How the 2020 oil crisis is set to disrupt Brazil

Monday, Brent oil contracts <a href="https://www.cnbc.com/2020/03/08/oil-plummets-30percent-as-opec-deal-failure-sparks-price-war-fears.html">plummeted 24 percent</a>—their worst day since the 1991 Gulf war—closing the day at USD 34.36 per barrel. Petrobras shares’ followed the rout, dropping nearly 30 percent in one day, which was enough to erase <a href="https://brazilian.report/business/2019/08/03/petrobras-recovery-crisis-debt/">nearly four years of gains</a>.</p> <p>Obviously, lower crude prices have an automatic impact on Petrobras’ revenues. In this regard, Levante Investimentos analysts Eduardo Guimarães and Rafael Bevilacqua believe that Petrobras has improved its capital structure in the past few years and may be able to withstand &#8220;a turbulent moment like this at ease.”</p> <p>Analysts at Bradesco BBI bank were not that optimistic. Vicente Falanga and Gustavo Sadka lowered their projections for Brent prices from USD 65 to USD 35, gradually moving to USD 55 “in the long term.” As a consequence, they downgraded Petrobras shares&#8217; outlook to neutral and slashed target prices from BRL 38.00 to 23.50 per share.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1546025"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <h2>What does the future hold?</h2> <p>Petrobras estimates a <a href="https://www.investidorpetrobras.com.br/ptb/16089/9512_724072..pdf">breakeven price of USD 16 per barrel</a> for 2020 in its cost of production. In other words, as long as oil prices remain above that threshold, the company has enough money to pay for its costs. But there’s a whole different scenario for new investments.</p> <p>Petrobras’ investment strategy is <a href="https://brazilian.report/business/2019/09/26/petrobras-new-plan-shrugs-alternative-energy-sources/">majorly focused on exploring oil in deep-water fields</a>. Over the next four years, it expects to spend 59 percent of its USD 64.3 billion exploitation and production investment budget in the so-called &#8220;pre-salt&#8221; oil layer.</p> <p>While the area has a lower breakeven point than overall prospects (USD 21 v. USD 25), the actual development production breakeven in the area is pegged at USD 35 to 45 per barrel. It wouldn’t be a problem considering <a href="https://brazilian.report/business/2019/09/26/petrobras-new-plan-shrugs-alternative-energy-sources/">Petrobras oil price estimates</a> of USD 50 for the next five years and USD 45 in the long-term.</p> <p>As we reported in the <a href="https://blog.guide.com.br/analises/petrobras-empresa-pode-ser-afetada-pela-guerra-de-precos/">Special Edition of our March 9 Daily Briefing</a>, this new scenario spells trouble for new investments, but also to the company’s divestment plans—which are pivotal to reduce Petrobras&#8217; debt levels.</p> <p>The company aimed to cut its net debt to less than 1.5 times its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) in 2020, which would allow for a new dividends payment policy as of 2021. Now, as Bradesco BBI’s analysts noted, the debt goal is unlikely to happen before 2025 and, therefore, “higher dividends should not happen anytime soon.”</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1546167"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <h2>One man&#8217;s loss is another man&#8217;s gain</h2> <p>As Petrobras’ prices are pegged to international benchmarks, fuel prices are expected to go down over the next few days. And that’s good news for distributors, according to Bradesco BBI.</p> <p>The bank says that a reduction of roughly BRL 0.60 per liter—or 12 to 16 percent at the pumps—provides room for better distribution margins which wouldn&#8217;t be possible in a scenario of higher oil prices and currency devaluation. In their calculations, margin gains of BRL 10 per cubic meter for fuel distributors would increase the earnings of companies such as Ultrapar and BR Distribuidora by 11 and 10 percent, respectively.</p> <p>Another side-effect pointed out by them is a change in fuels’ mix. Bioethanol is a major fuel in the Brazilian energy matrix and, from 2017 to 2019, as gasoline prices rose and sugar prices declined, it became even more competitive in the national scenario.</p> <p>Bioethanol, however, is less efficient than gasoline; to be a better choice for drivers, one liter of bioethanol must cost up to 70 percent of gasoline prices. As the oil-based fuel becomes cheaper and the currency devaluation makes dollar-traded commodities (such as sugar) more attractive for producers than bioethanol, the analysts see the fuel mix switching back to gasoline.&nbsp;&nbsp;</p> <p>In their views, this could add BRL 2.00 per share for Ultrapar and BRL 1.00 per share for BR Distribuidora.&nbsp;</p> <p>They also consider BR Distribuidora as their preferred option, given the company&#8217;s better logistics to import gasoline—which they think it’s likely to be need—lower leverage, and higher dividend yield.