1

"Petrozuata: Balancing Risk and Opportunity in a Politically

Volatile Landscape"

Name of the Student:

___ November 2024

 2

Contents
1. Why does PDVSA not finance the deal itself, but instead decides to work with Conoco? (2 points)3
2. Why does Conoco want to work with PDVSA despite having its Venezuelan assets expropriated in
1976? (2 points) 3
3. What are the main political, financing, and operational risks facing Petrozuata? How does the way
the deal is structured attempt to mitigate these risks? 4
3.1 Political Hazards: 4
3.2 Financing Diversion Risks: 4
3.3 Operational Diversion Risks: 4
3.4 Managing the risks in the Construction of the Deal: 4
4. Should the project proceed with a 1% annual decrease in oil prices over five years? Will it receive
an investment-grade credit rating? 5
4.1 Conclusion of the Project: 5
4.2 Evaluating Creditworthiness of the Project: 5
4.3 Where Oil Prices are Expected to Rise by +3%: 5
5. What is the leverage ratio that maximizes the NPV of the project? What assumptions does this
answer depend on? 6
5.1 Assumptions: 6
6. Make a case for why Petrozuata should get an investment-grade credit rating. 6
7. Make a case for why Petrozuata should not get an investment-grade credit rating. 7
8. What actually happened with Petrozuata? 7
Conclusion 8
 3

1. Why does PDVSA not finance the deal itself, but instead decides
to work with Conoco? (2 points)
For a variety of reasons, PDVSA opts not to pursue the possibility of self-financing the transaction.

To start with, the dependence of PDVSA on the sovereign debt for capital raising would result in a

more expensive debt in the fiscal markets due to the political and economic instability that

surrounds the country of Venezuela. In this regard, if Conoco partners with PDVSA, the latter will

benefit from Conoco’s private industry experience and financial strength, which will ultimately

improve the financing terms and reduce the state owned enterprise associated risks. Moreover, the

presence of Conoco enhances the ability to globalize the project and guarantees the project is

operatively and technically backed for a project of this magnitude, alleviating some financial and

risk exposure from PDVSA.

2. Why does Conoco want to work with PDVSA despite having its
Venezuelan assets expropriated in 1976? (2 points)
Even though its Venezuelan properties were expropriated in 1976, Conoco sights an opportunity for

cooperation with PDVSA due to the long-term possibilities brought by the Petrozuata project.

Venezuela is endowed with one of the deepest reserves of oil in the world, and Petrozuata allows a

foothold in the highly attractive heavy oil production. The fact that PDVSA is a state-owned

enterprise makes it a supportive organization in terms of regulation and construction designs for

dependent infrastructures. Conoco is prepared to bear the risk as there are attractive contract

provisions, PDVSA is ready to reduce its operational risks and high returns are expected in a joint

venture.
 4

3. What are the main political, financing, and operational risks facing
Petrozuata? How does the way the deal is structured attempt to
mitigate these risks?
3.1 Political Hazards:
The political hazards that Petrozuata faces are grave and include as an example o potential

alteration in the government’s policy, regulatory interference, and seizure of land and property. The

unstable political situation in Venezuela raises risks, especially in those related to taxation,

royalties, and contracts, all of which are subject to unpredictable changes.

3.2 Financing Diversion Risks:

Here, the country risk with its correlation along the country of Venezuela and the possibilities of

success in obtaining project revenues against predicted and actual oil prices leads to a very difficult

situation in which sustaining an investment grade rating may not be possible for the project.

Because such risks may cut demand for investment, the cost of debt will increase.

3.3 Operational Diversion Risks:

It is a high-risk investment and involves a lot of time and money to extract and refine heavy crude

oil. Reliability of operations and infrastructure of PDVSA being another factor on which the project

relies.

3.4 Managing the risks in the Construction of the Deal:

The promotion is constructed in a way that minimizes the risks by embedding a number of
mechanisms:
 The involvement of international banks serves to put pressure on PDVSA not to default on
its undertakings.
 Income is earned in US dollars to limit the risk of the local currency fluctuations.
 Debt-service reserves and other financial guarantees safeguard the lenders.
 5

 Operational risks are alleviated with the use of Conoco's oil extraction and project
management expertise which assures effectiveness and responsibility.

4. Should the project proceed with a 1% annual decrease in oil prices

over five years? Will it receive an investment-grade credit rating?

