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Robert Campbell :Petrobras cash burn
  shows "Pemexification" at work



Aug 6 (Reuters) - A Friday afternoon in August during the Olympics must be the best time to release bad news. Thus Petrobras' decision to reveal its first quarterly loss in 13 years on August 3.

In dollar terms, Petrobras lost $685 million, compared with profits of more than $5 billion in the first quarter.

It is a considerable accomplishment for an oil company to lose hundreds of millions of dollars during a quarter when crude prices are over $100 a barrel.

Indeed, a closer look shows the results for what they are; a damming indictment of Brazil's oil policy, which is sending Petrobras down the route of debt and financial losses that have long been the curse of Mexico's state oil monopoly, Pemex.

Petrobras' defenders will point out that much of the company's losses this quarter were non-cash items.

Indeed, a big upfront cost to Petrobras was a $3.6 billion charge to account for the change in the value of its mostly dollar-denominated liabilities due to the depreciation of the Brazilian real.

Pemex regularly racks up extraordinary losses and gains like this due to its huge debt load, and Petrobras will surely continue to do so as it borrows heavily to carry out its expansion plans.

But for Petrobras, this is not an easily ignored balancing item. Unlike Pemex, which earns a little less than half its revenues from exports and therefore has some of its foreign currency exposure naturally hedged, Petrobras is still mainly a domestic player.

Until Brazil becomes a significant oil exporter, exchange losses cannot be ignored by investors for a long time.

But beyond the exchange losses, there are other glaring problems.

Most obvious is the nearly $6.2 billion lost by Petrobras' refining and marketing business, largely due to the company subsidizing Brazilian oil consumption on government orders.

That looks a lot like Pemex. The Mexican firm regularly bleeds cash because it sells costly imported fuel at artificially low prices on the domestic market.

Petrobras is now doing the same.

But the real shocker is in the upstream business. Write-offs for dry hole expenses surged by nearly $1 billion.

Some of this loss was due to wells drilled prior to the second quarter being junked.

That looks like a sign Petrobras management decided to take a big write-off to wipe out some over-optimistic assumptions about profitability made in recent years.

If this is a one-off event, then it is a sign of progress. Getting realistic about upstream returns is probably the first step that needs to be taken if the company is to start to push back against more government claims on its cash flow.

On the other hand, it will leave many investors wondering if other underperforming assets may be lurking on the balance sheet.


What should be of greater concern to oil markets is Petrobras' persistent cash burn.

Cash on the books fell by a staggering $8.9 billion in the second quarter of 2009 as capital expenditures and financing costs dwarfed the amount of cash generated by operations.

Petrobras' business plans have always assumed heavy borrowing to compliment operating cash flows to fund its expansion plans.

Long-term debt, for instance, rose from $49 billion at the end of 2009 to $72 billion as of the end of 2011.

Between 2012 and 2016 the company believes it needs to issue $80 billion in debt, as well as use $15 billion in cash on its books.

Although more recently Petrobras has been largely financed by Brazilian state-backed banks, it has traditionally relied on overseas debt markets for a lot of funding.

Investors have tolerated Petrobras' heavy spending and in recent years and have lent it huge amounts of money at relatively low cost. But now the global financial environment is changed.

Deleveraging and risk-aversion are likely to have chipped away at the veneer of optimism over future oil production that helped Petrobras borrow in the past. In addition, Brazil's heavy-handed state direction of the company will have further dampened enthusiasm over its business plan.


The question now is whether the decline in cash flow can be quickly reversed in order to keep the financial plan on track and mollify lenders.

If not, it will add to questions over the viability of Petrobras' expansion plans. That doesn't mean Petrobras will not be able to fund its expansion plan. But it may have to accept a higher cost to do so.

Higher-cost debt may well feed into the pace at which the company decides to expand its operations.

Cash flow, rather than profitability, is probably the most important measure of Petrobras' operations for oil markets.

After all, the company is slated to take on the lions' share of the investment required to develop Brazil's oil reserves.

So it is alarming that Petrobras' operations generated only $5.6 billion in cash during the second quarter, down from $8.8 billion.

Cash flow strips out the impact of non-cash items like the exchange-rate charge and asset write-down, showing that a genuine problem has developed in Petrobras' business model.

Losses in fuel selling and an increasingly bloated cost structure in other parts of the business look to blame.

With Brazil still eyed as a major source of incremental oil production outside of OPEC in the medium term, the financial health of Petrobras should be of concern to all oil consumers.

After all, Pemex's heavy debt burden and layers of bureaucracy have long prevented the company from maximizing what it can do with Mexico's oil resources.

Even though Petrobras recently slashed its long-term expansion plans, it is still expected to be a large contributor to non-OPEC oil production growth in the medium term.

But just how much it is able to contribute will likely depend on how quickly the company can get a handle on containing costs, as well as the government letting it raise fuel prices to curb losses.

The greatest irony, perhaps, is that Mexican reformers constantly talk of remaking Pemex into "another Petrobras" just as Brazilian policy makes Petrobras more like the Pemex of today.

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Robert Campbell is a Reuters market analyst.The views expressed are his own. Petroleumworld does not necessarily share these views.

Editor's Note: This commentary was originally published by Reuters , on Aug 6, 2012 . Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld News 08/07/2012


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