An Olympic-sized headache
For ‘complicated beast’ Petrobas, Brazilian enthusiasm turns to dust
It’s 2006 and state-owned oil company Petroleo Brasileiro SA and partners have struck a pocket of eight billion barrels of oil in the massive pre-salt offshore basin that would kick off a number of similarly large discoveries.
The find has put Brazil on the oil map, with global energy observers quickly placing the South American country alongside Canada and Kazakhstan as expected leaders of non- OPEC oil production growth over the next two decades.
Brazilians were already brimming with pride after U.S. investment banker Goldman Sachs in 2001 had ordained the country to be one of the four new engines — with Russia, India and China — of the global economy to replace sputtering Europe and North America.
The BRIC acronym took a life of its own, propelling Brazil into the limelight, and the country rode the hype and the commodity boom, lifting millions out of poverty and instilling a more confident strut in its samba.
The country’s oil and economic embarrassment of riches inspired then-president Luiz Inacio Lula da Silva to declare “God was Brazilian,” while Venezuela’s late president Hugo Chavez jokingly contemplated calling his counterpart “Sheikh Lula.”
The Summer Olympics, following its hosting of the FIFA Soccer World Cup in 2014, was to be Brazil’s perfect coming-of-age party on the beach — a grown-up ready to host the world.
But a decade after the giant offshore find, the country, its oil industry — and Lula himself — are in need of divine intervention.
“That moment of enthusiasm right after the oil discovery and combined with what seemed like a very favourable moment for Brazil elicited some sort of exuberancy, if not hubris,” says Joao Augusto de Castro Neves, director of Latin America at the Washington-based Eurasia Group.
“There was a great degree of excessive confidence that led to increasing government intervention and brought operational and financial difficulties to Petrobras.”
Brazil’s list of woes is long: Brazil’s suspended president Dilma Rousseff is about to be impeached and Lula himself is to stand trial; Petrobras, the standard bearer of Corporate Brazil, is mired in the worst corruption scandal in its history; the economy is in a severe recession; and the Olympics, meant to showcase the country’s dynamism, are marred by — among other things — the insidious Zika virus that is keeping scores of athletes and tourists away.
The mood is “very bad” in the country, says Fernando Luiz Lara, an associate professor of architecture at the University of Texas in Austin, who is originally from Brazil.
“We have gigantic political problems,” says Lara who is currently holidaying in Belo Horizonte, in the southeast of the country, where he plans to watch a couple of soccer games. “I don’t see any good solution in the near future. We are in for at least two years of bad times. Then, who knows?”
The economy contracted 3.8 per cent in 2015 and is set to slide another 3.3 per cent this year, according to the International Monetary Fund, as the economy goes bust, and an interim government has replaced an elected government riddled by corruption and incompetence in equal measure.
The Olympic Games themselves are beset by cost overruns, human rights abuses, environmental disasters and security concerns, with 60 per cent of Brazilians believing the sporting spectacle will hurt the economy, according to a recent poll by Estado de S.Paulo, a Brazilian daily newspaper.
At the heart of the trouble sits Petrobras, the country’s stateowned oil company, currently embroiled in a massive corruption scandal that has seen hundreds of arrests and convictions already and could set the company back by billions of dollars.
In 2014, Brazilian prosecutors launched Operation Car Wash (Operacao Lava Jato), its name inspired by a foreign exchange service at a gas station in Brasilia that was used by money launderers to wire funds to Petrobras executives’ overseas accounts as kickbacks for construction contracts.
Rousseff, who is not personally accused of corruption even though the alleged incidents took place during her tenure as chair of the Petrobras board, was suspended as president in May and now faces an impeachment trial on unrelated charges of breaking fiscal responsibility laws on Aug. 29.
Lula, who presided over the boom period and was idolized by his countrymen, is also expected to stand trial for allegedly obstructing the Operation Car Wash investigation. Both have denied any wrongdoing and some analysts believe the politically-motivated charges are without merit.
