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Petrobras debt rating downgraded to junk status

Brazil’s national oil company saw its debt rating cut to junk status 10 September by Standard & Poors

The oil price, high debt and a multi-billion dollar corruption scandal continue to weigh on the company. S&P’s downgrade came after Moody’s, another of the major rating firms, cut Petrobras’ debt to junk in February this year.

It is a major blow to a company that not long ago wore its investment-grade credit rating as a badge of honour. The downgrades could make it more difficult and costly for Petrobras to raise debt. Investors in the company’s landmark 100-year bond released in June have already seen the value of that bond fall by 15%. The deteriorating conditions surrounding the company will also likely force it once again to scale back its production ambitions just months after releasing a dramatically scaled back business plan.

Petrobras, for its part, sought to downplay the S&P decision. “Petrobras reiterates that the medium-term fundability of its projects has been assured through loans taken out this year from financial institutions in Brazil and other countries,” the company said in a statement. It added that the company planned to reduce operating costs by $12bn by 2019 and had already cut its planned capital spending over the next five years by 40%.

But the company will likely be forced into further cuts as Petrobras’ scaled back business plan was based on financial assumptions that already look far too optimistic.

The plunging value of the Brazilian real is eating into earnings and will make it more difficult for the company to service its debts. In its latest five-year plan, the company had assumed the real would average 3.10 to the dollar in 2015, 3.26 in 2016 and 3.29 through the end of the decade. But the rate has stabilised at around 3.85 after Brazil’s sovereign debt was downgraded on September 9. In August, Fitch warned that Petrobras’ annualised pre-tax earnings would fall by 15%, from $27.9bn in the first half of the year to $23.6bn in the second half, if the rate remained at the 3.5 level it was at then. The further decline could mean a 20% decline, putting a major dent in the company’s cash flow.

Bleak oil price outlook for producers

Petrobras’ oil price assumptions also look overly optimistic, at least for the next two years, amid the much-feared double-dip price decline. The company had assumed Brent would average $60/barrel this year and $70/b from 2016 to 2019. Since oil prices started falling again in late June, analysts have been scrambling to lower their price forecasts. Analysts at Raymond James recently cut the Brent forecast to $56/b this year and $62/b in 2016. Goldman Sachs warned oil prices could fall to as low as $20/b and cut its 2016 Brent forecast to $49.50/b.

Taken together, Petrobras is likely to see much lower cash flow than expected. With management pledging to focus on debt reduction and strengthening the balance sheet, that leaves further asset sales – the company plans $15.1bn now – and spending cuts as the most likely tools to be used to plug the funding gap.

Petrobras has already cut its 2020 production outlook from 4.2m b/d to 2.8m b/d. Even this scaled back forecast implies a growth rate of more than 5% a year, however, and looks like it may need to be reduced further. The worst may not be over yet for Petrobras. 

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