How Does Petrobras Cope with Lower Oil Prices after Russia/Saudi Oil Battle?

RIO DE JANEIRO, BRAZIL – Despite a potential agreement between the world’s largest oil producers for a concerted cut in supply, the horizon is still one of decreasing demand this year due to the impact of the novel coronavirus, and analysts project a long period of declining prices.

In this scenario, Petrobras should be able to maintain its operations, but the company’s resilience will be critical to long-term financial sustainability.

On Thursday April 2nd, US President Donald Trump said he spoke with Saudi crown prince Mohammed bin Salman and expects an agreement to cut production by 10 million barrels per day (Bpd) between the Arab kingdom and Russia.

The statement comes after the ending of the treaty last Tuesday, March 31st, between members of the Organization of Petroleum Exporting Countries (OPEC) and Russia, which had been promoting concerted production cuts since 2016 to balance commodity prices, in an agreement that became known as OPEC+.

After disagreements, in early March Saudi Arabia, through state-owned Saudi Aramco, cut prices and quickly accelerated production to over ten million Bpd. For comparison purposes, average production in Russia is just over 11 million Bpd, as in the United States; in Brazil, the average volume is almost three million Bpd.

As a result, oil prices fell immediately. Since the start of the year, prices have dropped more than 60 percent, to about US$ 25 in the case of Brent crude, a global reference, and US$22 for the WTI crude (used in the United States).

Although analysts do not rule out a US$10 price in case Russians and Saudis fail to reach an agreement, this would not last long, mainly because high-cost producers would close wells or even collapse, in more extreme situations.

This is the case with the shale oil and gas companies in the United States, whose production cost is around US$60 to US$70 per barrel. This week, one of them has already filed for judicial reorganization.

But where does Petrobras fit in this scenario? The Brazilian oil company’s average production was already considered high cost, when the pre-salt was not yet at full steam. With the development of the fields, the productivity in ultra-deep waters was extremely high.

As a result, production costs dropped sharply. Currently, Petrobras’ breakeven point is US$21 per barrel in the pre-salt, which already represents more than half of the volumes extracted by the company.

Nevertheless, to face the current crisis, in recent days, in addition to reducing investments and deferring the dividend schedule, Petrobras announced a cut of 200,000 Bpd of production in shallow waters, whose costs are higher.

According to Henrique Lara, an analyst at Reach Capital, the Brazilian oil company was successful in providing a quick response to the current crisis by announcing important actions to reduce its exposure. However, Lara believes that the level of leverage measured by net debt on earnings before interest, taxes, depreciation and amortization (EBITDA), currently 2.41 times, is expected to grow to 3.8 times in 2020.

“Even at this level, Petrobras would not break. The resilience of the company lies in its management, which prioritizes results, not political interests,” Lara says. He adds that competitiveness in the pre-salt ensures that the company has long-term sustainability.

In fact, the pre-salt has achieved one of the most competitive production levels in the world. In addition to Saudi Arabia, countries like Iran, Iraq, Kuwait and Venezuela (conventional oil) top this list, with an average cost of US$10 to US$15 per barrel. Russia, which has one of the largest reserves in the world – many of them in icy areas – can extract for US$18 on average.

Petrobras’ competitiveness in ultra-deep waters is so great that, in certain fields, it compares to that of Saudi Arabia, where production is considered the cheapest in the world. There, the cost of extraction varies from US$5 to US$11; in Marlim and Roncador, fields operated by Petrobras in the pre-salt, this value ranges from US$5 to US$7.

“Even if the prices were to drop further, Petrobras would still be able to have an economically viable operation,” says Jan-Jacob Verschoor, director of Oil Analytics Consulting, London.

Discipline

However, having only a low extraction cost is not enough. Operations need to be downsized as much as possible to prepare the company for a period of reduced prices. “The main risk for Petrobras today is a slow return of demand, which will be decisive in global price dynamics,” says Lara.

Verschoor agrees: “Companies will report massive revenue losses. The resources that come in will probably cover only the variable costs, but the fixed ones remain”.

For this year, Tendências Consultancy is working with a drop in global demand between four and five percent, the first in ten years. Yet, the average Brent price should stand at US$41. “Around the second semester, the conditions of the oil market should improve a little, although it is far from ideal,” says Walter de Vitto, oil and gas analyst at the consultancy.

In parallel, on the supply front, many producers should break or interrupt the less profitable extraction processes, as announced by Petrobras. “Thus, the market will adjust.”

The investment cut announced by Petrobras for 2020, of almost US$4 billion in relation to the budget at the start of the year, is also perceived in the market as crucial for the survival of the company.

“Investment reduction is a measure that all its peers are taking, particularly when it comes to projects whose profits are principally long-term,” says Rivaldo Moreira Neto, president of Gas Energy Consulting, specializing in the area.

Risks

Another major effect of the crisis triggered by the coronavirus is the additional hardship in the sale of assets. Petrobras intends to raise between US$10 to US$15 billion with the sale of eight refineries.

The president of Petrobras, Roberto Castello Branco, said last week in a teleconference that the refineries “will not be sold at any price” and that those interested in the assets have maintained negotiations. “Right now, the company will not be able to sell the refineries at the price it would like,” says Lara.

On that horizon, what analysts believe is that the pre-salt will continue to be, in fact, the much talked about “crown jewel” of the Brazilian state-owned company. “With discipline and low costs in the pre-salt, Petrobras should be able to overcome this period towards a more stable market ahead,” adds the analyst.