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Petrobras' incomplete recovery

Brazil's state oil company has taken major strides forward, but further progress and support from the next government are needed

A company's share price doesn't tell its whole story, but it's one way to track a firm's fortunes. Petrobras has endured a rollercoaster ride through the market—during a tumultuous decade that saw it fly high as an investor darling, collapse and more recently mount something of a comeback.

At its peak in 2010, following the discovery of the massive pre-salt oilfields, Brazil's national oil company set a record with a $70bn share sale and, shortly after that, saw its market value peak at $229bn, surpassing supermajors Shell and Chevron. But Petrobras never lived up to that hype, and things got particularly ugly in early 2016 when it was hit by a perfect storm of scandal, debt and an oil-price downturn. The company's shares tumbled and its market value bottomed out at around $19bn, down more than 90% from its peak.

That's when Pedro Parente took the helm. The oil-price recovery helped put wind at Parente's back, but he has unquestionably led a turnaround at the company. His most important decision has been to prioritise the rebuilding of the firm's financial foundation, which had been hollowed out by a decade-long debt-fuelled spending binge.

Paying down the company's crushing debt load has been key to restoring its finances. Debt has been cut from a peak of $140bn in mid-2014 to around $109bn by the end of last year. Petrobras had long targeted a net debt-to-earnings before income taxes and depreciation (Ebitda) ratio of 2.5, a line seen as necessary to maintain its investment-grade credit rating. But as debt grew and earnings eroded, the company blew through its self-imposed debt line, with the net-debt-to-Ebitda ratio blowing out to 5.1 by the end of 2015. The credit rating agencies punished Petrobras with a sharp ratings downgrade, making borrowing costlier.

Parente has helped bring the leverage ratio back down to 3.2 and looks set to hit the 2.5 target by the end of this year, thanks to a reduced capital spending programme and billions of dollars in asset sales. "Moody's expects that Petrobras cash generation in the next two years will be more than enough to cover mandatory cash obligations plus annual capital expenditures," the ratings agency said in a recent statement upgrading the company's outlook. "Therefore, proceeds from asset sales will help the company to reduce debt and to reach its target of 2.5 x net-debt-to-Ebitda before the end of 2018."

Skeleton in the cupboard

One risk to this is the continued fallout from the Lavo Jato corruption scandal. Petrobras still faces lawsuits from shareholders who say they were victims of the scandal, in which billions of dollars were siphoned from the state oil company through corrupt arrangements between company officials, contractors and Brazilian politicians. Petrobras reached a preliminary agreement in one class action suit earlier this year that would see it pay $2.9bn. That, Moody's argues, significantly reduces the uncertainty around potential Lavo Jato-related liabilities and could clear the way for other settlements that would help Petrobras get out from under the scandal's cloud.

Petrobras' recovery has been aided by a string of confidence-boosting strategic partnerships with some of the most important international oil companies. Most recently, Petrobras reached a strategic-alliance deal with BP that would see the companies share deepwater technology and work together on projects in Brazil and beyond. The company has signed similar accords with Total, Statoil, China's CNPC and ExxonMobil, which have facilitated deals, including joint ventures and major offshore projects in Brazil, as well as billions of dollars in asset sales.

While the company has delivered on some important fronts over the past couple years, the upstream business performance remains deeply disappointing to investors. When the pre-salt reserves were discovered, Petrobras talked of becoming a super-producer capable of throwing its weight around global markets. A 2010 presentation outlining its strategic vision set a target of producing 4m barrels a day of oil in Brazil by 2020, made possible by its new pre-salt finds.

But the company has barely been able to move the needle on production over the past decade. At the time of that presentation, Petrobras was producing 2m b/d of oil in Brazil. Today the figure is 2.09m b/d. In other words, the tens of billions of dollars pumped into the upstream over the past eight years have barely been able to offset declines from older oilfields.

The good news

There have been successes. The flagship Lula and Sapinhoá pre-salt fields are two of the biggest producers in the country. Most recently, Petrobras started pumping crude from the Búzios pre-salt field, where several floating production storage and offloading (FPSO) systems are set to be deployed in the coming years. The Lula megaproject, where Petrobras is working alongside Shell, Total and China's Cnooc and CNPC, is also marching forward.

$109bn—Petrobras' debt

Although these projects have moved far slower than initially envisioned, they've proved the pre-salt is a world-class province and can be successful even with oil in the $60s. That's partly because the company, and its international partners, have wrenched cost savings out of their operations as they've gained experience. The pre-salt wells have also proved to be exceptionally productive, improving the economics of pre-salt drilling. Many of the Lula field's wells are producing more than 30,000 barrels of oil equivalent a day, more than twice what typical wells in the Gulf of Mexico pump out. That has reduced the number of wells needed at each field, a major cost saving where a single well can easily top $100m.

The company's fortunes in the coming years will turn on its ability to finally start pumping more oil. Petrobras has ambitious plans. According to its latest five-year business plan, the company reckons it can lift its Brazil output from today's 2.1m to 2.9m b/d by 2022, which is among the biggest growth agendas in the industry.

Questions remain

The Búzios field expansion, where a total of five FPSOs are planned between this year and 2021, will shoulder much of the load for the growth. Other key projects delivering significant growth will be two new Lula production systems planned for this year, a revitalisation of the Campos Basin's Marlim oilfield, and the development of the Mero oil find. In total, 19 new projects are due online in the next five years and the company plans to spend $74.5bn on the upstream business—around $15bn a year.

Given Petrobras' dismal track record, there's much scepticism in the market that the company will be able to follow through this time—given that debt reduction is a priority. Analysts at Raymond James, an investment bank, tagged the plans "wholly unrealistic" in a recent report. But if Petrobras can defy the sceptics it could usher in a new era for the company.

Hanging over this recovery are October's presidential elections. Petrobras is closely tied to the government and its fate blows with the political winds. After the jailing of the left-wing former president Luiz Inácio Lula da Silva, who had been leading in polls despite a looming corruption conviction, the field of candidates is now wide open. The Lula years saw Petrobras' finances wrecked and delivered little production promise; a repeat performance would have been a major risk to the company.

The best-case scenario is an administration that continues the hands-off approach of the current Michel Temer government, allowing Petrobras to continue operating along market lines-paying down debt, selling assets and focusing on profitable upstream projects.

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