Initiating Coverage Of Petrobras: $17 Trefis Price Estimate

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PBR: Petroleo Brasileiro logo
PBR
Petroleo Brasileiro

We are initiating coverage of Petroleo Brasileiro Petrobras (NYSE:PBR) with a $17/share price estimate, which values it at almost 8.1x our 2014 diluted EPS estimate of $2.1 for the company. Petrobras is a vertically integrated oil and gas company, which operates in both the upstream and downstream segments of the industry. The Brazilian multinational energy giant is one of the largest companies in Latin America by annual sales revenue. Its operations account for a large majority of the total oil and gas production in Brazil. Last year, Petrobras’ average daily oil production in Brazil was 1,931.4 thousand barrels per day (MBD), an estimated 90.9% of Brazil’s total oil production. [1]

Petrobras holds a large base of proved hydrocarbon reserves in Brazil, a vast majority of which (over two-thirds) are located in large, contiguous and highly productive fields in the offshore Campos Basin. This allows the company to optimize its infrastructure and limit costs associated with the exploration, development and production of these hydrocarbon reserves. In addition to exploration and production of hydrocarbons, Petrobras also operates substantially all of the oil refining capacity in Brazil and distributes refined products through its own retail network and to other fuel wholesalers. Like other integrated oil and gas majors, the company is also involved in the production of petrochemicals.

In our analysis, we have broken down the company’s operations into 3 segments:

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  • Brazil Oil and Gas – In this division we have consolidated financial results of 3 operating segments reported by Petrobras. These include Exploration and Production, Refining, Transportation and Marketing, and Distribution.
  • Brazil Gas, Power and Biofuels – This division values Petrobras’ gas transmission and distribution, electric power generation, fertilizer manufacturing and biofuels production activities in Brazil.
  • International Operations – Petrobras operates in 17 other countries outside of Brazil. This division values the company’s international operations.

See Our Complete Analysis For Petroleo Brasileiro Petrobras

According to our estimates, the Brazil Oil and Gas division contributes more than 95% to Petrobras’ total value. Here, we provide an overview of the key value drivers and challenges to growth for this division.

Key Value Drivers

  • Huge Base Of Proved Reserves

The amount of proved hydrocarbon reserves is an extremely critical metric for any oil and gas exploration and production company. It directly impacts the company’s production growth outlook, as it represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time.

Petrobras’ proved hydrocarbon reserves stood at 16.6 billion barrels of oil equivalent at the end of last year. Almost 96% of these reserves are located in Brazil and 85% of them are liquids (crude oil and natural gas liquids). Just to give some perspective on these numbers, Petrobras currently holds enough hydrocarbon reserves to produce oil and gas for the next 20 years at 2013 production rates.

More importantly, Petrobras has reported greater than 100% reserve replacement ratio for 22 years in a row now. This shows that the company has been able to consistently grow its reserve base through a successful exploration program. Last year, Petrobras’ reserve replacement ratio stood at 131%, which implies that it added 31% more proved hydrocarbons reserves to its reserve base than the amount of oil and gas it produced last year. This speaks volumes of the long-term sustainability of Petrobras’ upstream business. [2]

  • Growth In Hydrocarbon Production

Petrobras’ average daily hydrocarbon production has grown marginally from 2.1 million barrels of oil equivalent per day (MMBOED) in 2009 to 2.16 MMBOED in 2013. However, the company plans to ramp up its hydrocarbon production to 5.2 MMBOED by 2020. Most of this growth is expected to come from the development of pre-salt hydrocarbon reserves offshore Brazil.

The expression “pre-salt” refers to an aggregation of rocks that hold hydrocarbon reserves and are located in ultra-deep waters in a large portion of the Brazilian coast. It is called pre-salt because the rock interval ranges under an extensive layer of salt, which can be as much as 2,000 meters thick. The “pre” expression is used because these rocks were deposited before the salt layer. The total depth of these rocks can be as much as 7,000 meters from the surface of the sea.

