On 1 May, former coca grower turned president Evo Morales announced the nationalisation of Bolivia's gas and oil fields, wresting the country's hydrocarbon resources from the hands of foreign investors. The decree was followed by a speech Morales gave to a summit of European and Latin American leaders in Vienna, in which he stated that foreign companies should not expect to be compensated for assets that were now under state control.

To what extent Morales will pursue his goal of nationalisation is as yet unknown. In any case, Brazil is likely to the biggest casualty of the seizures. Petrobras is currently the biggest investor in Bolivia's energy sector, controlling some 45% of gas production, and has invested in the region of $1 billion in the country.

Seized, but what way?

As is frequently the case with Latin American politics, there seem to be a number of contradictions in play. Before Morales said that he would not give way on compensation, Jorge Alvarado, head of Bolivia's state energy firm Yacimientos Petroliferos Fiscales Bolivianos (YPFB), admitted that Petrobras would need to be compensated in light of its assets having been nationalised and not seized.

Moreover, Morales has been a steadfast ally of mercurial Venezuelan President, Hugo Chavez, who in July took the country into the South American trading bloc, Mercosur. Paradoxically, Brazil (along with Argentina) is the leading member of the trading bloc, though this role may be challenged by Venezuela in the next decade.
According to one regional expert, "In terms of real economic integration, Mercosur has been a failure. But I think Chavez's ideas for Mercosur may become one-dimensional and solely based on energy."

Morales has given foreign energy players up to 180 days to renegotiate contracts with YPFB. Failure to do so may lead to these foreign companies having to pull out of the country. During negotiations, Bolivia will secure 82% of revenues, leaving 18% in the hands of foreign investors. Yet how far Morales is willing to follow through with what is, in effect, the expropriation of the country's oil and gas assets is a subject upon which few are willing to speculate.

According to one political risk analyst, "We really don't know whether this is largely rhetoric or whether Morales is really going ahead with what he's put on record. So far no-one has lost any assets, but that doesn't mean they won't."

Back to the policies

Even so, political risk insurers will be taking a very close look at the expropriation clauses in their contracts of insurance. In the short term, however, a flurry of pay-outs is highly unlikely.

"We have seen no claims as yet because there have been no expropriatory events. However we're not sure what will happen in Latin America in the medium term. Globally, expropriation is unlikely: it hardly ever happens. The last real expropriation we dealt with was six to eight years ago," says Martin Stone, director of counter terrorism and political risk at Aon.

Political risk insurance contracts – especially those of OPIC and MIGA – will not always recognise failure to perform either as a contractor, supplier, off-taker or guarantor as expropriation. For those equity players that have made a bad call in terms of their government partner, it may just be a case of bad luck. Nevertheless, there may eventually be pay-outs, should arbitration or dispute resolution be frustrated by the host government. In any case, should there be even the slightest hint of a breach of contract, MIGA and OPIC are the types of entity that will dispatch a delegation to mediate before the claim can be filed.

"Political risk insurance doesn't cover all political risks. Policies and coverages need to be reviewed on case-by-case basis," says Kenneth Hansen, partner at Chadbourne & Parke. "Most expropriation coverage for equity investors contemplates 'total expropriation', a circumstance in which the investor is forced, or chooses, to abandon the project. The terms of doing business may be radically, and adversely changed by the government, as by changed taxes or royalties, but, so long as the project continues to operate with the investor remaining in charge, the prospects for a successful expropriation claim are likely to be dim.

"You also have to remember that, on the debt side, a claim requires a default. If the project continues to operate, even in difficult circumstances and with impaired prospects for profits, there may well still be adequate cash flow to pay that debt."

Although political risk insurers are still open for business, the reality may be somewhat different. "They may say they are open, but if you were to darken their door you may find out otherwise. The reality is no one is investing in these countries. Things are getting pretty dicey," says one political risk insurance expert.

When asked whether sponsors have started to beat a path to their lawyers, he adds, "I'm sure there have been a few enquiries, but let's put it this way: it's nothing like the devaluation in Argentina, when the door was spinning."

What Hugo does next

Whilst Morales has sought to re-nationalise Bolivia's oil and gas sector, it has wrongly been assumed in some quarters that Chavez is attempting to do the same.

But Chavez is seeking to extend governmental control of the country's hydrocarbon sector. In May, the National Assembly amended the Organic Hydrocarbon Law of 2001 to increase oil extraction tax to 33.3%, whilst hiking income taxes from the current 34% preferential rate to 50%. Other payment increases, including payment-in-kind royalties, are being mooted by the government.

