Fitch To Rate PDVSA Finance $800MM Notes.

Business Editors

NEW YORK--(BUSINESS WIRE)--Nov. 5, 2001

Fitch expects to rate PDVSA Finance Ltd.'s (PDVSA Finance) upcoming $800 million note issuance `A-', and to affirm the rating of the existing notes at `A-'. PDVSA Finance is a Cayman Islands special purpose company wholly owned by Petroleos de Venezuela, S.A. (PDVSA). Fitch's rating on the Republic of Venezuela's sovereign foreign currency obligations is `BB-'. The ratings on PDVSA Finance's notes reflect:

-- PDVSA's ability to produce and export crude oil to designated customers at
least close to current levels.

-- The minimum 4.0 times (x) debt service coverage ratio, which will protect
investors from a simultaneous sharp decline in price and demand for Venezuelan
oil and petroleum products.

-- The strong legal structure that makes it difficult for Venezuela to divert
cash flows from investors.

-- The very low likelihood that Venezuela would impose material or permanent
restrictions on crude oil and petroleum exports and/or force the remittance of
all export revenues, thus causing a loss to the holders of PDVSA Finance notes.


-- The liquidity account, funded with a portion of the issuance proceeds, which
will have a balance, on any day, equal to the greater of the next scheduled
debt service payment, or the amount of debt service scheduled to be paid in the
next 30 days.

In analyzing future flow transactions, Fitch looks to answer three questions: What is the company's capacity to continue selling its goods under the conditions in the contracts? Will what it generates be enough to repay the notes? And, how does the structure of the deal assure that if the first two conditions are met, that the noteholders will be repaid in a timely manner?

The first question is answered by looking at the company, the designated buyers, and the risk of any sovereign interference. The second question refers to the stress scenarios utilized by Fitch to ensure payment of the bonds. The final point considers the transaction structure, including relevant legal aspects (for more information on Fitch's approach, see Fitch Research on `Rating Securities Backed by Future Export Receivables,' dated Oct. 10, 2000, available on Fitch's web site at `www.fitchratings.com'). The structure follows the familiar pattern of other future flow securitizations. Sales to designated customers are directed to offshore accounts, isolating the cash flow from sovereign actions that would otherwise impede access to needed foreign currency. This mechanism allows the rating of the transaction to be higher than the sovereign rating. Unlike traditional asset-backed securities, future flow investors buy assets that depend on the generation of future receivables, so the rating of the deal is dependent upon the capacity to produce those assets, oil in this case. The structure also allows for the issuance of more series of securities from the special purpose vehicle.

PDVSA - Petroleo, PDVSA's principal operating subsidiary, initially notified 31 U.S. and Canadian customers, including its affiliates, that the receivables originated from the delivery of oil and petroleum products have been sold to PDVSA Finance and that payments should be made to a collection account held at Citibank, N.A. in New York. This group currently consists of 46 companies, and accounted for approximately 1.3 million bpd of export sales in 2000. Most of the 46 designated customers have investment grade public debt ratings, or guarantees from parents that have investment grade ratings. As is customary in the industry, non-investment-grade customers are required to provide a letter of credit (LOC). To date, PDVSA has not experienced delinquencies or losses with respect to any of the designated customers.

For the year 2000, PDVSA exported 65% of its total crude oil production and refined the balance in Venezuela. In the first half 2001, approximately 24% of PDVSA's crude oil deliveries to the designated customers was to wholly owned affiliates; most of which was to CITGO, rated `BBB' by Fitch. In the remote circumstance that CITGO failed to make payments, PDVSA - Petroleo will have to maintain sufficient sales to the other designated obligors or designate additional customers to satisfy the 4.0x debt service coverage ratio. Including partially owned affiliates, sales to affiliated companies in the first half of 2001 amounted to approximately 58% of total sales to designated customers. A default by the affiliates implies that the cash flow during a particular month may decline as much as 58%. Assuming that the cash flow in the month before the affiliates' bankruptcy was 4.0x, the amount required to service the notes, a decline of 58% would still leave enough cash to make the quarterly interest and principal payments to investors.

PDVSA Finance's `A-' rating is six notches higher than the Republic of Venezuela's `BB-' foreign currency rating, indicating the likelihood of PDVSA Finance continuing to service its debt, even in the midst of a sovereign default. The higher rating takes into account structural features of the issuer, historical evidence of different debt-paying capacity for Venezuela and PDVSA, and strong incentives for the government to not affect, in any way, PDVSA's creditworthiness.

