Construction. Inside Venezuela. Oil reserves worldwide

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1 Sector Report / Construction February 7, 2013 Overweight (Maintain) Company Rating TP (KRW) Hyundai Eng. & Constr. BUY 90,000 Sector performance (12M) Rel.to KOSPI (%p, RHS) 3, Construction & Engineering sector index (p, LHS ) 2, , , , Feb-12 May-12 Aug-12 Nov-12 Source: WICS provided by WISEfn Inside Latin America s potential: has the world s biggest oil reserves Latin America s weighting in Korean builders overseas orders stood at 13% in 2012, up significantly from 3% in And many of the orders originated from resources-rich. was recently recognized to have the largest proven crude oil reserves in the world, overtaking Saudi Arabia. is also home to the world s ninth-biggest gas reserves. But the country s production-to-reserves ratio is the world s lowest, which prompted President Hugo Chávez, who won another six-year term in 2012, to invest in the oil industry to reduce the country s debt and reap political benefits. As a change to s political landscape is a risk, we only take into account refinery and power plant projects with high mid to short-term visibility in our order value estimates. As such, we estimate s market size at USD8bn per annum through At present, plans to win no-bid contracts worth ~USD10bn are in the pipeline for Korean builders: Refineries and power plants by Hyundai E&C, gas fields by GS E&C and the Orinoco Belt oil field development by Daewoo E&C. Hyundai E&C shifts its values: From order-taking to creation Hyundai E&C was able to win the deal to build s Puerto la Cruz (PLC) refinery in 2012 by eschewing its conservative practices and directly making financing arrangements. It is remarkable because difficulties in project financing (PF) have been often cited as a major culprit in new markets such as ASEAN and Latin America. PF arrangement is a more critical factor than price in where there can be financing troubles due to its anti-us leaders. Since being taken over by Hyundai Motor Group, Hyundai E&C has seen major changes, including the overhaul of its PF development team and the expansion of development projects that involve financing arrangement and capital investment. Hyundai E&C aims to generate 20% of overseas orders in Latin America. The OPM should gain 0.8%p to 6.5% in 2013F thanks to better order quality with new strategies and bad debt reduction. We continue to mark Hyundai E&C as our second choice. Only a handful of companies fitting into the wider value chain, such as development, PF and EPC, will be able to enjoy growth. Oil reserves worldwide Kyungja Lee kyungja.lee@truefriend.com Hyungjun Ahn hyungjoon@truefriend.com Source: BP Saudi Iran Canada Iraq Kuwait UAE Russia Libya Nigeria Kazakhstan Qatar US China Brazil Ecuador Argentina Colombia Peru Bolivia Chile Ecuador 20th Argentina 32nd Colombia 35th (bn bbl) Oil reserv es rank 1-15 Peru 49th Bolivia 50th Chile 64th

2 Sector report focus What is the report about? Investors view toward the construction sector was distorted by 3Q12 earnings shocks at some builders coming from lowpriced projects in the ME in 2011 As builders efforts to advance on non-me regions such as emerging countries, Latin America and ASEAN are not fairly recognized, it is time to carefully examine the markets to draw the appropriate conclusions According to BP s Statistical Review of World Energy, sits on the world s largest proven crude oil reserves, even exceeding Saudi Arabia, but its production-toreserves ratio is the lowest, meaning huge potential for oil field development; It is essential to take a closer look at the market size, project proposals and risks in Key assumptions and valuation We assume major builders overseas orders will grow 18.5% YoY to USD44.8bn in 2013F, equal to 78.9% of each company s guidance Overseas order growth should be spurred by gains in non-me markets such as Latin America; The ME s weighting in the Korean builders overseas orders should fall to 50.2% in 2012 and 45.5% in 2013 after peaking at 73.5% in 2009 Major builders overseas orders by region 100% 80% 60% 40% 20% 0% ME Africa Asia Other Source: International Contractors Association of Korea Sensitivity & scenario analysis Each 10% drop in 2013 overseas orders from our assumption will pare down our full-year OP estimates by 1.2% for Hyundai E&C, 0.7% for Samsung C&T, 1.9% for GS E&C, 1.0% for Daelim Ind., 1.2% for Daewoo E&C and 2.5% for Samsung Eng. Risks/opportunities n leadership change may affect project timing and scale Sector highlights 1) market size USD8bn per annum through 2016 even after considering political risks Plans to win projects worth ~USD10bn are currently in the pipeline for Korean players s main project sponsor Petróleos de S.A. (PDVSA) to announce an investment plan totaling USD100bn through 2015 Even in a conservative assumption that the opposition party takes power, s power plant market should grow at an annual average of USD8bn through 2016 s power plant market outlook considering opposition rule (USD bn) Refinery Power Oil & Gas Source: PDVSA, Korea Investment & Securities 2) to prioritize tenders in the following order: Refineries power plants oil/gas projects Refineries to top the tender list; Given the gasoline import structure and resources comprising largely extra-heavy oil, must invest in refineries to market its oil exports Ample room to tender power plants fueled by the extra-heavy oil Orimulsion found mainly in the Orinoco Belt; Must lower its reliance on hydroelectricity due to El Niño s effect Oil/gas projects, which require massive funding and technology, are time consuming 3) How Korean players penetrate 1) Hyundai E&C was able to secure the Puerto la Cruz (PLC) refinery deal in 2012 by directly making financial arrangements 2) This is a prime example that shows the role of builders is expanding from EPC to planning, financing and management; Considering has a hard time raising funds due to its anti-us sentiment, it views financial arrangement as more important than EPC costs 3) In addition to Hyundai E&C, GS E&C is pursuing gas projects (expected to sign in 1Q13); Meanwhile, Daewoo E&C is pushing oil projects (expected to sign in 2014) and seeking orders by providing comprehensive services Peer comparison Some builders are trading at a high PE (10.1x on average) due to weaker earnings power in 2012 but their PB is near past lows (1.1x on average); If builders can increase the weighting of betterquality orders (including from Central and South America), their earnings power should fast recover and PE would fall (see page 7)

3 Contents I. Opportunities and conditions in Latin America...2 Full-fledged paradigm shift: From order-taking to creation Unlimited potential in Hyundai E&C s change and implications II. Inside...8 s oil reserves surpass Saudi Arabia s Anti-US sentiment in III. s strategy...12 Action 1. Refinery plans: Nine expansions through 2030 Action 2. Oil development: Orimulsion Action 3. Virtuous cycle of Orimulsion and power plants IV. How Korean builders could settle in Builders take a bigger starring role as organizers Taking advantage of China-friendly Korean builders in V. Review of political risks Chávez vs. Henrique Capriles Privatization to continue long-term regardless of political changes Glossary...26 Company Hyundai Eng. & Const. (000720)

