The Brazilian energy giant Petroleo Brasileiro S.A (PBR), more commonly known as Petrobras, has been eyeing a turnaround but so far, it has fallen short of expectations. It managed to deliver a decent performance in its last quarter, but its ADR has fallen by 21.45% this year. The company is controlled by the Brazilian government through its 63% voting power. Petrobras has struggled with profitability because the business has been used as a tool to curb inflation. The company is eyeing an uptake in production in H2-2013, but I believe that, for now, investors should avoid this stock.
Nearly two weeks ago, Petrobras announced the approval of a $2.1 billion asset sale. The company has a $9 billion divestment program outlined in its five-year business plan. The current sale was disappointing for investors as Petrobras sold its assets below market expectations. The company sold its 35% stake in block BC-10 for $1.54 billion to China's Sinochem, nearly $160 million below analysts' estimates. Nonetheless, the company has been operating under a pile of debt, and the current sale will lend Petrobras a hand to support its massive $236.7 billion capital expenditure plan.
Sinochem's investment in Brazil highlights the increasing footprint of Chinese energy firms in the emerging markets. China Petroleum and Chemical Corp (SNP), otherwise known as Sinopec, is aiming to construct a $20 billion 300,000 bpd refinery in Brazil through a possible joint venture with Petrobras. Sinopec has recorded a 24% increase in H1-2013 income to $4.95 billion due to a turnaround of its refining operations. This was a direct result of the government's new and more flexible fuel pricing policy. Sinopec's impressive result underpins the crucial role that the government can play in the revival of an energy giant's fortunes. Its refining business swung to a profit of $32.68 million in H1-2013 from a loss of $3.02 billion the same period last year.
During the second quarter, Petrobras swung to net income of $2.7 billion, or BRL6.2 billion from a loss of $953 million in the same quarter last year due to higher fuel prices. The profit was nearly BRL900 million above market's expectations. The company's refined output rose 6.5% to 2.1 million bpd while revenue rose 2.63% to $35.57 billion.
The Brazilian government has been keeping a lid on fuel prices in a bid to control inflation which has caused significant losses to Petrobras's refining division. However, the unit's losses shrank by 62% to $1.62 billion. Fuel prices went up last year and in the beginning of 2013 but have not risen since March. Both gasoline and diesel are still priced 30% below Gulf of Mexico benchmarks.
Future Outlook: Refining Woes and Production Targets
A turnaround of Petrobras's refining operations is not possible without the government support through an increase in fuel prices. However, President Dilma Rousseff's office has given a clear indication that this is not going to happen in the near future due to two main reasons.
1. The weakness in Brazil's currency, which slid 8% against the US dollar in August and has been down 20% in 2013, makes it difficult to justify an increase in fuel prices.
2. The Presidential elections are due next year and Ms. Rousseff's approval rating has dropped significantly. It is highly unlikely that Ms. Rousseff will take the extremely unpopular decision to increase fuel prices - particularly after the massive street protests.
This means that Petrobras will continue to incur refining losses in the coming quarters.
Analysts at Deutsche Bank have identified that Petrobras will find it increasingly expensive to replace its oil stocks due to the weakness in the Brazilian Real. This could translate into a sequential increase in refining losses. Therefore, Petrobras's near-term outlook of its refining business is negative.
Petrobras is expecting an uptake in its output in the last six months of the current year. The company will start up 4 new oil production platforms while it will connect 36 new wells to the existing platforms. This could offset the falling levels of output from some of its mature oil fields. Petrobras has set a highly ambitious target of producing 2 million bpd by the end of the current year. Although some of the new measures outlined earlier could boost Petrobras's production by 440,000 bpd, but since deep-water drilling is an inherently risky operation, therefore, the industry is treating Petrobras' ambitions with skepticism.
For investors looking for exposure toward Brazil's deep-water assets, BP (BP) could be a much better option than Petrobras. No other international oil major has a bigger Brazilian upstream asset portfolio than BP. The company now holds interest in 27 Brazilian blocks, of which BP will operate 8 blocks. This includes the recent farming-in to 5 concessions in the Potiguar Basin. In the long term, BP could go on to become the biggest foreign player in Brazil's oil and gas industry.
Despite the better than expected quarterly results, Petrobras still has a long and an extremely challenging road ahead. The company has been moving in the right direction and will become more Brazil-focused in the long run. While there is a possibility (however small) that Petrobras will start pumping 2 million barrels per day by the end of 2013, with little government support, the refining business will continue to drag its earnings in the coming quarters. Therefore, although the company could be an interesting long term play, I believe investors should stay on the sidelines for now.