If this were not bad enough, PDVSA's ownership in the country's four heavy oil projects is expected to be increased to 60%. Currently, the state-owned corporation owns 49.9% of Petrozuata, 41.67% of Cerro Negro, 38% of Sincor and 30% of Hamaca, though it derives much of its control from the preferred shares it holds.

In light of Chavez' policy changes, both Moody's Investors Services and Fitch Ratings have downgraded the secured long-term debt of four heavy oil projects in the country from 'Ba3' to 'B1' and 'BB' to 'B+' respectively.
At the end of 2005, Petrozuata's outstanding debt was $1.2 billion, of which $925.9 million was made up of senior secured bonds. The $2.4 billion project benefits from a 35-year offtake agreement. Given the change in government policy, it is expected that the project's debt service coverage ratio will fall to 1.57x.

Sponsored by Total (47%), PDVSA (38%) and Statoil (15%) to the tune of $5 billion, Sincor achieved completion in February this year. Total outstanding debt stands at $806.1 million, after the sponsors exercised a buy-down option earlier in the year. The three sponsors have guaranteed production volumes according to the size of their stake.

In 2001, Hamaca stunned the market as the first Latin oil and gas project with US Ex-Im pre- and post-completion cover, allowing for an extended tenor. It was also the first Venezuelan hydrocarbons deal to feature ECA support. The project sponsors are Phillips Petroleum (40%), PDVSA (30%) and Texaco (30%). The project is authorised to issue a second debt tranche of up to $1 billion, though whether it would tap the bond market remains to be seen.

The $1.6 billion Cerro Negro project's sponsors are ExxonMobil (41.67%), PDVSA (41.67%) and Veba Oel (16.66%). At the end of last year, the total outstanding debt of the project was $720.8 million, of which some $511 was made up of senior secured notes. Last year, debt service margins reached 9.0x, though under the new regime coverage would be expected to fall to 4.61x.

The Venezuelan government has also announced that it intends to restructure the four heavy oil projects as mixed enterprises. In effect, the mixed enterprise would act as a wholly-owned state entity, being government owned and controlled, as well as being subject to Venezuelan legislation. The entity would, however, be able to receive both equity and debt financing from a private or foreign partner.

According to Mauro Leos, senior analyst at Moody's Investors Service, "The question is: when will Chavez be satisfied? There is a distinct possibility that he will want full and total control of Venezuela's heavy oil projects. But there seems to be an equilibrium at this point in time. As long as oil prices are high, Chavez is making money. However, we can not completely rule out that he will ask for even more concessions, should oil prices remain at present levels. The real trigger for change in the region will come with a change in oil prices."

There is a limit as the amount that Chavez will be able to redistribute from his oil revenues. As one regional expert explains: "Oil is only a tool for social development, nothing else. In the end, everything that Chavez does is political: his aim is to pull the main players in Latin America away from the US towards his idea of what South America should be."

And with oil prices looking set to break the $80 per barrel mark, cash flows for operating expenditures, debt services as well as capital expenditures will rise well above expectation. Which means payment defaults will be unlikely.

"One of the peculiarities, paradoxes even, of Chavez is that, from a credit standpoint, he can be strongly counted on to pay on a timely basis. When oil prices were low he paid, so too during the coup d'état. These two occasions gave him ample opportunity to default, so why should he default on these very profitable oil projects," adds Leos.

Everything not roses

But there are contrary opinions. "Although liquidity has increased, the sovereign risk profile of Venezuela has worsened. The country is in a far more vulnerable fiscal position than it was when Chavez first came to power in 1999," says Gersan Zurita, senior director, global project finance, at Fitch Ratings.

The government's redistribution has hit PDVSA itself, in that there has not been enough investment in production over the past seven years. Production volumes, generated through the company's own resources, have been cut by one-half over that period. The new restructuring could cost the state entity dear, both in research and production.

Chavez will put further financial pressure on PDVSA through his PetroCaribe initiative, which seeks energy cooperation and the initiation of new projects throughout the Caribbean and Latin America. To this end, PDVSA is rumoured to be in the market with an RFP for a new bond issue.

Foreign bondholders and lenders may be disturbed by the current climate, but the probability that there will be defaults on the four highly lucrative heavy oil projects in the short term is slim. However, in the medium term, double-digit inflation, a slump in oil prices and tempered production could lead to a drop in revenue of up to 80%. This would mean certain projects may have difficulty in servicing debt payments as well as covering operating expenses.

According to Fitch, there is a possibility that, should the outstanding debts not be fully refunded, bondholders and funders will initiate enforcement actions and technical defaults. On the other hand, PDVSA's existing debt, which is not insubstantial, could be cancelled out, though it does not have access to a large balance sheet of, say, an ExxonMobil.