4 I. Opportunities and conditions in Latin America Full-fledged paradigm shift: From order-taking to creation Looking into the Latin American market, in particular To win non-me orders, it is crucial to offer comprehensive services covering financing, development and operation In our report Young ASEAN needs electricity published Jan 17, we highlighted the builders efforts to explore new market opportunities despite widespread skepticism about the construction sector. We viewed the ASEAN and Latin America regions as promising in 2013, and in this report we narrow focus to the n market. The ME projects are backed by large budgets and therefore orders are awarded mainly in open bidding. In contrast, most projects in ASEAN and Latin America are done in a sole-source contract with PF arrangement, which raises a question about the continuity of orders. Financing is crucial to turn ideas into action, and transform projects into reality. We witness that the construction industry is going through a transformation: Shifting focus from simple, passive order-taking to order creation, which involves builders proactive project suggestions and comprehensive service offering. In 2013, the builders order performance will vary depending on non-me orders. The ME projects are funded by the so-called petrodollars and therefore are very sensitive to EPC prices. In contrast, the non-me projects put more priority on securing a source of funding, such as via PF arrangement, when placing orders. Some builders have already adapted to the paradigm shift and such efforts are being rewarded. It was cost competitiveness and on-time delivery that drove the Korean builders growth over the past five to six years. Going forward, their growth would hinge on project organizing ability that covers financing arrangement, project planning and operation. Figure 1. Shift from ME concentration to diversification 100% 80% 60% 40% 20% 0% ME Af rica Asia Other Source: International Contractors Association of Korea, MEED Projects, company data, Korea Investment & Securities Figure 2. Comprehensive service offering is essential for market diversification Source: Company data, Korea Investment & Securities 2

5 Unlimited potential in has the world s largest oil reserves, making it a huge market with limitless potential n President Chávez beefs up investment in oil industry after winning another term Why do we focus on at this point? First of all, has ample natural resources. It surpassed Saudi Arabia to become the largest holder of proven oil reserves in early 2012, according to BP s Statistical Review of World Energy. Most of the new proven reserves were the country s unique heavy oil deposited in the Orinoco region (see page 15). Heavy oil reserves in the Orinoco Belt are sufficient to allow the operation of 200 power plants (500MW-grade) for 200 years. is also home to the world s ninth-biggest gas reserves. In contrast, s oil industry is underdeveloped, as demonstrated by its lowest production-to-reserves ratio in the world. was one of the few countries in Latin America to have negative GDP growth for the past two years, which was due to the oil industry s retreat. After winning another six-year term in 2012, President Chávez has stepped up investment in the oil industry to drive the country s growth and the move is in line with his anti-us political stance. We believe that political and economic changes in offer new opportunities for Korean builders. Figure 3. Oil reserves by country Saudi Iran Canada Iraq Kuwait UAE Russia Libya Nigeria Kazakhstan Qatar US China Brazil Ecuador Argentina Colombia Peru Bolivia Chile Source: BP (bn bbl) Ecuador 20th Argentina 32nd Colombia 35th Peru 49th Bolivia 50th Chile 64th Figure 4. Natural gas reserves by country Russia Iran Qatar Saudi US Turkmenis UAE Nigeria Algeria Iraq Australia Indonesia Kazakhsta Malaysia Egypt Norway Uzbekista Kuwait Canada Source: BP 0 10,000 20,000 30,000 40,000 50,000 Gas reserves rank 1-20 (bn m³) s politics: If the opposition party takes power, it is a longterm plus for oil development projects Assuming the opposition takes power, projects total value is estimated at USD60bn from 2013 to 2016 A change to s political landscape is a risk. It is believed President Hugo Chávez (elected 1999) is at present unable to perform his duties due to illness. Chávez named Foreign Minister Nicolas Maduro as Vice President but there is a good chance that opposition leader Henrique Capriles could become the next president if the country is forced to hold an election before Chávez s term expires. It is said Capriles agrees on the need to develop oil fields, suggesting there would be no change in the overall direction of projects in the pipeline. In the long-term, the opposition taking the helm may speed up the development projects given their favorable stance toward international oil companies (IOC) from the West. If the ruling party can hold on to power, orders from the projects in the pipeline should grow USD15bn-30bn per annum. But if the government clings to its closed approach to foreign companies, it would face challenges in terms of financing and technology to carry out the projects, and therefore orders will stabilize at lesser amounts in 2018 and beyond. If the opposition party takes power, only the ongoing projects will be carried out as planned while large-scale oil development projects that require huge capital will be delayed in the short-term. But in the mid to longterm, the n project market size should expand to reach more than USD30bn p.a. on the introduction of foreign capital and technology. In this report, we conservatively assume the current opposition leader would win an election, and 3

6 we only take into account refineries and power plant projects with high visibility in estimating the n projects value from 2013 to Figure 5. n plant market size estimates depending on which party takes power: Nationalism vs. internationalism (USD bn) 60 Refinery Power Oil & Gas Subject to change depending on next president (USD bn) Refinery Power Oil & Gas Source: PDVSA, Korea Investment & Securities Hyundai E&C s change and implications Hyundai E&C won the PLC refinery deal, its first PF arrangement, in 2012 For the PLC project, Hyundai E&C drew funds from China s strategic partner and Korea Export-Import Bank Hyundai E&C entered the Latin American market by winning the USD2.1bn PLC refinery project in May The deal has a greater implication than market diversification for Hyundai E&C. That is, it was the company s first no-bid, PF arrangement project. Traditionally, Hyundai E&C was strong in open bidding where price competition is more important while it was rather reluctant to get into project planning and development. But since being acquired by Hyundai Motor Group, Hyundai E&C has seen major changes and the overhaul of the PF development team was among the first actions taken by the company. Hyundai E&C sees its shift in strategy will bear fruit starting in. It was in 2010 when Hyundai E&C started contacting n officials for the project. Hyundai E&C took full responsibility for PF arrangement in 2012 to make the PLC project a reality. has a hard time raising funds due to its anti- US sentiment. Hyundai E&C aggressively sought to draw funds from China and the Korea Exim Bank. As a strategic partner, China-based Wilson Engineering was allocated works worth USD930mn while Hyundai E&C and Hyundai Engineering together secured USD2.07bn in orders. 4

