What are the pros and cons of relying on project finance, versus internally generated funds?

What other sources of financing can they find?

What are the risks: currency, country, project, future business? How can Conoco minimize them?

Petrolera Zuata, Petrozuata C.A. The first three weeks of January 1997 had been especially hectic for Jos Sifontes, Ted Helms, and Francisco Bustillos from the Corporate Finance Department at Petrleos de Venezuela S.A. (PDVSA), and Miguel Espinosa, Bob Heinrich, and Tom Caspeer from the Treasury Department at Conoco Inc. They had been working around the clock with their financial advisors, Chris Hasty and John Laxmi from Citicorp's Global Project Finance Group, developing the financing strategy for Petrolera Zuata, Petrozuata C.A (Petrozuata), a proposed crude oil development project in Venezuela. In less than a week, Petrozuata's planning team would conduct a series of meetings regarding financing for the $2.4 billion project. According to the plan, they would simultaneously pursue funding from development agencies, banks, and the capital markets. Depending on each source's interest and availability, they would choose an optimal mix from among the various options. In Washington, D.C., the team would meet with several multilateral and bilateral agencies including the US Export-Import (ExIm) Bank, the Overseas Private Investment Corporation (OPIC), and the International Finance Corporation (IFC) to gauge their interest in participating in the deal. Following these meetings, they would fly to New York to meet with Standard and Poor's (S\&P), Moody's, and Duff \& Phelps to discuss how the capital markets might view the project and whether project bonds might receive an investment-grade rating. To assist with the ratings process and a possible bond offering, the sponsors (PDVSA and Conoco) had just selected Credit Suisse-First Boston (CSFB) and Citicorp as lead underwriters, and bankers from each firm would also attend the meetings. Even though the team believed that the proposed deal structure merited an investment-grade rating, they were interested in the rating agencies' perspectives and would consider specific adjustments to the deal structure as long as the changes did not significantly diminish the sponsors' financial or operating flexibility/The Republic of Venezuela Although Venezuela enjoyed a thriving democracy following the overthrow of its last military dictatorship in 1958, its economy grew by fits and starts largely due to dependence on the petroleum industry. While petrodollars fueled growth in public expenditures during periods of high oil prices, the government's inability to curtail spending during periods of depressed oil prices led to inflation, currency devaluations, and macroeconomic instability. For example, a 20\% decline in oil prices in 1988 precipitated a debt crisis, a situation remedied after the Prez government restructured the country's bilateral debt as part of a comprehensive fiscal reform program backed by the International Monetary Fund and other intemational lending agencies. Although the Venezuelan economy improved in the early 1990s, political instability, including two failed military coups and the impeachment of President Prez, soon undermined the recovery. The country's second largest bank collapsed in late 1993 triggering a financial sector crisis of unprecedented severity. In response, the newly elected Caldera administration suspended a.number. of constitutional rights, imposed price controls on basic goods and services, and took direct control over most of the banking system. It also closed the foreign exchange markets and began rationing foreign currency to the private sector, a policy that had been used previously during the 1980s' debt crisis. Due to a lack of administrative procedures for converting bolivars, Venezuela's national currency, into foreign currency, several private firms temporarily defaulted on their foreign currency debt, even though some had sufficient funds to service their debt. The government also fell into arrears on its own foreign currency debt and even defaulted on some local currency bonds. After three years of economic turmoil, President Caldera announced an economic and social reform program called Agenda Venezuela in April 1996. The program eliminated price and exchangerate controls, deregulated interest rates, reinforced a restrictive monetary policy, increased taxes, privatized a number of state-owned enterprises and financial institutions, and again restructured Venezuela's bilateral debt. Agenda Venezuela met with opposition from various sectors including Venezuelan labor unions, which had historically opposed wage cuts and price increases. But by late 1996, the program was on track and the economy had begun to recover. However, with the 1998 presidential elections on the horizon, public pressure to relax the unpopular austerity measures was growing. Petrleos de Venezuela S.A. (PDVSA) The Venezuelan government nationalized the domestic oil industry effective January 1, 1976, paying Royal Dutch Shell, Exxon, Conoco, Gulf, and Mobil, among others, a total of $1 billion in bonds and cash for their Venezuelan assets.1 The government established PDVSA as a state-owned enterprise vested with commercial and financial autonomy to "efficiently develop and manage the country's hydrocarbon resources and promote economic development." Organizationally, PDVSA had three vertically integrated subsidiaries: Marayen, Lagoven, and Corpoven. Because Venezuela was a member of the Organization of the Petroleum Exporting Countries (OPEC), PDVSA was subject to OPEC policies and production quotas. As of 1996, PDVSA's oil and gas reserves were located exclusively in Venezuela, while its refining operations were.located in the United States, Europe, and the Caribbean, as well as Venezuela. Through its wholly-awned US subsidiaries, CITGO Petroleum Corporation and the Lemont Refinery, PDVSA had the third largest refinery capacity and the largest retail gasoline network in the United States. It was the world's second largest oil and gas company, 2 ranking behind Saudi Aramco and ahead of Royal Dutch Shell, the 10 most profitable corporation in the world, and generally viewed as one of the best managed national oil companies.3 Domestically, PDVSA provided 78% of Venezuela's export revenues, 59% of the government's fiscal revenues, and 26% of the nation's GDP. As a state-owned enterprise, PDVSA paid the standard 34\% corporate income tax rate; its operating subsidiaries paid royalties at the rate of 16.67% (times the value of crude oil produced) and income taxes at the rate of 67.7%. However, neither state nor municipal governments could tax PDVSA or its subsidiaries. Venezuelan law required the Central Bank to sell PDVSA foreign currency on a priority basis to meet its foreign exchange requirements, making it the only company granted such a priority. The government also allowed PDVSA to maintain an offshore liquidity account of up to $600 million. Consequently, it never rescheduled any of its debt or experienced debt payment delays. The law also required PDVSA to sell its foreign currency to the Central Bank after settling all foreign currency operating expenses, meeting external debt service obligations, and funding the liquidity account. La Apertura ("The Opening") In 1990, PDVSA began a long-term expansion initiative with the goals of doubling its domestic oil and gas production, increasing its refining capacity, and augmenting its international marketing operations. One of the company's major challenges was raising $65 billion to fund this initiative. According to PDVSA, "The most limited resource that our petroleum industry has today is money." 