AgendaTimelineIntroduction to international debt and debt ratingsDescription of the PDVSA and Conoco joint venturePetrozuatas debt ratingDebt financing: 144A BondsProject financing: advantages and disadvantagesThree types of project financing risksThe aftermath: Duponts sale of Conoco and state of Petrozuata todayQ&A

Timeline1976 1997 1998 1999Venezuelan government nationalizes interests of oil companies and forms PDVSAPetrozuata was formedDupont sold Conoco and first set of cost overrunsSecond cost overruns

The Case of PetrozuataPetrolera ZuataConoco Incorporated (USA)Petrleos de Venezuela (PDVSA)(50.1% Interest)(49.9% Interest)

The Partners - PDVSACurrently 4th largest oil company in the worldState-owned and formed through the nationalization of other companies assets (Mobil, Exxon, etc)Despite government instabilities, PDVSA has a strong track record

The Partners - ConocoSubsidiary of Dupont (USA)Has operations in over 200 countriesKnown for expertise in technology and extraction processes

The Joint VenturePetrozuata was formed in 1997 by PDVSA and ConocoThree key componentsProduction of heavy oil from a new field in Venezuelas interiorTransportation of the oil to coast via pipelineTransportation of oil to refineries along the US Gulf Coast

The Joint Venture (contd)Estimated $2.425 billion in costsConoco (50.1%) and PDVSA (49.9%) together invest $975 millionRemainder $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 marketsForeign Exchange Risk

Debt RatingsAn evaluation of the possibility of default by a bond issuerIt is based on an analysis of the issuer's financial condition and profit potentialMain providers: S&P, Moodys, Fitch

Debt Ratings (contd)AAA highest possible ratingD Default

Petrozuatas debt ratingConoco was rated single APDVSA was rated single BJunk Bond (it is state-owned company)Its target is to get a BBB ratingHow?

Crude Oil Price

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 overrunsThe 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 FinancingHigh leverage ratio (60%)Bank debt, the traditional source of debt and Rule 144A project bonds

Sources of Funds in million%Commercial Bank Debt$450 18.6Rule 144A Project Bond$1,000 41.2Paid-in Capital (incl. shareholder loans)$445 18.4Operating Cash Flow$530 21.9Total$2,425 100%

What is Rule 144A bondIs a relatively new security gaining popularityHas greatly increased the liquidity of 144A bondsCan 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 FinancingPopular in emerging marketsOften involves syndicatesProject is separate from legal and financial responsibilities of investorsUsed for large investments that are long-term and singular (cannot be commingled)Cash-flow from third parties is predictable Projects and their lives are finitePetrozuata used project financing to pay down large debts without the owners being accountable for deficits

Three types of riskPrecompletion riskNo operations = no cash flow coming from the investmentPostcompletion riskOccur when project is operating and effect the cash flowsPolitical riskMacroeconomic events in Venezuela

Why Project Finance?Project finance holds less risk for the partners in the joint venture than simply financing it themselves too expensivelocal governments offer loans to develop oil fields Protects the companies from bankruptcy risks because they have limited responsibilitythe project is regarded as legally independent equity returns are increased and the companies own debt capacity isnt used up.

Why not Project Finance?Project finance seems perfect as it allows the company to rid itself of responsibility and increase equity returnsHowever, it eliminates co-insurance and diversification benefits within the company so the free lunch is a myth.High legal costs associated with the setupDifficult to exit syndications

Another exampleBritish Petroleum: North Sea and Trans-Atlantic PipelineConstructed 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 HessCost: $1 billiontoo much for any one firm to handle

Duponts sale of ConocoDupont purchased Conoco in 1981 after high oil prices hurt profits during the 1970sDupont decided to sell Conoco in 1998, shortly after the Petrozuata deal, when oil prices were at their lowest levels in a decadeThe sale lowered Duponts debtSpinning off Conoco would help it be an industry leader, which was impossible under Dupontconflicted with Duponts strategic positioning

The AftermathBenchmark price of crude oil falls $5 per barrel over 6 monthsInflation 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 earlierCost of project increases by $553 million The costs ended up being covered by sponsorsPetrozuata is able to produce larger quantities than expectedInvestors made the right choice

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