PETROLERA ZUATA PETROZUATA CA CASE STUDY ANALYSIS

By
Kokumo-Oyakhire George
MAT NO: PG/MGS/1614352

The purpose of this write up is to analyze the costs and benefits of project finance and
to show properly how structured deals can lead to superior financial execution and
greater value creation. For this, the following questions were asked and suggested
solutions then provided.

Question One
Provide a size-up of the case identifying the key firms involved in the case and the
key issues to be addressed

Question Two
Identify the key risks associated with the project outlined in the case and identify
strategies to mitigate these risks. Perform any empirical analysis you believe is
warranted to outline these risks.

Question Three
Review the various parties to this project and discuss how project financing can
allocate risk to these different parties.

Question Four
Identify the components of the project financing, and discuss to which party each
component would best be allocated

Question Five
Carry out some sensitivity analysis using the information provided in the case study.

Question Six
Would you choose to invest in Petrozuata as Conoco and if so would you try to
impose any conditions?

1
 Question 1
Provide a size-up of the case identifying the key firms involved in the case and the
key issues to be addressed.

In 1996, Petrolera Zuata Petrozuata CA, a Oil and gas firm was set up by a joint venture
of two firms Petroleos De Venezuela SA - PDVSA and Conoco Inc. (a
subsidiary of Dupont) with the intention to embark on a crude oil development project in
Venezuela at a cost of $2.4billion. As at this time, Venezuela depended on
petroleum s its major source of revenue stream.

They intended to fund the project from two main sources of funds which were:
a. Development agencies and banks
b. Capital market (Equity and Bonds)

To fund the project through development agencies and banks, they then sought
to approach 3 (Three) institutions, which were:
 Us Export-Import Bank
 Overseas private investment corporation (OPIC)
 International finance corporation (IFC)
In other to acquire funds from the capital market, the company intended to seek funds
using the USA capital Market and therefore approached the following:
 S&P
 Moody’s & Duff
 Phelps
PDVSA i.e. Petroleos De Venezuela SA and Conoco Inc. then approached Credit
Suisse first Boston and Citicorp as underwriters for in other to access the USA capital
market.
The government of Venezuela established PDVSA as a state-owned enterprise which
had financial autonomy to develop and manage hydrocarbon resources in the country.
As at 1996, it has the world’s second largest reserve of oil. PDVSA had 3 vertically
integrated subsidiaries:
 Maraven – Produces 30% of Venezuela’s crude Oil and controlled 34%
of Venezuela’s reserve.
 Lagoven
 Corpoven
Wholly Owned US subsidiaries of PDVSA
 CITGO Petroleum Corporation
 Lemont Refinery

2
 QUESTION 2
Identify the key risks associated with the project outlined in the case and identify
strategies to mitigate these risks. Perform any empirical analysis you believe is
warranted to outline these risks.

The Risk associated with the project can be outlined as follows:

Before Completion:
Credit Rating risk
The credit rating of Venezuela and the company (PDVSA) is relatively low (S&P Rating
B) as compared to the S&P ratings of US companies that are in the same industry like:
Amaco AAA
Chevron AA
Exxon AAA
Mobil AA
Texaco A+
Shell (CN) AA

Resource Risk
After a test was conducted to confirm the presence and quality of the oil in the Orinoco
belt, the test was also verified by an independent consultant. Based on the conclusion
that petrozuata would extract only 7% of proven reserve, this project is seen as a
development project rather than an exploration.

Natural Disaster
Earthquakes or any other factors that is out of the organizations control like war or
terrorism. These kinds of risk are issued by third parties (Insurance companies) with
large and a well diversified portfolios.
To this end, an insurance policy of $1.5 billion was bought and the pipe lines where laid
underground while the loading facilities where constructed under water.

Technology Risk
Pile lines where laid horizontally as it was what Conoco had used to lay pipe lines in
the past. However, Conoco had sole access to the technology used for drilling diluted
Oil.

After Completion:
Market Demand of Crude Oil
The price of syncrude is not fixed. Given the historical volatility of Maya crude
prices which is the marker for setting syncrude prices the sponsors of the project failed
to lock in a price for the crude and thereby exposed the project to price risk. Recall that
the prices of oil in the open market has being on constant decrease over time.

