Petrobras 2Q Preview: Higher Production, Thicker Downstream Margins Expected

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PBR: Petroleo Brasileiro logo
PBR
Petroleo Brasileiro

Petrobras (NYSE:PBR) is scheduled to announce its 2015 second-quarter results on August 6. [1] We expect lower crude oil prices to weigh significantly on the company’s upstream earnings. Benchmark crude oil prices have fallen sharply over the past 12 months on rising supplies amid slower demand growth. The average Brent crude oil spot price declined by more than $48 per barrel, or almost 44% year-on-year, during the second quarter. However, we expect higher net upstream production, primarily driven by the growth in pre-salt production, and thicker downstream margins, to partially offset the impact of lower oil prices on the company’s overall performance.

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 2,033.6 thousand barrels per day (MBD), more than 90% of Brazil’s total oil production. We currently have a $10/share price estimate for Petrobras, which is about 50% above its current market price.

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Higher Upstream Production

Based on the monthly production figures reported by Petrobras, we estimate the company’s net hydrocarbon production to have grown by almost 6.4% y-o-y during the second quarter, primarily driven by the development of its hydrocarbon reserves in the Campos and Santos basins, located off Brazil’s southeast coast. The company recently provided its monthly hydrocarbon production update, according to which, its total net oil and gas production from Brazil increased to 2,547.4 thousand barrels of oil equivalent per day (MBOED) during the second quarter, up almost 8.1% over the year-ago quarter. Petrobras’ domestic crude oil production grew by over 7% from 1,972 thousand barrels per day (MBD) in 2Q 2014, to 2,111 MBD during the second quarter of 2015. Most of the growth in production came from increased development of the company’s pre-salt reserves offshore Brazil. Its operated production from pre-salt reserves in the Santos and Campos Basins stood at 747 MBD in the month of June, up more than 67% from last year. [2]

Thicker 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 -0.9% in 2014. This has been primarily because of lower price realization by the company for its refined products sales in Brazil due to government regulations. Up until recently, since January 2012, Petrobras was selling gasoline, diesel, and other refined petroleum products in Brazil at a sharp discount (around $10-15 per barrel on average) to international prices. This is because the Brazilian government did not allow the company to pass on higher input costs to its end consumers. The government’s reluctance in allowing the price of petroleum products to be increased, can be attributed to its policy focused on controlling inflation. Gasoline and diesel are heavily weighted in the country’s benchmark IPCA inflation rate. However, the recent decline in crude oil prices is a big positive for Petrobras’ downstream operations since it reduces the cost of importing refined petroleum products for the company. [3]

In addition, Petrobras also began crude oil processing at the new RNEST refinery in December last year. Located in Northeastern Brazil, RNEST is designed to process 230 MBD of crude oil to produce 162 MBD of low-sulfur diesel (10 ppm) along with LPG, naphtha, bunker fuel, and petroleum coke. The company also initiated the start-up of the second crude oil processing unit at RNEST in March this year. [4] Once the refinery is completely up and running, Petrobras’ reliance on imported refined petroleum products would shrink significantly. We believe that this new refinery start-up, combined with the increase in domestic fuel price, and the recent decline in global crude oil prices, will help improve its downstream margins significantly in the short to medium term. However, the positive impact from these factors is likely to be partially offset by the depreciation of the Brazilian Real against the U.S. dollar, which makes imports more expensive. Petrobras’ downstream director recently mentioned that he expects second-quarter fuel imports to remain stable at 1Q levels, which should provide a boost to the company’s downstream earnings. [5]

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Notes:
  1. Calendar of Events, investidorpetrobras.com []
  2. Oil and Natural Gas Production For June, investidorpetrobras.com []
  3. Brazil’s Petrobras Raises Gasoline Prices 3%, Diesel 5%, reuters.com []
  4. Petrobras starts up unit at Rnest refinery, ogj.com []
  5. 1Q 2015 Financial Results, investidorpetrobras.com []