The success of Exxon Mobil Corporation in its bid to freeze more than $12 billion of assets of PDVSA was a slap in the face for the Venezuelan oil giant and is making banks even more leery of dealing with the maverick state-controlled company. The measure, announced on 7 February, included a provision to include some accounts attached to a project finance transaction and is likely to forestall debt issuance from PDVSA in the next few months until some clarity emerges on the case, say bankers. Bankers, which had continued to do business with PDVSA, even as its dispute with the sponsors of the heavy oil projects escalated, are now adopting a wait-and-see approach.

Legal wrangles

Exxon obtained court orders freezing worldwide assets in the UK; assets in the Netherlands and the Netherlands Antilles; and a US court ruling in the Southern District of New York to attach $300 million in funds belonging to the very heavy oil Cerro Negro project. The moves came in the wake of Venezuela's nationalisation of four heavy oil projects in the Orinoco belt, worth some $30 billion in total. Exxon had a 42% stake in the Cerro Negro project but failed to reach agreement on the terms of a dilution and pulled out.

Bankers that have dealings with PDVSA are in shock, and the freeze of Cerro Negro funds is a particular concern. One PDVSA banker, who preferred to remain anonymous, said that he and his competitors have all been seeking the advice of lawyers. There is the possibility that the Cerro Negro asset freeze may cause a technical default, which would raise serious concerns in the market. Bankers and lawyers are still discussing this and many are investigating the potential ramifications on financing transactions with which PDVSA is directly or indirectly involved.

Even non-bank sources of financing, including export credit agencies have adopted a cautious stance, the banker says. He estimates that PDVSA will need to modify its fundraising activities and push back deals into the second half of 2008, at least.

One consolation is that the court order seems to freeze only existing assets and not the cash flow coming from future deals, the banker says, adding that there is some disagreement between lawyers even on this point. "Nothing is yet black-and-white, which is why the market is taking a cautious approach. PDVSA may not be able to get any funds until the outcome of the court case is clear," he says.

Much now depends on whether PDVSA is able to eliminate or win the cases, especially against the global asset freeze in the UK, or if oil prices continue to trend upward and reach new historical highs, says Luisa Palacios, managing director at energy and macro consultancy Medley Global Advisors in New York.

Future headaches

At the very least, Exxon's legal case has called into question future financing costs and techniques by PDVSA as well as further hurting the firm's already-battered reputation.

The aggressive move by Exxon clearly took PDVSA by surprise. PDVSA was geared up for international arbitration, but was thrown off by the coordinated freeze, says Palacios. The reaction of the Venezuelan government, branding Exxon Mobil's move an act of "judicial terrorism" and reiterating a threat to cut off oil supplies to the United States has once again raised the question of PDVSA's dependability. As Moody's bleakly noted: "the potential damage to PDVSA's commercial interests as a reliable supplier of crude and to its continuing ability to access to international capital markets."

Legal questions now centre on whether US and UK courts can rule on this case, or whether it falls in the realm of international arbitration, says Palacios. Clearly, PDVSA is state-owned, but it is unclear if bonds issued by a state-owned company qualify for sovereign immunity. The other controversy is the amount of the pre-attachment, set at what appears to be a high $12 billion, she says.

The timing for all this uncertainty could hardly be worse. Significantly poorer credit conditions worldwide had already taken their toll on emerging market issuers, particularly those in high-risk markets, such as Venezuela. Bond pricing often does not correlate with a firm's creditworthiness, particularly with high volatility paper, notes one banker, who points out that Argentine sovereign bonds jumped some 2,500 bp during the 2001 crisis.

Choppy market conditions make it difficult to separate out what stems from general investor credit aversion, and what is particular to PDVSA's story, as the firm's bond price tumbles. What is clear is that the firm's bonds have suffered since the announcement. The benchmark bonds due 2017 fell to 68bp from 73-74bp in the days following the announcement and have recovered only some of that territory, trading at some 69 on February 26th, points out Palacios.

Outstanding debt

Despite all the uncertainties surrounding the possibility of a technical default and the firm's access to capital markets, Exxon's case does not look likely to have any impact on PDVSA's plans to pay down its remaining outstanding debt related to two project finance deals, according to Aaron Freedman, an analyst at Moody's Investors Service in New York. PDVSA used project finance debt to finance four extra heavy crude oil projects operating in the Orinoco belt. Cerro Negro Finance and Petrozuata Finance were both funded through bonds while Hamaca and Sincrudos de Oriente Sincor (Sincor) were financed through bank loans.

There is a strong possibility that the already-completed buy back of Cerro Negro bonds and repayment of Hamaca loans will be used as a precedent for the buy-back of Petrozuata bonds and Sincor loans.

