Fitch Explains Rationale Behind Downgrade of Venezuela's Heavy Oil Projects

Fitch Ratings

Fitch Ratings has released a special report, titled 'Venezuela's Heavy Oil Projects: The Beginning of the End?' that details the rationale behind Fitch's May 11, 2006 decision to downgrade the senior secured debts of Petrozuata Finance Inc. (PZ), Cerro Negro Finance, Ltd. (CN), Sincrudos de Oriente Sincor, C.A. (Sincor), and Petrolera Hamaca, S.A. (Hamaca) from 'BB' to 'B+'. The ratings remain on Rating Watch Negative.

The downgrade considers the ongoing policy shifts affecting private and foreign hydrocarbon producers in Venezuela. Specifically, on May 11, the National Assembly amended the Organic Hydrocarbon law of 2001 to levy a new oil extraction tax at the rate of 33.33% on the strategic associations for the development of extra-heavy crude oil of the Orinoco Basin. The Rating Watch Negative signals that additional downgrades are highly probable in the short term. The expectation of further credit deterioration considers the government's announced intention to restructure the association agreements between Petroleos de Venezuela S.A. (PDVSA) and the foreign producers participating in the projects as 'Mixed Enterprises.' The restructuring could seriously impair the projects operations, assuming that the legal and economic hurdles to affect it are overcome. In essence, the downgrade and Negative Watch status are directly attributable to government policy.

'Notwithstanding the rating downgrade and Negative Watch status, all four projects are operating successfully and exceeding expectations. Were it not for the actions and intentions of the government, the projects' debt ratings would be significantly higher,' according to Gersan Zurita, a Senior Director of Project Finance at Fitch Ratings.

The strong fiscal and operating performance of the four EHCO projects demonstrates that despite the unanticipated increase in royalties that took effect during the last quarter of 2004, buoyant oil prices lifted cash flows available for operating expenses, capital expenditures and scheduled debt service above expectations. However, Fitch's revised project economics for the medium term are weaker. Higher royalties and taxes, persistent double-digit inflation in Venezuela, lower oil prices and the government's imposed limits on production, could result in net revenue declines of as much as 80%. Under these assumptions, the ability of the projects to service debt obligations in full could be impaired by 2011 or earlier. This negative outlook contrasts sharply with the original base-case assumptions, which suggested the projects would continue to cover amply all of their fixed operating expenses and debt-service payments, even with prices considerably lower than historical averages. Although Fitch believes the projects are more vital to Venezuela today than when they were initiated, Fitch expects that if, as a result, PDVSA takes over full operating control of the projects rather than just a greater stake in the revenue and profits, the future economic viability of the four EHCO projects would become increasingly uncertain.


Petrozuata benefits from long-term contractual commitments from its two sponsors: ConocoPhillips (Issuer Default Rating [IDR] of 'A-' Stable Outlook by Fitch), whose subsidiaries hold 50.1% of the equity in the project, and PDVSA (foreign currency IDR of 'BB-' Stable Outlook by Fitch), whose subsidiaries hold 49.9%.

Cerro Negro:

Cerro Negro is an unincorporated joint venture formed in 1997 among three subsidiaries of the following sponsors: ExxonMobil (Mobil Cerro Negro, Ltd., 41.67%), PDVSA (PDVSA Cerro Negro, S.A., 41.67%) and Veba Oel--now BP plc-- (Veba Oil and Gas Cerro Negro GmbH 16.66%). Under a 35-year offtake agreement, all of Cerro Negro's production is received by Chalmette Refinery LLC (a joint venture of Mobil and PDVSA) in Louisiana and Veba Oel's refinery system in Germany.


Sincor's $5 billion oil development project is sponsored by TOTAL (47%), PDVSA (38%) and Statoil (15%). The project, which achieved full completion in February 2006, produces approximately 150,000 bpd of syncrude. Unlike the output of Petrozuata and Cerro Negro, Sincor's product is a 30 degrees - 32 degrees API low sulfur oil. Unlike Petrozuata and Cerro Negro, Sincor's production is not designated to any offtaker. Sincor relies on the unique qualities of its syncrude for market acceptance.


Hamaca is sponsored by subsidiaries of the following: Phillips Petroleum (40%), PDVSA (30%) and Texaco (30%). Ameriven oversaw construction and operates the project on behalf of the sponsors. Hamaca reached full commercial operations in October 2004. Similar to Sincor, Hamaca sells its commercial production volumes into the USGC refining market, and unlike Petrozuata and Cerro Negro, Hamaca does not benefit from a predesignated refining relationship to provide a secure outlet for its production.

A full report explaining the rationale for these actions is available on the Fitch Ratings web site