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Brazil tightens its grip on Petrobras

Deep-water specialist Petrobras is now further under the Brazilian government's control, after a high-cost purchase of new oil reserves

PETROBRAS's minority shareholders are set to pay dearly for their right to be part-owners of a company with some of the best access to new oil reserves outside of Opec. The principal step in the long and convoluted "capitalisation" process, aimed at propping up Petrobras's finances with new oil reserves, has concluded with the state-controlled firm paying far more than investors had hoped for the right to develop some of the country's most promising offshore, pre-salt blocks.

At an average price of $8.51 a barrel, Petrobras, in the eyes of many shareholders, is paying a stiff price for new drilling rights in an area with huge potential, but also tricky technical challenges. Contrast that with the $5/b some analysts value rival OGX's offer of stakes in recent Brazilian shallower-water discoveries. The pre-salt fields remain costly developments that Petrobras freely acknowledges will require new technologies to develop properly. OGX's shallower-water discoveries are within proved basins where both the management and technical know-how needed to develop them are already within reach.

Uncharted territory

Petrobras's shareholders should have known since the first pre-salt discoveries that they were entering uncharted territory. The firm has made no secret of its majority shareholders' intentions in recent years and the government has been equally clear about its aim to increase its take from the promising pre-salt oilfields, the discovery of which has transformed Brazil's supply outlook.

And there has been little letup in the flow of astonishing news from the sector. September saw an announcement that a new discovery, Libra, could hold more than the huge 5bn-8bn barrels of oil equivalent (boe) Tupi find, with about 8bn boe in reserves.

Meanwhile, Petrobras is becoming more closely aligned with government industrial policy. Already facing a vast capital-spending programme to develop the pre-salt fields, Petrobras is also ramping up investments in refining and petrochemicals.

Under the drilling-rights transfer process, the government will receive shares worth $42.5bn in return for six pre-salt blocks. Petrobras will have the right to produce up to 5bn boe and a seventh block will be held in reserve in case the six areas are not as productive as expected. The transaction boosts the company's proved reserves by 35%.

The key element of the plan, however, is a rights offering by Petrobras to minority shareholders that will bring in more than $20bn to finance its business plan. Petrobras will offer at least $64.2bn in new shares, including those allocated to pay the government for the drilling rights, in what promises to be the world's biggest-ever share issue. Bankers could even allocate another $10bn in extra shares if there is heavy demand.

There are risks for shareholders, however. The steep price agreed for the reserves has dampened the appetite of some investors, so much so that Brazil has authorised state-owned banks to take up shares not bought by existing shareholders in the rights issue. That could leave the state with an even bigger stake and further dilute the holding of minority shareholders.

Meanwhile, upstart Brazilian oil firm OGX is already outperforming Petrobras in terms of returns to investors. Shares in the company, which is staffed by many former Petrobras employees, have soared by 80% in the past year as it unveiled a string of shallow-water discoveries. By contrast, Petrobras shares slumped by 20% over the same period, with worries about the government's intentions, as well as the company's ballooning business plan worrying investors.

This could benefit Chinese investors – state-owned Sinopec and CNOOC may pay up to $7bn for a 20% stake in the firm, according to local reports, which would equate to around $5/b based on OGX's published reserves estimates.

The six pre-salt blocks offered will carry a royalty of only 10% and will fall under the existing tax regime. Petrobras says a modestly rising oil price will make them attractive. However, a key clause in the contract allows the government to renegotiate the deal if the resources in the six blocks turn out to be greater than thought. So better-than-expected results could well cost shareholders more than they would like.

Nonetheless, Petrobras's ambitions are growing, with supermajor status within its sights. At 2.6m boe/d, its global production is rapidly approaching Chevron's and, by 2014, Petrobras aims to produce 3.9m boe/d, which would put it beyond Shell. With 5.4m boe/d targeted for 2020, it could even surpass BP and ExxonMobil.

But much will depend on Petrobras's $224bn, 2010-14 business plan, which has been growing rapidly. The 2009-13 version forecast spending of $186.6bn, or about $37bn a year. The new plan boosts average annual outlays by 20% to nearly $45bn a year. Upstream spending is expected to rise to $108bn in Brazil, up from $92bn in the previous plan, a modest increase compared with the huge jumps posted in prior revisions. Outside Brazil, upstream spending has been cut by around $0.5bn to $11.5bn, as the company prioritises domestic developments.

Worrying for investors, however, is the growth of downstream investments in the portfolio. While exploration and production accounted for more than three-quarters of the 2009-13 spending plan, it now has only 53% of the new planned outlay.

The steady increase in its plans for capital spending in lower-return downstream businesses has been blamed for the weakness in Petrobras's share price this year. The new business plan eyes $73.6bn for new refineries, petrochemicals plants and logistics, up from $43.4bn in the 2009-13 plan. Petrobras now aims to become a small, net oil-products exporter by 2020 by boosting refining capacity by more than 50% to just under 3.2m b/d. By then, it expects Brazilian oil demand to be 2.8m b/d.

Refining for export, however, is a capital-intensive business with slim margins. Analysts expect hard-pressed US refiners to push heavily into export markets to fight off slackening demand at home, while other Latin American countries, notably Mexico, a significant products importer, are also building new processing capacity. Similarly, the company expects to add a small amount of capacity to its loss-making electricity-generation portfolio, built in haste at the government's behest a decade ago, to the tune of $4.1bn by 2014. Another $5.7bn will be spent expanding fertiliser production to replace imports.

Petrobras is confident its plans are robust. The company expects Brent crude to gradually rise to $82/b by 2012 and hold steady at that level through the rest of the planning period, which should generate free cash flow after dividends of $155bn. Another $96bn will need to be raised in equity and debt markets to cover the rest of its needs, including maturing debt worth $38bn over the same period. Depending on how large the uptake is for shares in the offering, the overall expansion of the company's debt load will be only modestly higher than the $25bn envisioned between 2009-13.

And the bulk of Petrobras's production growth during the business-plan period will come from its traditional portfolio. Nine production facilities are set to come on stream in traditional areas between 2011-14, with more than 1m b/d in capacity. Petrobras plans to spend $75.2bn on its well established so-called "post-salt" deposits over the next five years, compared with outlays of $33bn on the pre-salt. Pre-salt output will be confined to extended well tests and early production from floating production, storage and offloading facilities at Baleia Azul, Guara and Tupi northeast. Even by 2020, less than 1.1m b/d will be flowing from the pre-salt, says Petrobras.

Libra in the hands of the state

This leaves out fields of huge potential, which are still in the hands of the state. Libra, which was tested as part of the capitalisation process, remains to be tapped. Brazilian officials are already talking about the supergiant field heading up a blockbuster list of pre-salt blocks to be offered after the new government takes office.

Yet the politics themselves are creating uncertainty for the company. The seemingly unstoppable march of Dilma Rousseff, President Luiz Inacio Lula da Silva's handpicked successor, to the nation's highest office adds to investor worries. Rousseff, a former energy minister, is viewed as favouring a strong role for the state in the energy industry.

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