4 To fund the expansion, PDVSA established a key strategy called La Apertura which opened the Venezuelan oil sector to foreign oil companies through profit sharing agreements, operating service agreements, and strategic joint venture associations. This strategy required a delicate balance between convincing the government that foreign investment would improve the domestic economy while at the same time making the business environment attractive to potential investors. As part of this strategy, PDVSA targeted the Orinoco Belt in central Venezuela, the largest known heavy/extra heavy oil accumulation in the world, for development through strategic associations. It put forth specific criteria for identifying and selecting foreign partners, the most important of which were technological know-how, crude oil marketing capacity, and creditworthiness. In terms of ownership, PDVSA, or its subsidiaries, would contribute less than 50% of the associations' equity but would retain voting control through the use of dual classes of stock (PDVSA would get "priority" shares while the foreign entities would get "partner" shares). Because PDVSA would be a minority owner, the associations would be classified as private companies, which meant that they would not be consolidated into PDVSA's balance sheet. More importantly, they would not be bound by the numerous regulations facing public companies on such things as contract bidding procedures. Finally, the government agreed to lower the royalty rate for strategic associations during the early operating years while the Congress agreed to lower the income tax rate to 34% to improve the economics for heavy crude projects. As part of the agreement, the strategic associations would maximize Venezuelan content subject to price, quality, and deliverability. In 1993, the Venezuelan Congress approved the first two in a series of planned strategic associations between PDVSA, its subsidiaries, and foreign oil companies. The first joint venture, Petrozuata, was between Marayen and Conoco Inc.; the second, Sincor, was between Maraven and three other international oil companies - TOTAL, Statoil, and Norsk, Hydro. Marayen, the PDVSA subsidiary involved in both deals, produced 30% of the Venezuela's crude oil, 14.5% of its natural gas, and 18.4% of its gas liquids in 1996 . It also controlled 34% of all proven Venezuelan reserves, owned and operated two refineries in Venezuela, and had recently completed a $2.7 billion expansion of its Cardn, refinery. Conoco Inc. Petrozuata's other sponsor, Conoco, was the petroleum subsidiary of E.I. du Pont de Nemours and Company (DuPont). DuPont, one of the largest chemical producers in the world, operated some 200 manufacturing and processing facilities in 70 countries around the world, and employed nearly 97,000 people in 1996 . Conoco was an integrated global petroleum company with some 15,000 employees in over 40 countries. It produced 445,000 barrels per calendar day (BPCD) of crude oil and refined 720,000BPCD in 1996.5 Its marketing activities included selling gasoline, diesel, and motor oils through some 4,000 retail outlets in the United States, Europe, and Asia, while its transportation operations included ownership of seven oil tankers and interests in 8,000 miles of pipelines. Conoco was a recognized world leader in both refining technology and project development. It recently completed the $750 million Excel Paralubes, hydrocracker project at its Lake Charles refinery in Louisiana, the $440 million Ardalin oil field development project in Arctic Russia, and the $3.5 billion Heidrun offshore oil field development project in Norway, for which it earned the 1996 Distinguished Achievement Award from the Offshore Technology Conference. Petrolera Zuata, Petrozuata C.A. (Petrozuata)_PDVSA and Conoco began early feasibility studies for a joint project in 1992. Initial conversations concerned the development of a refinery project in Venezuela using Conoco's technology, but soon the parties were considering a fully integrated production, transportation, and refining project. Mr. Espinosa described the decision to participate this way: In spite of our previous experience in Venezuela, we were eager to participate in the Venezuelan oil sector once again. We had long-standing commercial relationships with PDVSAbuying their crude to supply our refineries - and strong personal relationships. When the door opened, we took the opportunity. Conoco was enthusiastic about a project in the Orinoco Belt for several reasons. First, the joint venture would be a development and not an exploration project. Second, it would provide Conoco with a low-cost source of reserves and a long-term supply of crude for its Lake Charles refinery. Finally, Conoco had the project experience and technological know-how to get the job done. On the other side of the deal, PDVSA was excited to have Conoco as its first joint venture partner. Mr. Sifontes said: Because this was our first project, it would set the standard for future deals. Marayen had the heavy crude oil reserves and production technology, while Conoco had proven production and refining technology. The project could draw on Conoco's and Maraven's correctly, this deal would establish the benchmark for similar projects as Venezuela re-opened its oil sector to foreign investment. After four years of planning, Maraven and Conoco Orinoco, a Conoco affiliate established to hold equity in the project, formed Petrolera Zuata, Petrozuata C.A. (Petrozuata), the company responsible for constructing, financing, and managing the Petrozuata project. The association agreement, under which Marayen and Conoco Orinoco owned 49.9% and 50.1% of Petrozyata, respectively, had a term of 35 years beginning once production commenced in 2001. At the end of the agreement, Conoco would transfer its shares to Maraven at no cost. The Petrozyata Project The Petrozuata project had three main components: a series of inland wells to produce the extra heavy crude, a pipeline system to transport the crude to the coast, and an upgrader facility to partially refine the extra heavy crude. While it was somewhat unusual to finance a project with multiple components on a standalone basis, PDVSA and Conoco believed that Petrozuata was a truly integrated facility. Petrozuata's upstream oil field development consisted of drilling oil wells and constructing other related infrastructure. To independently evaluate the project's reserves, the company hired DeGolyer \& MasNaughton, a U.S.-based oil and gas consulting firm with 60 years of experience in over 100 countries. They estimated that Petrozyata's assigned area contained 21.5 billion barrels of extra heavy crude oil, more than enough to sustain the planned production level of 120,000BPCD. To produce the oil, Petrozuata planned to drill horizontal wells, an established drilling technique used in the Orinoco Belt and around the world. The crude would then be mixed with naphtha (a diluent) to reduce its viscosity and facilitate transportation from the oil fields to the coast. Petrozyata planned to build two 125-mile steel pipelines to transport the mixture from the Orinoco Belt to the northeastern coastal city of Jos. A 36 -inch pipeline would transport diluted crude to Jos, while a 20-inch pipeline would transport the diluent back to the oil fields for reuse. The pipeline would have the capacity to transport approximately 510,000BPCD of diluted crude, an amount greater than the 160,000BPCD capacity required for the project ( 120,000BPCD of extra heavy crude oil and 40,000BPCD of diluent). Petrozuata planned to sell the excess capacity to future projects in the area. The terrain between the oil fields and Jose was relatively flat and sparsely populated, and Petrozuata planned to lay most of the pipeline underground once it purchased the necessary land rights under the legal principle of eminent domain. The pipeline would lead to downstream facilities consisting of an upgrader and loading facilities which represented 60% of the project's total construction costs. The upgrader would refine the extra heavy crude into higher-grade syncrude, Although variability in the crude's quality would diminish refining efficiency, the engineers did not expect this to be a major problem. The upgrader was designed to produce 102,000BPCD of sncrude and several by-products using proven Conoco refining technology. Once produced, the syncrude would be transferred via undersea loading lines into ocean-going tankers. Petrozuata would act as the general contractor for the project. Although the project would be nearly self-sufficient in terms of electricity, water, and gas after completion, Petrozuata would contract with Venezuelan firms to provide these inputs during construction. The company anticipated awarding upstream construction contracts to Venezuelan engineering and construction companies that appeared in PDVSA's Registry of Authorized Contractors. The company put the engineering, procurement, and construction (EPC) contracts for the pipelines and downstream facilities out to bid to consortia of experienced contractors including Mitsubishi Heavy Industries and Bechtel, two of the world's leading engineering and construction companies. Stone \& Webster Overseas Consultants, Inc., a U.S.