7 Figure 6. Hyundai E&C s PF arrangement for PLC refinery project Source: Media reports, Korea Investment & Securities A builder s role is expanding to cover planning, financing and operation Samsung C&T, Hyundai E&C and Daelim Ind. stay ahead of peers in development projects It clearly suggests that a builder s role is expanding from EPC to planning, financing and operation. A wider value chain ensures Hyundai E&C can restore the margin by including price escalation (ensuring upward revision of the stated contract price in case of rapid cost increase) and large contingency costs in the contracts, provisions that are barely enforced in ME projects. Furthermore, Hyundai E&C is expected win a gas power plant project in Myanmar in Feb, in which it plans equity investment worth W40bn. It is similar to Samsung C&T s case where it earned a healthy margin by acting as a developer and EPC provider via equity investment in the Qurayyah independent power project (IPP) in Saudi Arabia. Hyundai E&C is diversifying its overseas markets and improving profitability by evolving from a conventional EPC provider. It will be the widening role as a developer, such as financing arrangement and project planning, that will facilitate the builders entry to new markets, regardless of region. Facing slow growth in 2013, Korean builders will find new core values in the developer s role. We believe Samsung C&T, Hyundai E&C and Daelim Ind. stay ahead of others in this regard. Samsung C&T was selected as a preferred bidder for the Rabigh No. 2 IPP in Saudi Arabia, by using the same funding structure and partnership as the Qurayyah project. As such, Samsung C&T sees its strategy proving successful. For Daelim Ind., it played a comprehensive role in Korea s Pocheon IPP covering W1.2trn financing arrangement, EPC and operation. By exploiting the experience as an opportunity to transform into a developer, Daelim Ind. is delivering a visible outcome in ASEAN (IPP) in partnership with a Japanese trading company. As such, in 2013 we recommend a selective approach toward companies that rapidly adapted to changing market norms. We mark Samsung C&T and Daelim Ind. as our top picks and maintain Hyundai E&C as our second choice. 5

8 Figure 7. Myanmar gas power plant project overview and equity breakdown Hana Securities 9% Korea Western Power 9% BKB 9% Project Memorandum of Agreement on construction and operation of gas-fired combined-cycle power plants in Myanmar Contract party Myanmar Electric Power Ministry Location Yangon, Myanmar Operation 30 years Size W700bn Source: Media reports, Korea Investment & Securities Hyundai E&C 9% PF 64% Besides Hyundai E&C, GS E&C and Daewoo E&C are also tapping opportunities in In addition to Hyundai E&C, GS E&C and Daewoo E&C are also tapping opportunities in. The two builders take a similar approach as Hyundai E&C as they work to win no-bid contracts via financing arrangement involving the world s export-import banks. GS E&C is working on a gas development project and will very likely ink a deal in 1H13. Daewoo E&C is focusing on the country s oil development. As such, Korean builders are seeking fresh growth by rapidly adopting a new order strategy. Table 1. Companies advances on the n market Company Project type Note Hyundai E&C Hyundai E&C Refinery Power plant Seeking to win the Santa Ines refinery project in a sole-source contract (USD2bn; MoU signed) Seeking to win the Carabobo power plant project in a sole-source contract (USD1bn; MoU signed) Daewoo E&C Oil development Seeking to win the project to develop Orimulson, an emulsion of extraheavy oil, beneath the Orinoco Belt in a sole-source contract (USD8.8bn; MoU signed) GS E&C Gas development Seeking to win the natural gas development project in the northeastern region in a sole-source contract (USD6bn; MoU signed) Source: Company data, Korea Investment & Securities Table 2. Major builders overseas orders (USD bn) Samsung Eng. Hyundai E&C Daelim Ind. GS E&C Daewoo E&C Samsung C&T a b target c orders orders achievement (c/b) 70.8% 104.0% 45.7% 44.4% 96.9% 77.1% 73.4% 2012 YoY (c/a) 41.2% 103.1% -45.1% -32.7% 17.4% 4.4% 13.1% d. 2013F guidance F YoY (d/c) 52.9% 8.6% 150.0% 50.0% 19.4% 103.7% 50.3% 2013F target YoY (d/b) 8.3% 12.9% 14.3% -33.3% 15.6% 57.1% 10.3% e. KIS assumption for 2013F F YoY (e/c) 29.4% 8.6% 56.3% 25.0% 3.2% 11.1% 18.5% KIS assumption for orders achievement (e/d) -15.4% 0.0% -37.5% -16.7% -13.5% -45.5% -21.1% Source: Company data, Korea Investment & Securities Total 6

9 Table 3. Peer group valuation- Petrofac Tecnicas Reunidas Chiyoda Saipem Technip Fluor Vinci Daelim Ind. Hyundai E&C Samsung C&T Country UK Spain Japan Italy France US France Korea Korea Korea Currency GBP EUR JPY EUR EUR USD EUR KRW KRW KRW Close (Feb 4) , ,600 66,400 63,200 Market cap (USD mn) 8,900 2,723 3,079 12,041 12,322 10,841 28,241 2,905 6,810 9,095 Sales ,801 2, ,675 12,593 6,813 23,381 37,646 7,988 11,920 21,546 (mn) ,447 2, ,229 13,200 8,044 27,769 38,384 10,253 13,325 25,326 (W bn) 2013F 6,734 2, ,850 13,428 9,255 29,466 38,736 10,540 13,971 28, F 7,394 3, ,210 14,057 10,436 31,202 39,870 11,872 15,201 31,080 OP ,197 1, , (mn) ,421 1, ,058 3, (W bn) 2013F , ,014 1,179 3, F 1, ,991 1,238 1,214 1,313 3, , NP , , (mn) , , (W bn) 2013F , , F , , EPS ,469 5,705 2, ,111 4,668 3,010 (KRW) 2013F ,102 5,518 3, F ,085 6,361 3,701 BPS ,427 37,711 60, ,036 40,353 65,572 (KRW) 2013F ,632 43,845 71, F ,205 48,181 77,112 PE (x) F F PB (x) F F EV/EBITDA (x) F F ROE (%) F F OPM (%) F F EPS growth 2011 (3.4) (17.5) (%) (1.0) (2.2) 4.5 (2.0) 6.8 (18.2) F (49.7) F Note: Bloomberg consensus for global peers; KIS estimates for Korean firms Source: Bloomberg, Korea Investment & Securities 7

