Corruption Allegations Hurt Petrobras; Should Investors Worry?

Several corruption scandals are affecting Petrobras' image and the Brazilian government. Should you still start a position in Petrobras?

May 18, 2014 at 9:04AM

Brazilian state-run oil company Petrobras (NYSE:PBR) is facing a money-laundering probe involving purchases of refineries in the U.S. and Brazil. The allegations, known as Operation "Lava Jato," Portuguese for car wash, revolve around potentially fraudulent transactions between Petrobras and companies involved in the construction of the $20 billion Abreu e Lima Refinery near Recife, Brazil. This amount is several times more than the original budget and it affects contractors Camargo Correa and Sanko Sider, which are also under investigation.

Corruption scandals are not new to the company, but things are getting a bit more complicated now and could mean that this time Petrobras will suffer consequences. Earlier this month, a Brazilian federal court gave police access to Petrobras' bank records as well as the banking records of its former head of refining and fuel supply at Petrobras, Paulo Roberto Costa, and his immediate family. Costa was arrested in March as part of the investigation. If there is a final court sentence affecting Petrobras, its future downstream developments and contract negotiations could be affected. Here's what you need to know.

More to find out
Another probe is looking at $4.52 billion in transactions between Petrobras, a currency broker, several politicians, and Costa in the $1.7 billion purchase of a Pasadena, Texas, refinery. A new parliamentary commission consisting of representatives and senators was specially created to investigate this issue.

G

Petrobras logo in a service station. Photo credit: Louie Grint.

What's the impact on Petrobras?
These issues are heating up and Petrobras' image is taking a hit. In fact, the company's offices were raided in March by the police, looking for documents related to Operation Lava Jato.

There are political complexities as well, since the company has close ties with the current administration. President Dilma Rousseff, who is running for reelection in October, was the chairwoman of Petrobras when the Pasadena operation took place. The investments in refineries, offshore oil exploration, and shipyards were key to Rousseff's campaign. Now these components are being put into question.

The Abreu e Lima refinery budget grew almost four times in less than a decade. It handles 230,000 barrels a day, but on a cost per barrel basis it is one of the most expensive refineries ever built. In an industry where capacity and cost efficiency are so important, these deviations could mean two things: mismanagement or corruption.

How's downstream performing?
The expansion of refining capacity remains a challenge for Petrobras, and this goes beyond these scandals. Despite some improvements, the company's downstream sector is still generating losses and will continue to be a drag this year. What's the deal?

Although net losses in the refining, transportation, and marketing segment were 30% lower in 2013, the sector lost almost $8.2 billion. Some initiatives helped, like improvements in domestic prices and the higher feedstock processed in the refineries. Average oil products production reached 2.124 million bpd, up 6% from 2012's output, and the utilization factor moved from 94% in 2012 to 97%.

Improving refining efficiency is important, as it helps Petrobras reduce its diesel and gasoline imports, which are more costly than just crude oil. Petrobras plans to construct nearly 1.5 million barrels a day of refining capacity in the next 10 years, but the new refinery projects are largely behind schedule and over budget, meaning they might never generate sufficient returns on capital. Management might decide to cancel future refinery projects unless returns are met. But the government is involved in future capital allocation decisions, so a scale-back in projects is unlikely. Expanding refining capacity remains one of Rousseff's objectives, and they will push for downstream expansion.

Domestic prices are the big issue here, as they can make refining locally profitable or not. Unfortunately, the company is unable to freely modify prices in accordance to international fuel values. In the end of 2013, though, a new undisclosed pricing policy was put into action, increasing diesel and gasoline prices 8% and 4%, respectively. This ameliorated the situation, along with a 6% growth in domestic sales volumes. However, with inflation picking up in an election year it will be hard to increase prices further.

Final thoughts
Construction has historically been used for money laundering, and because of the complexity of the case it will take the Brazilian courts a great deal of time to handle this case. Despite the future trial results, the damage to the company's image has already been done. The final fines and costs related to an unfavorable court sentence are hard to predict, and what seems to be baked into the stock price are the expectations over the presidential elections coming ahead. However, future fines could be a risk.

Investors believe that a change in government could mean less use of state companies as a political instrument, and although Rousseff's popularity has taken a hit, she still remains popular. Her party will do its best to delay the resolution of these issues and to try and separate its figures from the scandal. If justice confirms the allegations in time for the upcoming elections, it could be a catalyst for change. However, this scenario is very unlikely.

The expansion of refining capacity and efficiency is crucial for Petrobras, as it would reduce losses and help the company's financials. But not at any cost. The Brazilian government controls more than 60% of voting power in the company, so these strategic decisions will continue to be heavily influenced even with a change in government.

3 stock picks to ride America's energy bonanza
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Louie Grint has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers