Fitch Expects to Rate PDVSA's Proposed Notes 'CCC/RR4'
KEY RATING DRIVERS
PDVSA's credit quality reflects the company's linkage to the government of Venezuela as a state-owned entity, combined with increased government control over business strategies and internal resources. This underscores the close link between the company's credit profile and that of the sovereign. PDVSA's cash flow generation has historically been significantly affected by the large amount of funds transferred to the central government each year.
LINKAGE TO SOVEREIGN
PDVSA's credit quality is inextricably linked to that of the Venezuelan government. Venezuela's ratings (IDR 'CCC') reflect the sovereign's weakened external reserves, high commodity dependence, rising macroeconomic distortions, limited reduced transparency in official data, and continued policy and political uncertainty. The sovereign's strong repayment record and relatively low debt amortization profile mitigate imminent risks to debt service. PDVSA is fully owned by the government and its transfers have historically represented around 45% of the government's revenues. It is of strategic importance to the economic and social policies of the country, as oil accounts for around 95% of total exports.
The Venezuelan government displays limited transparency in the administration and use of government-managed funds, as well as in fiscal operations, which poses challenges to accurately assessing its fiscal state and the full financial strength of the sovereign. PDVSA also displays similar characteristics, which reinforces the linkage of its ratings to the sovereign.
UNCERTAIN LEVEL OF TRANSFERS TO GOVERNMENT
Although the excess hydrocarbon prices law eliminates transfers to the FONDEN national development fund when oil prices are below USD55/barrel (bbl), the low level of central government reserves will require the government to either reduce social expenditures or disregard the law and maintain historical levels of transfers from PDVSA. Fitch believes these transfers will continue to take place either in the form of royalties, social contributions, dividends or investments. The high level of transfers to the central government effectively renders PDVSA's cash flow from operations negative.
FOCUS SHIFTS TO RECOVERY
PDVSA's 'CCC' rating suggests a real possibility of default. If a restructuring occurs, Fitch anticipates average recovery for PDVSA's bondholders of 31%-50%, and likely closer to the lower end of the range. While Fitch's recovery analysis yields a high recovery, the willingness of Venezuela's government to extend concessions to investors will likely move actual recovery closer to the lower end of the 31% to 50% range. In addition, should oil prices remain depressed, an average recovery may lead to additional future defaults in order to further reduce obligations and allow for necessary transfers to the government. The proposed senior secured notes have also been assigned an 'RR4' average Recovery Rating as the collateral provided may only marginally enhance recovery given default, which could still range between 31% and 50%.
Linkage to government: PDVSA's ratings assume that implicit support from the government, given the company's strategic importance, would materialize should the company need it.
Slow hydrocarbon price recovery: Fitch assumes West Texas Intermediate crude prices to average approximately USD42 per barrel in 2016 and to slowly recover to approximately USD65 per bbl in the long term.
Stable Production: PDVSA's ratings assume the company's production will remain relatively flat or decline marginally over the rating horizon.
Catalysts for a downgrade include a downgrade to Venezuela's ratings, a substantial increase in leverage to finance capital expenditures or government spending and a sharp and extended commodity price downturn. Although not expected in the short - to medium-term, catalysts for an upgrade include an upgrade to Venezuela's sovereign rating and/or the company's real independence from the government.
PDVSA's current liquidity position is believed to be weak as a result of the current low oil price environment and transfers to the central government. As of December 2015, PDVSA reported cash of USD5.8 billion, which compared unfavorably with short-term debt of USD6.8 billion. The company's current liquidity position is uncertain given expenditures, transfers to government, and principal debt payments that might have driven down liquidity from the last reported amount as of year-end 2015. Under Fitch's base case scenario, which assumes oil prices of USD42/bbl in 2016 and USD45/bbl in 2017, and investments of USD25 billion annually, PDVSA's liquidity position will continue to deteriorate. Debt amortizations for 2017 are estimated at approximately USD7.2 billion, of which USD5.1 billion is capital market debt obligations. The proposed debt issuance could lower 2017 principle payments by USD1.6 billion. Venezuela's gross international reserves have declined by USD4.3 billion to USD12 billion between January and June 2016.
FULL LIST OF RATING ACTIONS
Fitch expects to assign the following ratings:
--USD7 billion of senior secured notes due 2020 'CCC/RR4'.