10 II. Inside s oil reserves surpass Saudi Arabia s In 2012, was recognized as holder of the world s largest oil reserves After winning reelection in 2012, Chávez resumed investment in the oil industry In 2012, BP announced that holds the largest proven oil reserves in the world. Most of the newly recognized reserves are s unique extra-heavy oil found primarily in the Orinoco Belt. Despite s emergence as a leading crude oil supplier, its GDP growth has been slipping since s oil exports account for roughly 95% of total exports but its reserves-toproduction ratio is the lowest in the world. The reason is President Chávez used most the oil money earned in early and mid-2000s for welfare and nationalizing the resources industry in order to prolong his presidency. Considering has the highest debt-to-gdp ratio in Central and South America, it urgently needs to ramp up oil production. Accordingly, Chávez has resumed investment in the oil industry after being awarded another term as president in Figure 8. Global oil reserves Figure 9. Oil reserves and production by country Saudi Iran Canada Iraq Kuwait UAE Russia Libya Nigeria Kazakhstan Qatar US China Brazil Ecuador Argentina Colombia Peru Bolivia Chile Ecuador 20th Argentina 32nd Colombia 35th (bn bbl) Oil reserves rank 1-15 Peru 49th Bolivia 50th Chile 64th 350, , , , , ,000 50,000 0 (mn bbl) Saudi Arabia Oil reserves (L) Iran Canada Iraq Kuwait UAE Oil production (R) Russia Nigeria Qatar US (mn b/d) China Brazil Source: BP Source: BP Figure 10. s GDP and major political events 17,000 16,000 15,000 14,000 13,000 12,000 11,000 10,000 9,000 8,000 (VEF bn) Fedecamaras strike (largest business Fedecamaras organization) second strike oil price plummets, Chavez won presidential election Oil strike Chavez re-elected Fixed double exchange rate system adapted Chavez re-elected on impeachment referendum Oil strike ends Oil law revision, nationalization of natural resources Referendum on president Chavez's impeachment Global financial crisis Chavez reelected GDP Source: Bloomberg, Korea Investment & Securities 8

11 Anti-US sentiment in, with an anti- US bent, nationalized its natural resources Resources nationalism has forced many IOCs to pull out of, causing the oil industry to move backward Both and Colombia sit at the northern end of South America. However, the two countries are very different when it comes to crude oil exports and production. We attribute this to differing political ideologies as has assumed an antagonist stance against the US while Colombia is considered pro- US. President Chávez has transformed into a socialist state by stepping up wealth distribution. Moreover, the country is at odds with the US over Iran s nuclear program. has also used money from oil exports to support anti- US nations such as Cuba. Overall, has expressed strong anti-us sentiment. In 2006, the country decided to nationalize its natural resources by amending the petroleum law. s state-owned oil company Petróleos de SA (PDVSA) is responsible for a third of the country s GDP, 80% of exports and 50% of government revenue. PDVSA was nationalized in 2006 as part of Chávez s nationalist approach to the country s energy assets. The government started imposing heavy royalties and taxes on western IOCs engaged in resources exploration & production (E&P) in and raised taxes from the 1-17% range to 20-30%. In Jan 2012, was ordered to pay ExxonMobil only 11% of the USD7bn in compensation the US oil giant sought for the nationalization of its large oil project. Overall, s resources nationalism has prompted IOCs to exit and the country s oil industry has been moving backward for the past 10 years. Figure 11. Oil exports/production: vs. Colombia Figure 12. Anti and pro-us nations in Central and South America (mn b/d) Production Exports ('000 b/d) Production Exports Mexico Cuba Honduras Nicaragua Anti-US Pro-US Source: Wall Street figures Colombia Source: Korea Investment & Securities Colombia Ecuador Brazil Relationship with Peru US is improving after Obama was sworn in as Bolivia president Paraguay Figure 13. PDVSA now one of the New Seven Sisters Figure 14. History of s oil nationalism Saudi Aramco Iran NIOC PDVSA China CNPC Russia Gazprom Brazil Petrobras Malaysia Petronas Exxon Mobil BP Chevron Shell New seven growing oil companies Old four major oil companies (mn b/d) Date 1980 Mar 2006 Apr 2006 May 2007 Jan 2007 May 2009 Jan 2012 Event PDVSA acquired CITGO, one of the big-three oil companies in the US Announced oil nationalism Terminated energy agreements with all companies at home and abroad Acquired a 100% stake in seven of 32 oil fields that were transferred to foreign companies Amended petroleum law to force foreign oil companies to accept PDVSA as a minority interest partner Nationalized all projects in the Orinoco Belt Reviewed options to nationalize natural gas in addition to oil Announced nationalization of five steel plants PDVSA ordered to pay only 11% of the USD7bn in compensation ExxonMobil sought for the nationalization of its large oil project Source: Korea Investment & Securities Source: PDVSA 9

12 US is still the top consumer of n oil has used oil as a bargaining chip in negotiations with the US What is interesting is that US is still the largest consumer of s oil exports. PDVSA s biggest downstream activities are handled by its US-based subsidiary CITGO. Most of the refineries operated by CITGO are located in the US Gulf Coast and all crude oil is imported from PDVSA. CITGO wields major influence in the US as it accounts for ~6% of total US refining capacity. Energy experts warn that if CITGO was to completely shut off the supply of petroleum products, the US economy could collapse in 90 days. By acquiring CITGO in 1986, PDVSA was able to find a safe destination for s oil exports. Accordingly, PDVSA has the second-most refineries in the US after. Given that most of the refineries are designed to process s extra-heavy oil, the US will likely remain the top consumer of n oil. has maintained its influence over oil supplies to the US. When Hurricane Katrina struck the US in 2005, CITGO was the only IOC to respond to President Bush s calls for heating oil assistance and the company delivered 25mn gallons of subsidized heating oil to 100,000 low-income households in hurricaneaffected areas. This is all part of s plan to strengthen its bargaining power over the US. Figure 15. Consumers of n oil Figure 16. PDVSA s refining capacity by region Other Asia 9% Others 6% (bbl/d) Caribbean 641,500 China 10% US 40% Europe 33,250 1,282,100 Europe 4% Caribbean 31% US 849,900 Source: PDVSA Source: PDVSA Figure 17. Refineries in the US Lemont, Illinois Refinery Ownership: CITGO PDVSA share: 100% Capacity (MBD): 167 Figure 18. CITGO has ~6% of US refining capacity Corpus Christi, Texas Refinery Ownership: CITGO PDVSA share: 100% Capacity (MBD): 157 Lake Charles, Louisiana Refinery Ownership: CITGO PDVSA share: 100% Capacity (MBD): 425 Chalmette, Louisiana Refinery Ownership: Chalmette PDVSA share: 50% Capacity (MBD): 184 Source: PDVSA Source: CITGO 10

13 Table 4. PDVSA s global refining capacity ( 000 bbl/day) Location Owner Stake (%) Total capacity PDVSA s capacity CRP, Falcón PDVSA Puerto la Cruz, Anzoátegui PDVSA El Palito, Carabobo PDVSA Bajo Grande, Zulia PDVSA San Roque, Anzoátegul PDVSA Total 1,303 1,303 Caribbean Isla, Curacao PDVSA Camilo, Cienfuegos, Cuba CUVENPETROL Jamaica Petrojam Haina, Dominican Rep. Refidomsa PDV SA Total Caribbean US Lake Charles, Louisiana CITGO Corpus Christi, Texas CITGO Lemont, Illinois CITGO Chalmette, Louisiana Chalmette Saint Croix, US Virgin Islands Hovensa Total US 1,428 1,089 Europe Nynäshamn, Sweden Nynäs Gothenburg, Sweden Nynäs Dundee, Scotland Nynäs Eastham, England Nynäs Total Europe Total Global 3,267 2,822 Source: PDVSA 11

