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Matthew Smith

Matthew Smith

Matthew Smith is Oilprice.com's Latin-America correspondent. Matthew is a veteran investor and investment management professional. He obtained a Master of Law degree and is currently located…

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Will Brazil’s Oil Production Growth Stall Under Lula?

  • Lula’s new energy reforms have struck a nerve among investors and financial markets.
  • Petrobras’ new renewable projects could affect profitability.
  • Besides a reduction in dividends, investors fear that Petrobras will be used as a tool to achieve government policy goals.
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Leftist Lula de Silva’s victory in Brazil’s controversial October 2022 presidential election provoked apprehension that many of the investor-friendly oil industry reforms undertaken by previous administrations will be undone. This caused the market value of Brazil’s national oil company Petrobras, which is 36.6% owned by the federal government in Brasilia, to tumble. After Lula assuaged market fears of any major changes occurring to integrated energy, major concerns have emerged that Brasilia will take a more interventionist role with regard to Petrobras’ operations. This is stoking fears of a return to earlier policies implemented by Lula during his first presidential term, where the company was used as a tool to achieve government policy goals, which eventually left Petrobras with a bloated balance sheet and near bankruptcy. If that occurs, it will sharply impact Petrobras’ operations, making it far less attractive to private investors. During the administrations of President Lula de Silva and then his protégé Dilma Rousseff, who was impeached for corruption in April 2016, Petrobras was used as a policy tool to subsidize fuel prices and fund government spending on social programs. By 2015 after the price of crude oil collapsed, with the international Brent benchmark plunging 49% between January 2014 and January 2015 alone, Petrobras had become the most indebted oil company in the world. It was not only the rapid deterioration of oil prices that was responsible. Long-running, deeply ingrained corruption and malfeasance at the national oil company, coupled with Brasilia using Petrobras to subsidize fuel prices and fund social programs, substantially weakened the company’s balance sheet forcing it to load up on debt.

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It was the appearance of the corruption investigation Operation Carwash in 2014 that illustrated the depth and breadth of corruption at Petrobras. That scandal eventually saw Lula imprisoned for corruption, while his successor and protégé Dilma Rousseff was removed from office. Those events not only destroyed billions of dollars of shareholder value but sparked considerable speculation that Petrobras would go bankrupt or, at the very least, require a government bailout. A spike in oil prices combined with asset sales and a focus on aggressive cost-cutting saw Petrobras avoid that ignominious fate. A series of business-friendly petroleum industry regulatory reforms, started by President Michael Temer and continued by Jair Bolsonaro not only strengthened Petrobras’ precarious position and saw it emerge as a leading investor-friendly national oil company but also attracted considerable foreign energy investment. 

Those pro-business industry reforms reinvigorated Brazil’s massive oil boom and garnered considerable attention from foreign energy companies. That saw offshore investment inflows, particularly from foreign energy supermajors, surge at a crucial time with oil prices recovering after a prolonged slump. Most of that investment flowed into Brazil’s crucial ultra-deep-water pre-salt oilfields, which are responsible for 74% of the country’s total petroleum output and are a key driver of production growth. For January 2023, Brazil’s hydrocarbon output hit a new record high, with Latin America’s largest oil producer pumping nearly 4.2 million barrels of oil equivalent per day or 7% more than a year earlier. Oil production also reached a record that month with Brazil pumping nearly 3.3 million barrels per day which were 8% higher year over year.

It is those reforms, along with reduced government interference in Petrobras’ operations and sharply higher oil prices after Russia’s invasion of Ukraine, which were responsible for the national oil company’s strong 2022 results. Full-year net income soared 84% year over year to $36.7 billion on the back of a 2% increase in hydrocarbon production and a 43% surge in the annual average Brent price, which was $101.19 per barrel compared to $70.73 per barrel during 2021. That impressive performance allowed Petrobras to hike its dividend yet again, which will see the company pay a total of $215.8 billion reals or nearly $42 billion in dividends for 2022, which is nearly double the payments to shareholders from a year earlier. This is far more than required by Petrobras’ dividend policy, where the company is obliged to pay a minimum dividend amounting to 25% of adjusted net income.

