Moody’s downgrades Petrobras as it turns 60

petrobras2As  Petrobras turned 60 years old on October 3rd, Moody’s Investors Service downgraded its global foreign currency and local currency debt ratings to Baa1 from A3. The downgrade reflects Petrobras’s high financial leverage and the expectation that the company will continue to have large negative cash flow over the next few years as it pursues its capital spending program. The outlook remains negative. “We see Petrobras’s leverage to be nearing peak levels in 2013 and 2014, significantly higher than those of its industry peers and only likely to decline in 2015 and beyond. Successful execution on its ambitious capital program and delivery on aggressive production targets will be key to reducing leverage in the next few years and to stabilizing the rating outlook,” said Thomas Coleman, Senior Vice President.

Meanwhile the company said it aims to double current oil production by 2020 to reach 4.2 million barrels per day (bpd). In 2013 alone, nine platforms with a total production capacity of 1 million bpd will be delivered to Petrobras. The company has contracted 28 offshore drilling rigs for ultra deepwater. This equipment is being built in Brazil for the first time, and deliveries will commence in 2015. Forty-nine transport ships have been commissioned to carry the oil to shore, five already delivered.

Petrobras is also planning a big step forward in refining. The production of oil products, including diesel, gasoline and jet fuel, will increase from the 2.1 million barrels per day it currently produces to 3 million bpd in 2020. The Abreu e Lima refinery in Pernambuco, and the COMPERJ (Rio de Janeiro Petrochemical Complex) are largely responsible for the increase. The first train for the Abreu e Lima refinery is expected to start running in November 2014 and the second in May 2015. The first train for COMPERJ will start running in August 2016.

In the fertilizer segment, Petrobras is set to nearly double its current production capacity of urea, reaching 3.5 million tons in 2020. For this to happen, two fertilizer units are being built, one in Mato Grosso do Sul and the other in Espírito Santo. Capacity was 1.1 million tons/ year, but in July this year, it reached 1.8 million tons/year with the acquisition of the Fertilizer Plant in Paraná.

To double output, the company is developing cutting edge technology. The Petrobras Research Center (Cenpes) coordinates 49 thematic networks with 88 universities, as well as carrying out research in its own laboratories. This is one of the greatest collaborative projects between business and academia in Brazil. The themes of each network are related to the Company’s technological targets. With the discovery of pre-salt reserves, the scale and complexity of Petrobras demands have increased, encouraging various suppliers, including multinationals, to build research centers in Brazil near Petrobras facilities or partner universities.

Rising debt

But Moody’s note that, with the largest capital program among its peers, Petrobras’s spending in 2013 could be almost double its internally generated cash flow. The company’s total debt liabilities increased in the first half of 2013 by $16.3 billion, or $8.36 billion net of cash and marketable securities, and should increase again in 2014, based on an outlook for negative cash flow through 2014 and into 2015. Leverage metrics have increased steadily and are elevated, with Total Debt/EBITDA of 3.8x, Debt/Proved Reserves of $11.25/BOE, and Debt/Daily Production approaching $64,000/BOE, the highest among its peer group of integrated and national oil companies.

While noting the company’s progress in bringing new units online to increase production, it also will continue to face significant execution risk on a plan targeting production to reach 3 million BOE/day in 2016 and 5.2 MM BOE/day in 2020. In addition to the inherent geological and technological challenges of the deepwater, the company faces staging, delivery and delay risks on drilling and development, which could be exacerbated by mandates to meet local content requirements.

Petrobras’s funding needs and leverage will also be pressured by continuing losses in its downstream operations. Petrobras’s refineries are running at higher rates and are increasing output in 2013, reducing the need for product imports, and the government has granted a series of price increases on regulated product prices. Still, the downstream is generating sizeable losses and it is not clear whether sufficient further price increases will be forthcoming, given political pressures on the government and its focus on controlling inflation.

According to Moody’s, Petrobras’s Baa1 ratings are supported by its large-scale reserve base and dominance in the Brazilian oil industry with a leading position in one of the industry’s most prospective offshore areas, and by its sizeable new pre-salt discoveries and technological expertise. In addition, the company’s focus on project execution and cost reduction should ease some of the cost overrun issues and delays it has experienced in the past.

Petrobras’s Baa1 rating reflects government support and the impact of joint-default analysis. Underlying the ratings downgrade, Moody’s has lowered Petrobras’s baseline credit assessment to baa2 from baa1, reflecting its rising leverage profile and execution risk. We are maintaining assumptions of high support from the government of Brazil (rated Baa2 with a stable outlook) and moderate dependence, or default correlation between Petrobras and the government.

While government support continues to provide one notch of uplift, Moody’s note increasing linkages between Petrobras and the sovereign. The government is playing a larger oversight role in Petrobras’s strategic direction and offshore development, and is promoting local content and other initiatives that will have an impact on its development program. Petrobras’s financing arrangements include strong ties to BNDES, the state development bank, which is also closely involved as a holder in Sete Brasil, the new entity charged with overseeing development of the Brazilian based offshore rig fleet that will be contracted to Petrobras.

Moody’s are maintaining a negative outlook on Petrobras’s ratings to assess the company’s execution on its capital program and achievement of targeted production growth, as well as the trend in leverage, which should begin to decline after 2014. The ratings could be downgraded as result of limited progress adjusting and finding flexibility in the capital program, if financial leverage increases and is sustained with Debt/EBITDA above 4x, or if production growth falls short of targets. Increased government linkages could also result in the convergence of the ratings with the sovereign rating.

Moody’s do not see momentum for an upgrade in the near-to-medium term. In the longer-term it could be upgraded as it delivers on rising and profitable production and reserves growth, with a decline in the leverage profile, in conjunction with a higher rating on Brazil’s government debt.

From Petrobras, Moody’s.

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