Petrolera Zuata

1. PDVSA should use project financing for better credit rating, cheaper financing, more flexibility, less exposure to interest rate risk, and less time to arrange financing:

• Bank debt will likely not provide sufficient financing, short maturity, restrictive covenants, variable interest rates, and it takes 12-18 months to arrange^[1]
• Bank debt could also be more expensive given that Petrozuata will be capped at sub-investment grade of Venezuela, thereby making bank financing expensive.

• Project financing (allows Petrozuata to leverage Dupont/Conoco’s investment-grade credit rating) is more likely to give Petrozuata investment-grade rating it needs to secure abundant cheaper financing in the shortest time frame possible (144A) for $650mm in project financing bonds, with remaining provided by banks / agencies.  
• Bonds are longer term, less restrictive covenants, fixed interest rates

2. Operating risk faced by Petrozuata: political risk given the 35-year term of the project (expropriation, renegotiation of contractual terms including tax/royalty – more likely to happen after debt is paid down), technology / design risk in construction, construction completion risk is concentrated at the beginning, forex/inflation (Bolivar appreciation increasing operating costs), crude oil price decline, credit worthiness of suppliers/contractors, risks imposed by Venezuelan financial sector and labor market.  Project financing can mitigate some of these risks in the following ways:

• Project financing is useful in mitigating political risk in the near-term given the non-recourse nature of project debt and the high leverage employed by projects.  

• Payment priority – the cash waterfall (part of contractual agreement) allows deposit of USD funds from sales to offshore proceeds account maintained by Bankers Trust. The reimbursement hierarchy would fund a 90-day operating expense account, service the project’s debt obligations, and make deposit to debt service reserve account for 6 months of principal and interest. The Trustee transfers remaining funds to equity shareholders, subject to the maintenance of a DSCR ratio of 1.35x (historical and forward 1-year).
• Project has higher risk prior to completion and project finance is structured (implemented by a series of contracts) around the key risk timelines: Investments by Conoco and Maraven are made prior to completion, guaranteed by parent corporations.  The completion guarantee also included severe penalties for failing to meet these obligations, and incentives to cover the other party’s shortfall.  There is a construction budget contingency sufficient to pay premiums on a construction all risk insurance policy covering up to $1.5bn of physical loss.  Upon Petrozuata completing construction, the sponsor guarantees would end and project debt would become non-recourse to the sponsors.  To declare completion Petrozuata would have to meet a number of criteria. All these contractual setups mitigate project completion risk.
• There are contractual agreement (i.e. off-take agreement) on the sales of syncrude and by-product (by Conoco which has the option to sell to the highest bidder and also marketing strategy/pricing assessment for by products), providing more certainty to the cash flows expected to be generated from the development project.

3. Appropriate leverage would be 60%, which is in-line with Ras Laffan project.  Similarly, debt should be sourced from 144A private placements, which has the shortest time to arrange, in addition to having all the benefits of public bond issuance, as long as Petrozuata can obtain investment grade rating.

Bond is most likely BBB, as half of the investments (severally provided by Conoco) are guaranteed by Dupont (AA-) and half (severally provided by Maraven) guaranteed by PDVSA (B).  Excluding expropriation, one of the biggest risk is the completion of the project.  Given the payment priority dictated by the contractual waterfall setup, investments are made to PDVSA prior to completion of the project.  The completion guarantee also included severe penalties for failing to meet these obligations, and incentives to cover the other party’s shortfall, plus contingency.  These contractual setup mitigates the risk of the project significantly. Lastly, off-take agreements lessen the uncertainty associated with cash flows generated by the project – Conoco will purchase most of the syncrude or sell them to the highest bidder, and both marketing and pricing strategies of by-products are assessed and confirmed by a third party consultant. All of these reduce the project financing and operation risk and should be appropriately reflected in an investment grade rating.