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Moody’s and Standard & Poor’s downgraded Petrobras to junk earlier this year. Here workers at a Petrobras facility. (Photo: Petrobras)
Wednesday, November 18, 2015

Petrobras Recovery Plan: Not Enough

The current recovery plan of Petrobras is not enough, experts warn.

Inter-American Dialogue

Brazil’s Petrobras announced on Oct. 5 it would cut $11 billion from its budget for the upcoming year, with plans to scale back both investment and operating expenses and to sell as much as $15 billion in assets by the end of next year. The state-run oil company added that it will be able to maintain levels of oil output, despite the cuts, through 2019. Does Petrobras have the right plan for recovery? What forces stand in its way? Which oil companies or countries could stand to gain from Petrobras restructuring? How are international investors viewing Brazil’s energy sector in light of the turmoil at Petrobras?

Armando Castelar Pinheiro, coordinator of applied economics at the Instituto Brasileiro de Economia at Fundação Getulio Vargas and professor of economics at the Federal University of Rio de Janeiro: Petrobras’ main problem is its large debt, estimated at half a trillion dollars. It does not help that Moody’s and Standard & Poor’s downgraded Petrobras to junk earlier this year and that the company is at the center of a major corruption scandal. The cuts aim at curbing the rise of the debt and improving the company’s cash flow, in a context in which new finance is scarce and expensive. In its 2015-2019 Business and Management Plan, disclosed in June, Petrobras had already committed to reducing expenses and to divesting as much as $15.1 billion by the end of 2016. The cuts just announced follow the company’s revision of prospects for Brent crude oil prices and the exchange rate. The parameters adopted now are more realistic, but remain somewhat optimistic when compared to market forecasts. The area most affected by the investment cuts has been exploration, so these changes should not affect production in the short-to-medium-term, although they will limit future growth. Although preserving cash makes sense, for the restructuring plan to work, the government needs to raise domestic fuel prices and free the company from obligatory investments in the pre-salt area. A law reviewing this legal obligation is under discussion in Congress, and it will likely be approved early next year. Low oil prices and the overall macroeconomic and political situation also complicate Petrobras’ restructuring program, since they make its assets less attractive to other investors. The crisis may force the government to reform regulation in a way that makes the sector more attractive to international investors. Companies with a more long-term focus and that are capital-rich will have more to gain from the opportunities opened up by the retrenchment of Petrobras. That is possibly the case for Chinese firms like Tek Oil and Gas, which [recently] debuted in Brazil’s oil and gas sector.

Lucas Aristizabal, senior director of Corporate Ratings at Fitch Ratings: Petrobras’ cash flow generation is expected to remain under pressure from Brazilian real depreciation and the fall in oil prices despite the recent price increase and capex reduction. The company is expected to generate enough cash flow from operations to cover capex and to depend on its access to the debt capital markets to service its upcoming maturities through refinancing. Any debt reduction over the coming years will depend highly on divestitures, which are uncertain and difficult to predict. The price increase is marginally positive as it demonstrates Petrobras’ ability to adjust prices upwards even during periods of economic downturn in the country and declining oil prices globally. The capex reduction may somewhat ease cash flow pressure yet it still remains uncertain what its impact will be on long-term production growth. Although the recent 6 percent and 4 percent price increases for local gasoline and diesel sales, respectively, will modestly bolster the company’s cash flow generation in real terms, it is not considered enough to offset the depreciation of the real seen since the last price adjustment in November 2014. Fitch believes the current price difference between domestic products and international markets is unsustainable in the long term and expects the differential to erode overtime, eliminating temporary trading gains. As a result, growing production remains strategic for Petrobras to have a strong balance sheet in the long term commensurate with an investment-grade rating. Petrobras currently benefits from low international oil prices as it is a net importer.

Adriano Pires, director at the Brazilian Centre for Infrastructure (CBIE): Petrobras recently undertook some positive adjustments toward financial responsibility, such as cuts in investment and operational expense, proposed asset sale of gas distribution with Mitsui and closing leasing contracts with Chinese banks, but these are not enough for a necessary recovery plan considering its critical financial crisis. To be successful, Petrobras’ financial recovery plan should include some of the following: adopting domestic prices of oil products at a premium; direct cash injection with Brazilian Treasury resources; debt rescheduling or debt guarantee to the Brazilian foreign exchange reserves; a transparent divestment plan which adopts a controlling and operating sales model of assets (with the exception of E&P assets). The obstacles and risks for using those are: higher oil products prices will increase already high inflation and will be unpopular for the government; using Treasury resources will further complicate the country’s fiscal situation; debt rescheduling will depend on good negotiation from Petrobras and government officials; compromising Brazilian foreign exchange reserves might lead to exchange rate devaluation and a transparent divestment plan may have political interests against it. The Brazilian oil and gas industry and supply chain is highly dependent on Petrobras’ demand. Meanwhile, Petrobras’ current partners—Shell, Chevron, Total, Statoil, Chinese oil companies and several others—would be the immediate winners with Petrobras’ recovery, while the development of the country’s oil sector would most benefit local and foreign companies in the longer term. Petrobras’ turmoil is worrying local and international investors, evidenced by the recent exploration block auction having shown limited foreign interest.

Editor’s note: The commentators in this issue submitted their commentaries before Brazil’s main oil workers union joined a strike on November 1 against Petrobras.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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