-based consulting and engineering firm with over 100 years of petroleum project engineering experience, independently evaluated the project design, reviewed the performance and cost projections, and assessed the construction schedule. They concluded that the project's design was in accordance with good industry practice, its projected performance and costs were reasonable, and its construction schedule was aggressive, but achievable. Moreover, it would comply with Venezuelan environmental laws and regulations as well as World Bank environmental standards. Petrozuata's, sponsors made a number. of commitments to ensure successful completion of the project. First, Conoco and Maraven agreed to severally6 provide funds to Petrozuata to pay project expenses, including any unexpected cost overruns, prior to completion. The parent corporations, DuPont and PDVSA, guaranteed these obligations. Given the difference in ratings between the companies_-DuPont (AA-) and PDVSA (B) - this grarantee structure was somewhat unique. More typical completion guarantees involved either a letter of credit covering the lower-rated party's obligation or a joint guarantee with a fee paid by the lower-rated to the higher-rated sponsor. The completion grarantee also included severe penalties for failing to meet these obligations, and incentives to cover the other party's shortfalls. Second, the construction budget contained a $38 million contingency for upstream facilities, a $139 million contingency for downstream facilities, and sufficient funds to pay premiums on a construction all risk insurance policy covering up to $1.5 billion of physical loss or damage. Once Petrozuata completed construction, the sponsor guarantees would end and project debt would become non-recourse to the sponsors. In order to declare completion, however, Petrozuata would have to meet a.number.of criteria, including a 90-day operations test during which the production, pipeline, and upgrader would have to meet prescribed production levels and quality specifications. If Petrozuata did not complete the project by December 2001, a date it could extend for a defined period in the case of force majeure, 7 all debt would immediately become due and payable. Engineering consultants described the criteria as comprehensive and sufficient to ensure lender protection. The Off-take Agreement Conoco and Petrozuata signed a purchase agreement under which Conoco, with a guarantee from DuPont, agreed to purchase the first 104,000BPCD of Petrozyata's. syncrude for the 35-year life of the project at a price based on the market price of Maya crude. Conoco planned to refine 62% of the syncrude at its Lake Charles refinery while Maraven would purchase the balance from Conoco and refine it at its Cardn. refinery in Venezuela (see Exhibits 5 and 6). Conoco was not required to purchase the syncrude during scheduled refinery downtime or in the case of force majeure. Because Petrozuata anticipated the development of a broader market for syncrude, it retained the right to sell the synchude to third parties if it could get a higher price. The most likely customers were refineries that could efficiently process syncrude, the majority of which were located along the U.S. Gulf Coast. Petrozuata hired Chem Systems Inc., a U.S.-based consulting firm specializing in petroleum marketing, to independently evaluate the project's marketing strategy and pricing formula. Chem Systems concluded that all of the by-products would be readily salable and that the synchude pricing formula was reasonable and consistent with expected market developments. It also estimated that a third-party market for Petrozuata's, syncryde would develop within three to five years and that thirdparty sales might realize approximately $1.00 per barrel (in 1996 dollars) more on average than the prices payable under the Conoco purchase agreement. Payment Priority: The Cash Waterfall The "cash waterfall," or prioritization of cash flows, was a key element of the contractual agreements. Petrozuata's customers would deposit their dollar-denominated funds from the purchase of syncrude and by-products into an offshore proceeds account maintained by Bankers Trust, an arrangement authorized by the Venezuelan government and governed by the laws of New York. The Trustee would then disburse cash according to a payment hierarchy. First, the Trustee would fund a 90-day operating expense account; second, service the project's debt obligations; and, third, make deposits to a Debt Service Reserve Account as needed to maintain six months of principal and interest. Finally, the Trustee would transfer any remaining funds to Petrozuata for distribution to its equityholders, subject to the restriction that the project maintain a one-year historical and queyears projected Debt Service Coverage Ratio (DSCR) of 1.35X.8. Funding the Petrozyata Project When PDVSA first embarked on La Apertura, it was unclear how the strategic associations would be funded. Mr. Bustillos described PDVSA's decision to use a project finance structure for the Petrozuata deal this way: We had a great project, but we didn't know if project finance was the best alternative. Given the strength of PDVSA's balance sheet, we would have had no trouble financing the deal through a corporate issue. But because this was the first in a series of planned projects, and because our financial flexibility is absolutely critical to our success, we decided to use the project finance structure to preserve our debt capacity. For these reasons, Petrozuata's planning team decided to proceed under the assumption that the project would be financed on a standalone, non-recourse basis (at least after the construction phase). The team decided that 60% of the $2.425 billion expenditure would come from debt financing. Mr. Sifontes described the choice this way: "We could have gone higher, but we chose to invest more equity to show our commitment to the project." If the funding were successful, it would far exceed the $50 to $200 million deals that were more typical in Latin America. Having decided on a capital structure, they still had to decide on where to get the equity and what kind of debt to use. Sources of Equity Funds Under the proposed capital structure, Petrozuata would need \$975 million of equity to finance construction between 1996 and 2000. To get the project started and cover expenses through 1996 , Maraven and Conoco contributed $79 million of paid-in capital. Because Petrozuata projected completion of the oil fields and pipeline in August 1998, the sponsors planned to sell early production crude and use the cash flows to fund $530 million of the financing need. Mr. Sifontes acknowledged that "... funding the construction with early production cash flows would be risky, but we had a good execution plan, strong sponsor guarantees, and experience marketing heavy crude." The sponsors planned to 7 provides sources and uses of funds for 1996 to 2000 . Sources of Debt Financing Given Venezuela's political and economic instability in early 1996 and the unprecedented size of the financing, Petrozyata's planning team initially envisioned raising debt from commercial banks with loan guarantees from bilateral and multilateral agencies. 