Country risk enters into the ratings equation in several ways. The general economic and business environment, which can determine underlying creditworthiness, is directly affected by government macroeconomic polices. In addition, changes in relevant legislation may affect the debt-paying capacity of the issuer. Another way country risk affects ratings is by limiting them to the sovereign rating. The government's foreign currency rating normally acts as a ceiling for resident issuers, since there is ample empirical evidence that countries, when in a default situation, have imposed exchange controls and other measures that precluded otherwise creditworthy issuers from servicing their foreign currency debt. The local currency rating, on the other hand, is not usually a cap, as governments have few incentives to limit access to their own currency.

In PDVSA's case, although the government has direct control of the company based on its 100% ownership, there is a long history of exempting it from exchange controls and ensuring continued preferential access to foreign exchange. Since its creation in 1976, PDVSA has weathered numerous different exchange rate regimes, not one of which limited its access to foreign currency, even during periods when other state-owned companies were forced to default. While PDVSA must hand over all its foreign earnings to the central bank, it is allowed to first service all obligations, and maintains a revolving fund in offshore accounts for working capital purposes.

The government has clear incentives to maintain PDVSA's special status. The company is Venezuela's largest corporation, unparalleled in its contributions to the country's economy, export earnings, and fiscal revenues. (For more information on Fitch's ratings approach, see Fitch Research on `Rating Securitizations Above the Sovereign Ceiling,' dated Dec. 29, 1998, available on Fitch's web site at `www.fitchratings.com').

A crucial concern in a cross-border transaction rated higher than the country of residence is whether the government will, in any way, impede the payment of foreign debt during a period of sovereign default. During many past sovereign defaults, a stress which must be assumed when rating above the sovereign ceiling, countries have imposed exchange controls or otherwise impeded access to foreign currency to creditworthy debtors, forcing them to default.

Because all cash flows to designated customers are captured offshore, the only way the Venezuelan government can force default is to make PDVSA divert its sales to new customers that do not have payment instructions for the PDVSA Finance account. Fitch believes that this is highly unlikely, given PDVSA's relationship with the Venezuelan government and the high costs of diverting oil sales.

Fitch has analyzed the probability that PDVSA - Petroleo will remain a going concern and continue to generate substantial export volumes, even under stress scenarios of lower crude oil prices. PDVSA has been able to generate reasonable cash flows and maintain a satisfactory credit profile, even during times when oil prices and cash flows declined. Over the past six years (1995-2000), total crude production rose to 3.1 million bpd from 2.8 million bpd, supported by a strong capital investment PDVSA's program.

Given the large role played by the company in the Venezuelan economy (almost two-thirds of the country's gross domestic product is tied to oil), it is highly unlikely that any government will interfere with oil exports to a material extent. In addition, the historical evidence shows that in the early 1990s, when the Republic of Venezuela defaulted on its obligations in foreign and domestic currency, PDVSA and its subsidiaries continued to operate normally, and the company's access to foreign currency was not restricted.

Fitch has also analyzed the economic disincentives that work against diverting sales from designated to new customers. The lack of abundant high-conversion refining capacity for PDVSA's heavier crude oil outside the U.S. effectively limits the ability to divert exports. Redirecting a substantial portion of these to Europe, for example, would entail additional transportation costs and substantial price discounts to induce buyers to purchase this difficult-to-process crude. The decline in foreign exchange revenues incurred as a result of the additional costs and discounts would probably offset, to a large extent, any short-term benefit that PDVSA would obtain by capturing the cash flow that otherwise would have been used for payments to investors.

An important consideration is that a meaningful part of the designated receivables are sold to PDVSA subsidiaries in the U.S. These include CITGO, the wholly owned subsidiary with refineries and service stations east of the U.S. Rocky Mountains, as well as Lyondell refinery. Also, PDVSA sells to its affiliates under long-term supply contracts, usually with initial terms of 20-25 years. Finally, PDVSA has had a 20-year relationship with several major U.S. oil companies (Texaco Inc., Exxon, Mobil Corp., Chevron Corp., Phillips Petroleum Co., and Conoco Inc.), whose subsidiaries in Venezuela were nationalized in 1976 and formed the basis of PDVSA. PDVSA recently entered into several joint ventures with the same oil companies. To divert sales of oil away from the major U.S. oil companies would disrupt long-term business relationships and would be against PDVSA's best interests.

PDVSA guarantees the performance by PDVSA - Petroleo of its obligations under the transaction documents. This implies that investors have full recourse against PDVSA in the event of a breach of representation, warranties, and covenants, including the covenant to deliver to the designated customers and to sell the receivables to PDVSA Finance. As a result, investors will have a general unsecured claim against the company in the event of a breach of representation, warranty, or covenant, which will allow the trustee to have a court declare PDVSA - Petroleo and PDVSA in default and place a lien on the companies' assets, including receivables generated from all customer sales. While the time necessary to obtain the court judgment would likely result in a delay in payments due to investors, the potential threat of such an action should be a deterrent to PDVSA or the Venezuelan government to divert sales.

