Alarm sounded on Petrobras leverage; investment-grade rating at risk

By:
Rob Dwyer
Published on:

Petrobras, Brazil’s oil behemoth, is poised to breach its self-imposed leverage rules and will continue to have a large negative cash-flow position in the coming years, bringing the company’s investment-grade status into question.

Amid calls for a shift in its pricing model and deteriorating investor sentiment towards Brazil, Euromoney discovers bankers dare not speak Petrobras’s name in an unflattering light.

Its board – headed by finance minister Guido Mantega – is due to meet on Friday to discuss the company’s proposal to introduce a pricing formula that will allow the company to adjust the price it charges for fuel to its domestic customers.

Currently, the government caps domestic fuel prices and Petrobras loses money on sales of domestically produced and imported oil – Deutsche Bank estimates the cost of this policy to Petrobras’s bottom line has been $8.7 billion in the first nine months of 2013 alone.

The oil ‘subsidy’ and other costly government regulations have exacerbated the impact that Petrobras’s huge capex programme – $236.7 billion over the 2013-2017 period, averaging $47.3 billion per year – has had on the company’s balance sheet.

In 2010, the company re-recapitalized through a world record $70 billion follow-on when its debt-to-equity ratio neared its internal threshold of 35%.




Three years on and that ratio has again been reached, and one leading analyst predicts it could be at 37% by year-end. If this rate deterioration continues into 2014, it will bring the company’s investment-grade rating into question.

Moody’s has already downgraded Petrobras one notch to Baa1, citing the company’s “high financial leverage and the expectation the company will continue to have large negative cash flow over the next few years as it pursues its capital spending programme”.

The rapidly deteriorating balance sheet should spark sufficient concern in the Brazilian government to eliminate the cost of the oil subsidy. However, with inflation at 5.82%, above the central bank’s 4.5% target – with a two percentage point margin for error – the timing of this decision is complicated by the wider macroeconomic challenge.

Also, recent large, popular demonstrations were sparked by – among other things – a proposed bus-fare increase of 10 centavos to R$3.10, making price rises politically sensitive.

Demonstrations also occurred in Rio de Janeiro outside Petrobras’s headquarters at the time of the recent auction of the rights to the huge pre-salt Libra oil field – and so announcing petrol-price increases shortly after a controversial sale of rights to a consortium dominated by foreign oil companies would be a huge political gamble.

Local press reports in Brazil have suggested the government will resist Petrobras’s plan to introduce a new pricing formula. The Folha de S Paulo reported this week the government is instead willing to raise gasoline prices 5% and diesel prices 10% this year, pushing the discussion about automatic adjustments into 2014.

However, such a compromise won’t solve the urgent challenge that Petrobras faces to its leverage position. The company doesn’t expect positive cash flow until 2015 – at the earliest – and the company is also adding substantial debt to fund its capex. So far in 2013, the company has added $26 billion.

The post follow-on share price performance makes an equity injection that includes the private sector unthinkable, and governance issues would make any government-led recapitalization that diluted minority shareholders very unlikely and hugely controversial.

In our December edition, Euromoney – which reported in-depth on the 2010 transaction – takes a fresh look at the company’s financial position and options, and asks, given the pressures on its cash flow and leverage position, what is likely to give way and when? And why won’t Brazilian bankers discuss the issue?