Between 2014 and 2018, Petrobras plans to invest $153.9 billion in the exploration and production of hydrocarbons in Brazil. It plans to invest a lion’s share of this amount ($112.5 billion or 73%) in the development of existing proved reserves, with more than 64% of that going into the development of pre-salt reserves. Currently, production from pre-salt reserves accounted for just 16% of Petrobras’ total oil production but the company plans to increase this figure to 53% by 2020. [3]

Growth In Refining Capacity

The demand for refined petroleum products in Brazil is expected to grow faster than the worldwide average rate in the coming years, primarily driven by the growth in fleet size due to rising middle class. Between 2014 and 2018, the country’s fleet size is expected to grow at an average annual rate of 5.8%. In order to take full advantage of the anticipated growth in refined petroleum products demand, Petrobras plans to ramp-up its throughput capacity in Brazil significantly from 2.1 million barrels per day (MMBPD) last year to over 3 MMBPD by 2020. Most of this growth in refining capacity would come from the construction of 2 new refineries, Premium I and Premium II, in northeastern Brazil. Petrobras plans to initiate the bidding process for the construction of these two refineries this year itself. [1]

Key Challenges To Growth

  • Negative Downstream Margins

Petrobras’ downstream operations in Brazil have been under considerable pressure over the past few years. According to our estimates, the company’s refining, marketing and distribution EBITDA margins have declined significantly from around 14% in 2009 to -1.4% in 2013. This has been primarily because of the sharp increase in global crude oil prices over the same period and lower price realization by the company for its refined products sales in Brazil due to government regulation.

Since January 2012, Petrobras has been selling gasoline, diesel and other refined petroleum products in Brazil at a sharp discount (around $15 per barrel on average) to international prices. This is because the Brazilian government has not allowed the company to pass on higher input costs to its end consumers. The government’s reluctance to allow the price of petroleum products to increase can be attributed to its policy focussed on controlling inflation. Gasoline and diesel are heavily weighted in the country’s benchmark IPCA inflation rate. [2]

We forecast Petrobras’ refining, marketing and distribution EBITDA margins in Brazil to increase to around 3% in the long run. This is because we expect the new fuel-pricing policy signed by the Brazilian government last year and approved by Petrobras’ board to result in the convergence of Brazilian oil product prices with international prices in the long run. However, if Petrobras’ downstream margins in Brazil increase to just around 2% in the long run, there could be a 15% downside to our current price estimate for the company.

  • Weakness In The Domestic Currency

In addition to the Brazilian government’s reluctance to increase refined petroleum product prices, the weakness in Brazilian Real against the U.S. Dollar has also weighed significantly on Petrobras’ financial performance over the past couple of years. This is because the depreciation of domestic currency against the U.S. Dollar further reduces the company’s price realization on refined product sales in U.S. Dollar terms.

The U.S. Dollar has strengthened significantly against many international currencies, especially the emerging market currencies, since 2012, primarily due to the U.S. Federal Reserve’s move to start scaling back its bond-buying program. According to historical currency charts provided by xe.com, the U.S. Dollar strengthened by more than 42% against the Brazilian Real (BRL) between 2011 and 2013. This more than offset the cumulative increase in gasoline and diesel prices of 32% and 34%, respectively allowed by the Brazilian government over the same period. If the domestic currency continues to devalue against the U.S. Dollar at the same rate, it could pose a significant challenge to Petrobras. [4]

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Notes:
  1. Petrobras 2013 20-F SEC Filing, sec.gov [] []
  2. Webcast 2013 Results, 2030 Strategic Plan and 2014-2018 Business Plan, investidorpetrobras.com.br [] []
  3. Aggregate Production From The Pre-Salt Layer Reaches 343 Million Barrels, petrobras.com []
  4. XE Currency Charts (USD/BRL), xe.com []