9 According to the initial financing plan, Petrgzyata would approach a number of agencies including the U.S. ExIm Bank, Export Development Corporation of Canada (EDC), OPIC, and IFC to gauge their interest in providing political risk insurance (PRI) or, in some cases, investing directly in the project. While the team initially thought they could get up to $200 million of uncovered bank loans (loans without PRI), the. majority. of the debt would probably require PRI. The major advantage of using bank debt was that Petrozuata could draw on its credit line as needed, thereby allowing it to match its cash inflows and outflows. In the current interest rate environment, they expected to pay 6-month LIBOR plus 75 to 200 basis points for the bank debt (a rate of 7.50 to 8.75% ). Bank loans, however, had a number of disadvantages: short maturities, restrictive covenants, variable interest rates, and limited size. The problem with a short maturity was that payments during Petrozuata's early years of operation would increase the financial risk posed by oil price volatility and construction delays. Bank debt would also be expensive if lenders required PRI to cover Venezuelan country risk. While the inclusion of PRI might add an additional 300 basis points on top of the borrowing rate, the main problem with covered bank debt was that it could take 12 to 18 months to arrange. Because of the time and cost of arranging "covered" bank debt, the team began to consider other options including the public bond market. Generally, public bonds had long maturities (often greater than 10 years), fixed interest rates, and fewer, more flexible covenants. They were also available in larger amounts (often greater than $100 million). The major disadvantage of bond financing was that the funds had to be raised in lump sum. To the extent that there were unused proceeds, the excess funds would create a drag on earnings (known as negative carry) because the investment rate on those funds would be less than the borrowing rate on the debt. In any case, it was highly unlikely that an emerging market project could tap the public debt markets. Instead, a more feasible alternative was the private placement market and, in particular, the Rule 144A market. Privately placed bonds not only shared the advantages of public bonds, but also had the additional advantage of speed: 144A bonds could be underwritten within six months because they did not require initial disclosure to the Securities and Exchange Commission (SEC). In exchange for less onerous initial and on-going disclosure requirements (although no less complete) only qualified institutional investors could buy 144A bonds (similar rules applied to resales). The bankers felt that a window of opportunity was opening in late 1996 as Venezuela's financial condition was improving and the U.S. bond market was heating-up. As a result, the bankers thought they might be able to issue up to $650 million in project bonds at rates of 8.0% to 9.0% as long as the markets remained hot and Petrozuata could get an investmentgrade rating. If the markets cooled a little, then they would decrease the size of the offering; if the markets cooled down significantly or if Petrozuata could not get an investment grade rating, then they would drop the offering completely. In any case, they would continue discussions with the development agencies and banks as alternative sources of funds. Towards that end, the team sent Requests For Proposals (RFP) to several banks to gauge their interest in the deal and to see whether they would require PRI coverage. The fact that both Venezuela and PDVSA had sub-investment grade ratings remained a potential stumbling block because it would not be economical to issue non-investment-grade bonds. One note of cautious optimism came when Ras Laffan, a $3.7 billion natural gas project in Qatar, issued $1.2 billion of 144A project bonds in mid-December 1996.10 The bonds not only received an investmentgrade rating, but also set a record as the largest emerging market project financing to date. Given PDVSA's substantial capital needs, opening the capital markets as a new source of funds was important both to this deal and to future deals. Rating Petrozuata's, Project Bonds In addition to the financial advisors from Citicorp, the newly-hired bankers from CS First Boston, Wallace Henderson, Jonathan Bram, and Andy Brooks, would play an important role in shepherding the project through the ratings process. They knew that the rating agencies' credit risk assignment process centered on identifying a project's weakest links in operations, financing, or between the two. In Petrozuata's case, the rating agencies would assess three main factors: the sponsors' creditworthiness, the project's economics, and Venezuela's sovereign risk. Because Conoco and Marayen were subsidiaries without publicly-traded debt, the rating agencies would primarily consider the creditworthiness of their respective parent companies. S\&P and Moody's rated DuPont's long-term senior unsecured debt Aa3 and AA-, respectively. Conoco's standalone creditworthiness was also relevant because DuPont could spin-off or sell its petroleum subsidiary. As for PDVSA, its long-term senior unsecured debt had the same credit rating as the Republic of Venezuela, B from S\&P and Ba2 from Moody's. According to Mr. Bustillos, "PDVSA would have a AAA rating if it were located in the United States-but because it was in Venezuela and its lone shareholder was the Venezuelan government, its rating was capped by the sovereign rating." To assess Petrozuata's economics, the rating agencies would analyze the project's technical, reserve, and construction risks, and examine its financial projections. Then, to assess the inherent business risk, they would analyze companies in similar lines of business or similar projects. See Exhibit 8. Because Petrozuata would have to meet its debt obligations even if oil prices decreased, Petrozuata's planning team would present a scenario analysis using historical crude prices to illustrate the project's vulnerability to oil price declines. On the issue of sovereign risk, the rating agencies would consider three principal risks: possible government action, currency market volatility, and Venezuelan business conditions. The government could impose foreign exchange controls once again; it could ask Conoco to divert its payments for syncrude outside of the structure of the revenue waterfall; or it could order Petrozyata to sell syncrude to an entity other than Conoco. Beyond outright seizure of assets, the government could effect the project's economics by changing the tax or royalty rates. The second sovereign risk centered on exchange rates. An appreciation of the bolivar would increase Petrozyata's operating expenses and tax liability relative to its dollar-denominated revenues. Finally, Petrozuata would be exposed to Venezuelan business risks such as the creditworthiness of local suppliers and contractors, the fragility of the Venezuelan financial sector, and the volatility of the labor market. Exhibit 9 provides sovereign credit ratings for Venezuela and other countries. Financial Projections and Analysis Inpreparationforthemeetings,theplanningteamputthefinishingtouchesontheirfinancialprojectionsandsensitivityanalysis. They used their financial model to assess the project's revenue assumptions, operating costs, sponsor returns, and debt coverage ratios. First, along with Chem Systems, the team finalized the syncrude price projections used in the model. For 1998, the base case assumed a syncrude price of $12.87 per barrel, well below the current Maya price of $18.62 per barrel. As the meetings approached, however, petroleum analysts were predicting a decrease in the price of Maya to about $16.00 per barrel within the next few months. In terms of operating costs, the project's major post-completion costs included labor and overhead ( 38% ), well servicing (15%), utilities (13%), and maintenance materials (8%). Its projected finding and development (F&D) costs were very low, approximately $0.25 per barrel. In comparison, Athabasca, a Canadian project with a cost structure more typical of oil and gas projects, had F&D costs of $1.13 per barrel, while the petroleum industry's median F&D cost was $4.96 per barrel.11 Furthermore, Petrozuata's 2001 cash operating cost of $3.19 per barrel was well below both and the industry median and Athabasca's cash operating costs of $8.55 and $9.36, respectively. The team then analyzed sponsor returns. Exhibit 10 a presents cash flow projections assuming reduced income tax rates for the project's 35 -year life, a reduced royalty rate through 2008, and a mixture of bank, agency, and bond financing. In particular, the projections assumed that the sponsors could issue at least $650 million in project bonds, and that the rest of the debt would come from banks and agencies. Exhibit 10b provides capital markets data while Exhibit 11 shows the calculation of the project's cost of capital. Finally, the team assessed the project's debt capacity, minimum debt service coverage ratio (DSCR), and break-even oil price. To get an investment-grade rating, the project's base case DSCR would probably have to exceed 1.80X (if not 2.0X ); its DSCR under various stress cases would probably have to exceed 1.50X; and its break-even price would have to be low enough so the project could cover all operating and financing costs if oil prices fell substantially. The team estimated the project's nominal break-even price (i.e. where DSCR =1.0 ) to be $8.63 per barrel in 2008, the year of highest forecasted debt service. Exhibit 12 provides information on historical crude prices. Conclusion The upcoming meetings in Washington and New York were indicative of the planning team's financing strategy. In Washington, the team would advance the agency financing option; in New York, they would advance the capital markets and bank financing options. The plan, at least with the rating agencies, was to tell them "we consider Petrozyata an investment-grade project." According to Mr. Sifontes: We could not leave any gaps in the documentation. We needed to convince the rating agencies that the project was an excellent opportunity for the sponsors and for potential lenders. While we would admit there were risks, we would show how the deal structure effectively mitigated those risks where possible. In fact, the theme for the meeting was: "Petrozuata: sterling sponsorship, sound project fundamentals, and strong financial structure." If the rating agencies agreed, then the sponsors might get the investment-grade rating they were after. On the other hand, if the rating agencies disagreed, then the sponsors would have to pursue the original plan of agency and bank financing. Petrolera Zuata, Petrozuata C.A. The first three weeks of January 1997 had been especially hectic for Jos Sifontes, Ted Helms, and Francisco Bustillos from the Corporate Finance Department at Petrleos de Venezuela S.A. (PDVSA), and Miguel Espinosa, Bob Heinrich, and Tom Caspeer from the Treasury Department at Conoco Inc. They had been working around the clock with their financial advisors, Chris Hasty and John Laxmi from Citicorp's Global Project Finance Group, developing the financing strategy for Petrolera Zuata, Petrozuata C.A (Petrozuata), a proposed crude oil development project in Venezuela. In less than a week, Petrozuata's planning team would conduct a series of meetings regarding financing for the $2.4 billion project. According to the plan, they would simultaneously pursue funding from development agencies, banks, and the capital markets. Depending on each source's interest and availability, they would choose an optimal mix from among the various options. In Washington, D.C., the team would meet with several multilateral and bilateral agencies including the US Export-Import (ExIm) Bank, the Overseas Private Investment Corporation (OPIC), and the International Finance Corporation (IFC) to gauge their interest in participating in the deal. Following these meetings, they would fly to New York to meet with Standard and Poor's (S\&P), Moody's, and Duff \& Phelps to discuss how the capital markets might view the project and whether project bonds might receive an investment-grade rating. To assist with the ratings process and a possible bond offering, the sponsors (PDVSA and Conoco) had just selected Credit Suisse-First Boston (CSFB) and Citicorp as lead underwriters, and bankers from each firm would also attend the meetings. Even though the team believed that the proposed deal structure merited an investment-grade rating, they were interested in the rating agencies' perspectives and would consider specific adjustments to the deal structure as long as the changes did not significantly diminish the sponsors' financial or operating flexibility/The Republic of Venezuela Although Venezuela enjoyed a thriving democracy following the overthrow of its last military dictatorship in 1958, its economy grew by fits and starts largely due to dependence on the petroleum industry. While petrodollars fueled growth in public expenditures during periods of high oil prices, the government's inability to curtail spending during periods of depressed oil prices led to inflation, currency devaluations, and macroeconomic instability. For example, a 20\% decline in oil prices in 1988 precipitated a debt crisis, a situation remedied after the Prez government restructured the country's bilateral debt as part of a comprehensive fiscal reform program backed by the International Monetary Fund and other intemational lending agencies. Although the Venezuelan economy improved in the early 1990s, political instability, including two failed military coups and the impeachment of President Prez, soon undermined the recovery. The country's second largest bank collapsed in late 1993 triggering a financial sector crisis of unprecedented severity. In response, the newly elected Caldera administration suspended a.number. of constitutional rights, imposed price controls on basic goods and services, and took direct control over most of the banking system. It also closed the foreign exchange markets and began rationing foreign currency to the private sector, a policy that had been used previously during the 1980s' debt crisis. Due to a lack of administrative procedures for converting bolivars, Venezuela's national currency, into foreign currency, several private firms temporarily defaulted on their foreign currency debt, even though some had sufficient funds to service their debt. The government also fell into arrears on its own foreign currency debt and even defaulted on some local currency bonds. After three years of economic turmoil, President Caldera announced an economic and social reform program called Agenda Venezuela in April 1996. The program eliminated price and exchangerate controls, deregulated interest rates, reinforced a restrictive monetary policy, increased taxes, privatized a number of state-owned enterprises and financial institutions, and again restructured Venezuela's bilateral debt. Agenda Venezuela met with opposition from various sectors including Venezuelan labor unions, which had historically opposed wage cuts and price increases. But by late 1996, the program was on track and the economy had begun to recover. However, with the 1998 presidential elections on the horizon, public pressure to relax the unpopular austerity measures was growing. Petrleos de Venezuela S.A. (PDVSA) The Venezuelan government nationalized the domestic oil industry effective January 1, 1976, paying Royal Dutch Shell, Exxon, Conoco, Gulf, and Mobil, among others, a total of $1 billion in bonds and cash for their Venezuelan assets.1 The government established PDVSA as a state-owned