3
The company should fix the price using derivative instruments and enter a
forward contract with the Oil service industry companies in other to hedge themselves
against the risk of dwelling oil prices.

Petrozuata also protected from this risk by setting its breakeven price well below
the industry average. As such, it would still be able to operate profitably with the
dwelling Oil prices.

Exchange Rate and Inflation

The rate of the local currency (Bolivar) to the USD and the inflation has being on
a constant rise since 1990. This would reduce the cash flow of the project as it would
take more local currency to purchase the USD.

Over the years, the government had restricted currency convertibility between 1994
and 1996. This made several firms to default on foreign currency obligations.

Hence the reason for poor credit ratings of the country by S&P in combination with
the relatively unstable government in the country.

To mitigate this risk, the company should keep oil revenues out of the country. This
can be arguable because the sources of funds (Equity and Debt) where denominated in
USD.

Question Three
Review the various parties to this project and discuss how project financing can
allocate risk to these different parties.

Petroleos De Venezuela SA – PDVSA

One of the partners to the joint venture and would provide less than 50% of equity to the
project but would retain control through dual classes of stock.

Maraven
This is a subsidiary of PDVSA and has a reputation in the oil industry by producing
30% of the Venezuela’s crude oil and controlling 34% of Venezuela’s reserve.
Resources risk can be allocated to this company because they have the experience.

Conoco Inc.
The other partner to the joint venture and contributes more that 50% equity to the
joint venture. Conoco Inc has the technology to drill and export the crude oil. This makes
them capable to handle the technological risk of the project.

4
 Question
Four
Identify the components of the project financing, and discuss to which party each
component would best be allocated.
Transaction Cost
This relates to time and money spent in negotiating the deal. Conoco and Maraven
spent more than 5 years negotiating the project deal and paid up to $15Million as
advisory fees. This amount does not factor in the time and money spent by
employees of the organisation working on the deal.
Question
Five
Carry out some sensitivity analysis using the information provided in the case study.

NPV of the project

Year Cashflow Discount PV
Factor
(2,400,000) (12.29%)
1.0000 (2,400,000)
1996 1 0.8906 -
1997 2 - 0.7931 -
1998 3 78,524 0.7063 55,460
1999 4 429,059 0.6290 269,869
2000 5 804,108 0.5601 450,411
2001 6 569,156 0.4988 283,913
2002 7 583,597 0.4442 259,254
2003 8 598,398 0.3956 236,734
2004 9 613,568 0.3523 216,169
2005 10 629,117 0.3138 197,388
2006 11 645,052 0.2794 180,237
2007 12 661,386 0.2488 164,574
2008 13 678,126 0.2216 150,271
2009 14 695,283 0.1973 137,210
2010 15 712,869 0.1757 125,283
2011 16 730,892 0.1565 114,392
2012 17 749,365 0.1394 104,447
2013 18 768,299 0.1241 95,365
2014 19 768,798 0.1105 84,983
2015 20 769,309 0.0984 75,732
2016 21 769,831 0.0877 67,489
2017 22 770,365 0.0781 60,144
2018 23 770,911 0.0695 53,599
2019 24 771,468 0.0619 47,767
2020 25 781,859 0.0551 43,112
2021 26 782,441 0.0491 38,422
5
 2022 27 783,036 0.0437 34,243
2023 28 783,644 0.0389 30,519
2024 29 784,266 0.0347 27,200
2025 30 784,901 0.0309 24,243
2026 31 785,550 0.0275 21,607
2027 32 786,214 0.0245 19,259
2028 33 786,891 0.0218 17,166
2029 34 787,584 0.0194 15,300
2030 35 788,291 0.0173 13,638
2031 36 789,014 0.0154 12,156
2032 37 789,753 0.0137 10,836
2033 38 790,508 0.0122 9,659
2034 39 791,279 0.0109 8,610
NPV 1,356,664

a. Sensitivity to Outlay

NPV of the project X

100% PV of Outlay

1,356,664 X 100%
2,400,000

= 56.53%
If the project increases by more than 56%, then the project would become unviable.