Because the deal has 4.0x debt service coverage, Fitch believes that a single `A-' stress scenario is unlikely to result in a shortfall. Over the past two years, quarterly debt service coverage ratios have been in the 30x range, well in excess of the required 4.0x. The $800 million issuance will bring the total amount of debt issued by PDVSA Finance to $4.08 billion, approximately $3.90 billion of which will still be outstanding. While the new issuance will place a further burden on the structure, a drop in oil prices to US$10 a barrel during the life of the deal, as well as a 10% drop in volume exported, is still insufficient to trigger any of the covenants, much less result in a default.

Another stress scenario involves a drop in reserves such that there is insufficient oil to pay for the bonds. Given current reserve levels of 69 years at current production levels, this is unlikely. However, if reserves were to fall, it would probably be a gradual decline, which would lead to an acceleration of payments as debt service coverage dropped below the 4.0x trigger but not result in default.

The legal structure is typical for transactions involving future export receivables. The documents allow for the issuance of additional series of securities from the special purpose vehicle.

PDVSA - Petroleo, the principal operating subsidiary of PDVSA, sells to PDVSA Finance all existing and future receivables generated from sales to designated customers in the U.S. and Canada. Initially, only receivables from customers that purchase crude oil are included. PDVSA - Petroleo has the option of adding receivables generated from customers that purchase other petroleum products. The receivables are sold at a discount equal to the weighted average coupon on all the series of notes issued by PDVSA Finance, plus 50 basis points.

The designated customers have been notified and have acknowledged the sale of the receivables. They have also been instructed to make payments to a Citibank account in New York, held in the names of PDVSA Finance and PDVSA - Petroleo. PDVSA Finance uses the issuance proceeds to purchase the receivables from PDVSA - Petroleo. Each quarter, investors will receive interest and, starting at various dates in the future, principal payments, which will be paid in equal installments until the expected maturity date.

To protect investors from the potential adverse effects of certain events, up to 25% of the monthly cash flow from the receivables, in excess of what is required to make the quarterly interest and principal payments, will be trapped by PDVSA Finance in a liquidity account, rather than transferred to PDVSA - Petroleo. These `specified events' include:

-- PDVSA Finance's three-month average debt service coverage ratio

falling below 4:1.

-- The monthly average amount of receivables generated by PDVSA -

Petroleo's sales to designated customers during any consecutive

12-month period falls below either 27 million barrels of medium

and heavy crude oil or 80% of PDVSA - Petroleo's total sales of

medium and heavy crude oil.

In addition, but only if a qualified majority of the noteholders approve, all amounts held in the liquidity account plus 100% of all excess cash received from designated customers will be used to repay the outstanding principal if any of the following events of default occur:

-- PDVSA Finance fails to make any interest payment when due or

the full repayment of principal by the maturity date.

-- PDVSA Finance fails to pass the debt service coverage ratio

test for more than 60 days.

-- Either PDVSA Finance or PDVSA - Petroleo ceases to be

controlled by PDVSA, and Fitch's rating of the securities is

adversely affected as a result of any such change of control.

-- All, or substantially all, of PDVSA - Petroleo's oil-producing

assets are transferred to an entity other than PDVSA and

Fitch's rating of the securities is adversely affected as a

result of any such transfer.

-- PDVSA - Petroleo fails to deliver any payment that may

erroneously have been made to it by the designated obligors to

the collection agent.

-- PDVSA - Petroleo, having failed the production test mentioned

earlier, sells more than 30% of its exports of medium and heavy

crude oil to a third party, with the understanding that such

party would then resell the oil to designated customers.

-- There is a breach of the representations and warranties made by

PDVSA and PDVSA - Petroleo.

-- The Venezuelan government prevents PDVSA - Petroleo from

generating receivables and transferring them to PDVSA Finance.

-- The agreements executed in connection with the transaction are

repudiated by PDVSA - Petroleo.

Finally, the bankruptcy of PDVSA Finance, PDVSA - Petroleo, and/or PDVSA would also be deemed an event of default and would trigger an immediate fast amortization of the notes, without the need of prior investors' approval.

Throughout the life of the notes, PDVSA - Petroleo has the option of substituting receivables by removing designated customers, subject to trustee approval, and by designating new customers, provided the latter have been notified.