Agenda • Timeline • Introduction to international debt and debt ratings • Description of the PDVSA and Conoco joint venture • Petrozuata’s debt rating • Debt financing: 144A Bonds • Project financing: advantages and disadvantages • Three types of project financing risks • The aftermath: Dupont’s sale of Conoco and state of Petrozuata today • Q&A
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
The Case of Petrozuata Petróleos de Venezuela (PDVSA) Conoco Incorporated (USA) (49.9% Interest) (50.1% Interest) Petrolera Zuata
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
The Partners - Conoco • Subsidiary of Dupont (USA) • Has operations in over 200 countries • Known for expertise in technology and extraction processes
The Joint Venture • Petrozuata was formed in 1997 by PDVSA and Conoco • Three key components • Production of heavy oil from a new field in Venezuela’s interior • Transportation of the oil to coast via pipeline • Transportation of oil to refineries along the US Gulf Coast
The Joint Venture (cont’d) • 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
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
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: S&P, Moody’s, Fitch
Bond Rating Grade Risk Moody's Standard & Poor's Aaa AAA Investment Lowest Risk Aa AA Investment Low Risk A A Investment Low Risk Baa BBB Investment Medium Risk Ba, B BB, B Junk High Risk Caa/Ca/C CCC/CC/C Junk Highest Risk C D Junk In Default Debt Ratings (cont’d) • AAA – highest possible rating • D – Default • <BBB – junk bonds • Venezuela • Long term: B- • Short term: B
Petrozuata’s 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?
Petrozuata’s debt rating (Cont’d) • 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
Debt Financing • High leverage ratio (60%) • Bank debt, the traditional source of debt and Rule 144A project bonds
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)
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
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
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 isn’t used up.
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
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 billion—too much for any one firm to handle
Dupont’s 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 Dupont’s debt • Spinning off Conoco would help it be an industry leader, which was impossible under Dupont—conflicted with Dupont’s strategic positioning
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
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
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
Q&A • Any questions?