There is considerable anxiety among energy investors concerning the outlook for Petrobras after President Lula criticized the national oil company’s dividend policy in a recent Reuters article. Brazil’s leftist president was quoted in the article as stating;

"We cannot accept the idea of today's news that Petrobras delivered more than 215 billion reais in dividends,”

According to Reuters, Lula asserted that half of Petrobras’ annual dividend payment should have been invested in Brazil’s economy, notably the country’s naval and petroleum industries. Those comments suggest the potential for a rethink of how Petrobras will manage its capital and allocate dividend payments in the future. 

That conclusion is supported by an interview (Portuguese) between the Brazilian radio station BandNews FM Radio and President Lula. During that dialogue, Lula called on a rethink of how Petrobras will manage dividend payments going forward, stating:

“We have to think of Petrobras as a company of strategic interest for Brazil. It could have distributed half of the dividends and invested the other half,” 

He then pointed out that:

“Petrobras is not a company just to make money, it is a company to give energy sovereignty to the country.”

Chief Executive Prates, in a recent Reuters article, attempted to reassure investors by stating that Petrobras will continue paying “robust” dividends during 2023. He went on to state that this will occur after accounting for the needs of all parties with a balanced formula employed to ensure profits are reinvested, and investors are remunerated at the same time. Lula’s statements, however, struck a nerve among investors and financial markets. They indicate that Brazil’s leftist president intends to return to employing Petrobras as a government policy tool. That could see Brasilia using the company to bolster finances and execute public policy, particularly through investing in specific economic sectors and subsidizing fuel prices which history has shown is a costly strategy. If that occurs, it will be to the determinant of Petrobras’ profitability and likely lead to value destruction for private shareholders. 

Brazil’s president has already halted Petrobras’ divesture program, which was steadily progressing during Bolsonaro’s administration. The aim of that strategy was for Petrobras to raise capital by selling non-core assets, specifically shallow water and onshore oilfields, pipelines, and refining facilities, with the proceeds employed to reduce debt and bolster investment in core operations. Brazil’s president, in a surprise move, introduced a new oil export tax a week ago which caught energy companies off guard. That further suggests the business-friendly reforms introduced by Temer and Bolsonaro will be overturned.

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Another worrying event was newly appointed Chief Executive Jean-Paul Prates' announcement that Petrobras will pursue a major expansion of its renewable energy assets. Earlier this month, Norwegian energy supermajor Equinor revealed it had signed a letter of intent with Petrobras to assess the technical, economic and environmental feasibility of seven offshore Brazilian wind projects with up to 14.5 gigawatts of capacity. That plan, along with halting asset sales, could see Petrobras’ core profit-generating assets, its ultra-deepwater pre-salt operations, denied the considerable and necessary capital required to continue expanding production. Petrobras had originally earmarked capital expenditures of $64 billion in its 2023 to 2027 strategic plan, with 67% or nearly $43 billion to be invested in developing its pre-salt assets. That included plans to add an additional 18 Floating Production Storage and Offloading vessels, known as FPSOs, to Petrobras' pre-salt operations between 2023 and 2027.

For those reasons, Petrobras’ shares tumbled sharply recently as doubts arose that the company can continue at the current pace, unlocking considerable shareholder value. The integrated energy company’s stock has lost just over 2% during the last month and is down 21% over the last year. A recalibration of Petrobras’ dividend payments will cause the national oil company’s monster dividend yield, quoted by the Wall Street Journal as a whopping 57%, to fall considerably. If Lula forces Petrobras to change direction and Brasilia takes a more interventionist role, then not only will its operations suffer, but Brazil’s petroleum production will not expand as rapidly as originally planned. Such a move will also deter foreign oil investment, which has been among the main drivers of production growth.

By Matthew Smith for Oilprice.com

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