Agenda

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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
  of Petrozuata today
• QA

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Timeline
1976
1997 1998 1999
Venezuelan government nationalizes interests of
oil companies and forms PDVSA
Petrozuata was formed
Dupont sold Conoco and first set of cost
overruns
Second cost overruns
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The Case of Petrozuata
Conoco Incorporated (USA)
Petróleos de Venezuela (PDVSA)
(50.1 Interest)
(49.9 Interest)
Petrolera Zuata
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The Partners - PDVSA

• Currently 4th largest oil company in the world
• State-owned and formed through the
  nationalization of other companies assets
  (Mobil, Exxon, etc)
• Despite government instabilities, PDVSA has 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 and extraction
  processes

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The Joint Venture

• Petrozuata was formed in 1997 by PDVSA 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 the US
  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 of
  capital
• Diversification effects similar to that of
  diversifying portfolios
• But there are risks -
• Illiquid markets
• Foreign Exchange Risk

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Debt Ratings

• An evaluation of the possibility of default by a
  bond issuer
• It is based on an analysis of the issuer's
  financial condition and profit potential
• Main providers SP, Moodys, Fitch

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Debt Ratings (contd)

• AAA highest possible rating
• D Default
• ltBBB junk bonds
• Venezuela
• Long term B-
• Short term B

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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 that
  Petrozuata 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 only represented a small fraction of total
  cost)
• Conoco PDVSA guaranteed to pay project
  expenses, including any unexpected cost overruns
• The project passed six completion tests (to make
  sure that 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 144A bonds
• Can waive the time consuming SEC registration
  process (implied it is less expensive to issue
  Rule 144A bond compared to other types of bonds)
• 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
  large debts without the owners being accountable
  for deficits

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Three types of risk

• Precompletion risk
• No operations no cash flow coming from the
  investment
• Postcompletion risk
• Occur when project is operating and effect the
  cash flows
• Political risk
• Macroeconomic events in Venezuela

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Why Project Finance?

• Project finance holds less risk for the partners
  in the joint venture than simply financing it
  themselves
• too expensive
• local governments offer loans to develop oil
  fields
• Protects the companies from bankruptcy risks
  because 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 allows the
  company to rid itself of responsibility and
  increase equity returns
• However, it eliminates co-insurance and
  diversification benefits within the company so
  the free lunch is a myth.
• High legal costs associated with the setup
• 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 high oil
  prices hurt profits during the 1970s
• Dupont decided to sell Conoco in 1998, shortly
  after the Petrozuata deal, when oil prices were
  at their lowest levels in a decade
• The sale lowered Duponts debt
• Spinning off Conoco would help it be an industry
  leader, which was impossible under
  Dupontconflicted with Duponts strategic
  positioning

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The Aftermath

• Benchmark price of crude oil falls 5 per barrel
  over 6 months
• Inflation in Venezuela causes interest rates to
  jump from 25 to 70
• Cost overrun for Petrozuata is announced

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Were Investors Correct?

• Petrozuata encountered some of the types of risk
  mentioned earlier
• Cost of project increases by 553 million
• The costs ended up being covered by sponsors
• Petrozuata is able to produce larger quantities
  than expected
• Investors made the right choice

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Where Are They Now

• Conoco has merged with Philips Petroleum and is
  the 3rd largest integrated energy company
• PDVSA is starting to collect oil from some newly
  found sources despite a worker strike at the end
  of 2002
• Petrozuata is making new contracts and continues
  to run well they still have an their B rating

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QA

• Any questions?