Company Trend Analysis - Petrobras: On An Upstream Upswing - MAR 2018

BMI View: Petrobras' 2018-2022 Business and Management Plan illustrates the company's improved financial and operational status while underscoring its offshore focus . Ambitious divestment and production targets will be offset by more conservative pricing assumptions, suggesting the company is well-positioned to achieve its targets .

On December 21, Brazilian national oil company (NOC) Petrobras released its five year Business and Management Plan (BMP) for 2018-2022, its first since September 2016. An improved operating environment and strong offshore performance resulted in minor changes to its development strategy while increasing planned capex by USD400mn versus its 2017-2021 plan.

Less than 18 months after taking the helm of the company, Petrobras' more business-friendly CEO Pedro Parente showcased the NOC's ongoing transformation via a more pragmatic approach to spending and development. The company emphasised its continued emphasis on reducing its financial leverage and revealed a growing focus on digital and emissions-targeting advancements.

Petrobras maintained its five-year output target while implementing more modest crude and foreign exchange assumptions, suggesting it is well-positioned to execute its BMP. The company will continue sending the bulk of its funds upstream as it focus on exploration and development in ultra-deepwater acreage.

E&P Remains The Focus
Petrobras - BMP Capex Breakdown, USDbn
Source: Petrobras BMP

The potential for further development delays and a heavy reliance on divestments informs our less bullish outlook with respect to output. We expect the company will achieve total liquids production of 2.76mn b/d by 2022 compared to its own projection of 2.88mn b/d.

Improved Operating Environment Cements Strategy

Following a tumultuous period characterised by low profitability and weakened investor confidence, Petrobras has undergone significant changes, creating a more solid foundation for future growth. We believe a continued focus on improving above-ground dynamics will support efforts to sustainably develop its high-value assets.

  • Easing debt constraints: As the most indebted oil company in the world, the NOC was forced to repeatedly downgrade its output targets due to lower crude prices. While the company remains heavily indebted - with total debt of USD114bn as of Q317 - the extension of maturities and improved revenue generation has increased the company's ability to invest upstream. Moreover, a market-based approach to fuel pricing has boosted earnings, helping Petrobras reduce its leverage ratio from 5.1 in 2015 to 3.2 in Q317. The company hopes to reduce net debt/EBITDA to 2.5 by Q418.

Relieving Pressure Up Front
Petrobras - Total Amortisations of Principal for 2018-2020, USDbn
*does not include pre-payment of USD2.8bn with CDB, Source: Petrobras
  • Lower costs, higher profits : Given Petrobras' focus on more costly offshore assets, managing operating expenses will be essential over the next five years. Continued efficiency gains have already reduced lifting costs in the presalt from upwards of USD15/bbl in 2014 to an estimated USD8/bbl as of Q317. We expect greater application of digital solutions within the deepwater space will enhance reservoir management and recovery rates, increasing cost efficiency while boosting profitability.

  • Improving corporate governance: In the wake of the Lava Jato corruption scandal, Petrobras will be eager to show how its more proactive business practices make it a viable partner in the upstream space. Namely, enhanced internal due diligence, stronger compliance training for employees and implementation of global anti-corruption guidelines will encourage private sector investors to revisit their relationship with Petrobras. This will accelerate development offshore, supporting our more upbeat production forecast.

Deepwater Boosting Brazilian Supplies
Petrobras - Total Domestic Liquids Production (mn b/d)
e/f = estimate/forecast. Source: Petrobras BMP, BMI

Deepwater Leading The Charge

We maintain that the bulk of Petrobras' growth will come from Brazil's ultra-deepwater deposits. Estimates suggest the presalt polygon could hold upwards of 50bn bbls of oil in place, a volume nearly four times greater than the country's current reserves of just under 13.0bn bbl. Though investment into this space slowed over the past two years, the presalt remains at the core of the company's long-term upstream strategy.

The NOC's robust project pipeline will cement the importance of these assets, supported by the company's expertise in ultra-deepwater development. In 2018 alone, eight offshore projects are expected to begin producing, six of which will tap presalt deposits.

Big Plans For 2018
Petrobras - Offshore Production Pipeline
*Note: Egina FPSO located in Nigeria. Source: Petrobras 2018-2022 BMP

This is a more robust 2018 plan vs the 2017-2021 BMP, with the Tartarugas Verde and Lula Norte projects having been delayed from 2017. The three Buzios presalt projects and Lula Norte will produce upwards of 150,000b/d. The Egina FPSO is a Total-operated project off the coast of Nigeria in which Petrobras holds a 16% stake and is therefore not accounted for in our Brazil forecast. Accounting for the seven Brazilian projects, we expect the NOC's domestic capacity will increase by over 800,000b/d.

Given Petrobras' continued focus on ultra-deepwater E&P, we believe this segment will lead the country's production growth before 2019. The NOC is directing 81.0% of its spending upstream over the next five years (USD60.3bn), 58.0% of which will be focused on the presalt ( see ' Ultra-Deepwater Will Dominate Output ' , August 9 2017).

While we remain optimistic, we caution that Petrobras' continued reliance on a USD21bn divestment plan for 2017-2018 could limit its ability to invest upstream. The company closed just USD4.5bn worth of deals in 2017, implying a substantial number or high value deals must be signed this year. This will prove challenging in the wake of a nascent oil price recovery as buyer/seller valuations may begin to diverge.

However, we note that Petrobras' more conservative crude pricing and foreign exchange assumptions will offset downside divestment risks. Namely, the BMP's average oil forecasts are considerably lower than ours, implying its revenue expectations face upside risk, particularly through 2020. Our exchange rate forecast broadly aligns with the new BMP, suggesting debt repayment expectations will remain largely intact over the five-year period.

BMP Main Assumptions
Brent Price Forecast, USD/bbl BRL/USD Forecast
2018-2022 = forecasts. Source: Petrobras BMP, BMI
Petrobras BMI Petrobras BMI
2018 53.0 65.0 3.44 3.36
2019 58.0 69.0 3.55 3.51
2020 66.0 72.0 3.62 3.60
2021 70.0 75.0 3.69 3.70
2022 73.0 75.0 3.80 3.79

Forward-Looking Practices Distinguish NOC

In a region known for its state-led dominance of the oil and gas sector, Petrobras' increasing focus on technological advancement and operating improvements will differentiate it within Latin America. The majority of fellow NOCs in the region have also emphasised upstream efficiencies at the expense of mid and downstream developments ( see ' LatAm NOCs Work To Strengthen Their Core ' , September 12 2017).

Looking ahead, Petrobras plans to take this strategy even further by boosting investment into digital technologies which remain widely underutilised in the region. Greater automation and implementation of cloud computing and big data will further the NOC's expertise in the ultra-deepwater drilling space. This will encourage greater participation of international partners who will seek to tap Petrobras' extensive knowledge of the presalt polygon.

In addition, Petrobras is increasingly focused on positioning itself within a low carbon economy. The company hopes to cut its emissions from upstream processes and facilitate renewable energy development. We caution that these efforts are in the very early stages, suggesting advancements will not materialise until the latter part of its BMP rollout.