Fitch's Analysis of PDVSA: biased and inaccurate

Fishy Fitch...


Fitch has conducted a financial and operational analyisis of Petroleos de Venezuela in order to rate the company's new emission of bonds. Fitch was paid by the Venezuelan state-owned petroleum company to do this. This analysis has just been made public (see below) and after reading it I feel compelled to make the following comments:
1. In general I find the analysis very poorly researched and clearly biased in favor of the company. I am not an expert in these matters but, should a ratings agency get paid by the issuer of the debt? Is the customary thing to do? It smells of conflict of interest to me.
2. According to the analyst the credit quality reflects the company's strong balance sheet; sizeable proven hydrocarbon reserves; strategic interests in international downstream assets; private participation in upstream operations and geographic proximity to the North American market. I find these reasons very shaky.
First of all,  the balance sheet is not strong, due to increasing debt, insufficient investments in the core business, its need to borrow money from the central government to meet some of their obligations and the diversion of funds to projects and expenditures not related to the oil business. Hydrocarbon reserves have been grossly inflated in a fraudulent manner by asssuming recovery factors of oil in place in the Orinoco region that are not based on factual data; international downstream assets have been in a process of liquidation in recent years, as shown by the sale of refineries in Germany, in the U.S. and oil terminals in the Caribbean. Private participation in upstream operations is at a minimum of what would be required and important multinationals have left the country, making room for state-owned companies from Iran, Vietnam, Cuba, China and Russia that do not have the technology, management capabilities or even the real intention to invest the amounts of capital needed. The proximity to the North American markets makes little difference, as Venezuelan exports to this destination have been dwindling.
3. The analysis mentions that the government has used the company's balance sheet to "promote government initiatives" and that  the Charter and Mission Statement of PDVSA have been changed to allow participation in social, agricultural, construction and other non-oil related activities. However, they make no comment at all on how these two actions have been the cause of PDVSA's significant deterioration. A professional analysis should have mentioned the detrimental effects of both the use of PDVSA by the government as a vehicle to get in debt and of the changes in the company's charter and mission in its financial quality and stability.
4. The analysis mentions "strong capital expenditures" of $65 billion during the last 5 and a half years, this is, over $12 billion per year. A careful examination of PDVSA's own published figures shows that oil investments amount to no more than $8 billion per year, since significant amounts of capital have been dedicated to non-oil, social expenditures. In contrast competitors such as Petrobras and ExxonMobil invest close to $40 billion every year.
The analysis also mentions that PDVSA is expected to invest "more than $200 billion during the next 4 to 5 years", without adding any comments on the capacity of the company to do this. It is hard to believe that PDVSA could suddenly increase its levels of yearly investments by a factor of five or more, without a major overhaul in its managerial and technical capabilities and without important new sources of capital that seem nowhere in sight. 
5. The analysis accepts as a fact that "proven reserves continue to increase", mentioning a level of 330 billion barrels of oil equivalent, 89 percent of which would be oil. Again, I fail to understand how a professional analysis should not add a strong caveat to these figures, which violate all internationally accepted definitions of proven reserves.
6. The same can be said of the acceptance of the analyst of PDVSA's "official" production figures of around 3 million barrels per day, when even a Memo of company President Ramirez  to President Chavez places PDVSA's production at less than 2.7 million barrels per day, while independent observers estimate this production at some 2.4 million barrels per day. According to the analyst PDVSA has been able to maintain a production of 3 million barrels per day thanks to investments in the upstream of some $6.5 billion per year. This is, in my view, most unlikely.

I transcribe the Fitch Report in its entirety, including their disclosure about receiving payment from PDVSA.

                                           MARKET WATCH
CHICAGO, Nov 15, 2011 (BUSINESS WIRE) --
Fitch Ratings expects to rate Petroleos de Venezuela, SA's (PDVSA) proposed USD2.4 billion senior unsecured debt issuance due 2021 'B+/RR4'. The company expects to use the proceeds to pay down approximately USD1.3 billion of notes outstanding due 2013 and the balance for general corporate purposes.
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 ratings also consider the company's strong balance sheet; sizeable proven hydrocarbon reserves; strategic interests in international downstream assets; private participation in upstream operations; and geographic proximity to the North American market.

RATINGS LINKED TO GOVERNMENT:

PDVSA is a state-owned entity whose royalties and tax payments represent more than
50% of the government's revenues, and it is of strategic importance to the economic and social policies of the country. Over the past five years, PDVSA's total transfers to the government have averaged approximately 35% of revenues. Also, the government has used PDVSA's balance sheet to promote various government initiatives. In 2008, the government changed PDVSA's charter and mission statement to allow it to participate in industries that contribute to the country's social development, including health care, education, and agriculture.

STRONG CREDIT METRICS:
PDVSA continues to be an important player in the global energy sector. The company's
competitive position is strong and supported by its sizeable proven hydrocarbon reserves, strategic interests in international downstream assets, private participation in upstream operations, and geographic proximity to the North American market. The company also benefits from a strong balance sheet, which is in line with its competitors. PDVSA's ratings are tempered by its stated-owned nature and linkage to government.
For the last 12 months ended June 30, 2011, PDVSA reported EBITDA (after royalties and social expenditure) and funds from operations (FFO) of approximately USD32.1 billion and USD12.6 billion, respectively. Total financial debt as of June 30, 2011 increased to USD31.2 billion from USD24.9 billion as of 2010. The leverage level remains strong for the rating category with a total adjusted-debt-to-EBITDA ratio of 1.2 times (x). Capital expenditures remain high, amounting to approximately USD65 billion over the past five and a half years.
Going forward, the company's credit metrics could be pressured by aggressive capital
investments to increase production coupled with considerable transfers to the central
government. PDVSA is expected to invest more than USD200 billion over the next four to five years to increase production, refining capacity and develop reserves. This will require issuing additional debt given the long lead times before additional production starts coming online. Additional funds could also come from joint ventures. PDVSA's total financial debtto- EBITDA could range between 2.0x and 2.5x in the long term depending on prevailing hydrocarbon price and production levels. Tha analysis adds that PDVSA is

LARGE HYDROCARBON RESERVES:
Hydrocarbon reserves in the country continue to increase, with proved hydrocarbon
reserves of 330.1 billion barrels of oil equivalent (boe) (approximately 89% oil and 11%
natural gas) and proved developed hydrocarbon reserves of 20.5 billion boe as of
December 2010. Venezuela's reported oil production has remained relatively stable during the past few years at appoximately 3 million barrels per day, despite USD6.5 billion of upstream investment during the past five years, which has helped to offset declining production rates.

The ratings above were solicited by, or on behalf of the issuer, and therefore, Fitch has been compensated for the provisions of the ratings.
(my italics).