enterprise vested with commercial and financial autonomy to "efficiently develop and manage the country's hydrocarbon resources and promote economic development." Organizationally, PDVSA had three vertically integrated subsidiaries: Marayen, Lagoven, and Corpoven. Because Venezuela was a member of the Organization of the Petroleum Exporting Countries (OPEC), PDVSA was subject to OPEC policies and production quotas. As of 1996, PDVSA's oil and gas reserves were located exclusively in Venezuela, while its refining operations were.located in the United States, Europe, and the Caribbean, as well as Venezuela. Through its wholly-awned US subsidiaries, CITGO Petroleum Corporation and the Lemont Refinery, PDVSA had the third largest refinery capacity and the largest retail gasoline network in the United States. It was the world's second largest oil and gas company, 2 ranking behind Saudi Aramco and ahead of Royal Dutch Shell, the 10 most profitable corporation in the world, and generally viewed as one of the best managed national oil companies.3 Domestically, PDVSA provided 78% of Venezuela's export revenues, 59% of the government's fiscal revenues, and 26% of the nation's GDP. As a state-owned enterprise, PDVSA paid the standard 34\% corporate income tax rate; its operating subsidiaries paid royalties at the rate of 16.67% (times the value of crude oil produced) and income taxes at the rate of 67.7%. However, neither state nor municipal governments could tax PDVSA or its subsidiaries. Venezuelan law required the Central Bank to sell PDVSA foreign currency on a priority basis to meet its foreign exchange requirements, making it the only company granted such a priority. The government also allowed PDVSA to maintain an offshore liquidity account of up to $600 million. Consequently, it never rescheduled any of its debt or experienced debt payment delays. The law also required PDVSA to sell its foreign currency to the Central Bank after settling all foreign currency operating expenses, meeting external debt service obligations, and funding the liquidity account. La Apertura ("The Opening") In 1990, PDVSA began a long-term expansion initiative with the goals of doubling its domestic oil and gas production, increasing its refining capacity, and augmenting its international marketing operations. One of the company's major challenges was raising $65 billion to fund this initiative. According to PDVSA, "The most limited resource that our petroleum industry has today is money." 4 To fund the expansion, PDVSA established a key strategy called La Apertura which opened the Venezuelan oil sector to foreign oil companies through profit sharing agreements, operating service agreements, and strategic joint venture associations. This strategy required a delicate balance between convincing the government that foreign investment would improve the domestic economy while at the same time making the business environment attractive to potential investors. As part of this strategy, PDVSA targeted the Orinoco Belt in central Venezuela, the largest known heavy/extra heavy oil accumulation in the world, for development through strategic associations. It put forth specific criteria for identifying and selecting foreign partners, the most important of which were technological know-how, crude oil marketing capacity, and creditworthiness. In terms of ownership, PDVSA, or its subsidiaries, would contribute less than 50% of the associations' equity but would retain voting control through the use of dual classes of stock (PDVSA would get "priority" shares while the foreign entities would get "partner" shares). Because PDVSA would be a minority owner, the associations would be classified as private companies, which meant that they would not be consolidated into PDVSA's balance sheet. More importantly, they would not be bound by the numerous regulations facing public companies on such things as contract bidding procedures. Finally, the government agreed to lower the royalty rate for strategic associations during the early operating years while the Congress agreed to lower the income tax rate to 34% to improve the economics for heavy crude projects. As part of the agreement, the strategic associations would maximize Venezuelan content subject to price, quality, and deliverability. In 1993, the Venezuelan Congress approved the first two in a series of planned strategic associations between PDVSA, its subsidiaries, and foreign oil companies. The first joint venture, Petrozuata, was between Marayen and Conoco Inc.; the second, Sincor, was between Maraven and three other international oil companies - TOTAL, Statoil, and Norsk, Hydro. Marayen, the PDVSA subsidiary involved in both deals, produced 30% of the Venezuela's crude oil, 14.5% of its natural gas, and 18.4% of its gas liquids in 1996 . It also controlled 34% of all proven Venezuelan reserves, owned and operated two refineries in Venezuela, and had recently completed a $2.7 billion expansion of its Cardn, refinery. Conoco Inc. Petrozuata's other sponsor, Conoco, was the petroleum subsidiary of E.I. du Pont de Nemours and Company (DuPont). DuPont, one of the largest chemical producers in the world, operated some 200 manufacturing and processing facilities in 70 countries around the world, and employed nearly 97,000 people in 1996 . Conoco was an integrated global petroleum company with some 15,000 employees in over 40 countries. It produced 445,000 barrels per calendar day (BPCD) of crude oil and refined 720,000BPCD in 1996.5 Its marketing activities included selling gasoline, diesel, and motor oils through some 4,000 retail outlets in the United States, Europe, and Asia, while its transportation operations included ownership of seven oil tankers and interests in 8,000 miles of pipelines. Conoco was a recognized world leader in both refining technology and project development. It recently completed the $750 million Excel Paralubes, hydrocracker project at its Lake Charles refinery in Louisiana, the $440 million Ardalin oil field development project in Arctic Russia, and the $3.5 billion Heidrun offshore oil field development project in Norway, for which it earned the 1996 Distinguished Achievement Award from the Offshore Technology Conference. Petrolera Zuata, Petrozuata C.A. (Petrozuata)_PDVSA and Conoco began early feasibility studies for a joint project in 1992. Initial conversations concerned the development of a refinery project in Venezuela using Conoco's technology, but soon the parties were considering a fully integrated production, transportation, and refining project. Mr. Espinosa described the decision to participate this way: In spite of our previous experience in Venezuela, we were eager to participate in the Venezuelan oil sector once again. We had long-standing commercial relationships with PDVSAbuying their crude to supply our refineries - and strong personal relationships. When the door opened, we took the opportunity. Conoco was enthusiastic about a project in the Orinoco Belt for several reasons. First, the joint venture would be a development and not an exploration project. Second, it would provide Conoco with a low-cost source of reserves and a long-term supply of crude for its Lake Charles refinery. Finally, Conoco had the project experience and technological know-how to get the job done. On the other side of the deal, PDVSA was excited to have Conoco as its first joint venture partner. Mr. Sifontes said: Because this was our first project, it would set the standard for future deals. Marayen had the heavy crude oil reserves and production technology, while Conoco had proven production and refining technology. The project could draw on Conoco's and Maraven's correctly, this deal would establish the benchmark for similar projects as Venezuela re-opened its oil sector to foreign investment. After four years of planning, Maraven and Conoco Orinoco, a Conoco affiliate established to hold equity in the project, formed Petrolera Zuata, Petrozuata C.A. (Petrozuata), the company responsible for constructing, financing, and managing the Petrozuata project. The association agreement, under which Marayen and Conoco Orinoco owned 49.9% and 50.1% of Petrozyata, respectively, had a term of 35 years beginning once production commenced in 2001. At the end of the agreement, Conoco would transfer its shares to Maraven at no cost. The Petrozyata Project The Petrozuata project had three main components: a series of inland wells to produce the extra heavy crude, a pipeline system to transport the crude to the coast, and an upgrader facility to partially refine the extra heavy crude. While it was somewhat unusual to finance a project with multiple components on a standalone basis, PDVSA and Conoco believed that Petrozuata was a truly integrated facility. Petrozuata's upstream oil field development consisted of drilling oil wells and constructing other related infrastructure. To independently evaluate the project's reserves, the company hired DeGolyer \& MasNaughton, a U.S.