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Petrobras targets low-hanging fruit

Brazilian company revises spending and downgrades production from high-cost assets to lessen financial burden

Latin America’s leading producers, like much of the global oil sector, are bracing themselves for an arduous operating year. Colombian state-owned Ecopetrol announced cutbacks of $1.2bn, while Mexican NOC Pemex was struggling to post a profit even before economic conditions nosedived. For beleaguered Venezuelan state producer Pdvsa, emergency measures only compound its financial woes.

Even in Brazil, one of Latin America’s most attractive oil provinces, state-run Petrobras has scrambled to revise down its financial exposure. The NOC pledged to reduce investments by $3.5bn this year and has slashed oil production by 200,000bl/d to help balance the books.

“The impact of the Covid-19 crisis on Petrobras, and all other upstream companies that have been forced to cut capital budgets, will be significant,” says Muhammed Ghulam, senior associate at US bank Raymond James. “Reducing spending now is likely to slow production growth for years to come.”

Short-term gains

The immediate effect on Petrobras’ upstream portfolio will be trimmed output and the shutdown of shallow-water fields—the most obvious source of high-cost barrels. Uneconomic fields in the Sergipe, Rio Grande do Norte and Ceara basins will be targeted first to help stem revenue losses.

Divestment of non-core shallow-water assets has been one of the core pillars of Petrobras’ upstream strategy in recent years. Successive governments have prioritised offloading uneconomic and maturing fields in place of low-cost prolific production from the pre-salt region. Before the downturn, Petrobras had allocated 59pc of its 2020-24 E&P investments for the pre-salt, with another 29pc for the ultra-deep post-salt region.

“Reducing spending now is likely to slow production growth for years to come” Ghulam, Raymond James

For now, though, company cuts are not projected to hurt pre-salt output. The breakeven remains globally competitive at $21/bl and multiple floating, production storage and offloading vessels are scheduled for 2020 and beyond—aiding the company’s ambition of hitting 3.5mn bl/d of output by 2024.

“Petrobras did not announce suspension of new projects in the pre-salt [already] in its business plan,” says Fernanda Delgado of Brazilian thinktank FGV. “The cut in investments should not affect their plan much.”

Spell trouble

But while Petrobras is well-positioned to endure low prices, plunging demand is the immediate concern. “If we look at the cut in production, 20pc has to do with the shutting of fields and 80pc with lack of demand,” says Carlos Alberto Pereira de Oliveira, Petrobras’ chief exploration and production executive officer. If Petrobras announces further cuts, it will most likely be due to the dearth in global demand and less related to lifting and production costs.

The key determining factor will be whether the global economy can return to normal or whether lockdowns related to Covid-19 will persist for months ahead. Any curtailment or possible field closures within the pre-salt would have a significant bearing on Petrobras’ financials, felt much stronger than any shutdowns from shallow-water or onshore production.

The gradual reopening of China’s economy is at least one positive for the company. The Asian giant is Petrobras’ principal customer, taking around 80pc of the company’s oil exports. If China’s economy is able to rapidly recover and resume international exports without delay, then this would at least offset much of the demand losses expected in the rest of the world.

Grind to a halt

Another pressing concern for Petrobras is planned divestments. The sale of eight refineries was suspended following the Covid-19 outbreak, and other planned sell-offs are likely to face similar delays. “Petrobras’ divestments, including both refining and upstream, are ‘on pause’ right now, as is the M&A market in general,” says Ruaraidh Montgomery, director at research consultancy Welligence Analytics.

Petrobras assured the market on a conference call that sales were still on track but would not go ahead if asset prices slumped below the company’s valuation. “The oil price shock is not considered a deal breaker for the refinery sales, in part because buyers are more concerned about crack spreads,” says Delgado.

3.5mn bl/d – 2024 production target

But with most firms focused on surviving extreme market volatility, and plunging global energy demand impacting refiners, potential buyers are likely to adopt a wait-and-see approach that could potentially add months to final sale closures.

Concerns over investor sentiment forced Brazil to shelve planned licensing auctions, which could now be pushed back into at least next year. Brazilian oil and gas regulator the ANP suspended the 17th bidding round auction, which offered acreage across five offshore basins including the pre-salt, due to the impact of Covid-19. Another transfer of rights auction in the pre-salt was also potentially in the offing this year but will now be rescheduled.

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