PETROLERA ZUATA, PETROZUATA C. A.
CASE ANALYSIS
ALTERNATIVE MODELS OF FINANCING THE ORINOCO BASIN:
Entire project as Project finance Entire project as Corporate finance
Pros: Pros:
• PF reduces Information cost significantly. Separation of projects from the sponsoring firm • In this financing method cost of transaction reduces significantly, which occurs in
facilitates initial credit decisions allowing creditors to analyze the project on a stand-alone Project financing.
basis. With segregated cash flows and dedicated management, there is little room for the
kind of intentional or judgmental misrepresentation. These improvements reduce • High cost of political risk insurance may increase interest rate associated with
asymmetric information costs and can lower a project’s cost of capital debt. So leverage through PF would be costlier, as Venezuela has a rating of B.
• PF also reduces cost of financial distress. Project finance adds value by reducing the • Chances of Negative carry if we opt for issuing government bonds. So
probability of distress at the sponsor level and by reducing the costs of distress at the investment gains would be lower and higher interest rate payment would lead to
project level. This cost is offset though by the benefit of coinsurance wherein the project loss.
cash flows might prevent the parent from defaulting.
• There is probability of getting investment grade bonds. Cons:
• Higher debt capacity will be possible, which gives higher flexibility to operate and which • High Information cost
also enables them to get incremental tax shield.
• High cost of financial distress
• It reduces Corporate taxes paid. Petrozuata will pay income taxes at the rate of 34% and
royalty rates at the rate of 1% for the first nine years of operations and no municipal taxes • If project financed internally, the risks were to be borne by PDVSA and home
compared to Maraven’s conventional on-balance sheet financing, its income tax rate would government.
be 67.7% and its royalty rate would be 16.67%. • Also banks providing capital to PDVSA would charge higher interest rate for high
risk.
Cons: • There is lesser scope of foreign direct investment in the project through JVs etc.
• Increase in transaction cost as Conoco and Maraven spent more than 5 years and millions
of dollar in advisory fees to negotiate this deal.
SUGGESTIONS: Project financing the entire venture is a better option.
SOME OF THE OPERATING RISKS INVOLVED IN PETROZUATA
1. POLITICAL RISK: Risk associated with downfall of Venezuelan government & unpredictability of government to abruptly
change tax rate or royalty.
2. EXCHANGE RATE RISK: With Venezuelan economy developing, risk of interest rate fluctuation is there as currency
Bolivar would appreciate against Dollar, which would increase expenses & tax liability of project as against to revenue
which would be in dollar, hence reducing profitability of project.
3. OIL PRICE VOLATILITY: Oil prices have been fluctuating in a high range if $8.14 to $37 per barrel, hence risk of price
volatility is high.
DEAL STRUCTURE TO MINIMIZE THESE RISKS
1. Inclusion of PRI: This insurance given by US ExIm bank, IFC, OPIC, EDC etc., that increase the lending rate by 300bps to
10.5 - 11.75 %.
2. To mitigate sovereign risks, one of the key features was the decision to keep oil revenues out of the country. Conoco
as the purchaser would deposit US dollar proceeds with a trustee in NY who would then disburse the cash. This also
eliminated exchange rate risk as the revenues and debt service were both denominated in dollars.
3. High debt coverage ration of 1.35X is the bare minimum requirement.
4. To account for price volatility low breakeven point of $8.63 per barrel is set that is achievable with market rate $14.27.
5. Cash waterfall or Payment priority to account for high risks. Priorities were, 1st to 90 day operating expenses account,
then to project’s debt obligation, then to debt service reserve account for 6 months, lastly to equity holders.
EXPECTED RETURNS TO SPONSORS
The IRR for the project comes to 26% when the leverage ratio is 60%, hence for the project to be attractive to
the sponsors the cost of equity should be lower than 26%
On calculating the Ke for various years given the cash flow to equity, we find that the cost of equity is around
22.8% on an average and goes above IRR only for the initial years (upto 2006) when the D/E ratio is very high.
Hence as a sponsor the leverage of 60% gives us adequate returns.
EFFECT ON DSCR AND IRR WITH CHANGE IN LEVERAGE
Leverage of 60%:
The DSCR remains well above 2.0x during the initial years and also the IRR is 26% which is much higher than the
average cost of equity (22%).
Even with the variability in cash flows due to price or currency rate fluctuations, the project will be in the condition
to service it’s debt hence it is an investment grade project.
Leverage of 50%:
The DSCR increases and remains about 2.5x during the initial years on decreasing the leverage to 50% hence being a
safe investment project. But the IRR decreases to about 22% which is very close to the cost of equity hence being of
no advantage for the sponsors to invest in this project.
Even with the variability in cash flows due to price or currency rate fluctuations, the project will be in the condition
to service it’s debt hence it is an investment grade project.
Leverage of 70%:
The DSCR decreases considerably and is sometimes below 1.8x (assuming cost of debt to be 10% which is optimistic
hence the DSCR might reduce even further if cost of debt increases with leverage) making the project risky to invest
in though it still remains above the minimum requirement of 1.35x, also the IRR increases to about 29% with the
increase in leverage making it lucrative for the sponsors.
Since the project cash flows might vary with price or currency fluctuations, a leverage of 70% will not get the project
an investment grade.
Hence 60% seems to be optimal leverage ratio.
DIFFERENT SOURCES OF DEBT
Development Agencies and Banks 144A Bonds Market
Pros: Pros:
• Draw on credit line, matching the cash inflows and outflows • Time and cost savings (no “covered” debt requirements)
• Reliable option when nowhere else to turn to • Long maturities of greater than 10years
• Fixed interest rates & private bonds could provide high value of debt of $1.4 bn.