That’s not how it was supposed to play out for Petrobras, once seen as the poster child for all state-owned oil enterprises. Listed on the New York Stock Exchange and the domestic bourse in Sao Paulo, the company was run by competent managers and boasted deep technical and managerial bench strength.
With strong corporate governance in place, the company walked the tight rope of managing its commercial interests and aligning itself with the policy of the Brazil government, its largest shareholder.
But the Lula era that lifted millions from poverty and ushered in the boom period, saw govern- ment increasingly interfering in the company’s operations as political appointees who came on board made political rather than commercial decisions that rapidly eroded the company’s fiscal strength.
“Petrobras is a complicated beast,” says Eurasia’s Neves. “We have seen moments in the last 15 to 20 years where Petrobras was driven by market dynamics rather than political dynamics — more recently it was the other way around. Now we are seeing the pendulum swing again.”
Government creep in Petrobras saw the company’s market cap fizzle to US$52.2 billion today from $241 billion in 2007 as it became a pure policy tool, forced to keep prices down to control inflation.
Petrobas’ debt has ballooned five-fold over the past nine years, while net income of US$13.1 billion in 2007 shrivelled to a US$1.1 billion loss in the first quarter of 2016. Analysts have cast doubt over the company’s US$130 billion investment plans during the next five years.
“Our business and strategic plans are being revised and the new plans will be announced (at) the beginning of October,” Estephani Zavarise, a Petrobras media executive, said in an emailed statement.
The company declined to comment on a list of questions submitted by the Financial Post, saying it is in a quiet period until Aug. 11 when it releases its second quarter earnings.
The corruption scandal has triggered a class-action lawsuit against Petrobras in New York that has weighed on the company’s outlook. The stock has lost 75 per cent of its value over the past five years, but is up 94 per cent this year to US$8.34 on Friday as analysts believe the stock is oversold.
There are also concerns that Petrobras may be dragged into a domestic lawsuit that mirrors the U.S. legal action, says Bruno Meyerhof Salama, a professor of law at the Fundacao Getulio Vargas School of Law in Sao Paulo.
“The Brazilian shareholder will be hurt twice,” Salama said. “They are hurt because the company was mismanaged and if the company awards damages (in the U.S), they will be hurt again, which is unfair. It’s a reasonable argument, but it’s questionable whether the lawsuit can proceed.”
On Wednesday a U.S. federal appeals court approved Petrobras’ request to delay the U.S. case that was set to go to trial in September.
Then there is the matter of Petrobras’s massive debt load, which at US$126 billion has made it the most indebted company in the world. Last year the company unveiled a $15.1 billion, two-year divesting program to make a dent in its debt pile.
“By 2019-20, they would like to reduce the debt leverage from five per cent, to about 2.5 per cent,” says Ricardo Bedregal, a Rio de Janeiro-based senior director upstream at IHS Markit, noting that it will bring additional challenges for the company.
“Petrobras would have to either divest or need around US$50 billion from the government to reduce this debt ratio.”
Ironically, Brazil’s saviour may come in the form of the offshore pre-salt basin in the Atlantic that contains at least 40 billion barrels of reserves that can be produced at a break-even price of US$20US$50 per barrel — which is considered an ‘unbeatable’ proposition compared to the U.S. Gulf of Mexico and Africa, says Bedregal. “In the next five to 10 years, Petrobras will come back on the road and by 2020 Brazil would be a major player in the global oil market,” he says.
The company has been monetizing the pre-salt basin, with production from the region growing to about one million bpd today from almost zero five years ago. And that’s just scratching the salty surface — the IEA estimates more than 100 billion barrels are locked in the basin.
Further production would require sinking billions of dollars to extract the riches buried under a layer of salt two kilometres thick, and 340 kilometres offshore.
The combination of heavy investment requirements and Petrobas’ own frail fiscal situation provides an opening for international oil companies to take greater control in the offshore basin.