Petrobras has recently found itself mired in corruption scandals and holding sky-high debts that have led to the downgrade of its credit rating. Much of what’s behind the lagging performance can be traced back to the company’s main shareholder, the Brazilian government.
Ascension and decline
Over the past decade, years of rampant growth for Brazil have coincided with the heydays of its oil giant, Petrobras, starting with the discovery of Brazil’s largest oil field in the Campos basin in 2007. Soon after that, the company’s shares reached a historical high and were traded at US$ 72 in May 2008.
As production continued to grow, the state-controlled enterprise executed the largest share sale in history in 2010, raising US$ 70 billion and driving its market value up to US$ 220 billion. As a result, Petrobras ranked fifth in the world’s largest companies by market cap in 2011, topping companies like Microsoft and General Electric.
In the past few years, however, both Brazil and Petrobras have experienced a reversal of fortune. From one of the world’s most reputable enterprises, Petrobras made it to 2014 as one of the most indebted. Its market value was reduced from US$ 240 billion in 2011 to US$ 88 billion in 2014.
Moreover, the company’s debt soared from US$ 57 billion in 2010 to US$ 170 billion in June 2014 and, last October, Moody’s downgraded Petrobras’s investment grade from Baa1 to Baa2, the second lowest offered by the agency.
What’s behind the sluggish performance?
First of all, costs have risen significantly following the devaluation of the real. This was especially severe given the growing demand for oil products import in the Brazilian market. After a brief period of auto sufficiency in 2006, production did not keep up with the rising consumption and gasoline and diesel imports met over a fifth of local demand in 2013.
Meanwhile, governmental regulations for local content requirements have further aggravated costs and inefficient planning has negatively affected investment in new refineries. The construction of Abreu e Lima refinery, for instance, had its costs increased from an original plan of US$ 2.3 billion to US$ 20.1 billion. The Comperj refinery, which should start running in 2011, has been postponed to 2016. Similarly, refineries Premium I and II, planned to run in 2013 and 2015, respectively, will not be delivered before 2018 and 2019.
The most detrimental factor to the company’s financial soundness, however, has been its political use to control inflation. Price controls imposed by the government have rendered Petrobras unable to sell gasoline and diesel at market price.
The regulation kept the company from passing costs onto final prices and the estimated loss due to the gap between international and domestic prices has mounted to US$ 24 billion since 2010. Interestingly, the combination of price controls and rising gasoline and diesel imports has turned Petrobras into the only oil company that actually loses money as international oil prices go up.
Growing leverage and the corruption scandal
The rising debt and insufficient production growth led Petrobras to becoming increasingly leveraged. According to Moody’s, in the twelve-month period ending June 2014, the company’s total debt/EBITDA increased 5.3 times, which was pointed out by the agency as a main reason for the downgrade.
Despite the elevated debt, Petrobras continues to carry out an ambitious capital expenditure program, with a business plan of US$ 221 billion in investments between 2014 and 2018. It is, however, unclear whether the company will be able to capture enough resources in capital markets next year to fund new spending.
Political risk has further increased in the past few months as Petrobras’s has been pushed towards the centre of what is thought to be Brazil’s largest ever corruption scandal. An investigation of money laundering that started earlier this year has uncovered a cartel composed of Brazil’s largest construction companies to win public contracts, many of which involved Petrobras.
In a plea bargain arrangement, the company’s refining director, Paulo Roberto Costa, has admitted to receiving bribes from the builders. The proceeds were then allegedly split with political parties in the ruling coalition.
The Brazilian Federal Police has arrested over twenty high-profile executives and politicians last week under the operation ‘Car Wash’, as it has been called. Morgan Stanley has estimated the write-offs from the corruption scam to mount to US$ 8.1 billion.
In a climate of uncertainty, Petrobras has been unable to release its third-quarter financial statement as PwC has refused to sign it off before further investigation.
Prospects for the future
Petrobras’s main challenge for the moment is to reduce its debt. A depreciating real has only made matters worse in that regard and not much is expected to change in the foreseeable future. The recent corruption scandal has only added to the enhanced exposure faced by investors and, along with the recent downgrade, might result in some resistance from debt markets next year that can negatively impact the company’s investment plan.
There are however, factors playing out in the company’s favour. Although price controls over oil products are likely to remain in place, the recent decline in international oil prices has eliminated the gap between domestic and international prices and positively affected downstream operations.
Moreover, it is worth noting that oil production has continued to increase – total crude oil production reached 2.1 million bpd in September – and the start of two new refineries, RNEST and Comperj, in 2015 and 2016, is likely to help alleviate the debt and reduce dependence on imports.
Furthermore, despite all trouble caused by active state intervention, having the government as main shareholder still provides the company the guarantee of financial support.
The recent developments have tilted a delicate balance unfavourably for Petrobras. To a great extent, the company’s downfall is a consequence of regulations that kept it from responding to market forces.
Notwithstanding the overly nationalistic tone employed by the Worker’s Party when referring to the company over the past decade, it appears that not even the largest of oil discoveries or the highest technological expertise can salvage a business when it starts to work as a function of its government.