14 III. s strategy PDVSA plans to invest USD10bn through 2015 There is big domestic demand for oil, particularly gasoline After a successful re-election, Chávez said Oil is a big driver of the comprehensive development of the nation and stressed that he would push for oil development to promote s growth. As the US is becoming more energy self-sufficient helped by the recent development of tight oil, needs to diversify its oil exports to Asia and elsewhere and increase its influence over the US. Moreover, reviving the oil industry is the only way to ease the national debt. Accordingly, PDVSA has designed an investment plan totaling ~USD10bn through 2015 that includes building refineries and developing oil and natural gas fields. The state-run oil company will focus on developing refineries in the near to mid-term and promote oil/gas development projects that require massive funds in the longterm. PDVSA also plans to invest in domestic power plants that use Orimulsion (oil produced from the aforementioned projects) as fuel. s domestic demand for oil is growing. Of note, oil production has been on a steady decline since 2001 due to aging fields, delayed repairs and maintenance, and the IOCs reducing investment because of nationalization. also faces a shortage of refineries, which has created an inefficient market structure where the country exports oil for USD100/bbl but imports gasoline for USD400/bbl. But it is ironic that has among the cheapest gasoline prices in the world thanks to massive subsidies provided by the government. As the government s effort to keep gasoline prices low is contributing to a fiscal imbalance, needs to invest in oil development projects and refineries given all these circumstances. Figure 19. Pipeline plans to bring oil to Asia Figure 20. s investment plan for oil industry China ASEAN Russia Japan, Korea Indonesia Pipeline (Scheduled) Colombia Type Investment period Amount (W bn) Remarks Refinery Refining capacity: 1.3mn bbl/day 2.3mn bbl/day Oil Production: 48.6bn bbl Production: 129bn bbl Unconfirmed Production: 80bn bbl Oil/gas investment expected to reach an annual average of USD22bn over Source: PDVSA, Korea Investment & Securities Source: PDVSA Figure 21. s energy consumption breakdown Figure 22. s oil production and consumption Coal 2% Hydroelectric 23% Oil 47% Natural gas 28% Source: PDVSA Source: PDVSA 12

15 Action 1. Refinery plans: Nine expansions through 2030 started investing in refineries first Hyundai E&C was the first to secure a private contract for a refinery project in 2012; Plans to pursue follow-up orders in 2013 s oil industry investment began with refineries. PDVSA announced it would increase refining capacity from 1.3mn bbl/day to 2.3mn by investing USD34.9bn from and USD8.5bn from PDVSA s near to mid-term investment will be directed toward refineries considering 1) s gasoline shortages, 2) the need for high value-added products as produces much less oil than Saudi Arabia due to slow E&P activities and 3) the big demand to refine the country s unique extra-heavy oil. Hyundai E&C was the first to secure a PF-type private contract for the USD3bn Puerto la Cruz (PLC) refinery project in May The builder is also pursuing a private contract for the Santa Ines refinery project in 2013 using the same funding method. Unlike the PLC refinery that is situated in a coastal area, the Santa Ines refinery will be inland and this may lead to greater construction costs. Accordingly, it appears Hyundai E&C is pursing the project by fully considering the risks involved according to a thorough feasibility study. Figure 23. s refinery investment plans over Paraguana complex INV: 3,914 USD mn SY: 2017 Upgrading CRP INV: 4,000 USD mn SY: 2016 El Palito Refinery expansion INV: 3,317 USD mn SY: 2016 Deep conversion, Puerto la Cruz Refinery INV: 5,164 USD mn SY: 2012 Zulia Refinery INV: 3,500 USD mn SY: 2021 CAP: 200 TBD Jose Refinery INV: 9,712 USD mn SY: 2018 CAP: 350 TBD INV: Investment SY: Start Year CAP: Capacity Batalla de Santa Refinery INV: 2,974 USD mn SY Phase I: 2013 SY Phase II: 2014 CAP: 100 TBD Cabruta Refinery Phase I: 9,390 USD mn SY: 2017 Phase II: 1,741 USD mn SY: 2022 Phase III: 1,842 USD mn Sy: 2027 CAP: 220 TBD Total Investment ( ) 34,890 USDmn Total Investment ( ) 8,513 USD mn Source: PDVSA Action 2. Oil development: Orimulsion overtook Saudi Arabia as no. 1 for proven oil reserves The United States Geological Survey (USGC) recently released a study claiming has oil reserves greater than Saudi Arabia by two-fold. In 2012, BP said the country s oil reserves are more than 10% larger than Saudi Arabia s. Most of the former s crude is extra-heavy oil. Figure 24. Proven oil reserves Figure 25. Surge in s reserves on the recognition of extra-heavy oil as crude (bn bbl) 300 Saudi Arabia Source: BP Source: BP 13

16 Most of s crude is extra-heavy oil deposited in the Orinoco Belt Development of Orinoco Belt with USD74bn investment from 2012 to 2030 s extra-heavy oil deposits are mostly in the inland areas of the Orinoco Belt. Among the proven reserves of 1.2trn barrels, recoverable reserves amount to 235bn barrels, which could operate 200 power plants (500MW-grade) for 200 years. The country began oil development in the Orinoco Belt from 1998 according to the Oil Sowing Plan. But in May 2007, the nationalization of all projects ongoing in the belt urged many IOCs to withdraw and stagnated development projects there. Only the projects in which PDVSA has more than a 60% stake are allowed to go ahead. is now committed to oil development given the statement, 2012 is likely to be a crucial year for the climate, as aims to ramp up production of huge reserves of tar sands-like crude in the eastern Orinoco River Belt (Sarah Wykes, The Green Political Foundation, The Orinoco Belt, Oct 10, 2012). After investing USD56bn during , the country plans to spend USD74bn on the second-phase development of the Orinoco Belt from 2012 to Figure 26. Conventional and unconventional oil reserves and production costs Figure 27. Features of Orimulsion Source: PDVSA Source: Google Orimulsion mainly used as a power generation fuel Orimulsion s price merit, thermal efficiency, long distance transportability, free of OPEC quotas and tax exemption Extra-heavy oil deposited in the Orinoco Belt is an unconventional type. Typically, the biggest drawback of extra-heavy oil is high viscosity. But in the case of Orinoco crude, the incorporation of multilateral technology enables it to run underground. It also has better economic feasibility than other unconventional oil resources (production costs only half of bitumen production in Canada; has less viscosity than oil sand). The burning of Orinoco crude generates 20% less dust and CO² than coal-fired power generation and thus meets the environmental restrictions set by developed nations. Orinoco crude is an emulsion of natural bitumen with fresh water and surfactant (called Orimulsion) and is mainly used as a fuel substitute for heavy oil and coal in power generation. Orimulsion is emerging as a promising power generation fuel that can replace coal and high-sulfur heavy oil. 1) Orimulsion costs only half of heavy oil, even considering less heat generation (70%). It excels coal in heat generation and thermal efficiency. 2) As a liquid, it can be transported over long distances via existing oil tankers. 3) Unlike heavy oil, it is not restricted by OPEC quotas and also exempt from import tariffs. In the early 2000s, Orimulsion was supplied to 10 countries including Japan, Germany and Korea (Samsung Fine Chemicals and Youngnam thermal power plants). But it is difficult to buy the fuel as President Chávez has asked to make direct E&P investments or sign government agreements in exchange. 14

