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Petrobras: The Recovery of the State Oil Company

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Brazil’s state oil company reported its annual earnings last week and the results impressed. To start with, the company made money. After four years of huge losses, write-downs and financial losses related to the Car Wash corruption scandal, Petrobras made a profit in 2018 of $ 6.9 billion.

That compares to 2017 when it was $ 123 million in the red, as well as 2015 when Petrobras was forced to delay the launch of its audited financial statements for months by tabulating the long list of accounting write-offs related to Car Wash. Subsequently, it recorded a loss of $ 8.1 billion that year, the highest ever.

Free cash flow and adjusted profit before interest, taxes, depreciation, and amortization were record highs. It is important to note that Petrobras has cut a huge burden of its debt. Net debt, until recently the highest of all oil companies, declined 18 percent from 2017 to $ 69.4 billion and fell 30 percent from its lowest point in 2015 when its debt was $ 100 billion.

The company is not without problems. Despite the cuts, his debt is still huge. Operationally, oil and gas production declined five percent year-on-year. And while at least the weight of the Car Wash seems to be in the past, with billions of dollars in settlements paid for, the investigation is active and in progress. Brazilian federal police, along with US officials, has recently opened a new phase of the investigation that is investigating undue payments from traders who buy and sell Petrobras commodities.

But the results of Petrobras recovering its financial house are undoubtedly encouraging. They reflect a focus on their core oil and gas deepwater business. Committing to this approach opens up attractive opportunities for foreign investors to fill where Petrobras is willing to retreat. It is a good start for a Brazil that is promoting more open trade and promoting better investment conditions under a new president.

The future of Petrobras is inextricably linked to the Brazilian pre-salt, the huge reservoirs of deep-sea oil trapped under layers of salt beneath the ocean floor. The size of the resources is so great and its operating costs so competitive that it is in Petrobras‘ interest to zero in on its development. Pre-salt oil and gas production already accounts for almost three-quarters of Petrobras‘ total production. The company’s average production costs, according to the new CEO, Roberto Castello Branco, are the only US $ 10 per barrel. By gross comparison, the production costs of the US shale projects  considered among the most attractive oil games in the world, along with the Brazilian pre-salt  are equal to or greater than US $ 30 per barrel.

Any assets that are not directly linked to the exploration and production of pre-salt oil and gas are theoretically for sale, management has repeatedly suggested. Oil blocks on land and shallow water, oil pipelines, gas transmission infrastructure, and refineries, among other assets, were offered to the market and generated billions of dollars in resources. Sales and divestitures play a double role in allowing Petrobras to focus on its basic commitment to the pre-salt while paying its debts. In fact, despite lower total oil production in 2018, Petrobras‘ profitable year was aided by reduced interest payments on its debt, although higher oil prices and the depreciation of the real against the dollar also performed great paper.

Asset sales will gain a new life under Castello Branco, which has indicated that Petrobras will move forward with a bold divestiture plan. Among the assets valued for disinvestment is the natural gas pipeline business, which operates the infrastructure throughout the densely populated southeast of Brazil. In an annual conference call with investors, Castello Branco made it clear that he wants Petrobras to significantly reduce its share of national refining capacity from the current 98% to less than 50%. The idea behind the divestment is that the pre-salt oil produced competitively by Petrobras can be sold to private refineries at competitive prices.

These should be encouraging signs to private industry that Brazil is maintaining its openness for energy investments. For each business segment in which Petrobras recovers, a new opportunity will open up for private investors. This adoption of a competitive and market-oriented energy scenario can at least ease concerns and provide some initial indications about the direction of industrial policy in the early days of Jair Bolsonaro‘s administration.

The opening of Brazil’s energy sector was under debate in last year’s elections. Bolsonaro had been mercurial in market openings in the past and, as a member of Congress, repeatedly voted in favor of maintaining Petrobras‘ monopoly on oil and gas production. He also never really focused on economics as his central issue, instead, on a platform of law and order.

The apparent indifference to the economy and its delegation of all economic things to Paulo Guedes as finance czar exposed the question of which school would influence the Brazilian energy sector: the pro-market orthodoxy of Guedes or the nationalist tendency of the military factions that see control strategic assets such as energy and infrastructure as in the national interest.

At the start of Bolsonaro‘s presidency, the status quo of the former Temer energy markets administration was vis-à-vis the divestments of Petrobras is winning. It is a policy of strengthening Petrobras, keeping it lean and focused on its main strength  exploration and production of the pre-salt  and offering partnerships and foreign investment opportunities to achieve this.

For Latin American observers, it is the opposite approach to that adopted by the new president of another major energy producer. The president of Mexico, Andrés Manuel López Obrador, is pushing for a policy of strengthening the state-owned Pemex, consolidating its monopoly and closing Mexico to investment opportunities for international energy companies. Pemex  which posted a loss of $ 7.6 billion in 2018  had its credit rating recently lowered to a rung above junk status due to heavy fiscal and operating burdens.

Oil and gas resources in Mexico and Brazil are abundant enough for both state oil companies and foreign investors. The Brazilian government, for example, is preparing to hold a mega auction at the end of 2019 for excess volumes of pre-salt oil for which Petrobras has exclusive development rights, but are more than the company can afford. time. If and when it is approved, it is expected to be one of the largest public auctions for international investors, with pumping rights of up to 15 billion barrels of recoverable oil at the auction, as well as the potential to generate up to $ 100 billion in subscription bonuses for the Brazilian federal government.