Petrobras: A Victim of Politics?

Brazilian opposition lawmakers have recently accused state-run oil giant Petrobras (NYSE: PBR  )  of irregularities in an oil refinery purchase. The 2006 operation, approved by Dilma Rousseff -- then chairperson of Petrobras and now the president of Brazil -- involved the acquisition of a 50% stake in Pasadena Refining System from Astra Oil Trading for $370 million.

At issue is the put option that in 2012 forced Petrobras to buy the remaining stake as part of a $820.5 million legal settlement. Rousseff admitted she was unaware of the put option's existence, though it was a huge sum that had to be paid with investors' and taxpayers' money.

The case has already been presented to the Federal Court of Auditors. Now, the opposition is considering a congressional inquiry into the matter. There is already an existing commission investigating separate allegations of irregularities in Petrobras' contract with another company, SBM Offshore. This only adds to the political pressure on Rousseff's government coalition, which is up for for re-election in October.

How is this affecting the company?
Petrobras is already not in its best shape, as the company is struggling to increase production in the face of a series of setbacks this year.
The biggest so far has been the dropping of a 2.3-kilometer steel pipe 5,900 feet down into the Atlantic Ocean by a contractor working on the expansion of Roncador, Brazil's No. 2 oil field. The pipe alone cost $2 million, but the expense increases when you add in the accident itself, the replacement pipe, labor, and the work delay.

Stagnant production
Despite the investor enthusiasm stirred up by the giant offshore discoveries Petrobras announced in 2006, the company struggled to increase its output.

A $221 billion, five-year investment plan is underway, and $153.9 billion of this sum will go toward exploration and production -- although increasing oil and gas production looks all but impossible. February's data showed another year-over-year decay, and output has been stagnant for more than five years. As a result, Petrobras' revenue has dropped and the company has been forced to take on more debt.

In February, the company announced plans to increase its Brazilian output by 6.5% to 8.5% to as much as 2.1 million barrels per day. Knowing how things are evolving, this will a hard goal to reach.

Debt issuing
Part of this year's operations have been financed by the $25 billion Petrobras raised partly via global notes denominated in dollars. However, Petrobras will need more money, so it is considering selling $1.35 billion of so-called "infrastructure notes," as well as offering global bonds denominated in euros and British pounds this year.

The context for issuing debt locally is worsening, as the Brazilian central bank just raised its Selic reference interest rate by 25 basis points to 11%. This is the ninth consecutive raise in interest rates in the country since May, and it's primarily intended to cool inflation and control the country's finances. Nonetheless, it's not the best scenario for Petrobras for reaching the domestic market.

Final thoughts
Despite the political interest behind the opposition's accusations in an election year, it's clear that Petrobras is not in the best shape. And even if this possible inquiry is a purely political operation, it doesn't help Petrobras or the current Brazilian government.

Production setbacks and delays with new fields are putting Petrobras' output growth goal at risk. Considering that production from older fields is falling, the outlook is not promising, and the company could enter a vicious cycle in which financing its operations becomes more costly.

Politically, there are negotiations going on inside the Brazilian Congress. According to local news sources, one head of Rousseff's coalition is threatening to start investigating irregularities in contracts run by the opposition, like Sao Paulo's railways. We could see the conflict escalate, or perhaps the politicians will come to an agreement and the cases will be dropped.

Certainly Rousseff will do everything she can to show progress in Petrobras' offshore fields before the presidential elections. Will she succeed? Stay tuned.

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