Oil Rich and Dollar PoorThe Venezuela Credit Paradox

June 16, 2011

2

The Paradox Venezuela

Higher oil prices…

…are no longer helping Venezuela’s debt position…

…or its hard currency reserves

Venezuela Basket ($/barrel)

0

50

100

150

03/03 03/05 03/07 03/09 03/11

Gross External Debt/GDP (%)

0

20

40

60

03/03 03/05 03/07 03/09 03/11

Hard Currency Reserves (US$b)

0

10203040

03/03 03/05 03/07 03/09 03/11

Source: Bloomberg, BCV, Morgan Stanley Latam Economics

3

PdVSA Total Debt (US$ billion)

0

5

10

15

20

25

30

35

40

45

The Paradox PdVSA

2006 2007 2008 2009 2010e 2011e

14.4 Estimated net issuance for remainder FY2011*

32.0 Total est. debt as of 31-Mar 2011

46.5

Source: PdVSA, Bloomberg, Morgan Stanley Research estimates

Despite higher oil prices, PdVSA may need to borrow up to an additional $14.4B in 2011

*Estimated funding needs for the remainder of 2011 using our cash-flow based oil price sensitivity model; please see report for more details.

4

Why? 1. Imports are rising along with price of oil

0

20

40

60

80

100

120

03/99 03/01 03/03 03/05 03/07 03/09 03/110

2

4

6

8

10

12

14

Venezuela Basket($/bbl, 4-q rolling)

Imports($b, 4-q rolling)

Source: BCV, Morgan Stanley Latam Economics

The economy is becoming more import-dependent

5

Why? 2. Oil production levels have been declining…

BP Statistical Review

Official PdVSAfigures

International Energy Agency

2002 2003 2004 2005 2006 2007 2008 2009 2010

2.0

2.5

3.0

3.5

PdVSA Production(mmbpd)

Source: PdVSA, BP Statistical Review of World Energy, 2010, IEA

6

… and PdVSA has not kept up with its capex goals

PdVSA Total Investment(US$ billion)

0

5

10

15

20

25

30

Original Plan

Actual/Revised

31.1

16.4

2011e2010e

11.9 12.0

2009

13.5

Source: PdVSA, local press, Morgan Stanley Research

7

Why? 3. Increasing share of exports are non-cash-generating

An estimated 30% of 2010 production did not capture upside from rising oil prices.

Cash- generating

exports 70%

Energy Cooperation Agreements

22%

Oil-for-loan commitments

to China 8%

Estimated PdVSA 2010 Exports The terms of the ECAs involve PdVSA supplying crude oil and products to countries in Latin America and the Caribbean.

Source: Morgan Stanley Research

8

Why? 4. PdVSA social contributions rising with price of oil

0 20 40 60 80 100

VNZ Crude Price(US$/bbl)

R2 = 0.8099

0

4

8

12

16

20

Social Contributions (US$b)

20042009

2005

20062007

2010

2008

Source: PdVSA, Bloomberg, Morgan Stanley Research; Relationship between Venezuela’s crude oil basket price and PdVSA’s social contributions (US$m) for 2001-10.

PdVSA funds are transferred for government social projects

9

300

350

400

450

500

600

650

700

550

Sensitivity Analysis

2014 Debt /

Exports

Key Drivers for Venezuela and PdVSA Debt

$85

15.25%

10.25%12.75%

Marginal Cost of Capital

8.8 / USD

FXDevaluation

4.3 / USD

$125

$105

Price of Oil

current

Source: Morgan Stanley Research

10

Also… cost of litigation for expropriated assets

$27 billion

amount sought by Conoco Phillips and ExxonMobil

$2.5 billion

government’s estimate of the

maximum liability

2H 2011

headlines risks from

hearings / decisions

11

Our View Short-term: Buy the belly of the curve

0 1 2 3 4 5 6 7 8 9

Mod. duration

600

700

800

900

1,000

1,100

1,200

1,300

1,400

Z-Spread

$ '24

$ '28

$ '16

$ '37

$ '27

$ '22

$ '17

$ '17N

$ '15$ '14

$ '13

$ '11 $ '38

$ '27

$ '34$ '25

$ '20

$ '23$ '19

$ '22

$ '18N

$ '18

$ '16

$ '14$ '13

PdVSAVenezuela

MOST ATTRACTIVE

Sovereign:Venz ’24Venz ’25

Corporate:PdVSA’17 (old)

Source: Morgan Stanley Research

12

Risks are reflected in the current level of spreads

We see attractive risk/reward in the near term

Elevated spreads should compensate for higher total external debt/exports vs. other EM countries

Ukraine

IsraelHungary

IndonesiaBulgaria

RomaniaPoland

TurkeyCzech Rep.

Mexico

Malaysia

Argentina

Colombia

Ven (Adj)

Peru

China RussiaKorea Chile

Thailand

BrazilS Africa

R2= 0.609

5-year CDS

200

400

600

800

1000

1200

00 50 100 150 200 250 300

Debt/Exports in 2010

Source: Morgan Stanley Research; total external debt/exports in Venezuela is based on our adjusted estimates for oil exports in 2010.

13

Our View Long-term: Debt path not sustainable

237312

419

666

542

External Debt/Exports (%)

100

200

300

400

500

600

700

2011 2012 2013 2014 2015

Source: Morgan Stanley Research

14

Contact…

Paolo Batori, CFA +44 207 677 7971

Vanessa Barrett +44 207 677 9569

Robert Tancsa +44 207 677 6671

Daniel Volberg +1 212 761 0124

EM Fixed Income Strategy

Latam Economics

Rosa Velasquez +1 212 761 8278

… or click here

… to download our report