This week, Brazil’s state-owned oil and gas company Petrobras recorded the highest quarterly profits in its history: BRL 18.8 billion—87 percent more than one year ago. The main driving factor of these numbers was the sale of a major pipeline network to a French-Canadian consortium for BRL 33 billion. But analysts were not only focused on the profits column in the company’s earnings reports—there was more to be excited about.

The company has continued to reduce its debt and increase its focus on deepwater oil and gas exploitation—which helps cut costs.

Operational and maintenance costs in pre-salt fields (which account today for almost 60 percent of the company&#8217;s oil output), finished Q2 2019 at USD 6 per barrel, down 9 percent from one year ago. Morgan Stanley highlighted Petrobras&#8217; strong free cash flow, which has been in the black for 17 straight quarters, at BRL 11.3 billion.</p> <p>The government&#8217;s willingness to continue the divestment program kickstarted in 2016 also excites investors. The company&#8217;s current management, led by CEO Roberto Castello Branco, wants Petrobras to continue diminishing its presence in midstream activities, such as transportation segments, and downstream ones, such as oil refining and distribution. Per Morgan Stanley, the company&#8217;s EBITDA (earnings before interest taxes depreciation and amortization) was pushed down by non-essential activities. &#8220;We are confident in Petrobras&#8217; growth trajectory in relation to its global peers,&#8221; said the bank.&nbsp;</p> <p>Just four years ago, Petrobras was the <a href="">most-indebted oil company</a> in the world, with liabilities of USD 127 billion as of September 2015, thanks to rampant corruption and (perhaps even more importantly) years of bad management. </p> <p>Its debts now stand at USD 76 billion, with an average maturity of 10.25 years and a stable average cost of 6 percent a year. We explain how Petrobras become so troubled—and how it has crawled back from catastrophe—even if a complete recovery may only happen in three to four years.</p> <div class="flourish-embed" data-src="visualisation/563893"></div><script src=""></script> <h2>How did Petrobras fall into crisis</h2> <p>From 2012 on, analysts in the oil and gas sector began raising red flags about Petrobras&#8217; financial management. The company was rapidly increasing its debts and posting successive losses in the fuels commercialization segment. But unlike a &#8220;regular&#8221; company, Petrobras wasn&#8217;t shaken by these numbers and continued to get access to credit thanks to the potential of the pre-salt deepwater oil reserves.</p> <p>In February 2014, the company announced its business plan for the following five years, with investments of USD 220.6 billion—the largest in the world for an oil company. The goal was to more than double its oil output, from 2 million to 4.2 million barrels per day in just six years. With that, Petrobras sought to become one of the top 5 integrated energy companies in the world. At that moment, it was the 13th biggest oil producer, and the 28th in revenue.</p> <p>To invest heavily in pre-salt fields and four major new refineries, Petrobras saw a twelvefold increase of its net debt between 2006 and 2014: from USD 8.7 to 106.2 billion. &#8220;As a result, the net debt to EBITDA ratio passed from 0.38 to 4.77, way above the sensible threshold of 2.5,&#8221; wrote economist José Mauro de Moraes, of the Brazilian Institute of Applied Economic Research.</p> <p>During that same period, the Dilma Rousseff administration&#8217;s policy of controlling fuel prices imposed major losses on Petrobras&#8217; operations. Just as the company was accruing more debt, profits began a steep decline: from USD 20.1 billion in 2010–2011 to USD 11 billion in 2012–2013. In 2014, the financial deterioration was more flagrant and the company went into the red, with losses of USD 7.4 billion (losses in the fuels segment were as high as USD 15.4 billion).</p> <div class="flourish-embed" data-src="visualisation/563883"></div><script src=""></script> <p>In that same year, Operation Car Wash was launched. The anti-corruption probe discovered a widespread scheme to siphon money from the company into the pockets of high-profile politicians—with the help of corrupt contractors, such as construction firm Odebrecht. It is hard to say how much money Petrobras actually lost. At one point, Car Wash prosecutors estimated losses hovering around USD 5 billion, but the Federal Police says they are at least double that.</p> <p>The operation showed that projects were <a href="">intentionally poorly-planned</a>, in order to allow construction companies to make amendments to the contracts and earn more money—paying hefty bribes to political parties, of course. One such example is Comperj, designed to be a major refinery in the state of Rio. Its construction was initially estimated at USD 6.1 billion. When the Federal Accounts Court (a sort of audit tribunal that monitors public spending) suspended the works due to corruption, it had already consumed USD 12.5 billion (and it remains unfinished to this day).</p> <p>Last year, the company agreed to pay USD 2.95 billion to settle a U.S. class action from investors accusing the company of deliberately lying to them and doctoring balances. According to investors, the company was liable for the resource-draining corruption scheme. Stanford Law School reported that the deal was one of the biggest ever settled in the U.S., behind Enron&#8217;s (USD 7.2 billion), WorldCom (USD 6.2 billion), and Tyco Intl. (USD 3.2 billion).&nbsp;</p> <h2>The path to recovery</h2> <p>The crisis in Petrobras hurt the company&#8217;s image among markets, creditors, and investors. That started to change in May 2016, when then-President Michel Temer named Pedro Parente as Petrobras CEO. He initiated a harsh divestments plan, selling off assets that were not related to the company&#8217;s core business—that is, the production of oil and gas, and its derivatives. For the 2017–2021 stretch, investments were slashed to USD 74 billion— a third of what was in the previous business plan.</p> <p>Among the assets sold by Petrobras during Mr. Parente&#8217;s tenure was the infamous Pasadena oil refinery—a prime example of when poor management and corruption meet. In 2006, Petrobras closed a USD 360 million deal to purchase 50 percent of an <a href="">obsolete refinery in Pasadena</a>, Texas—which had been bought one year prior for just USD 42.5 million, making it a 3,000 percent profit for its previous owner, Belgium’s Astra Oil. By 2012, the Brazilian company was forced to buy the remaining 50 percent after a legal dispute, causing losses of USD 1.18 billion.</p> <p>But changing Petrobras&#8217; fuel pricing policy was arguably Mr. Parente&#8217;s biggest legacy, for better or worse. He stopped using the company as a political tool to control inflation, instead pegging fuel fares to international oil prices, which, at some point, had daily changes.</p> <p>Between Mr. Parente&#8217;s nomination to lead Petrobras and his resignation, one year later, the price of diesel fluctuated 121 times—going up 56.5 percent, according to data from the Brazilian Infrastructure Center. That led to a 10-day truckers&#8217; strike that nearly brought the country to a halt, and made the government cave and agree to change its pricing policy.</p> <p>Mr. Parente defended his policy on numerous occasions, affirming that state and federal taxes were the main reasons for fuel becoming so expensive in Brazil. That argument was not enough to spare him from political interference—and he chose to resign.&nbsp;</p> <p>Still, his bold divestment plan was carried out by Ivan Monteiro, his successor, and Mr. Castello Branco, appointed to the job this year. Last week, Petrobras sold its controlling power over distribution subsidiary BR Distribuidora, keeping 37 percent of shares—which will be sold in the future.&nbsp;</p> <p>In 200 days, the Jair Bolsonaro government has reportedly sold off BRL 16 billion in assets (not counting BR Distribuidora). The plan is to reach five times that mark by the end of the year.

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MoneyAug 03, 2019

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BY Gustavo Ribeiro

Gustavo is the founder of The Brazilian Report, and is an award-winning journalist with experience covering Brazilian politics and international affairs. His work has been featured across Brazilian and French media outlets.