Following a multi-year downturn in global oil and gas prices and a subsequent sharp reduction in investment in oil production in Brazil, the local oil and gas market is beginning to show signs of life. Since April, oil production in Brazil has risen from 2.3 million barrels per day to 2.7 million barrels per day, and shares of the state-owned oil major Petrobras have risen by 73% during that same period.
However, much of this turnaround could be momentary, with much riding on key policy changes as well as the current upward trend in global oil prices.
Overhaul of regulatory regime
When the pré-sal reserves were discovered in 2007, the PT (Workers Party) government made it a priority to ensure that as much of the wealth created as possible would stay in Brazil. In order to achieve this, the party (then in power) created two key regulations: the first stating that Petrobras would need to operate all drilling concession while participating financially with at least a 30% share, and second that a certain lower floor of inputs used by companies operating in the pré-sal formation would be sourced from Brazil.
On October 5th, the Brazil Congress officially ended the obligation of Petrobras to function in all pré-sal operations. This was immediately viewed by the market as a positive sign, which realized that Petrobras would be unable to expand its current operation as it looks to deleverage and divest.
Meanwhile, the government has already announced plans to relax local content requirements for the next round of concession auctions. Furthermore, a team has been put together within the national regulatory agency (ANP) to make further regulatory adjustments that would be aimed at selectively reducing local content requirements to accelerate investment in the near term into the sector.
While Petrobras has seen its share price jump in recent months, its debt to EBITDA ratio (a key credit indicator) still floats just below x5 while the company has stated the goal of lowering the indicator to x2.5 by 2018. Petrobras’ issue stem from various challenges. Not only was Petrobas hit by the sharp drop in global oil prices, but was also hit by large losses generated from the Lava Jato corruption scandal, losses caused by having to sell gasoline at below market prices (in order to tame inflation) during the Rousseff administration, and finally by currency translation losses due to exposures to dollar denominated debt. The combination of these factors sent the company’s key debt metrics soaring high with Petrobras total debt exceeding US$ 120 billion.
In recent months, however, through a combination of investment reductions, cost cutting, asset sales, and increased production (in addition to domestic fuel prices held above global levels), Petrobas has been able to place its debt on a downward trajectory.
- Investment reductions: In September, Petrobras announced that it would once again revise downward its planned investments through 2022, from US$ 98.4 billion to US$ 74.1 billion (from an originally planned US$200 billion in investment), or approximately 25% of Petrobras’ planned investment in the market during that period
- Cost cutting: Petrobras has thus far undergone cuts of over 170 thousand jobs, with another 11,700 layoffs planned and more supposedly to come
- Asset sales: Petrobras plans to sell approximately US$ 19.5 billion in assets over the next 12 months in order to help pay down its outstanding debt and make room for further investments. Up for sale are key assets such as BR Distribuidor and Liquigás
- Increase production and high gasoline prices: Petrobras has seen its overall production jump in the last 6 months as new wells have come on line or productivity has increased. Likewise, with domestic gasoline prices held above international levels, Petrobras has been able to recuperate some of its losses from the period in which domestic prices were in fact held below international ones in order to help tame inflation
Threats to outlook
Despite the positive outlook on several fronts, there remain multiple downside threats that could negatively affect the positive progress in Brazil’s oil and gas market:
- Return to falling global oil prices: Petrobras has stated that its breakeven price is US$ 40 per barrel, and with oil hovering just above US$ 50 (and on an upward trajectory), the company’s operations will remain profitable. Inasmuch, should prices fall back to levels seen in the beginning of 2016, Petrobras would either need to cut investments further, or find a way to drastically reduce costs and increase productivity (both of which it would be hard pressed to achieve)
- Retrenchment on liberalization policies following 2018 presidential elections: Perhaps the greatest threat to the industry is posed by the possibility that a new government elected in 2018 would reverse the movement toward market liberalization that the Temer government is now pursuing
- Underinvestment by Petrobras lowers production levels: Some analysts have pointed out that Petrobras’ cuts to investment has brought its total investment in the market over the next five years to a level that is not conducive to holding outputs at current levels
Over the long-term Brazil’s oil and gas sector will continue to be a significant motor of investment and growth in the market, however, the current positive signs confront significant threats.
Multinationals with direct exposure to the market should continue to closely monitor key legislation as it passes through Congress, and conduct scenario planning in order to firewall key strategic initiatives. Those companies without direct exposure to the oil and gas market should consider the potential knock-on effects for investment and consumption across Brazil’s geographies. Key consideration include government budgets in petroleum producing states (mainly Rio de Janeiro and Espirito Santo) that are closely tied to oil production and prices, as well as employment and thus private consumption in these states and the northeast, where Petrobras has many large infrastructure projects.