-based oil and gas consulting firm with 60 years of experience in over 100 countries. They estimated that Petrozyata's assigned area contained 21.5 billion barrels of extra heavy crude oil, more than enough to sustain the planned production level of 120,000BPCD. To produce the oil, Petrozuata planned to drill horizontal wells, an established drilling technique used in the Orinoco Belt and around the world. The crude would then be mixed with naphtha (a diluent) to reduce its viscosity and facilitate transportation from the oil fields to the coast. Petrozyata planned to build two 125-mile steel pipelines to transport the mixture from the Orinoco Belt to the northeastern coastal city of Jos. A 36 -inch pipeline would transport diluted crude to Jos, while a 20-inch pipeline would transport the diluent back to the oil fields for reuse. The pipeline would have the capacity to transport approximately 510,000BPCD of diluted crude, an amount greater than the 160,000BPCD capacity required for the project ( 120,000BPCD of extra heavy crude oil and 40,000BPCD of diluent). Petrozuata planned to sell the excess capacity to future projects in the area. The terrain between the oil fields and Jose was relatively flat and sparsely populated, and Petrozuata planned to lay most of the pipeline underground once it purchased the necessary land rights under the legal principle of eminent domain. The pipeline would lead to downstream facilities consisting of an upgrader and loading facilities which represented 60% of the project's total construction costs. The upgrader would refine the extra heavy crude into higher-grade syncrude, Although variability in the crude's quality would diminish refining efficiency, the engineers did not expect this to be a major problem. The upgrader was designed to produce 102,000BPCD of sncrude and several by-products using proven Conoco refining technology. Once produced, the syncrude would be transferred via undersea loading lines into ocean-going tankers. Petrozuata would act as the general contractor for the project. Although the project would be nearly self-sufficient in terms of electricity, water, and gas after completion, Petrozuata would contract with Venezuelan firms to provide these inputs during construction. The company anticipated awarding upstream construction contracts to Venezuelan engineering and construction companies that appeared in PDVSA's Registry of Authorized Contractors. The company put the engineering, procurement, and construction (EPC) contracts for the pipelines and downstream facilities out to bid to consortia of experienced contractors including Mitsubishi Heavy Industries and Bechtel, two of the world's leading engineering and construction companies. Stone \& Webster Overseas Consultants, Inc., a U.S.-based consulting and engineering firm with over 100 years of petroleum project engineering experience, independently evaluated the project design, reviewed the performance and cost projections, and assessed the construction schedule. They concluded that the project's design was in accordance with good industry practice, its projected performance and costs were reasonable, and its construction schedule was aggressive, but achievable. Moreover, it would comply with Venezuelan environmental laws and regulations as well as World Bank environmental standards. Petrozuata's, sponsors made a number. of commitments to ensure successful completion of the project. First, Conoco and Maraven agreed to severally6 provide funds to Petrozuata to pay project expenses, including any unexpected cost overruns, prior to completion. The parent corporations, DuPont and PDVSA, guaranteed these obligations. Given the difference in ratings between the companies_-DuPont (AA-) and PDVSA (B) - this grarantee structure was somewhat unique. More typical completion guarantees involved either a letter of credit covering the lower-rated party's obligation or a joint guarantee with a fee paid by the lower-rated to the higher-rated sponsor. The completion grarantee also included severe penalties for failing to meet these obligations, and incentives to cover the other party's shortfalls. Second, the construction budget contained a $38 million contingency for upstream facilities, a $139 million contingency for downstream facilities, and sufficient funds to pay premiums on a construction all risk insurance policy covering up to $1.5 billion of physical loss or damage. Once Petrozuata completed construction, the sponsor guarantees would end and project debt would become non-recourse to the sponsors. In order to declare completion, however, Petrozuata would have to meet a.number.of criteria, including a 90-day operations test during which the production, pipeline, and upgrader would have to meet prescribed production levels and quality specifications. If Petrozuata did not complete the project by December 2001, a date it could extend for a defined period in the case of force majeure, 7 all debt would immediately become due and payable. Engineering consultants described the criteria as comprehensive and sufficient to ensure lender protection. The Off-take Agreement Conoco and Petrozuata signed a purchase agreement under which Conoco, with a guarantee from DuPont, agreed to purchase the first 104,000BPCD of Petrozyata's. syncrude for the 35-year life of the project at a price based on the market price of Maya crude. Conoco planned to refine 62% of the syncrude at its Lake Charles refinery while Maraven would purchase the balance from Conoco and refine it at its Cardn. refinery in Venezuela (see Exhibits 5 and 6). Conoco was not required to purchase the syncrude during scheduled refinery downtime or in the case of force majeure. Because Petrozuata anticipated the development of a broader market for syncrude, it retained the right to sell the synchude to third parties if it could get a higher price. The most likely customers were refineries that could efficiently process syncrude, the majority of which were located along the U.S. Gulf Coast. Petrozuata hired Chem Systems Inc., a U.S.