17 Figure 28. Overview of Orinoco Belt projects Junin Block 2 Pterovietnam (Vietnam) Junin Block 1 negotiating with Belarus Junin Block 5 Eni (Italy) Orinoco belt AYACUCHO Carabobo project 1 Repsol (Spain) Petronas (Malaysia) Oil India Ltd. (India) CARABOBO MACHETE JUNIN Junin Block 11 negotiating with Japanese consortium Junin Block 4 CNPC (China) Junin Block 6 Gazprom, Lukoil, TNK- B, Surgutneftegaz (Russia) Junin Block 10 PDVSA () Carabobo project 3 Cheveron (US) Suelopetrol () Mitsubishi, Inpex (Japan) Project Year Production (100,000b) Partners Active Petroanzoategui ,000 PDVSA (100%) projects Petromonagas ,730 PDVSA (83.3%), BP (16.7%) Petrocedeno ,000 PDVSA (60%), Total (30%), Statoil (10%) Petropiar ,100 PDVSA (70%), Chevron (30%) Bilateral Junin ,000 PDVSA (60%), PetroVietnam (40%) agreements Junin ,000 PDVSA (60%), CNPC (40%) Carabobo big round Source: PDVSA Junin ,000 PDVSA (60%), Eni (40%) Junin ,000 PDVSA (60%), Russian consortium (40%) Carabobo ,000 Carabobo ,000 PDVSA (60%), Indian consortium (18%), Petronas (11%) PDVSA (60%), Chevron (34%), Japanese consortium (5%) Figure 29. Orimulsion s merits ½ cost of heavy oil Huge amount of reserves OPEC quotafree Import tax exempt High thermal efficiency Long-distance transportable Source: PDVSA 15

18 Action 3. Virtuous cycle of Orimulsion and power plants Power generation projects gradually picking up near the Orinoco Belt Hyundai E&C s experience with Orimulsion-fired power plants lets it pursue s power plant orders With oil development efforts ongoing in the Orinoco Belt, the construction of power plants in nearby areas is gradually picking up. relies on hydroelectric plants to meet 75% of its power demand using four dams (incl. Raul Leoni and Guri). But due to weak precipitation caused by El Niño and unstable power supply, there has been a growing need to diversify power generation sources. Most new power plant projects started in are set to use Orimulsion as fuel coming from Orinoco Belt crude. As Orimulsion is a non-newtonian shear-thinning fluid (viscosity decreases when shear rate increases), designing Orimulsion-fired power plants is technologically demanding. In the past, Youngnam thermal power plants nos. 1 and 2 were remodeled to use Orimulsion as a fuel, and the EPC provider for the project was Hyundai E&C. Based on the experience and its track record in, the builder has signed a MoU for the construction of a power plant in Carabobo (part of the Orinoco Belt) and is pressing ahead for a contract in a non-competitive bid. Figure 30. Youngnam thermal power plants #1 and #2 for which Hyundai E&C offered EPC for fuel change - The fuel change project for Youngnam thermal power plants nos. 1 and 2 was completed in The plants were originally built to use heavy oil but remodeled to generate power by using low-cost Orimulsion (produced only in ) as a fuel Hyundai E&C s company newspaper on Dec 30, 2003 Figure 31. Hyundai E&C s MoU for power plant project in Junin Block 2 Pterovietnam (Vietnam) Junin Block 1 negotiating with Belarus MACHETE Junin Block 11 negotiating with Japanese consortium Junin Block 4 CNPC (China) Junin Block 5 Eni (Italy) JUNIN Junin Block 6 Gazprom, Lukoil, TNK- B, Surgutneftegaz (Russia) Orinoco belt Junin Block 10 PDVSA () AYACUCHO Carabobo project 1 Repsol (Spain) Petronas (Malaysia) Oil India Ltd. (India) CARABOBO Carabobo project 3 Cheveron (US) Suelopetrol () Mitsubishi, Inpex (Japan) Source: KEPCO, Hyundai E&C Source: Korea Investment & Securities 16

19 IV. How Korean builders could settle in Builders take a bigger starring role as organizers What does conservative Hyundai E&C s winning of refinery project mean? Non-competitive contract with the PF arrangement offered fat margins to Hyundai E&C Hyundai E&C given more of a starring role to organizer in addition to market diversification In pursuit of Myanmar gas power plant via equity investment s PLC refinery project that Hyundai E&C and Hyundai Engineering won for USD2.1bn in May 2012 was a landmark event that can accelerate the paradigm shift in the construction industry. Despite its huge potential as a country that holds the world's biggest crude oil reserves, was mired in country risks and had difficulty attracting PF loans. Accordingly, its project tenders have hit rough patches so far. But tendering for the large-scale PLC refinery was faster than expected, driven by Hyundai E&C s aggressive PF arrangement, which was unusual considering the builder s usual conservatism. Hyundai E&C designed the PF structure comprising Chinese and Korean export-import banks and completed the funding process. At the time, Hyundai E&C could achieve fat margins by inserting all escalation clauses, which are difficult to be applied in the ME market, via a non-competitive contract with the PF arrangement., labeled as anti-us, finds it difficult to attract global IB capital. For the reason, Hyundai E&C turned to Chinese and Korean export-import banks for funding and allocated some of the EPC orders to China s Wison Engineering in a strategic partnership. The combined orders going to Hyundai E&C and Hyundai Engineering were worth USD2.1bn. With the project victory, Hyundai E&C made a big stride with its bigger role to an organizer as well as market diversification. Until 2011, the builder was good at winning competition-based projects via open bidding and was rather passive in project development. But after being acquired by Hyundai Motor Group in Apr 2011, Hyundai E&C reinforced its PF development team as a priority task, and yielded the first result by winning the PLC project in. This vividly shows builders role is expanding from EPC providers to organizers in charge of project planning, funding and operations. Taking a step further, Hyundai E&C plans to make a W40bn investment in Myanmar s gas-fired power plant project for which the tender result should come in Feb. This reminds us of Samsung C&T becoming the equity investor and EPC provider for Saudi Arabia s Qurayyah IPP in By assuming the dual role, Samsung C&T could earn appropriate EPC margins. Likewise, Hyundai E&C is departing from its EPCfocused conservative stance and achieving regional diversification and better margins at the same time. Figure 32. Hyundai E&C s PLC refinery PF structure Source: Media reports 17

