Following the publication of its sobering audited accounts earlier this year, at the start of this week, on Monday 29 June 2015, Petrobras published its 2015 – 2019 Business and Management Plan. The long-delayed document, in which the company provided details of its plans to cut investment 37% over the next five years, charts a very different course for the company over the next few years.

The plan “has as its fundamental objectives to de-lever the Company and to generate value for its shareholders,” according to Monday’s press release. Petrobras anticipates capital spending during the five years to total $130.3 billion, far below its previous five-year plan which ran to 2018 and budgeted investments of $206.8 billion.

Alongside the investment strategy, Petrobras announced that it would be increasing its asset divestment plan from the $13.7 billion, as stated in February, to $15.1 billion. Perhaps the most attractive assets expected to be put up for sale are four “Pre-Salt” oil fields under development in the offshore Campos and Santos basins; however, Petrobras is also selling various other assets, likely at discounted prices, and anticipated to include seven gigawatts of thermoelectric power plants, a 49% share in Gaspetro - the holding company that controls its 21 gas distributors - and its controlling stake in petrol stations in Chile, Colombia, Paraguay and Uruguay. Exploration and production assets will constitute 30% of the total sales, while downstream and gas and power assets will account for 30% and 40%, respectively.

A further indication of the significant impact of this new plan on Petrobras projects is the reduction, by almost a third, of the number of production units due to enter operations in the country by 2020, down from 30 to 21, with 16 already contracted. However, the company did state that projects that lost priority in this plan may be brought back into the schedule from 2020.

Developments will now focus on the Santos basin pre-salt area. “For other business areas, investment will be largely limited to maintaining operations, and for projects related to offloading oil and natural gas,” the company said.

The company’s domestic production target for 2020 has been reduced to 2.8 million barrels of oil equivalent a day, down from a previous target of 4.2 million barrels; meaning that Brazil would fall well short of its goal of joining the world’s top five oil-producing nations by the end of the decade.

Why such drastic cuts?

Brazilian Finance Minister Joaquim Levy told The Wall Street Journal, "All the majors are [cutting] because oil prices are down. That's how it should be done. The price is down, you factor that into your core business".  Although this may be true, it fails to acknowledge the unique situation in which Petrobras finds itself, which some have described as a perfect storm.

The Brazilian economy has been struggling and is expected to contract by more than 1% in 2015, and the Brazilian currency has depreciated significantly against the US Dollar and most other major currencies.  Besides the macroeconomic factors, the most obvious cause of Petrobras’ malaise is theLava Jato corruption scandal.  This has required Petrobras to write off billions of Dollars in asset values and has sent shockwaves through it supply chain.  Many Petrobras suppliers are implicated and in a precarious financial situation, as they have been suspended from contracting with Petrobras and are unable to secure financing to meet current liabilities.

However, perhaps an even bigger factor in Petrobras’ downfall has been government interference. The left-leaning governments of President Dilma Rousseff and her predecessor, Luiz Inácio Lula da Silva, have used the company as a tool of state policy. Their interference has taken a number of different forms:

  1. Petrobras was required to sell diesel and gasoline at an undervalue for many years in a bid to control inflation, which starved the company of cash flow to fund its investment programme;
  2. Petrobras is subject to local content obligations, which require procurement of a certain value of goods and services from the domestic Brazilian oil and gas industry, and it has been encouraged by the Government to go even further than it is obliged in supporting the Brazilian supply chain.  Unfortunately, this seems to have been done without proper regard to the ability of local suppliers to deliver on time or on budget or for an internationally competitive price, resulting in delays and cost overruns, as Petrobras foots the bill for the industry’s learning curve;
  3. the government seems to have encouraged obliged, and even required, Petrobras to invest in certain areas, without regard to commercial priorities. For example, Petrobras is currently required to operate all pre-salt areas with a minimum 30% stake.  While many fields in this province are very profitable, Petrobras has recently relinquished another area that it did not deem commercially viable, but it could be required to resume development with different partners following a new bid round. At the same time, Petrobras has continued to operate a huge number of onshore fields that are very marginal, presumably under pressure to support local economies.

This threefold interference resulted in a disconnect between Petrobras’ income and its vast capital expenditure requirements, which drove Petrobras to borrow more and more, and has left it as the most indebted company in the world, outside of the financial services sector.  This has damaged Petrobras’ credit rating, increased its borrowing costs and left the company with little choice, but to scale back its spending and dispose of certain assets.

The future

The recent cuts were therefore widely expected and represent a belated attempt to get to grips with the company’s new reality.  However, a number of questions remain.

The Brazilian Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (ANP) recently published the initial tender protocol and draft concession contract for its 13th licensing round, to be held on 7 October this year in Rio de Janeiro. The protocol contains details of the 266 offshore and onshore blocks on offer, in the first auction for more than two years. Traditionally, Petrobras has been the largest and most successful bidder in previous licensing rounds. However, this round will not offer any pre-salt licences and will provide the first sign of how closely Petrobras will follow its stated aim of focussing on the pre-salt areas.  If so, that may open up other areas to increased participation of international operators.

The industry had pushed hard for changes to local content obligations under the new concessions, particularly in light of the difficulties of the Brazilian supply chain and the need to control inflation in a low oil price environment.  Unfortunately, the 13th round maintains the strict rules from the previous round in May 2013, although the government has admitted that these regulations may be reviewed for future rounds.  The legislature is also reconsidering the requirement for Petrobras to operate all pre-salt areas; another change that could open up Brazilian oil and gas to increased international competition.

However, given Petrobras’ pre-eminence in the Brazilian oil and gas industry, and indeed the entire economy, it is in everyone’s interest to put the oil giant back on track as soon as possible. With many of Petrobras’ largest domestic suppliers blacklisted from future contracts while corruption investigations are ongoing, international contractors will have an important role in future developments.

The Brazilian government continues to support Petrobras and the quality of its oil and gas assets and expertise in deep water development is without doubt.  For these reasons, it will continue to play a key role in the oil and gas industry for many years to come.  It seems likely though, that Petrobras will increasingly seek to partner with other leading oil and gas companies, to share the capital and operational requirements and risks of developing the oil huge reserves offshore Brazil.  This scaled-back business plan is an early indication of a different Brazilian oil industry to come.