Cons: • Fewer and more flexible covenants
• Additional speed advantage of underwriting within 6 months due to non requirement of
• Short maturities, serious risk in case of constructional delays initial disclosure/ less disclosure to the SEC
• Restrictive covenants • Better scope of investment as, Venezuelan financial condition is improving and hot bond
• Variable interest rates, Limited size of loans market leading to higher chances of getting large fund
• Majority of remaining debt would require PRI, taking cost to ceiling • Partnership with Dupont company improves creditworthy image of Petrozuela
• Time and cost of arranging sufficiently required “covered” debt
Cons:
Public Bond Market • “Emerging market” unreliability in terms of creditworthiness – both Venezuela and PDVSA
had sub investment grade ratings
Pros: • Required continued financial, political stability of Venezuela
• Time and cost savings (no “covered” debt requirements) • Required continued “hotness” of the bond market for sustainability
• Long maturities of greater than 10years
• Fixed interest rates
• Fewer and more flexible covenants
• Larger loan size available
Cons: SUGGESTIONS:
• Funds to be raised in lump sum with investment rate for remaining
cash lesser than borrowing rate Getting debt through 144A bonds is a better option to
• “Emerging market” unreliability in terms of creditworthiness – making finance this project.
it difficult to succeed in public debt markets
SENSITIVITY ANALYSIS Percentage variation from forecast price
Year Price
-25% -20% -10% 0% 10% 20% 25%
2001 $ 13.86 -1.86 -1.97 -2.19 -2.42 -2.64 -2.86 -2.97
Assumptions: 2002 $ 14.21 -1.92 -2.03 -2.26 -2.49 -2.72 -2.95 -3.07
1. Forecast price of Syncrude much 2003 $ 14.56 -1.70 -1.80 -2.00 -2.21 -2.41 -2.62 -2.72
lower than Maya (base 1998: 2004 $ 14.93 -1.69 -1.79 -2.00 -2.20 -2.40 -2.60 -2.71
Syncrude $12.87 – Maya $18.62) 2005 $ 15.30 -1.58 -1.67 -1.86 -2.05 -2.24 -2.43 -2.52
2006 $ 15.68 -1.66 -1.76 -1.96 -2.16 -2.36 -2.56 -2.66
2. Assuming the production of oil to be 2007 $ 16.07 -1.63 -1.72 -1.92 -2.11 -2.31 -2.50 -2.60
constant. So taking only minimum 2008 $ 16.47 -1.69 -1.79 -1.99 -2.20 -2.40 -2.60 -2.70
guaranteed production in the 2009 $ 16.89 -1.96 -2.08 -2.31 -2.55 -2.78 -3.02 -3.13
contract i.e. 104,000 BPCD 2010 $ 17.31 -1.85 -1.96 -2.18 -2.40 -2.62 -2.85 -2.96
2011 $ 17.74 -1.80 -1.91 -2.12 -2.34 -2.55 -2.77 -2.88
2012 $ 18.19 -2.39 -2.54 -2.82 -3.11 -3.40 -3.68 -3.83
2013 $ 18.64 -2.92 -3.10 -3.45 -3.80 -4.15 -4.50 -4.67
Conclusion: 2014 $ 18.64 -2.59 -2.75 -3.06 -3.37 -3.68 -3.99 -4.14
2015 $ 18.64 -2.30 -2.44 -2.71 -2.99 -3.26 -3.54 -3.67
DSCR drops below the required 1.8X in
extreme cases of 20-25% variation in price 2016 $ 18.64 -2.23 -2.36 -2.63 -2.89 -3.16 -3.42 -3.56
for 6 years even when it is around 1.6x, and 2017 $ 18.64 -44.33 -46.98 -52.26 -57.55 -62.83 -68.12 -70.76
then is almost always above 2.0X. Hence 2018 $ 18.64 -37.93 -40.19 -44.71 -49.23 -53.75 -58.27 -60.53
price fluctuation is not a major concern. 2019 $ 18.64 -35.68 -37.81 -42.05 -46.30 -50.54 -54.79 -56.91
Therefore, the project should get an 2020 $ 18.64 -32.92 -34.84 -38.69 -42.54 -46.40 -50.25 -52.17
investment grade rating. 2021 $ 18.64 -34.84 -36.87 -40.94 -45.01 -49.08 -53.15 -55.19
2022 $ 18.64 -2.92 -3.09 -3.43 -3.77 -4.11 -4.46 -4.63
WILL THE PROJECTS BONDS RECEIVE INVESTMENT GRADE RATINGS?
Stable Revenue Stable Cost No extra debt Completion Tests
• Conoco • Except labor costs, • Conoco & PDVSA • The project passed
guaranteed to buy all costs are also guaranteed to pay six completion
all the output that under long-term project expenses, tests to make sure
Petrozuata would contracts including any that the project
produce for the unexpected cost can produce
next 35 years overruns syncrude at pre-
• The sensitive determined
analysis also quantities and
shows that qualities
maintaining the
DSCR of 1.8x is
achievable
The above points support that the project will receive an investment grade.
WOULD YOU INVEST IN THE PROJECT’S BONDS?
Yes we should invest in such Project’s bonds, primarily because
• The DSCR is well above 1.8x and the sensitivity analysis also does not
indicate any red flags, hence the bonds will get any investment grade.
• It is sensible to invest in the bonds since the rate is fixed and the
sponsors will pay any extra costs incurred.
• Also the data shows that investment in project bonds are increasing
over the years and project bonds have a high spread over treasury
rates, indicating that the attractiveness of project bonds is increasing.
THANK YOU!