20 GS E&C and Daewoo E&C also engaged in projects In addition to Hyundai E&C, GS E&C and Daewoo E&C are proceeding with projects in. GS E&C is trying to sign natural gas development contracts (USD6bn) in a non-competitive bid in the three northeastern regions of San Joaquin, Pirital and El Jose. In 2H10, the builder signed a MoU with PDVSA and agreed to estimate details. In a similar PF structure to Hyundai E&C s PLC project, GS E&C is seemingly in the final phase of PF with Japanese and Korean exportimport banks. EPC orders for GS E&C (possibly out in 1H13 at the earliest) should be determined in a range of USD1bn-2bn depending on Korea Exim Bank s funding weight. Figure 33. Overview of GS E&C s gas development project 1) Extraction of natural gas liquids (NGL) - San Joaquin train 4 (1,000mmscfd) - Pirital train (1,000mmscfd) 2) NGL separation/production: El Jose 4 (50,000b/d) In 2H10, GS E&C and PDVSA signed a MoU and agreed to estimate details Currently in the process of PF arrangement by K-EXIM, K- SURE, JBIC, etc. Source: PDVSA Daewoo E&C engaged in developing extraheavy oil in the Orinoco Belt; Contract to be signed in 2014 Sizable deal on unique funding structure of offtake guarantee Korean builders have come up with several funding methods In Apr 2012, Daewoo E&C in a consortium with STX Construction signed a MoU with PDVSA to develop heavy oil in the Orinoco Belt. The USD8.8bn project is to build pipelines and tanks in Junin and Carabobo and construct oil storage facilities and transportation terminals in Araya and Punta Cuchillo. Oil produced in Junin and Carabobo would be transported to Araya through pipelines and then shipped across the northern river for export. Punta Cuchillo will be used as an export base for refined cokes that will be supplied to steel mills as a fuel. The project s huge scale made funding a challenge. As such, Daewoo E&C is expected to win orders for the front-end engineering and design (FEED) in 2013 and then for EPC in Due to the funding difficulties, the consortium of Daewoo E&C and STX Construction came up with the unique structure of an offtake guarantee. In the structure, STX Pan Ocean that annually imports USD1.5bn of oil will purchase fuel oil for ships from (total USD5bn USD1bn p.a. for five years). This means the government will pay the project costs with crude. Accordingly, the consortium s funding needs shrank to USD3.8bn, which were planned to be financed by Mitsui & Co. (equipment provider for the project, USD1.1bn), Korea Exim Bank (USD600mn) and the China Exim Bank (USD1.6bn). But as STX Pan Ocean has been put up for sale, its participation in the project seems uncertain and a change to the funding structure looks inevitable. Although the project hit a snag, the Korean builders coming up with diverse financing methods for market penetration (like using the unfamiliar off-take concept) is an encouraging change in our view. 18

21 Figure 34. Daewoo E&C project: Location, overview and PF structure 2 Oil production is shipped to northern river for export 3 Coke (byproduct of oil refining) is shipped by river for export for use as a fuel at steel mills 1 Oil production is delivered to Araya via pipeline #1: Junin and Carabobo: Oil pipeline and tank farm #2: Araya: Oil storage and shipping terminal #3: Punta Cuchillo: Solid storage and shipping terminal Source: PDVSA, Daewoo E&C, Korea Investment & Securities 19

22 Taking advantage of China-friendly China Exim Bank s capital accounts for a big portion of n PF Should harness Chinese capital with big influence in established via a loan Interestingly, China Exim Bank s capital makes up a large portion of the Korean companies n PF. In 2007, (in light of its antagonist stance toward the US) signed a deal where China would lend it USD32bn at low interest in exchange for a stable oil supply. The enormous amount of capital contributed much to a housing project for low-income households, a 2012 election pledge by Chávez called the Mision Vivienda program, and allowed a gasoline subsidy. has paid down USD28bn of the USD32bn through oil exports. The oil prices were flexible determined by international prices and ranged between USD /bbl. With China-friendly and anti-us political sentiment, it is difficult for to attract investment from Western investment banks. Thus, the most likely financing sources for Korean builders are export credit agencies (ECA), especially the China Exim Bank and the Japan Bank of International Cooperation (JBIC). Since PDVSA has signed a MoU for E&P with Japan s Marubeni and Mitsubishi, it is also easy to finance from a Japanese ECA. An off-take agreement that was mentioned along with Daewoo E&C s case will likely be a popular PF option. As was the case with the loan deal with China, oil prices are flexible determined by international prices and thus related risks are limited. Figure 35. Crude capitalism: Crude oil exports to China and US Figure 36. Chávez s La Mision Vivienda program (mn b/d) Export to U.S (mn b/d) Export to China Source: Wall Street Source: Google Figure 37. JBIC s and China s Latin American PF Figure 38. China s oil production and consumption (USD bn) JBIC China banks (Exim+CDB+ICBC) 12,000 10,000 ('000 bbl/d) Production Consumption 20 8, , , , Source: JBIC, China Exim Bank Source: CEIC 20

23 Korean builders in Not very competitive local companies, less aggressive European builders and an exclusive market for development projects Recently, Hyundai E&C and other Korean builders have been able to perform well in for the following reasons. 1) In the Latin American market, has weak local competitors. 2) European builders that are main rivals in Saudi Arabia and other ME countries are not aggressively engaging in the n market due to the nation s political risks and the corresponding ECAs reduced capital position. 3) The market requires builders to take care of financial arrangements and in turn limits potential competitors. Figure 39. Builder rankings in the Latin American construction market Figure 40. Latin American company rankings by competitiveness Rank Company Country Main area Sales (USD bn) 1 Norberto Odebrecht Brazil Transportation 13 2 GRUPO ACS Spain Transportation 43 3 OHL SA Spain Transportation 6 4 ABEINSA SA Spain Power 6 5 FLUOR US Ind./Petroleum 19 6 TECHINT Italy Ind./Petroleum 3 7 GRUPO ISOLUX Spain Power 4 8 BECHTEL US Ind./Petroleum 25 9 IMPREGILO SPA Spain N/A 3 10 TECHNIP France Ind./Petroleum 9 Brazil Peru Argentina Chile Colombia Dominican Rep. El Salvador Mexico Panama Uruguay Costa Rica Ecuador Guatemala Paraguay Bolivia Honduras Nicaragua Source: ENR Source: ENR In 2011, Korea moved a step forward with MoU and LoI with PDVSA, the main ordering organization in, refuses to individually meet overseas companies and exclusively deals with those that have forged cooperation agreements with the country. Thus, it is very meaningful that the Korean government inked four MoUs and one letter of intent (LoI) at the Korea- energy resources cooperation meeting in Apr Among Korean builders, Hyundai E&C is most aggressively taking advantage of the deal, exchanging most actively with the n government and making notable progress. SK E&C, GS E&C and Daewoo E&C are following suit. Figure 41. Korean builders ongoing projects in USD6bn Gas development MoU Sandiego-Hose Industrial: USD0.5bn Extra-heavy oil storage, pump MoU, USD35mn Petrochemical complex LoI Puerto la Cruz #1,2 Refinery (USD3bn) Carabobo: USD1bn Oil power plant MoU Orinoco Belt Santa Ines Refinery (USD1.5) Carabobo/Araya:USD8.8bn pipeline/tank/port construction MoU Source: Korea Investment & Securities 21