b. Sensitivity to Cost of capital

IRR - COC X 100%

COC

IRR = LR + NPV (LR) x (HR-

LR) NPV(LR) + NPV (HR)

LR = 12.29%
HR = 20%
NPV(LR) = 1,356,664
NPV (HR) = (542,068)

IRR = 12.29% + 1,356,664 x (20%-12.29%)

1,356,664+ 542,068

6
 IRR = 12.29% + 1,356,664 x (20%-12.29%)
1,898,732

IRR = 12.29% + 0.7145 x (7.71%)

IRR = 12.29% + 0.0551

IRR = 0.178
IRR = 17.8%

Therefore:

IRR - COC X 100%

COC
17.8% - 12.29%
12.29%

=44.8%
44.8% IRR is relatively high. Although the case doesn’t state a benched marked IRR, its
safe to say that with this calculate IRR, the project should be accepted.

IRR of the project

Year Cashflow Discount PV Discount PV
Factor Factor
(12.29%) (20%)

(2,400,000) 1.0000 1 (2,400,000)

(2,400,000)
1996 1 0.8906 - 0.8333 -
1997 2 - 0.7931 - 0.6944 -
1998 3 78,524 0.7063 55,460 0.5787 45,442
1999 4 429,059 0.6290 269,869 0.4823 206,915
2000 5 804,108 0.5601 450,411 0.4019 323,153
2001 6 569,156 0.4988 283,913 0.3349 190,609
2002 7 583,597 0.4442 259,254 0.2791 162,871
2003 8 598,398 0.3956 236,734 0.2326 139,168
2004 9 613,568 0.3523 216,169 0.1938 118,914
2005 10 629,117 0.3138 197,388 0.1615 101,606
2006 11 645,052 0.2794 180,237 0.1346 86,816
2007 12 661,386 0.2488 164,574 0.1122 74,179
2008 13 678,126 0.2216 150,271 0.0935 63,380
2009 14 695,283 0.1973 137,210 0.0779 54,153
2010 15 712,869 0.1757 125,283 0.0649 46,269
2011 16 730,892 0.1565 114,392 0.0541 39,532

7
2012 17 749,365 0.1394 104,447 0.0451 33,776
2013 18 768,299 0.1241 95,365 0.0376 28,858
2014 19 768,798 0.1105 84,983 0.0313 24,064
2015 20 769,309 0.0984 75,732 0.0261 20,067
2016 21 769,831 0.0877 67,489 0.0217 16,734
2017 22 770,365 0.0781 60,144 0.0181 13,954
2018 23 770,911 0.0695 53,599 0.0151 11,637
2019 24 771,468 0.0619 47,767 0.0126 9,704
2020 25 781,859 0.0551 43,112 0.0105 8,196
2021 26 782,441 0.0491 38,422 0.0087 6,835
2022 27 783,036 0.0437 34,243 0.0073 5,700
2023 28 783,644 0.0389 30,519 0.0061 4,754
2024 29 784,266 0.0347 27,200 0.0051 3,965
2025 30 784,901 0.0309 24,243 0.0042 3,307
2026 31 785,550 0.0275 21,607 0.0035 2,758
2027 32 786,214 0.0245 19,259 0.0029 2,300
2028 33 786,891 0.0218 17,166 0.0024 1,918
2029 34 787,584 0.0194 15,300 0.0020 1,600
2030 35 788,291 0.0173 13,638 0.0017 1,335
2031 36 789,014 0.0154 12,156 0.0014 1,113
2032 37 789,753 0.0137 10,836 0.0012 929
2033 38 790,508 0.0122 9,659 0.0010 774
2034 39 791,279 0.0109 8,610 0.0008 646
NPV 1,356,664 NPV (542,068)

Question Six
Would you choose to invest in Petrozuata as Conoco and if so would you try to
impose any conditions?

Investing in Petrozuata might be a good deal, but the unstable political environment of
the country is too great a risk to take. The economic has being plagued with High
inflation rates and exchange rate, which would make local costs more expensive
than usual.
Using the sensitivity analysis calculated above, the project seems very viable
quantitatively.
Before I invest in Petrozuata, I would make sure that revenue generated are reported
in USD and the company would have an agreement with the tax authorities where I
would have any glitches in taking funds out of the country.