A successful tender offer for the $482 million bonds of the Cerro Negro project was made in January and soon after S&P put the single-B rating on Petrozuata's $987.2 million in bonds on credit watch with positive implications, reasoning that the Cerro Negro deal would prove a blueprint. PDVSA is also negotiating with Petrozuata bondholders in part to prevent them from accelerating the bonds, a possibility because of a change in control.

Freedman cautions, however, that although the Cerro Negro deal was ultimately successful, with more than 99% of bondholders finally accepting the offer to redeem their bonds, the deal was messy, as the terms of the indenture were not honoured. Bondholders received par plus just one-third of an early call premium specified in the indenture, he points out. Given the failure to pay the premium in full, S&P considers the tender a distressed exchange.

Furthermore, the Cerro Negro offer came with a nasty sting in its tail. Any bondholder accepting the deal automatically consented to an approval to amend the indenture, he notes. That would eliminate all restrictive covenants, events of default other than payment defaults, and the trustee-administered waterfall of accounts, and release all bondholders' collateral and security interests. The amendment required the approval of a minimum 75% of bondholders. Once that 75% threshold was achieved, other investors were left with an unpalatable choice, either to hold bonds with a very much weaker covenant or to exchange their bonds, he says. Many agreed to the deal under duress.

It is possible too that PDVSA will prove a tougher negotiator in the case of Petrozuata. Cerro Negro lenders were very active in clubbing together and negotiating hard with the company for a deal while the bondholders in Petrozuata have not been as organized and active, says Freedman. The weaker bondholder grouping means they may not be able to negotiate the same terms, he says. Finally, a payout would probably be funded from the Petrozuata trustee-held funds. If there are restrictions on these funds from legal cases, it could make it more challenging for PDVSA to tender the bonds.

On the project finance bank loan side, the oil giant inked a deal last December to tender the outstanding $1.1 billion in Hamaca's senior secured debt that lay with a syndicate that included BNP Paribas, Royal Bank of Scotland and US Exim, leaving just the debt of Sincor outstanding. That project was financed in part through a $1.2 billion, 14-year senior bank loan.

Operational normality

The Exxon case does not present any near-term operational risk for PDVSA. For now, the high oil price gives PDVSA an enormous cushion, say bankers. That will continue to allow the firm to support the generous social programs launched by Venezuelan President Hugo Chavez, without resorting to capital markets. Furthermore, PDVSA has an internal budget calculation that is based on an oil price of close to $40 per barrel against today's prices of $100. The firm had cash of some $3.6 billion in the second quarter of last year and total assets of about $92 billion.

And some financiers seem unfazed by the case, says Palacios, pointing to the continuation of deals that were already underway. A $6 billion bi-national oil fund with Chinese contributions of $4 billion and Venezuelan funding of $2 billion and the recent renewal of a credit line with international banks led by BNP Paribas suggest that financing will not be completely curtailed, she says. Furthermore, PDVSA can finance itself through the local markets, with retail investors desperate for US dollars.

That said, the clear pressure on the bonds means that PDVSA will need to offer security to obtain cheap financing. One likely outcome is that PDVSA will step up its use of securitisation, reasons Palacios.

Goldman Sachs analyst Alberto Ramos is more pessimistic. In a report, he says that he believes that the company has cash-flow problems that will be tested by upcoming bond payments. At the same time that pressure is on for PDVSA to raise cash, the court action may make such sales problematic, he reasons. PDVSA is due to make debt repayments of $2.87 billion this year alone.

PDVSA has certainly been increasing its debt burden fast, in large part to carry out cherished government programmes. Its accumulated debt is $16 billion, based on recent financial statements. Most of these obligations were created in 2007, when both the firm and its US-based refining branch Citgo contracted debts amounting to $13.1 billion.

In the longer-term, risks continue to accumulate. The biggest danger now lies in a combination of weaker oil prices and intransigence from the Chavez government in demanding high levels of financing for social programs, reckons one analyst. That would prove a toxic combination.

Finally, there remains the ever-present risk of an unexpected and harmful decision by president Hugo Chavez. Recently, he has been airing the idea of a windfall petroleum tax, which would be the fourth tax imposed on the industry in so many years although for now this remains conceptual.

International implications

The drama playing out in Venezuela is creating waves not just locally and in the US but worldwide, particularly at a time when resource rich countries are determined to capture more of the gain from the high price of commodities.
"There was always a feeling that Exxon was going to play hardball. It wanted to use Venezuela as an example to warn other countries thinking about resource nationalization to be careful," points out one analyst. Exxon's holdings in Venezuela were negligible compared to its worldwide asset base, and so the country is a good place to draw the line. The legal precedents that it sets means that Exxon-PDVSA case will be followed through all its twists and turns by oil and gas companies and bankers around the world.