-based consulting firm specializing in petroleum marketing, to independently evaluate the project's marketing strategy and pricing formula. Chem Systems concluded that all of the by-products would be readily salable and that the synchude pricing formula was reasonable and consistent with expected market developments. It also estimated that a third-party market for Petrozuata's, syncryde would develop within three to five years and that thirdparty sales might realize approximately $1.00 per barrel (in 1996 dollars) more on average than the prices payable under the Conoco purchase agreement. Payment Priority: The Cash Waterfall The "cash waterfall," or prioritization of cash flows, was a key element of the contractual agreements. Petrozuata's customers would deposit their dollar-denominated funds from the purchase of syncrude and by-products into an offshore proceeds account maintained by Bankers Trust, an arrangement authorized by the Venezuelan government and governed by the laws of New York. The Trustee would then disburse cash according to a payment hierarchy. First, the Trustee would fund a 90-day operating expense account; second, service the project's debt obligations; and, third, make deposits to a Debt Service Reserve Account as needed to maintain six months of principal and interest. Finally, the Trustee would transfer any remaining funds to Petrozuata for distribution to its equityholders, subject to the restriction that the project maintain a one-year historical and queyears projected Debt Service Coverage Ratio (DSCR) of 1.35X.8. Funding the Petrozyata Project When PDVSA first embarked on La Apertura, it was unclear how the strategic associations would be funded. Mr. Bustillos described PDVSA's decision to use a project finance structure for the Petrozuata deal this way: We had a great project, but we didn't know if project finance was the best alternative. Given the strength of PDVSA's balance sheet, we would have had no trouble financing the deal through a corporate issue. But because this was the first in a series of planned projects, and because our financial flexibility is absolutely critical to our success, we decided to use the project finance structure to preserve our debt capacity. For these reasons, Petrozuata's planning team decided to proceed under the assumption that the project would be financed on a standalone, non-recourse basis (at least after the construction phase). The team decided that 60% of the $2.425 billion expenditure would come from debt financing. Mr. Sifontes described the choice this way: "We could have gone higher, but we chose to invest more equity to show our commitment to the project." If the funding were successful, it would far exceed the $50 to $200 million deals that were more typical in Latin America. Having decided on a capital structure, they still had to decide on where to get the equity and what kind of debt to use. Sources of Equity Funds Under the proposed capital structure, Petrozuata would need \$975 million of equity to finance construction between 1996 and 2000. To get the project started and cover expenses through 1996 , Maraven and Conoco contributed $79 million of paid-in capital. Because Petrozuata projected completion of the oil fields and pipeline in August 1998, the sponsors planned to sell early production crude and use the cash flows to fund $530 million of the financing need. Mr. Sifontes acknowledged that "... funding the construction with early production cash flows would be risky, but we had a good execution plan, strong sponsor guarantees, and experience marketing heavy crude." The sponsors planned to 7 provides sources and uses of funds for 1996 to 2000 . Sources of Debt Financing Given Venezuela's political and economic instability in early 1996 and the unprecedented size of the financing, Petrozyata's planning team initially envisioned raising debt from commercial banks with loan guarantees from bilateral and multilateral agencies. 9 According to the initial financing plan, Petrgzyata would approach a number of agencies including the U.S. ExIm Bank, Export Development Corporation of Canada (EDC), OPIC, and IFC to gauge their interest in providing political risk insurance (PRI) or, in some cases, investing directly in the project. While the team initially thought they could get up to $200 million of uncovered bank loans (loans without PRI), the. majority. of the debt would probably require PRI. The major advantage of using bank debt was that Petrozuata could draw on its credit line as needed, thereby allowing it to match its cash inflows and outflows. In the current interest rate environment, they expected to pay 6-month LIBOR plus 75 to 200 basis points for the bank debt (a rate of 7.50 to 8.75% ). Bank loans, however, had a number of disadvantages: short maturities, restrictive covenants, variable interest rates, and limited size. The problem with a short maturity was that payments during Petrozuata's early years of operation would increase the financial risk posed by oil price volatility and construction delays. Bank debt would also be expensive if lenders required PRI to cover Venezuelan country risk. While the inclusion of PRI might add an additional 300 basis points on top of the borrowing rate, the main problem with covered bank debt was that it could take 12 to 18 months to arrange. Because of the time and cost of arranging "covered" bank debt, the team began to consider other options including the public bond market. Generally, public bonds had long maturities (often greater than 10 years), fixed interest rates, and fewer, more flexible covenants. They were also available in larger amounts (often greater than $100 million). The major disadvantage of bond financing was that the funds had to be raised in lump sum. To the extent that there were unused proceeds, the excess funds would create a drag on earnings (known as negative carry) because the investment rate on those funds would be less than the borrowing rate on the debt. In any case, it was highly unlikely that an emerging market project could tap the public debt markets. Instead, a more feasible alternative was the private placement market and, in particular, the Rule 144A market. Privately placed bonds not only shared the advantages of public bonds, but also had the additional advantage of speed: 144A bonds could be underwritten within six months because they did not require initial disclosure to the Securities and Exchange Commission (SEC). In exchange for less onerous initial and on-going disclosure requirements (although no less complete) only qualified institutional investors could buy 144A bonds (similar rules applied to resales). The bankers felt that a window of opportunity was opening in late 1996 as Venezuela's financial condition was improving and the U.S. bond market was heating-up. As a result, the bankers thought they might be able to issue up to $650 million in project bonds at rates of 8.0% to 9.0% as long as the markets remained hot and Petrozuata could get an investmentgrade rating. If the markets cooled a little, then they would decrease the size of the offering; if the markets cooled down significantly or if Petrozuata could not get an investment grade rating, then they would drop the offering completely. In any case, they would continue discussions with the development agencies and banks as alternative sources of funds. Towards that end, the team sent Requests For Proposals (RFP) to several banks to gauge their interest in the deal and to see whether they would require PRI coverage. The fact that both Venezuela and PDVSA had sub-investment grade ratings remained a potential stumbling block because it would not be economical to issue non-investment-grade bonds. One note of cautious optimism came when Ras Laffan, a $3.7 billion natural gas project in Qatar, issued $1.2 billion of 144A project bonds in mid-December 1996.10 The bonds not only received an investmentgrade rating, but also set a record as the largest emerging market project financing to date. Given PDVSA's substantial capital needs, opening the capital markets as a new source of funds was important both to this deal and to future deals. Rating Petrozuata's, Project Bonds In addition to the financial advisors from Citicorp, the newly-hired bankers from CS First Boston, Wallace Henderson, Jonathan Bram, and Andy Brooks, would play an important role in shepherding the project through the ratings process. They knew that the rating agencies' credit risk assignment process centered on identifying a project's weakest links in operations, financing, or between the two. In Petrozuata's case, the rating agencies would assess three main factors: the sponsors' creditworthiness, the project's economics, and Venezuela's sovereign risk. Because Conoco and Marayen were subsidiaries without publicly-traded debt, the rating agencies would primarily consider the creditworthiness of their respective parent companies. S\&P and Moody's rated DuPont