Petrolera Zuata, Petrozuata C.A.

Group #14Anupama Prakash (PGP/17/009)

Anuradha Dhote (PGP/17/010)Sarika Chauhan (PGP/17/044)

Corporate Finance Option

Total Investment = $ 2,424 MnIf only CF is used, investment by PDVSA(49.9%) = $ 1,209 Mn

• PDVSA had given several guarantees to Petrozuata for payment of project expenses, including unexpected cost overruns, prior to completion • This was the first in a series of future deals to be taken up with foreign Oil & Gas companies, for development of Orinoco basin, hence, it was important to

preserve parent’s debt capacity and financial flexibility

Under PF, it was decided that 60% of investment would be sourced from debt, hence – Total Equity Investmnt = $ 975 MnPDVSA’s share(49.9%) = $ 487 Mn

• As we can see, with PF, PDVSA’s investment is significantly lesser, as compared to its investment obligation with CF – this helps to preserve its debt capacity• Sufficient lender protection was ensured under the PF deal structure by putting a time limit (Dec 2001) on project completion – extendable by a finite time.

If this was not met, all debt would become due and payable.• Under PF, PDVSA had the option of getting a higher investment rating for issued bonds, as compared to current country and parent company ratings (B)

There are issues of political risk insurance (PRI) due to which leverage could be costlier, and chances of negative carry due to inflow of large amounts of funds via bonds at the start. However, as PF maintains financial flexibility of parent company, thus putting it in a better position to handle future uncertainties, hence, it can be concluded that project financing is a better funding option.

Project Finance Option

CF and PF as alternative financing models

Operating Risks Involved

Pre-completion risk

• Chances of cost overrun & ensuring funds for project expenses• Sponsors- Conoco & Maraven obliged to pay for project expenses including cost overruns, If any.• Obligations guaranteed by parent companies- DuPont & PDVSA• Severe penalties if sponsors fail to meet these obligations• Incentives to make up for the other party’s shortfall

• Construction All Risk Insurance Policy• Insurance policies to cover physical loss or damage up to $1.5 Billion

• Provision for Contingency in construction budget for upstream, downstream facilities & payment of insurance policies

• Force Majeure• if the project could not be completed with a specified period, all debt will become due and payable

with immediate effect

Post-completion risk• Conoco was not liable to purchase the syncrude

in the case of force majeure• High debt service coverage ratio of 1.35X as the

bare minimum requirement• Break even price was kept quite low so that

operating & financing costs can be recovered even if prices fall to a very low value

• Payment through “cash waterfall system”- • 1st priority- 90 day operating expense

account• 2nd priority- Project’s debt obligations• 3rd priority: Debt Service reserve account

for 6 months• 4th priority: Equity holdersPolitical & Economic Risk• Initial Planning to raise debt from commercial

banks and getting loan guarantees & Country Risk Insurance from agencies like EDC, OPIC & IFC

Tax Rate 34%Asset Beta 0.6Leverage 60%

Cost of Debt 10%

Risk free rate (Rf) 5.60%Market Risk Premium (MRP) 7.00%Country Risk Premium (CRP) 6.67%

Start-up Premium (SP) 2.10%

Return on assets (rA) = Rf+βA*(MRP)+CRP+SP

18.57%Expected Return (Equity) =rA+(1-Tc)*(rA-rD)*(D/E)

27.05%

IRR 25.58% ROA 18.57%

Year Equity Cash Flows Equity Value Debt Value D/E Cost of Equity

1996 ($79,035) $79,035 $0 0.00 18.57%1997 ($1,986) $81,021 1,000,000$ 12.34 88.38%1998 ($550,148) $631,169 1,024,299$ 1.62 27.75%1999 $1,576 $631,169 1,267,280$ 2.01 29.93%2000 $185,047 $631,169 1,450,000$ 2.30 31.56%2001 $225,457 $631,169 1,411,111$ 2.24 31.22%2002 $233,074 $631,169 1,372,222$ 2.17 30.87%2003 $200,600 $631,169 1,333,333$ 2.11 30.52%2004 $218,903 $631,169 1,268,856$ 2.01 29.94%2005 $203,857 $631,169 1,187,614$ 1.88 29.21%2006 $232,620 $631,169 1,086,961$ 1.72 28.31%2007 $229,393 $631,169 977,484$ 1.55 27.33%2008 $238,588 $631,169 849,556$ 1.35 26.18%2009 $226,629 $631,169 755,137$ 1.20 25.34%2010 $216,878 $631,169 669,137$ 1.06 24.57%2011 $216,655 $631,169 567,137$ 0.90 23.65%2012 $262,881 $631,169 449,137$ 0.71 22.59%2013 $242,378 $631,169 401,689$ 0.64 22.17%2014 $251,988 $631,169 348,241$ 0.55 21.69%2015 $260,474 $631,169 252,034$ 0.40 20.83%2016 $250,893 $631,169 134,448$ 0.21 19.77%2017 $376,215 $631,169 75,000$ 0.12 19.24%2018 $320,878 $631,169 75,000$ 0.12 19.24%2019 $301,370 $631,169 75,000$ 0.12 19.24%2020 $276,398 $631,169 75,000$ 0.12 19.24%2021 $292,810 $631,169 75,000$ 0.12 19.24%2022 $217,227 $631,169 -$ 0.00 18.57%2023 $294,578 $631,169 -$ 0.00 18.57%2024 $289,656 $631,169 -$ 0.00 18.57%2025 $289,705 $631,169 -$ 0.00 18.57%2026 $278,074 $631,169 -$ 0.00 18.57%2027 $276,806 $631,169 -$ 0.00 18.57%2028 $274,449 $631,169 -$ 0.00 18.57%2029 $263,604 $631,169 -$ 0.00 18.57%2030 $247,540 $631,169 -$ 0.00 18.57%2031 $250,329 $631,169 -$ 0.00 18.57%2032 $242,937 $631,169 -$ 0.00 18.57%2033 $240,644 $631,169 -$ 0.00 18.57%2034 $226,196 $631,169 -$ 0.00 18.57%

