and

Rule 144A project bonds

Sources of Funds in million %

Commercial Bank Debt $450 18.6

Rule 144A Project Bond $1,000 41.2

Paid-in Capital (incl. shareholder loans) $445 18.4

Operating Cash Flow $530 21.9

Total $2,425 100%


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What is Rule 144A bond

Is a relatively new security gaining popularity

Has greatly increased the liquidity of 144Abonds

Can waive the time consuming SEC registrationprocess (implied it is less expensive to issueRule 144A bond compared to other types ofbonds)

Can only be sold to professional investors(at least has $100 million in investible assets)


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Project Financing

Popular in emerging markets

Often involves syndicates

Project is separate from legal and financial

responsibilities of investors Used for large investments that are long-term and

singular (cannot be commingled)

Cash-flow from third parties is predictable

Projects and their lives are finite Petrozuata used project financing to pay down largedebts without the owners being accountable fordeficits


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Three types of risk

Precompletion risk

No operations = no cash flow coming fromthe investment

Postcompletion risk

Occur when project is operating and effectthe cash flows

Political risk

Macroeconomic events in Venezuela


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Why Project Finance?

Project finance holds less risk for the partnersin the joint venture than simply financing itthemselves

too expensive local governments offer loans to develop oil fields

Protects the companies from bankruptcy risksbecause they have limited responsibility

the project is regarded as legally independent

equity returns are increased and the companies

own debt capacity isnt used up.


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Why not Project Finance?

Project finance seems perfect as it allowsthe company to rid itself of responsibilityand increase equity returns

However, it eliminates co-insurance anddiversification benefits within the companyso the free lunch is a myth.

High legal costs associated with thesetup

Difficult to exit syndications


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Another example

British Petroleum: North Sea and Trans-Atlantic Pipeline

Constructed to move oil from the North Slope of

Alaska to the northern most ice- free port- Valdez,Alaska

Joint venture between BP, Standard Oil of Ohio,Atlantic Richfield, Exxon, Mobil Oil, Philips

Petroleum, Union Oil and Amerada Hess Cost: $1 billiontoo much for any one firm to

handle


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Duponts sale of Conoco

Dupont purchased Conoco in 1981 after highoil prices hurt profits during the 1970s

Dupont decided to sell Conoco in 1998, shortly

after the Petrozuata deal, when oil prices wereat their lowest levels in a decade

The sale lowered Duponts debt

Spinning off Conoco would help it be an

industry leader, which was impossible underDupontconflicted with Duponts strategicpositioning


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The Aftermath

Benchmark price of crude oil falls $5 perbarrel over 6 months

Inflation in Venezuela causes interestrates to jump from 25% to 70%

Cost overrun for Petrozuata isannounced


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Were Investors Correct?

Petrozuata encountered some of thetypes of risk mentioned earlier

Cost of project increases by $553 million The costs ended up being covered by

sponsors

Petrozuata is able to produce largerquantities than expected

Investors made the right choice


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Where Are They Now

Conoco has merged with PhilipsPetroleum and is the 3rd largestintegrated energy company

PDVSA is starting to collect oil fromsome newly found sources despite aworker strike at the end of 2002

Petrozuata is making new contracts andcontinues to run well they still have antheir B rating

the case of petrozuata

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