Petroleum and Investment Grade Rating

Petrolera Zuata, Petrozuata C. A. case study La Apertura (The Opening) Target Orinoco Belt life-threatening/extra heavy oil accumulation (biggest known in the world) Key Strategy Opening Venezuelan oil sector to foreign oil companies How Profit sharing agreements, operational service agreements, strategic joint-venture associations Ownership PDVSA or subsidiaries contribute10 years), fixed interest rates, fewer more flexible covenants, larger amounts. Cons fund must be raised in a lump sum.Excess funds create a drag on earnings (negative carry) Rule 144A market (private placement market) Pros Like public bonds + speed, underwritten within hexad months Cons nevertheless qualified investors can invest in them Conditions needed hot markets and investment ramble rating What kind of debt to choose? The sponsors should use 144A (private bonds) to fund the handle because of the important advantages and the significant disadvantages which can arise by using the other debt kin ds. Rule 144A has big advantage of time Markets seem to be going in the right direction (Hot markets) What else is needed? (on the next slide Investment grade) Investment Grade Rating Agencies look at 3 main factors sponsors creditworthiness, projects economics and Venezuelas sovereign risk. Problem Venezuelas rating S&P B Moodys Ba2 Petrozuata is strictly connected with countrys risks because it is controlled by PDVSA which is Venezuelas state oil company and operates in Venezuela If Venezuela defaults on its debt Petrozuata will default too unless Conoco Inc. is a subsidiary of DuPont which operates worldwide and has investment grade rating Investing in Petrozuata is indirectly investing in DuPont If you invest in Petrozuata your real investment is also in Venezuela and DuPont Petrozuata project has a real good structure and business projections Same comparables with other oil companies operating in other countries and having investment rate grading Ras Laffan example of oil company having higher rating than the country in which it operates(Qatar) In order to obtain investment grading it is very important to have DuPont in the multitude If rating agencies consider the fact that Petrozuata will repay its debt although Maraven defaults on its part of debt because DuPont wants to mantain its good reputation it might obtain an investment grading If Venezuela is strictly tie in to Petrozuata and has a B then Petrozuata should have at least a B rating plus a considerable bonus because the risk is diversify into DuPont Projects base case DSCR would probably have to communicate 1. 0X Break-even point low enough so the project can cover all(prenominal) operating and financing costs if oil impairments fall substantially Is it a good spate? We would invest in project bonds as they will probably yield a higher return comp bed to the 21% cost of equity. Factors that need to be considered Hierarchy of payments is good (referred to Cash Waterfall) Balance Sheet and Income tilt suggest PDVSA and DuPont are supposed to be solid companies Oil prices are not that volatile fluctuating but arresting more or less a price between $20 and $25 per barrel (suggested nominal break-even price in 2008 $8. 3 per barrel) Lower operating costs with respect to competitors (cash operating cost around $3. 19 against industry median at $8. 55) More than enough heavy crude oil reserves to sustain the planned production according DeGolyer & MacNoughton (U. S. base oil consulting firm) Projects design in accordance with good industry practice complying with Venezuelan and International environmental laws as stated by Stone & Webster Overseas Consultants, a U. S. ngineering and consulting firm What should Conoco take into account? True problem is not very favorable business environment Theoretically, if all contracts are respected and hierarchy of payments holds, the only entities bearing risks are PDVSA and DuPont with their capital inve stment Banks and whoever invests in project bonds according to the hierarchy of payments should be a safe investor doubtfulness in governments future actions could be very harmful.Remember that in January 1976 the Venezuelan government nationalized the domestic oil industry and the compensation package was only 20% of market value (according to foreign oil companies). Lending to Petrozuata is indirectly investing in Venezuelas business environment and doing business with the government as PDVSA is 100% government owned, which has a non-investment grading by rating agencies What should Conoco do? Take carefully in consideration what has been mentioned Make an in depth summary on Venezuelas macroeconomic issues Try to revise the Off take agreement to be sure of having the right to buy the 104,000 BPCD at the pre-fixed price If benefits exceed these further costs then consider equity investment Otherwise the best move would be to take some other entity in the deal to diversify r isks even more Personally, we would be very cautious with investing equity capital as Conoco.