Question 1
How should PDVSA finance the development of the Orinoco Basin? What are the costs and benefits of using project finance instead of traditional internal debt finance?
By taking current facts into account PDVSA is mainly trying to expand its business by financing the development of many different enterprises in different areas. Apart from that, it is also considering the development of Orinoco Basin. It is involved in public and private partnerships including foreign subsidiaries in its group.
Therefore, in order to pursue the developments, PDVSA will have to keep its focus on its cash and cash equivalents, the retained earnings and the debt structure. However, it should not highly rely on debt because of the variability in the interest rates and also because of the current economic downturn in the market.
By using cash, PDVSA will be able to avoid future uncertainties if it will not rely on a huge amount of borrowings in order to keep itself safe from risk factors. PDVSA should choose the development of Orinoco Basin.
Benefits attached with Project Financing
The main benefits of project financing as compared to the use of traditional debt financing are;
- The project financing is beneficial in a way that it is able to protect the enterprises from going bankrupt as a result of their limited responsibility
- The project financing includes the involvement of numerous partners.
- By project financing, the company does not have to rely on borrowing debt because of the increase in the returns on their investments.
- In project finance, the risk is low because of the involvement of several partners and the risk is being shared among them as compared to the financing if it were being performed by them on their own. As a result, PDVSA may be able to gain the benefits that are being obtained by private firms.
- Project financing can result in increasing the number of investors in foreign markets by becoming a private company.
- With project financing, there is a chance that PDVSA will be able to achieve better investment grade rating respectively.
- By choosing the project finance, PDVSA will be able to reduce its debt and it will ultimately result in increased flexibility in future ventures.
- The project financing can be done for a long time periods of almost 20 years.
Costs attached to Project Financing
The main costs of project financing as compared to the use of traditional debt financing are;
- The increased leverage with project finance is expensive because of the higher cost attached to the insurance of political risk.
- Project financing can be considered as costly as compared to the other ways of financing because of the increased agreements and the monitoring costs.
- In project financing, there are quite high margins and increased political risks and this type of financing has performed in those countries mostly which entails high risk.
- In project financing, there is a large issue of bonds and as a result, there is an increased cash inflow, which can result in a negative carry because of no later use. Hence, it will result in lower returns on these bonds later on.
Question 2
What are Petrozuata's three or four most important project risks? How does the deal structure to address those risks? Who would bear the risk if the project were financed internally by PDVSA instead?
THREE PROJECT RISKS
The three major risks associated with the project are;
Exchange Rate Risk
The most vital risk that Petrozuata will have to face is the currency rate fluctuations, also because there is a development in the overall economy, which can lead to the high risk of bolivar being appreciated against dollar after sometime. As a result, it will lead to an increase in tax payments and expenses on the revenues that it will generate in dollars, which will ultimately affect the profitability of a company. Therefore the company, will have to hedge itself from exchange rate variations respectively in order to avoid upcoming problems in future.
Petrolera Zuata, Petrozuata C.A The Case Solution
Business Risk
The company will also have to face the business risks in terms of its dealings with the creditors that are they have a good past record. It will also have to take into account that the company will not be able to get funds from financial institutions very easily because of the problematic circumstances in the economy. Petrozuata also has to face the risk of the decrease in sales volume and revenues. The raw material costs will also rise and there will be an increased risk of competition and the regulations imposed by the government that this company will have to manage effectively................
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