4.1 Conclusion of the Project:

If oil prices decrease by 1% per annum, the NPV calculation of the project fa lls to slightly lower at

$319 million as compared to the base case of $340 million. The project still has a positive NPV,

which shows that it is worth undertaking. Hence, the sponsors should continue, provided they are

willing to accept the thinner margin of safety.

4.2 Evaluating Creditworthiness of the Project:

This project is also expected to be rated below investment grade credit rating in this concern. If oil

prices keep falling then there will be a decrease in revenue predictability which will increase the

risk in the project.

4.3 Where Oil Prices are Expected to Rise by +3%:

Where oil prices are expected to grow by 3% compound annually, the NPV rises to dollar 460

million, improving the project’s financial metrics considerably. The positive growth is likely to

enhance chances of such a project being awarded an investment grade rating, as it demonstrates less

exposure to unfavorable market conditions.

 6

5. What is the leverage ratio that maximizes the NPV of the project?
What assumptions does this answer depend on?
The best achievable optimum leverage ratio is one which takes full advantage of the available tax
shields but at the same time avoids the costs of financial distress. In this case, a leverage ratio of
approximately 70% is desired in that it produces the highest NPV.

5.1 Assumptions:
 Constant oil prices allowing for stable cash inflows.
 Absence of severe shifts on the political and regulatory front.
 Debt coming at a favorable cost of capital.
 Business as usual without any substantial cost overruns.
 These assumptions may not be realistic considering Venezuela’s temperature in politics, oil
price instabilities and operational restrictions.

6. Make a case for why Petrozuata should get an investment-grade

credit rating.
The following points serve to support the notion that Petrozuata may become eligible for an
investment-grade credit rating:

 Revenue Structure With Low Variation: The project has inalienable off-take agreements
in place and generates revenues in US dollars, which alleviates the concern for foreign
exchange risk.
 Robust Backers: The participation of Conoco and PDVSA brings assurance, know-how,
and operational continuity to the venture.
 Measures to Reduce Risk: The project has a debt-service reserve account in place, as well
as other protection for the lenders through guarantees.
 Positive Net Present Value: The project still delivers profits even in some unfavorable
conditions such as falling oil prices, which indicates its strength and assures growth.
 7

7. Make a case for why Petrozuata should not get an investment-grade

credit rating.
The company Petrozuata will not be able to achieve an investment-grade credit rating for the
following reasons:

 Country Risk: the unstable political and economic environment in Venezuela comes with
serious risks including the risk of expropriation and the risk of contract re-negotiation;
 Oil Price Risks: changes in oil prices raise doubts on the project’s capability of generating
sufficient income to service the debts;
 High Leverage: With significant debt levels, the project carries more financial risk,
especially in negative market conditions;
 Execution Risks: there are challenges in producing heavy oils, and any operational
inefficiencies could lead to lower profits.

8. What actually happened with Petrozuata?

(i) Credit Rating Assigned: On the issuance day, Already none of the project financing
structures, and revenue forecast proved to be their challenging aspect received an investment
graded credit rating of BBB -

(ii) Performance (up to 2005): The project was reasonably performing within its financial
means and sustaining production in the early years. It proved the possibility of extracting
heavy oil as per the structured agreements.

(iii) Political Risk Outcome: Political risk events were triggered by the Venezuela
authorities increasing grip on the governments oil revenue using dolphin tactics such as
increased royalties and taxes. In the end, owing to ten tied rights, all of ConocoPhillips’
assets including Petrozuata’s were taken away in 2007.

(iv) Hindsight Analysis: In all probability, had ConocoPhillips accessed such information
earlier on, it would have thought twice before making any investments in light of the
expropriation threat and adverse political conditions. Indeed, it was possible to make money
from the project during its early years, but it was not sustainable due to the long-term threat
of political risk.
 8

Conclusion
The Petrozuata project serves as an interesting example of the interrelationship between corporate

strategy, operations, and sovereignty in the context of the energy sector. PDVSA’s engagement

with Conoco was a practical solution to existing problems of sovereign debt and provided access to

Conoco’s technology and finance. For Conoco, this was a strategic partnership and made it possible

to operate in and access the oil reserves in Venezuela that were regarded highly although were

fraught with risks of expropriation.

Nevertheless, the project’s viability faced the strongest confrontations from the political and

economic climate that existed in Venezuela. Although mechanisms such as dollar-denominated

revenue and debt-service reserves were put in place to limit risk, these mechanisms failed to negate

all the risks of the venture particularly political, volatile oil prices, and operational risks. The

eventual expropriation of Conoco's assets highlights the importance of conducting political risk

analysis of such ventures in comparable cases.