Average 24.31%

Project has IRR of 25.58% for 60% leverage but since debt is being repaid Debt-equity ratio will keep changing.

Cost of equity has been shown for differnent debt-equity ratios which is very high initially. Average cost of equity

comes to be 24.31% which is below IRR

For Fixed Debt-Equity ratio 60%

Expected Returns

Change in LeverageAt 60% leverage, the equity cash flows are such that –

IRR = 26% and Minimum DSCR ratio = 2.08x, against prescribed requirement of 1.35x

For 50% leverage, the advantage of tax shield and lower cost of debt financing reduces. However, the minimum DSCR increases to 2.68x, while IRR suffers and comes down to 23%

For 70% leverage, greater debt impacts minimum DSCR which comes down to 1.91x, however, IRR increases to 29%, giving the project equity investors substantial returns

Advantages• Flexibility to

withdraw as per requirement, matching of cash inflows & outflows

Disadvantages• Short Maturities,

restrictive covenants, small size

• Longer Processing Time• Expensive if PRI is

required

Advantages• Long Maturities,

Fixed Interest rates, Flexible covenants, Available in larger amount

Disadvantages• Can only be raised in lump

sum amount• Results in loss, as funds

can not earn higher return than cost of borrowing (Negative Carry)

Advantages• Advantages similar to

Public Bonds • Can be underwritten

within 6 months

Disadvantages• Less liquid as these

can sold back to only QIBs (Qualified Institutional Buyers)

Rule 144A marketPublic Bond MarketBank Debt

Petrolera Zuata should use combination of Bank Debt & Rule 144A market. Since Rule 144A market offers advantages of Public Bonds, funds can be raised in two or three phases according to funds requirement. At the same time, to ensure liquidity, band

debt can also be taken to make up for the deficit. Going for all the three option will increase the cost of raising fund with no incremental benefit and it is not possible to raise the

entire amount through one instrument only.Hence bank debt and Rule 144A bond market will give Petrolera Zuata ease of raising funds for a longer maturity in large

amount & flexibility to withdraw as per fund deficit.

Sources of Debt

Sensitivity Analysis

Crude Oil Prices• Revenue of the project driven by

market price of Maya crude• Historical data shows that price of

Maya crude has been heavily fluctuating – lowest of $8.14 per barrel recorded around 1986

• During the course of project financing meetings, price of Maya crude was expected to fall from $18.62 to $16 per barrel

• With DSCR of 1.0 (highest forecasted debt service), break even price estimated at $8.63 per barrel

Exchange Rate• Project’s topline would be

affected by exchange rate fluctuations

• Revenues are to be earned in US dollars as against operating expenses that are to be met with local currency of bolivar

• Appreciation of bolivar to increase operating expenses, tax liability, as well as increase pressure on revenues

• Sensitivity analysis can be done by assuming bolivar to become overvalued by 20% to return to PPP

Reserves• Current reserve estimate of

Orinoco belt stands at 21.5 billion barrels

• Planned production level is set at 120000 BPCD

• Sensitivity analysis with lower estimates of reserves will lead to lower production and hence lower realized revenues

• It will also lead to increased capital expenditure for drilling, completion and related oil-well servicing costs

• Impact on project’s topline as well as costs

Sensitivity analysis can also be carried out on other parameters like increased operating costs and substandard upgrader performance.Lower or pessimistic estimates will tend to increase the minimum DSCR requirement based on which the project would be analysed.

Is Investment Grade Rating Possible?• There are good chances for the project bonds to be rated as investment grade despite PDVSA and Venezuela having sub-

investment grade ratings• Possible reasons for an investment grade rating are

Mitigation of risks through well-planned deal structure that entails high debt coverage ratio requirement, strict break-even price threshold and waterfall model payment priority

Positive outlook owing to low operating costs of the project as aginst industry standard – project’s cash operating cost was $3.19 per barrel as against industry median of $8.55

Involvement of sponsor like Conoco which has huge experience in completing large-scale projects of the same nature and whose parent, DuPont, has Aa3 and AA- as credit ratings for its long-term senior unsecured debt

Decision to Invest in the Project:• With the given cash flows and leverage of 60%, the project maintains a minimum DSCR of 2.08x, which is greater than

prescribed 1.35x DSR• Conoco, with a guarantee from DuPont had agreed to purchase the first 104,000 BPCD of Petrozuata’s syncrude for the

35-yr life of the project, based on market price of Maya crude, while, both the parent companies had agreed to severally provide funds to Petrozuata to pay project expenses, including cost overruns -> thus with stable revenues and costs, there are chances of project bonds getting an investment grade rating

• Hence, investing Petrozuata bonds seems like a feasible option

Investment in Project Bonds