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Trying to right the Petrobras ship

Brazil's oil major is on the course of recovery, but has a long way to go

The one-two punch of the multi-billion dollar Lavo Jato (Carwash) corruption scandal followed by a collapse in the oil price was punishing for Petrobras, leaving the company's reputation and balance sheet in tatters. The task of putting it all back together and delivering its promise of world-beating production growth has fallen to new chief executive Pedro Parente. It's a monumental ask, but the company might have put the worst behind it.

Start with the upstream business, where the company's fortunes ultimately lie. After years of disappointingly stalled output, Petrobras is at last starting to reap the gains from years of heavy investment in its pre-salt oilfields. Three new floating, production, storage and offloading (FPSOs) ships started producing from the pre-salt Lula and Lapa fields in 2016, helping lift output to new heights. Petrobras's Brazilian oil output hit an average monthly record of 2.3m barrels a day in December, and it set a high-water mark of 2.4m b/d on 28 December. The company is now regularly pumping more than 1m b/d from its pre-salt fields, and that figure is headed higher.

Output levels are a far-cry from where the company thought they would be a few years ago. Still, average 2016 production rose to 2.15m b/d, a modest 0.75% gain on 2015, but 5.5% higher than 2014. It has also won bragging rights as Latin America's largest oil producer, surpassing longtime regional rivals PdV and Pemex, both of which are struggling to arrest declining output. That Petrobras is pumping all this new oil into a glutted market with much lower prices than it had planned on is bad for bottom line. But the liquid flow still shows the company is starting to deliver on some pre-salt promise.

While the past two years have at last seen steady output growth for Petrobras, 2017 might bring a pause. The company forecasts domestic output of 2.07m b/d for the year, implying a 75,000-b/d, or 3.5% fall. This is due to a slowdown in new FPSOs coming onstream.

While the pre-salt has been pushed up the global cost curve by US shale, it is still the most attractive deep-water prospect in the world

But Petrobras sees output roaring back to 2.77m b/d by 2021, a 0.7m-b/d increase in the four years from 2018 to 2021. It plans to bring 15 new FPSO's online over that time frame, mostly at the Libra and Buzios pre-salt fields and the Marlim post-salt field.

It's probably not realistic. First, this outlook implies average annual growth of 7.5%-around 175,000 b/d. Petrobras has never come close to achieving this in a single year, let alone sustaining it for many. The company is facing steep natural declines from its historic production base in the conventional Campos Basin deep water fields, which still accounts for most of its output. Campos production has fallen 20% since 2011 and the company expects it to keep slipping, by about 9% a year. Pre-salt gains won't make up for this and deliver net growth.

Petrobras is also proposing this stronger-than-ever production performance in the face of steep spending cuts and a deeply uncertain outlook for crude prices. The company assumes oil prices will rise to around $70 a barrel by 2018 and plateau there. On top of that, debt costs are rising and will draw funds away from the upstream. The company has $59.4bn in maturing debt coming due in 2017-20, roughly equal to what it plans to spend on developing oilfields over the same period.

A more realistic growth rate would be closer to what the company has pulled off in the past two years—2.5-3% a year. That would land 2021 output in the range of 2.28m b/d and 2.33m b/d. This is lower than the target, but would put production on a sustainable upward path.

Rising output will help the company's bottom line, but it still has to repair its balance sheet. For chief executive Parente, this is more central to his programme than output growth. Petrobras ran up around $140bn in debt as it pumped cash into new oil projects—and into the pockets of some corrupt businessmen and politicians—in the decade after the pre-salt discoveries. It was a risky strategy when oil was trading above $100/b, and is downright unsustainable with oil at half that price. The economic viability of Brazilian pre-salt has been called into question by the rise of cheaper and more nimble US shale output.

Slashing debt

Parente is taking a two-pronged approach to reducing Petrobras's massive debt: cutting spending and selling off assets. His goal is to win back the company's prized investment-grade credit rating by bringing its net debt to earnings before income tax depreciation and amortization (Ebitda) ratio down from a high of 5.3 in 2015 to 2.5 by 2018. There has been some progress. Net debt has stabilised over the past year, dropping by $1bn to $100.3bn, and the net debt/Ebitda ratio was down to 4.1 in the third quarter of 2016. But the road is long.

Parente has taken a chainsaw to Petrobras's budget. It wasn't long ago that the company wore its monster capital spending numbers as a badge of honour. That has changed as cash becomes more scarce. The 2014-18 business plan, for instance, envisioned spending $221bn—around $44.2bn a year. The 2017-21 budget is a radical departure. It sees the company spending $74bn in total—around $14.8bn a year, down nearly 70%.

Parente is re-shaping the business in the process, funneling relatively more cash to the upstream business while paring down the refining and gas units. The 2012 business plan called for spending around 30% of the total budget—$71bn on the downstream, with 56% going to the upstream and 14% elsewhere. The new budget calls for more than 80% of the $74bn budget to be spent in the upstream and just 17% on the downstream.

The company also plans to sell around $19.5bn in assets from 2017 to 2021 to raise cash to pay down debt. It wants to get out of biofuels, liquefied petroleum gas, fertilisers and petrochemicals altogether. It also wants to bring in partners for a couple of its major new refining projects—Comperj and Abreu e Lima. But buyers know Petrobras has been forced into a fire sale, and will be bargain hunting.

$59.4bn—Petrobras debt maturing in 2017-21

Petrobras will also probably need to sell off stakes in its prized pre-salt assets. Here, the company got a helping hand from the new Michel Temer government, which has eased restrictions on foreign ownership and operatorship of the pre-salt oilfields. Two deals have already been done. Statoil paid $2.5bn for a 66% stake in the Carcara pre-salt field. Total paid $2.2bn for a package of assets that included a 22.5% stake in the Iara fields and an operating 35% stake in the Lapa projects. On top of helping the company to raise cash, it will also ease the capital spending burden from those projects. The Statoil deal, Parente said, will save Petrobras $11bn in spending, which it can use to pay down debt or for projects that will deliver a quicker return.

More such deals are likely even as international oil companies keep a tight grip on their purse strings. While the pre-salt has been pushed up the global cost curve by US shale, it is still the most attractive deep-water prospect in the world. And most majors think the market will still need deep-water reserves to meet demand. Petrobras has put its pre-salt breakevens at around $45/b, but says it is still lowering costs and getting more out of each well. Lifting costs, the company claims, have fallen from $14.6/b in 2014 to $10.50/b in the third quarter of 2016. It says average output from its pre-salt wells has risen from 20,000 b/d a well to 26,000 b/d.

While Petrobras would probably prefer spending more time talking about its progress in the pre-salt, the massive Lavo Jato corruption scandal is not fading away. Several executives at Odebrecht, Brazil's largest contractor and a central player in the corruption scheme, recently signed plea deals to cooperate with prosecutors. That could prompt a fresh wave of accusations and ensnare more of Brazil's political and business elite in the scandal, not to mention produce a steady stream of embarrassing headlines for Petrobras. The oil major says it has learned hard lessons. A raft of new governance measures has been put into place, including adopting international anti-corruption standards. Just as important, Parente has said one of his most urgent tasks it to change the company's culture, though that isn't something that can be pulled off in a few quarters. Parente has the company once again pointed in the right direction, but there's still a long way to go.

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