São Paulo – So, it is Petrobras time again. The undisputed champion in Latin America. But how long will the reign last? Brazil’s state-controlled energy giant is boosted by its oil business and by its findings in ultra-deep waters. But the now-famous “pre-salt” oil represents a formidable challenge: it has to be extracted from great depths, under the ocean floor and a thick layer of salt.
This is no easy task. The company has to get enough rigs and platforms in place, and also invest large sums in a rather turbulent environment. Meanwhile, its oil output has been stagnating and gas prices have remained under government control. Governance issues have weighed on financial performance, and investors have severely punished the Petrobras stock. In mid-May, Petrobras’ market value ($123.8 billion) was briefly overtaken by Colombia’s Ecopetrol ($126.7 billion), according to Economatica, a São Paulo based consultancy. A humbling experience … Between its peak in December 2009 and late May, Petrobras stock sank by more than 50 percent.
The profitability rate of the company has also declined. Economatica says the “return on equity of 9.7 percent during the first quarter of 2012 had not been that low since the last quarter of 1999.” The main issue is that government-set fuel prices remained artificially stable while crude oil prices were soaring. “This hurts the company’s margin,” as Petrobras still needs to import refined gas, says Eric Scott, oil and gas analyst at the SLW brokerage firm in São Paulo. Last year, Petrobras sales increased by 6 percent to 244.2 billion reais, but its profits fell by 5 percent to 33.3 billion reais (in local currency terms– IFRS standard).
“The long term outlook is positive,” says Scott. “But in the past two or three years, they have not hit their output targets.” Last year, Petrobras produced 2 million barrels per day on average. Worse, the company is unlikely to achieve its own target this year either, as production from the mature fields in the Campos basins is declining and new fields have not yet come on stream.
Still, Petrobras still has a pretty good name in the market. Its brand is the only one from Latin American featured on the Top 100 chart issued annually by the Millward Brown consultancy. It also ranks as the fifth most valuable brand in the global oil industry.
While most of its assets are offshore, Petrobras’ physical presence on land is also an imposing one. Wherever you go in downtown Rio de Janeiro, the former Brazilian capital where the company was founded almost 60 years ago, Petrobras seems to be spreading its tentacles. Next to the old company headquarters in Avenida da República do Chile, two new office towers are being completed. And Petrobras has just announced it intends to buy the nearby police headquarters to expand still further.
Financial and Industrial Challenges
The “pre-salt” hurdle is enormous and some are even questioning whether Petrobras is up to the challenge. “The pre-salt will be a watershed. The investment volume is so huge, the managerial capacity to deal with such degree of complexity is so great, that the future of the company depends on how it is handled,” says Eduardo Bernini, from the Tempo Giusto energy consultancy in São Paulo. Some 100 billion barrels of crude oil may be trapped 6,000 meters below the sea bed, but pumping it up poses a Herculean task.
Petrobras is poised to play a key role in exploring this new oil frontier, but it will have to invest accordingly and acquire the right equipment in time– not a foregone conclusion. Its 2012-2016 investment plan was unveiled last June and set at $236.5 billion.
Take drills, oil rigs and platforms. Dozens of them are necessary to pump the oil to the surface, and then onto tankers. But to avoid ‘Dutch disease’ and the specter of deindustria-lization, the government has imposed stiff local content regulations (65 percent on average) and has vowed to revive local shipyards. Even if Petrobras cannot be held accountable for the strategic choices made by the government, its main shareholder, it has to suffer the consequences.
“Sometimes it does not only depend on Petrobras itself… Whether it will be able to get all the sophisticated equipment it needs –such as drills and floating platforms– in time for its production in high seas, is an open question,” says SLW’s Scott.
So far, the attempted revival of Brazilian shipyards has fallen flat. The João Candido ship that was built in the Estaleiro Atlântico Sul (South Atlantic shipyard, or EAS) was finally launched last May after a two-year delay. It had been launched in 2010 by former president Luiz Inacio Lula da Silva, but the ship had to go back to the shipyard for repairs immediately afterwards.
The episode highlighted two factors that may hamper Petrobras’ grand extraction plans: skills shortages and slack productivity. (To make things worse, Samsung, which was ope-rating EAS, has since left the consortium.) A long list of ships and FPSOs will also suffer delays, according to Emerson Leite and André Sobreira from Credit Suisse.
Maria das Graças Foster, the former company’s gas and energy director, was promoted to Petrobras’ top job by President Dilma Rou-sseff earlier this year. She will have to tackle all these challenges and one more: the output target of 6.4 million barrels of oil equivalent per day by 2020.
Regardless of her competence, government interference in fuel prices and local content regulations represent two key issues that seem unlikely to be resolved in the short term. For one, rising fuel prices could trigger inflation, which is not welcome when the central bank lowers inte-rest rates. Secondly, the government has vowed to avoid deindustrialization and intends to do all it can to prop up the local industrial base.
Until these issues are addressed, Petrobras will continue to perform under par. Adriano Pires, a former director of the National Petroleum Agency turned consultant, has the final world: “The best business in the world is a properly managed oil company. The second best business in the world is a poorly managed oil company. And the third one is Petrobras”.
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