MOODY'S CONFIRMS Baa3 LONG-TERM DEBT OF PDV AMERICA AND Baa2 RATING OF CITGO PETROLEUM
Moody's Investors Service confirmed PDV America Inc.'s Baa3 senior debt rating and the Baa2 senior long-term debt rating of CITGO Petroleum Corporation, its wholly owned operating subsidiary, concluding a review for downgrade initiated on September 4, 1998. The rating reviews were prompted by the sovereign-ceiling linked downgrade of Petroleos de Venezuela's (PDVSA) B2 senior foreign currency debt obligations, and by Moody's concern over potential parent financial and political pressures on the subsidiary operations.
The rating confirmations reflect Moody's view that the recently-elected Chavez regime in Venezuela is not likely to significantly interfere with the operations and financial position of either CITGO or PDV America. These refining and marketing operations encompass PDVSA's largest and most important investments outside Venezuela and are key to PDVSA's efforts to add value to and secure markets for its lower value heavier crudes. During his election campaign, President Chavez made highly negative comments about whether these operations were necessary or beneficial to PDVSA and to Venezuela. Although still early in his term, the administration's recent views seem to be more pragmatic and indicate not only support for the economic rationale for these operations, but the possibility of further downstream expansion overseas.
CITGO Petroleum's Baa2 long-term debt rating fundamentally reflects its solid position as an independent refiner/marketer in the U.S. with a leading market position and cash flow and financial leverage comparable to its peers'. CITGO benefits from long-term crude supply contracts with PDVSA affiliates that enhance CITGO's margin and cash flow stability. Any significant changes in the contracts could become an event of default for CITGO and would also undermine PDVSA's downstream integration strategy. PDV America is a holding company. Its Baa3 rating reflects structural subordination to CITGO and the holding company's primary reliance on a mirror note receivable from PDVSA (rated B2) for debt service. While this note obligation is constrained by the Venezuelan sovereign ceiling, we continue to believe an interruption to the debt service would be unlikely, since it could trigger an event of default and PDVSA's possible loss of control of PDV America's assets. To date, there has been no delay in mirror note payments, including a $250 million principal amortization in 1998, and there is no evidence the new regime would interfere with either the mirror note debt service or with CITGO's long-term crude supply contracts.
Moody's recognizes that lower oil prices and government fiscal needs will continue to put pressure on PDVSA to generate higher cash flows. One cash source could be subsidiary dividends, and CITGO in fact paid a significant dividend to PDV America in 1998. The dividend ultimately facilitated investments in other affiliated North American refining assets and a return of cash to PDVSA. However, CITGO also completed significant capital investments in the mid-1990s and is expected to generate significant free cash flow for the forseeable future, even in a difficult industry environment. We thus have factored current elevated financial leverage into our rating confirmations, but also that the dividend will be managed in a flexible manner to help preserve the financial flexibility of both entities. Moreover, both PDV America and CITGO bondholders benefit from public (and bank) debt covenants that limit dividends and debt incurrence based on financial tests, which should prevent undue de-capitalization of either entity.
While both PDV America's and CITGO's debt ratings could be affected in the future by fundamental credit erosion or leveraging events such as acquisitions, we expect to continue to rate them above PDVSA's B2 ceiling constrained rating. Although a downgrade of PDVSA's B2 rating would not necessarily result in downgrades of these entities, the government's need for cash and PDVSA's management of their financial position will continue to influence the subsidiary ratings.
CITGO Petroleum Corporation is headquartered in Tulsa, Oklahoma. PDV America, Inc. is located in New York, New York. Petroleos de Venezuela is headquartered in Caracas, Venezuela.
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