In Brazil, all eyes are focused on the impeachment process against President Dilma Rousseff, after a senate vote on May 12th forced her to leave office for up to 180 days while the legislature conducts her impeachment trial. But while Brazil’s political future hangs in the balance, Petrobras – the state oil company at the center of Brazil’s largest corruption scandal – is also facing great uncertainty. The massive corruption scandal has shaken Brazil’s political establishment, contributed to its economic downturn and damaged its already troubled state energy giant and oil industry. Though it will take time to reverse these ills, momentous changes may be on the horizon for Petrobras and the entire energy sector.
The greatest challenge facing Brazil’s energy sector is its struggling national oil company which can no longer fulfill its critical role in Brazil’s economy. Petrobras is central to every aspect of the energy sector in Brazil –from oil exploration and production to refining, retail fuel sales and gas distribution – and has stakes across other industries like power generation, petrochemicals and ethanol.
But the company is weighed down by enormous debt, with about $130 billion in obligations – the result of massive investments based on what proved to be overly optimistic production targets. Petrobras has been hit by a combination of low oil prices and the devaluation of Brazil’s currency, the real, as 80% of the company’s debts are dollar-denominated, but much of its revenue comes from domestic fuel sales in reals.
Though oil production has been rising, growth has been much lower than projected. Petrobras’ domestic oil output has risen by only 300,000 barrels per day since the first discoveries of giant oil reserves in the deepwater pre-salt region were made nearly a decade ago. The company has revised down its production target to 2.7 million barrels per day by 2020 – far short of the more than 5 million barrels per day it projected for 2020 in its 2013 business plan.
Yet, Petrobras lacks a viable plan to improve its finances and a clear vision of its future. The company has a $15 billion divestment plan for this year but has made little progress on its asset sales, shedding only small assets like its Argentine unit. Management is hoping to sell non-core assets and non-controlling stakes, but given lower oil prices and Brazil’s precarious economic and political situation, investors are reluctant to take minority stakes in Petrobras-controlled companies and it has proved difficult to sell at attractive prices. As a result, the company may have to pull out of entire market segments, such as pipelines, power generation, logistics facilities, refineries and natural gas distribution — reshaping the midstream, downstream and natural gas businesses in Brazil. Petrobras has long played a critical role in ensuring fuel supplies and distribution for Brazil and if it pulls back, it is unclear who would fill this role, what the state company’s new role would be, and whether regulatory changes would be necessary.
Petrobras also plans to cut capital expenditures but is nearing the threshold necessary to maintain current production and revenues. The company’s spending cuts have been enormous – in 2015, it cut planned spending in its five-year business plan by 37% compared to 2014. Petrobras has delayed the release of its 2016-2021 business plan until June, when it may announce further reductions.
Though Petrobras is shrinking, the many barriers to private investment in Brazil’s oil sector prevent the private sector from filling the void left by the state oil company. The country has few domestic oil companies, and international companies complain of onerous local content rules and permitting delays. Many local suppliers implicated in the corruption scandal are now in disarray, with some entering bankruptcy and executives in jail. A 2010 reform under former President Luiz Inacio Lula da Silva requires Petrobras to be the sole operator in all pre-salt fields with a minimum 30% stake, severely limiting private investment in those areas.
However, in the longer term, there may be new opportunities for private investment and important reforms to the sector. Opposition Senator Jose Serra has proposed legislation to reverse the pre-salt reform, recognizing that Petrobras lacks the financial and operational capacity to fill this role. The bill has already been approved by the Senate and now must be passed by the Chamber of Deputies and signed by the president. Both interim President Michael Temer and Pedro Parente, his choice for the new CEO of Petrobras, support revising Petrobras’ mandatory participation in the pre-salt, and the pre-salt bill will likely be approved quickly by the Chamber of Deputies and signed into law. The lower house has named the bill as one of its top priorities for the legislative session and Temer’s party, the Brazilian Democratic Movement Party (PMDB), will want to send a signal that it is seeking to attract investment.
If the pre-salt bill is approved, there may soon be fresh opportunities for increased foreign investment and production. The government has discussed holding an auction to sell licenses to produce oil from areas adjacent to previously awarded pre-salt blocks where the reservoir extends beyond the licensed area. These extended reservoirs could hold billions of barrels of oil. In addition, Petrobras is hoping to farm out some of its stakes in onshore fields and sell equity stakes in some mature fields to raise capital for enhanced oil recovery. Recently, the government extended Petrobras’ contracts for some older fields awarded in 1998, creating more incentive to invest in those areas.
Major changes to Brazil’s oil and gas sector in the near future seem all but inevitable. In the coming months and years, state oil giant Petrobras will likely shrink. Brazil’s oil production will still grow, but much more gradually than was projected in recent years, and Petrobras will become a leaner company focused primarily on its core business of oil and gas production. New spaces will open up for private investment from international companies and new local companies and Brazil’s energy sector will have to undergo important reforms. But the timeline for these changes largely depends on Brazil’s uncertain political future.
This article was also published in The Fuse.