Petrobras Earnings: Increased Upstream Production And Higher Downstream Margins Fail To Mitigate The Negative Effects Of Low Oil Prices

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Petroleo Brasileiro

Petroleo Brasileiro Petrobras (NYSE:PBR) released its Q3 2015 earnings report recently. [1] The company has been hit hard by the current downtrend of low energy prices and its average price realizations for oil and natural gas have suffered as a result. Petrobras was able to mitigate part of the damage caused by low oil prices by increasing upstream production. However, the company is currently facing down one of the worst worker strikes in the last 20 years, which will affect future production numbers. The reduction in the cost of procuring raw crude oil has led to a surge in net earnings from Petrobras’ downstream operations. However, this is not enough to compensate for the damage caused by low oil prices and the company’s operating income for 2015 so far has dropped by 80%. [2] We believe that the current low oil price environment will persist in the near term and Petrobras will continue to operate in a challenging environment for the next few months.

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Upstream Production Increases, But Lower Oil Prices Continue To Hurt Operations

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Petrobras’ net hydrocarbon production for the first nine months of 2015 has grown by 6% as compared to the prior year period. [2] Most of the growth in production has come from new projects and continuing ramp-ups of pre-existing projects in the Santos and Campos Basins, which are located off Brazil’s southeast coast. The production boost has also helped Petrobras in negating the negative effects of the natural decline in production in its other fields. Petrobras’ domestic crude oil production grew by 7% during the January-September period, from 1,995 million barrels per day (MBD) in 2014 to 2,132 MBD in 2015. [2] However, the company is currently facing down one of the worst worker strikes in the last 20 years, which will affect production numbers in the near term. [3] While the workers have claimed that the strike has affected production by around 500,000 bbl/day, Petrobras maintains that that the loss of output was around 300,000 bbl/day initially and the company has been able to reduce that to around 115,000 bbl/day as of November 9. [4] [5]

Even though production has increased, the extended period of depressed oil prices has affected Petrobras’ upstream operations significantly in 2015. The average domestic sales price for crude oil is down 53% for the year so far, which has translated into a 72% drop in upstream net earnings before certain items. [2] The average realizations from natural gas have also declined by 23% in 2015. We believe that the current low oil price environment will persist in the near term as the ongoing production related stand-off between OPEC and Non-OPEC producers is creating excess supply in the global markets. This leads us to believe that Petrobras will continue to operate in a challenging environment for the next few months.

Downstream Segment Benefits From Cheaper Raw Material Procurement

The depressed crude price environment has yielded one silver lining for Petrobras. The decline in crude oil prices has reduced the cost of procuring raw crude oil for Petrobras’ downstream operations. This has led to a surge in net earnings from downstream operations. The net income before certain items attributable to the segment has amounted to $7.15 billion for the first nine months of 2015, a far cry from the loss of close to $11 billion the company sustained in the prior year period. [2] Petrobras’ downstream operations in Brazil had been under considerable pressure prior to 2015. According to our estimates, the company’s refining, marketing, and distribution EBITDA margins had declined significantly from around 14% in 2009 to -0.9% in 2014. This was primarily because of lower price realizations by the company for its refined products sales in Brazil due to government regulations. Petrobras was not allowed by the government to pass on higher input costs to its end consumers and the company had to sell gasoline, diesel, and other refined petroleum products in Brazil at a sharp discount to international prices. The government’s reluctance in allowing the price of petroleum products to be increased was due to its policy focused on controlling inflation. However, Petrobras has been allowed more rope in recent years with regards to raising prices. The company has raised prices across Brazil twice in the last year or so, with the most recent hike coming last month. [6]

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Notes:
  1. Financial Results, November 12, 2015, Petrobras Investor Relations []
  2. Petrobras SEC Filings [] [] [] [] []
  3. Worst Petrobras strike in 20 years endangers debt plan, November 4, 2015, Reuters []
  4. Petrobras Turns Into Worst-Performing Oil Stock Amid Strike, November 3, 2015, Bloomberg []
  5. Update on Oil Workers’ Strike – 11/09, November 9, 2015, Petrobras Press Release []
  6. Brazil’s Petrobras Raises Fuel Prices, September 30, 2015 []