Petrobras (PBR 0.14%) is responsible for the majority of Brazil's oil production. Last year, Petrobras' average domestic oil production was 1,931.4 Mbbl/d. Petrobras' 2013 oil production represented 90.9% of the country's total. The company operates in 17 countries worldwide, with upstream, midstream, and downstream operations in South America; production and refining in North America; exploration and production in Africa; and refining operations in Japan. Despite this global presence, 91% of Petrobras' worldwide production came from Brazil last year.
With these facts as a foundation, we will turn to look at how offshore operations are critically important for Petrobras and how their performance will impact the company.
Where offshore developments fit in
Last month at the World Petroleum Congress, Petrobras general manager Anelise Lara stated that Brazil's deepwater oil fields are developing at a faster rate than the North Sea or the Gulf of Mexico. These deepwater oil fields are located in the Espírito Santo, Campos, and Santos basins.
Source: Platts
Some of the world's largest recent oil discoveries have been made in the "pre-salt" regions of these basins. The term "pre-salt" refers to how reserves are situated in rock layers below the salt layers deposited on top of them. Pre-salt reserves are located deep under dense layers of salt and rock, and extraction requires a tremendous amount of investment.
Brazil made huge discoveries in fields in these basins in 2006. Daily production now totals approximately 400,000 bbl/d -- a level Petrobras reached in just eight years. The North Sea reached 400,000 bbl/d after nine years, and the Gulf of Mexico took 19 years to do so.
Petrobras is the full owner and operator for most of these fields, but entered into partnerships for several fields as well. The ultra-deepwater Lula field in the Santos Basin is operated by Petrobras, BG Group (LSE: BG), and Petrogal Brasil, with respective shares of 65%, 25%, and 10%. A new well in the Lula field with an estimated production potential of 26,000 bbl/d began production in May. Another ultra-deepwater field in the Santos Basin, Sapinhoá, is operated by Petrobras, BG Group, and Repsol Sinopec Brasil S.A. The latter company was formed in 2010 when Sinopec (SNP +0.00%) bought 40% of Repsol's Brazilian subsidiary. Last October, exploration rights to the supergiant Libra oil field -- estimated to hold up to 12 billion barrels of oil -- were sold by the Brazilian government to a consortium including Petrobras, Royal Dutch Shell plc (NYSE: RDS-B), Total S.A. (TOT +0.00%), Chinese oil companies, and two private firms. Brazil's commitment to developing these basins bodes well for these foreign firms and lessens the strain on Petrobras at a few fields.
Heavy investment in offshore plays
The deepwater fields' rapid production has been good for Petrobras, as the deepwater plays are central to the company's portfolio and growth strategy. Almost 70% of Brazil's proved domestic reserves rest in the Campos Basin. Petrobras notes that the Campos Basin's large size and contiguity allows for infrastructure optimization and E&P cost savings. Most Petrobras refineries are located in the southeast, close to the abundance of oil coming from the Campos Basin.
Petrobras budgeted $153.9 billion between 2014 and 2018 for offshore E&P. $6.21 billion will be used for pre-salt exploration. Pre-salt production is projected to become a much more important part of Petrobras' oil production mix: currently, the company produces 2.1 million bbl/d, of which 16% comes from pre-salt wells; in 2020, pre-salt wells are expected to contribute 53% of Petrobras' 4 million bbl/d.
With this degree of reliance on offshore and pre-salt operations for growth, it is critical that they deliver for Petrobras. We may be seeing signs that the future reality won't meet expectations, however.
The investment may not pay off
As the controlling shareholder of Petrobras with 50.26% of shares, the Brazilian government can exert direct power over the company to have it act in service of state objectives. To keep inflation low, the government capped petrol prices in 2006. This price cap forces Petrobras to import petrol and diesel to meet the government-induced excess demand in the country; the company sells the products at a loss in the domestic market. The subsidy has cost Petrobras well over $21 billion since 2010.
Losing out on over $21 billion is especially tough for a company in Petrobras' position. The company carries a heavy debt load that has almost doubled since 2010 and increased by about $20 billion since 2012. Revenue has decreased by about $4 billion since 2012.
Source: PBR Total Long Term Debt (Annual) data by YCharts
The Brazilian government has also made Petrobras responsible for developing the pre-salt fields. While this is a great opportunity given the massive potential of the basins, it is also a tremendous technical and financial challenge. Pre-salt investment has been driven by debt, to the tune of $40 billion annually. Production has stagnated. Developing the fields is, and will continue to be, an extremely capital-intensive undertaking. It is also an undertaking that Petrobras has little say in and will have to continue with as long as the Brazilian government directs it to do so. Along its current trajectory, Petrobras will likely be forced to reduce pre-salt investments in the future because of its financial health.
Foolish conclusion
Petrobras is a troubled company with much potential. The Brazilian government is betting big on pre-salt developments, which means Petrobras is as well. If Petrobras can gain more autonomy and slash its debt, it will be better positioned to tap into Brazil's considerable reserves in a way that preserves its financial health. If it can't do these things, and/or pre-salt production stays stagnant, even rougher times lay ahead.
