petrozuata case study

PETROLERA ZUATA PETROZUATA C.A

GROUP MEMBERS •ALIM MUSHTAQ •BILAL ALAM •BASIT ALI •KHURRAM ALI •ATEEQ TAJ

The Case of Petrozuata Petróleos de Venezuela (PDVSA) (49.9% Interest)

Conoco Incorporated (USA)

Petrolera Zuata

(50.1% Interest)

The Sponsors - PDVSA • Currently 3rd largest oil refinery and gasoline network in

USA. • State-owned and formed through the nationalization of other companies’ assets (Mobil, Exxon, etc) in 1976 of

$1 billion bonds and cash. • Purpose of PDVSA is to mange country resource and promote economic development • PDVSA is a member of (OPEC) organization of petroleum exporting countries.

The Sponsors – Conoco Inc. • Subsidiary of Dupont (USA) • Has operations in over 200 countries in

1996. • Known for expertise in technology and extraction processes • Conoco was recognized world leader in both refinery technology and project development.

The Joint Venture • PDVSA & Conoco began early feasibility

studies for joint project in 1992. • Three key components  – A series of inland wells to produce the extra

heavy crude.  – Transportation of the crude oil to coast via pipeline  – An upgrader facility to partially refine the extra heavy crude.

The Joint Venture (cont’d) • Estimated cost is $2.4 billion • Conoco (50.1%) and PDVSA (49.9%)

together invest $975 million • Remainder $1.450 billion to be financed through debt

Petrozuata’s debt rating • Conoco was rated single AA• PDVSA was rated single B • 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 BBB • stable revenue + stable cost + no extra costs

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

$2,425

100%

Total

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

Question no: 1 Whether Petrozuata should use traditional (Internal Finance or Project Finance (External) to fund the Petrozuata development? Project finance  is the long-term financing of infrastructure and

industrial projects based upon the projected cash flows of the project rather than the balance sheets of its sponsors. • Petrozuata should use project finance Because many of reasons  – For example project finance allows firms to isolate project risk,  –  to increase equity return,  –  to preserve debt capacity,  –  to mitigate sovereign.  – Project finance create value by resolving agency problems and improving risk management. • Project finance allow the firm to minimize the net cost associated with market imperfections such as transaction cost, asymmetric information, incentive conflicts, financial distress and taxes.

Question no: 2 What are identifications of major risks, assessment of their severity and attempts to mitigate important risks faced while using project finance in case of Petrozuata?

Project finance create value is by improving risk management. • Risk management consists of identifying, assessing, and allocating risks with the goal of reducing cost and of ensuring proper incentives. • The identification of project risks and the assessment of severity are typically done by the sponsors in conjunction with their financial advisors. • Then to add credibility to the process the key assumption are •

verified using independent experts.

Question no: 2 What are identifications of major risks, assessment of their severity and attempts to mitigate important risks faced while using project finance in case of Petrozuata?

In this case the sponsors hired three independent consultant to analysis the oil reserve, project design, construction schedule, operating cost, syncrude demand, and price. • in this case there are some risks that are identified in project finance that are pre-completion risk, operating risks, sovereign •

.risk, and financial risks. •

allocate residual risk return to the party best able to influence the outcomes. By thus joining risk and return you increase the probability that parties will act in ways that maximize efficiency.

Question no: 3 Keeping in mind the financial risk, how much leverage should the project have?

an umbrella term for multiple types of risk associated with financing, including financial transactions that include company loans in risk of default. Risk is a term often used to imply downside risk, meaning the uncertainty of a return and the potential for financial loss. • There are three primary financial risk, interest rate risk, funding risk and credit risk. • Initially the sponsors hoped to finance 70% of the project. • Firstly they discussed whether to use 60% or 70% leverage. They chose 60% leverage to show their commitment to the project and to improve the project minimum debt service coverage ratio. •

Financial

risk  is

Question no: 4 Does Petrozuata financing strategy make sense? Yes Petrozuata financing strategy make sense. • The sponsors achieved high leverage ratios, attracted new source of capital and obtain better capital and obtain better pricing then previous deal. •  Because The sponsors agreed to use $975 million of equity (40%) and $1.45 billion of debt (60%) to finance the project $2.425 billion total cost. •  In the end the sponsor raised $450 million in bank finance and $1 billion in rule 144A bonds all of which was non-resource to the sponsors following completion of the project. •

Question no: 5 Do you think whether Petrozuata can pierce the sovereign risks?

Project finance is most valuable as an instrument for mitigation sovereign risks. • Indeed it is the one feature that cannot be replicated under conventional corporate financing scheme. • Sovereign risk was one of the biggest concern about the Petrozuata deal because of Venezuela historical macroeconomic and political instability. • The Venezuela government has more influence over political and economic factors than any other entity if the government fails to mitigate sovereign risk then it will lose the monetary benefits from taxes royalties and dividend as well as accompanying benefits of increased employment and access to refining technology. •

Question no: 5 Do you think whether Petrozuata can pierce the sovereign risks?

The final reason why project structure helps mitigate sovereign risk is that it facilities participation by local government local financial institutions, multilateral agencies like the international finance corporation and bilateral agencies like the U.S export import banks. • The deal had many feature to mitigate risk one of the key feature was the decision to keep oil revenue out of country. •

Question no: 6 Whether Petrozuata would invest in the project?

•

Yes Petrozuata would invest in this project because this project has many benefits and hallmarks like,….

it was an economically and legal independent entity. • it was an operating company with limited life (35) year. • it was funded with non-recourse debt for the least part of the life. •

Q&A