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Petrobras issues stark warning on oil

Brazilian heavyweight announces huge losses on assets it believes are no longer commercially viable

Forecasters have for years predicted a Brazilian oil boom. State firm Petrobras projected its crude production would grow rapidly to 3.5mn bl/d by 2024. With an expected average Brent price of $65/bl, the potential revenue was enormous.

But the collapse of crude during the first quarter of this year, combined with the crippling impact of the Covid-19 pandemic, has meant Petrobras’ assumptions now look way off the mark. The firm has downgraded its short and long-term price guidance and warned it will take years to recover to anywhere comparable to its original Brent prediction. 

“We are carrying out a full review of the portfolio and believe that the recovery will be slow and plateau to $50/bl,” says Petrobras CEO Roberto Castello Branco. The company expects crude to average just $25/bl in 2020, considerably lower than the just shy of $50/bl it averaged during the first quarter. Looking further ahead, Petrobras believes the oil price will increase by just $5/bl annually until it peaks at $50/bl by 2025.

Petrobras cited social distancing measures, structural economic changes brought about by increased home-working and government incentives for low-carbon energy as significant drags on the oil price and part of the rationale for the price revision.

Stemming the losses

The seriousness of the oil price message was showcased in Petrobras’ first quarter results. The company registered a $13.4bn impairment charge on devalued long-term assets and a $9.7bn non-recurring loss after updating its oil price assumption. “It is the biggest loss ever recorded by the company,” says Fernanda Delgado, professor at Brazilian thinktank FGV Energia. “Not even the Lava Jato [or Operation Car Wash] corruption scandal had such a negative effect on the company's balance sheet.”

“It is the biggest loss ever recorded by the company” Delgado, FGV Energia

Most of these charges were on shallow water fields currently generating negative cash flow. Petrobras mothballed 62 production platforms across the quarter at fields including Caioba, Guaricema and Camorim, wiping 23,000bl/d from the company’s portfolio.

On top of the long-term price downgrade, Petrobras is wrestling with the collapse in the Brent price and a significant shrinking of the Chinese market in Q1. Brent fell by around 33pc in the quarter, and China’s share of Petrobras’ crude exports dropped from 68pc to 48pc of total volumes.

Petrobras is relying on the return of Chinese demand in the second quarter. The Brazilian company produces crude grades well-suited for Asian refineries, and Asia is by far its largest market. Petrobras says it is in direct discussions with Shandong teapot refiners to boost exports as China gradually restarts economic activity.

And unlike the US, which has suffered storage problems, Petrobras has many floating and onshore storage options that allow it to keep pumping. In April, the company set a new export record of 1mn bl/d and has not pledged any cuts as part of the Opec+ alliance. “Although Petrobras cannot control demand, it has done a good job so far finding a market for its crude and managing access to storage,” says Ruaraidh Montgomery, director of Latin American research consultancy Welligence Energy Analytics.

Pre-salt in the spotlight

While the downgraded oil price will have a significant impact on Petrobras’ future potential revenues, it highlights the increasing importance of its low-cost pre-salt production. The Brazilian company lowered lifting costs across its portfolio by 10pc in Q1, from $6.56/bl to $5.88/bl, mostly because of the growing share of pre-salt production. Overall lifting costs in the pre-salt fell by 4.9pc as output from the Buzios and Lula fields ramped up.  

Petrobras plans to start up several further pre-salt projects as part of its five-year strategy plan. A combined 990,000bl/d in floating production, storage and offloading (FPSO) capacity is forecast to start up across seven new systems over the next four years. Petrobras has committed $16.3bn in total spend across the new systems.  

“Asset sales will be limited as M&A typically requires stability in asset prices” Montgomery, Welligence Energy Analytics

The company also announced two new pre-salt oil discoveries in the quarter. The Natator find in the Sudoeste de Tartaruga Verde block could potentially be tied into the nearby Cidade de Campos dos Goytaczes FPSO if it is commercially viable. Prospects for the Araucaria discovery in the Uirapura block are less clear given it would need a new FPSO and Petrobras already has seven planned. “Investment in new fields is likely to remain limited until we see a significant recovery in oil prices and therefore cash flows,” says Muhammed Ghulam, senior associate at US bank Raymond James.

To lower expenditure, Petrobras has pledged to reduce capex by $2bn from its initial budget and is reassessing its portfolio further given the oil price revision. “Petrobras and the Brazilian government have shown an optimistic view of the future considering that low-sulphur pre-salt oil will be needed and very valuable at the international market, especially in Asia,” says Delgado. “But everything depends on the demand. If there is a small and timid economic recovery, it is worthless having even the best oil in the world.”

Downstream destruction

And while there is uncertainty surrounding the impact of oil price volatility on the upstream sector, Petrobras’ downstream segment also faces challenges. Domestic demand has plummeted in recent months as states enforce quarantines to safeguard populations from Covid-19. “Operating income [in Q1] turned negative for the first time since 4Q18, as Covid-19 impacted global refining margins,” says Ghulam.

990,000bl/d – FPSO start-up capacity from planned systems

Brazil has become the epicentre of the pandemic in Latin America and a battleground pitting Brazilian president Jair Bolsonaro, who opposes the shutdowns, against much of the country’s political elite. Two health ministers have been and gone in as many months, and the resignation of justice minister Sergio Moro—who spearheaded the Lava Jato corruption probes—threatens to turn the situation into a full-blown political crisis.

Registered cases of Covid-19 have surged in Brazil over the past month. Medical researchers expect the peak is unlikely be controlled until at least July, but the lack of testing has made it difficult to gauge the scale of the outbreak. Much of the population lives in cities near the coast, and the virus has begun to sweep through Brazil’s poorer neighbourhoods. If the infection rate cannot be contained, then quarantines will likely be extended. Under this scenario, Petrobras’ domestic downstream sector will suffer further demand losses across the second quarter. This would make international sales even more crucial.

M&A pushback

Petrobras had hoped to offload several non-core assets this year, including seven refineries and several pipelines, to improve its balance sheet. Last year, the company completed $16bn in asset sales and generated $276.6bn during the first quarter through field sales.

But market volatility has already pushed back the deadline on refining sales and, while Petrobras still aims to complete its divestment plan in 2020, further delays are likely. “Asset sales will be limited as M&A typically requires stability in asset prices and the availability of credit, both of which is in short supply in the oil and gas industry these days,” says Montgomery.  

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