Transcript Petrozuata’s Use of Debt Financing International Financial Management Ricky Chen Anna Pakman

Petrozuata’s Use of Debt Financing
International Financial Management
Ricky Chen
Anna Pakman
James Tobin
Janie Wang
Agenda
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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
Venezuelan
government
nationalizes
interests of oil
companies
and forms
PDVSA
1997
Petrozuata was
formed
1998
Dupont sold
Conoco
and first set
of cost
overruns
1999
Second
cost
overruns
The Case of Petrozuata
Petróleos de
Venezuela
(PDVSA)
(49.9%
Interest)
Conoco
Incorporated
(USA)
Petrolera
Zuata
(50.1%
Interest)
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
Debt Ratings (cont’d)
• AAA – highest
possible rating
• D – Default
• <BBB – junk bonds
• Venezuela
– Long term: B– Short term: B
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
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?
Crude Oil Price
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 predetermined 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
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%
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 TransAtlantic 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?