24 Beginning with, Korean firms Latin American advance accelerates Beginning with, Korean companies are advancing on the Latin American market at a faster clip. In 2012, a number of Korean builders finished setting up subsidiaries and acquiring local companies mainly in but also in Colombia, Ecuador, Brazil, etc. (see Figure 42). We believe n projects are the opening salvo in the Korean firms regional differentiation. Figure 42. Korean firms Latin American exposure: Advancing via subsidiaries and M&A Subsidiary in Bogota, Colombia (Expected) Columbi Ecuador Bogota, Colombia established subsidiary in Caracas, Subsidiary in Colombia (expected) Acquired Inima, (more than 70% of Inima's backlog is from Latin America) Peru Chile Bolivia Paraguay Brazil Sao Paulo, Brazil Chile subsidiary (expected) Acquired 70% of Santos CMI (Ecuador's plant EPC company) Argentina Source: Korea Investment & Securities 22

25 V. Review of political risks Chávez vs. Henrique Capriles Political ties, especially with the Chávezes, are crucial to enter s closed market s political changes are short-term risks ruled by opposition open to Western oil firms is a long-term positive To enter s closed market, it is important to build ties with the political ring that is represented by the Chávezes. Most of President Chávez s six brothers are politically involved (see Figure 43). Among them, the eldest and third-eldest brothers are closest to Chávez. In particular, the presidential committee to which third-eldest brother Argenis Chávez belongs comprises minister-level members and formulates policies for housing, electricity and other major government issues. Argenis Chávez is a key figure for Korean builders to discuss their n projects. s political changes could pose short-term risks. At present, President Chávez is reported as being effectively absent. Although Vice President Nicolas Maduro has been pointed as successor, may hold an election if there is sufficient backlash from the opposition. Since there is no one in the ruling party big enough to replace Hugo Chávez, the opposition party stands a good chance to win in an election. Although the nation s opposition leader Henrique Capriles lost to Chávez by 10%p in the 2012 election, he is a very strong candidate for the next vote. Capriles shares Chávez s direction for s oil development but opines differently in terms of methods according to statements such as: We have to revise every deal. Capriles political inclination is similar to former Brazilian President Lula s centerleft position which advocates a public-private combination model. Unlike Chávez who limits IOC investment from the West, Capriles plans to attract many IOCs by opening up the country and ultimately boost the nation s oil industry. Figure 43. Chávez and brothers Hugo Chavez - President Eldest: Adan Chavez - Barinas governor - Previous minister of education Third: Argenis Chavez - President of National Electric Corp. Anibal Chavez Sabaneta mayor Narciso Chavez Cuba embassy Adelis Chavez Banco Sofitasa president Asdrubal Chavez PDVSA vice president Source: Google With no administration change, tenders would grow to USD15bn-30bn in the mid-term but could stabilize to less With the opposition ruling, tenders market should grow USD60bn in Thus, the industry forecasts that an administration run by the current opposition party open to Western oil companies investment would add momentum to oil project tenders. If the current administration continues, USD15bn-30bn should be tendered p.a. in the mid-term and projects currently being prepared would lead the growth. If the government stays exclusive, however, the market should stabilize downward from 2018 due to difficulty in obtaining capital funding and technology. If the opposition party takes power, tenders would be placed only for ongoing projects and oil development projects that require large-scale capital would inevitably be postponed. However, from a mid/long-term perspective, the market would expand to tender more than USD30bn p.a. as the government allows the 23

26 inflow of overseas capital and technology. In this report, we conservatively assume the current ruling party will remain in power, and listed refinery and power plant projects that will very likely be tendered in are potential orders for Korean builders. Even if the opposition party takes over, it is very unlikely for a new government to radically cancel or delay numerous projects that are being pursued by Korean firms as PDVSA effectively leads the projects. Figure 44. Brazil s development under former Pres. Lula Figure 45. Henrique Capriles Source: Google Source: Google Figure 46. Brazil s energy liberalization The Petroleum Investment Law was passed in 1997; Liberalization of oil production and free competition in the energy sector lead to greater investment in energy development and power plants Source: Google Figure 47. Possible scenarios for continued absence of President Chávez and IOCs mid/long-term investments Nationalism Nationalism Nicolas Maduro - Vice President, Chavez's 10 0 Ruling party Hugo Chavez - President of Internationalis Henrique Capriles - Miranda governor - Opposition's sole candidate in Oct 2012 presidential election Lost against Chavez by only 10%p Opposition Source: Google, PDVSA, Korea Investment & Securities Source: Korea Investment & Securities 24

27 Privatization to continue long-term regardless of political changes likely to continue oil industry privatization regardless of which party rules Privatization attempts such as lowering PDVSA s stake in ventures Regardless of which party rules the nation, will likely continue its efforts to privatize the oil industry. In Mar 2012, Petropia, jointly established by PDVSA and the US Chevron sold PDVSA s 10% stake to CITIC, China s state-run investment company. Initially, the venture was 70% owned by PDVSA and 30% by Chevron and was formed to develop the extra-heavy oil buried in the Orinoco Belt. Moreover, is reviewing a plan to lessen PDVSA s stake in venture companies from the present 60% or more to 51% or more. Energy experts view it as a de facto partial privatization measure. Also noteworthy is the nation s gradual opening up to stimulate its oil industry such as PDVSA s decision to list on Hong Kong s stock market. In the case of Peru, privatization of the oil industry has expanded the IOCs investments and royalty income from IOCs, which in turn helps the nation s budget. too will likely continue its privatization effort at a reasonable pace. In the long-term, such attempts should be a factor that brightens the outlook for construction projects. Figure 48. Oil company s partial privatization? Figure 49. Peru royalty income from the oil industry: Income from IOCs jumped after privatization 6,000 (SOL bn) Oil royalties 5,000 4,000 3,000 2,000 1, Source: Bloomberg Source: Google 25