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Petrobras hopes for strong output growth

Having over-promised and under-delivered in recent years, Brazil's state firm thinks its pre-salt is at last primed for strong output growth

For Brazil's state-controlled oil company Petrobras, waiting has been the hardest part. The Lula pre-salt discovery in 2006 promised to transform the country into a major global oil power, with Petrobras leading the charge. Subsequent discoveries, uncovering potentially tens of billions of barrels offshore Brazil, added to the hype. But so far that promise has gone unfulfilled, and investors have turned sour on the company.

Their concerns have mounted over recent years. Petrobras has racked up nearly $100 billion in debt to fund its five-year $236.7bn investment programme, the largest corporate capital spending plan in the world. And all it has to show for it so far is declining oil output and a long list of delayed projects.

Some have also accused Petrobras of taking its eye off its mature projects in the Campos basin. Historically its power base and still the source of about 85% of its production, production declines have accelerated in the basin as the company has turned its focus to pre-salt projects in the Santos basin.

Government policy has also hampered Petrobras. A strict local content policy, aimed at supercharging Brazilian industry, has required Petrobras to rely on the country's underequipped domestic supply chain, contributing to delays and higher costs.

The government has also put retail pump prices at the front of its inflation-busting strategy, which has been problematic for Petrobras. Because the company has failed to build up domestic refining capacity it is forced to buy diesel, gasoline and other fuels internationally and sell them at a loss on the domestic market.

For investors, all this has been a huge let down. Petrobras's New York-listed shares are trading at about a third of levels seen just after the first pre-salt discovery nearly seven years ago.

But there is nothing like success to wipe the slate clean. And for Petrobras, that success could be just around the corner: almost 1m barrels a day (b/d) of new pre-salt production capacity is scheduled to come on stream by the end of 2014.

"In the second half of the year you can expect a vigorous ramp up of production," Jose Formigli, the head of Petrobras's upstream business, said earlier this year. Meanwhile, the 120,000 b/d Cidade de Sao Paulo floating, production, storage and offloading (FPSO) vessel has been deployed at the Sapinho" field and the 120,000 b/d Cidade de Paraty FPSO at the Lula Nordeste pre-salt field. As a result, pre-salt production hit a record 322,100 b/d in June. And there are a string of new projects to come.

The power of ten

Table 1: Petrobras by the numbers

In total, 10 new offshore production vessels are scheduled to be brought online by the end of 2014. With that new capacity in place, Petrobras should see a significant increase in production and cash flow by 2015. "Petrobras is installing a total of 1.3m b/d of gross new capacity - 1m net to Petrobras - which should contribute to strong output growth in 2014-2015," analysts at Bank of America Merrill Lynch said in a recent research note. From 2014, the company has enough projects in the pipeline to see strong output growth through the end of the decade. Petrobras is targeting oil production of 4.2m b/d by 2020, more than double this year's production level of just under 2m b/d.

It is an unprecedented undertaking. And the test for Petrobras, and chief executive Maria das Gracas Silva Foster, will be bringing these projects into production on time. If the company is able to come close to meeting its targets through the end of next year, it will go a long way towards winning back the credibility and trust from investors that has been lost after several years of over-promising and under-delivering on production targets.

Another challenge that Foster has taken up with gusto is getting Petrobras's financial house in order. Ratings agencies have given Petrobras some slack because of the huge potential of its oil discoveries, but have warned that the company could put its investment-grade credit rating at risk if it cannot keep its debt and spending under control.

As well as maximising cash flow from new production, which should go a long way towards boosting the company's bottom line, Foster's strategy has two main planks: improving operating efficiency and selling non-core assets.

The efficiency programme, known as Procop, aims to reduce costs by $32bn reals ($14.28bn) by 2016. The plan has won plaudits from investors, but a central part of the programme appears to involve asking more for less from suppliers. This has led to complaints from many of the company's equipment and services providers that they are being squeezed too hard. An executive from a port operator told Petroleum Economist earlier this year that Petrobras had asked his company to double its capacity and halve its delivery time. Petrobras's dominant role in the industry, though, means that companies have little choice but to work on its terms. Foster appears keen to take advantage of that privileged position.

Petrobras has also launched a $9.9bn divestment programme, focused primarily on selling off some of its non-core international projects. The company has been a pioneer among a crop of national oil company peers that over the past decade or so have looked to use their technological, financial and political clout to compete on a global scale. But as Petrobras's domestic commitments have grown, it has partially retrenched from its internationalisation strategy, pulling back from projects across Latin America, the Gulf of Mexico and West Africa.

While the company has seen progress in the upstream, its refining business continues to struggle. At the heart of the problem is finding sufficient funding to build new refining capacity. The company says it will spend more than $40bn on its downstream business over the next five years. But it will be late 2014 at the earliest before significant new domestic fuel production capacity is on line.

But new domestic refining capacity is crucial for Petrobras. The company has failed to keep up with domestic demand, which means that it has been forced to increase fuel imports to keep Brazilian drivers moving. The government, though, scarred by a long history of high inflation, has kept a lid on domestic fuel prices, despite rises in international prices. This price cap means Petrobras is forced to sell at a loss on the domestic market. The government allowed a small increase in gasoline and diesel prices earlier this year, which helped Petrobras, but it is unlikely to raise prices again before elections in 2014, and it will almost certainly not allow prices to rise to parity with international prices anytime soon.

The refining business, then, is likely to continue to be a drag on the company. But Petrobras' fortunes are pinned to development of the pre-salt oil province, and that is where the spotlight will remain. 

Table 2: Petrobras Major Upstream projects
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