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Petrobras turns page as corruption saga draws to a close

An SEC fine as part of the firm’s long-running corruption scandal looks the least-worst outcome and may mark the beginning of the end of its international headaches

American financial watchdog the Securities and Exchange Commission (SEC) has hit Brazil's Petrobras with fines in the wake of its much-publicised corruption scandal. But the penalty may allow the firm—outside Brazil at least—to finally see an end in sight to its woes.

In a forensic report into over a decade of bribery, rigged bids and false financial statements involving senior executives, members of government, major suppliers and contractors, the SEC concluded that individuals employed by the state-owned giant systematically misled investors at heavy cost to the company.

The report, released in late September, also paints a picture of a lax organisation with weak internal accounting controls overseen by a corrupt board. The cost to Brazil was enormous. As Petrobras acknowledged in a statement in response, the "corrupt scheme harmed and caused severe financial loss to Petrobras".

Because Petrobras raised about $10bn in American depositary shares, much of it based on "false certifications" and "material misstatements and omissions", and its shares are traded on the New York Stock Exchange, the SEC was empowered to act. "If an international company sells securities in the United States, it must provide truthful information about its business operations," says Steve Peikin, co-director of the SEC's enforcement division.

The fines imposed are relatively modest-$933.5m as "disgorgement" to the commission and a $853m penalty. According to Petrobras, it will pay only another $85.3m because the fines are subject to offsets, and it has already settled a securities class action lawsuit filed by the SEC and handed over $680m to the Brazilian authorities.

"Petrobras is turning the page on the corruption scandal," says Gabriel Fonseca, analyst at Brazilian investment firm XPI, particularly given that the US authorities went for a fine, rather than prosecution. The company is still facing ongoing legal processes in the Netherlands and Argentina, but Fonseca feels that the US ruling lays down a marker on sanctions that other jurisdictions are unlikely to ignore with harsher penalties. While "there is no end in sight" for Petrobras' legal issues in Brazil, the US decision "sets a good precedent" internationally.

Nor should the size of the fine be an issue for the company, which Fonseca says is generating "lots of cash" due to the higher oil price, but also because the weaker Brazilian real reduces Petrobras' input costs.

Not just window dressing

Fonseca sees a genuine change in Petrobras' culture as it moves forward from the scandal. "It has made several strides in corporate governance; it has empowered its independent counsel and its board of directors. There is way more transparency," he says, pointing to a sharp increase in the frequency of public statements and analyst calls whenever Petrobras has an announcement, such as last year's partnership agreement with China's CNPC, to make.

"It's not just one man, it's less concentrated on that" says Fonseca, which is significant given the sudden departure of chief executive Pedro Parente at the end of May and his replacement by chief finance officer Ivan Monteiro. "[Monteiro] successfully portrays a continuity; Petrobras' direction remains the same, if not better," he continues, highlighting Monteiro's key role in Petrobras' divestment of non-core assets, such as the $1.1bn October deal to combine its Gulf of Mexico assets with US independent Murphy Oil with a reduced 20% minority stake and its proposed $1.3bn sale of its 50% share in Petrobras Africa.

The impending election, and the likely victory for Jair Bolsonaro, isn't expected to jolt Petrobras' course significantly. The candidate has already expressed intentions to leave members of the current government and other key institutions such as the central bank in place, and there is little reason to assume Petrobras' management would not see the same approach.

"As long as the transparency culture and reform agenda remain intact, that is positive. If [Monteiro] also remains in place, so much the better," says Fonseca, while admitting that speculation on potential successors as chief executive have already swirled within the Brazilian corporate community.

Bolsonaro's stated energy policy aims thus far look broadly positive for Petrobras-including his commitment to following international reference prices when setting domestic fuel prices, even if his preference for hedging to try to offset short-term fluctuations may increase complexity and put pressure on Petrobras' refinery margins. Petrobras divesting a significant portion of its Brazilian refining capacity would also be a boon, both for the firm's balance sheet but also, notes Fonseca, for a reduction in political risk as the end of Petrobras' virtual monopoly in setting the prices in the fuels market would reduce the impact of, and thus the appetite for, government interference.

High refining margins

But neither international benchmarking nor refiner diversification solves the key problem within the fuels sector, Fonseca warns. Petrobras' Brazilian refining margins aren't, at around 14%, excessive by international standards of 10-11%, so greater competition is unlikely to pull the ex-refinery cost of fuel much lower. The issue is that average ex-refinery gasoline costs are in the region of BRL210 ($60)-220 a litre, while pump prices are more like BRL470/l, even though the midstream-to-downstream value chain of distributors and retailers do not take excessive cuts.

The Brazilian government must find a better way to fund perennially short-of-cash state governments-which are responsible for the lion's share of this mark-up due to their setting of ICMS, a Brazilian version of VAT, tax rates at 20-30%-if it genuinely wants to solve the problem of fuel affordability, says Fonseca.

Bolsonaro's proposal to end Petrobras' monopoly of the Brazilian gas market could also have consumer benefits. With the country vulnerable to power shortages when droughts affect hydro-electric output, expanding its gas-fired power plant fleet would offer cost benefits compared to fuel oil peaking plants. At current gas tariffs and even allowing for an attractive rate of return on investment, Fonseca estimates that new build gas plant could deliver power at BRL200-250 per megawatt hour, compared to the BRL500/MWh peak prices achieved by current fuel oil-fired units.

Gas potential

Additional gas supply could come from increased evacuation of associated gas production from pre-salt oilfields. While volumes are currently re-injected to boost oil recovery, the projects' recovery rates are at "amazing" levels and gas could be re-allocated without substantial impact, says Fonseca. As well as new power plants, the domestic heating and industrial sectors could also benefit from increased gas availability.

Petrobras is expected to bid in the ANP's 17th and 18th bidding rounds, under the concession regime, for blocks to be explored in 2020 and 2021, which were announced in August. The firm needs to pick up additional acreage, says Fonseca, as some of the assets it brought on stream in the early 2000s in the Campos Basin are now depleting swiftly, in some cases at 10-11% per annum. But he concedes that Petrobras' big upstream focus is around the Transfer of Rights assets (see p24), where considerable uncertainty remains.

"The incentive for the government to approve the draft bill is aligned with Petrobras'-it can only auction the transfer of rights volumes that do not belong to Petrobras once it has agreed which volumes do belong to it. If Petrobras owns 30% of the volumes, then the government owns a much bigger 70% share. And Petrobras is moving very slowly on developing these reserves, which has royalty implications," he points out.

But there's no visibility on whether a deal is likely to happen, whichever candidate wins. The senate's rejection of a proposed privatisation of a distributor owned by state-controlled power firm Electrobras leads Fonseca towards pessimism, though, that a swift post-election transfer of rights deal will be thrashed out.

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