Petrobras Revised To $21 On Rising Upstream Production, Improving Downstream Margins

by Trefis Team
Petroleo Brasileiro Petrobras
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Petroleo Brasileiro Petrobras (NYSE:PBR) reported lower second quarter earnings due to higher import costs and unfavorable currency impact. The company’s oil and oil products, and natural gas imports rose higher because of increased transportation fuel and thermoelectric power demand in Brazil. On the other hand, stronger U.S. Dollar against the Brazilian Real resulted in negative translation effect on its financials. The company’s diluted earnings per share (EPS) declined by ~22% year-on-year. However, we believe that its fundamental outlook is positive and improving because of rising upstream production and bottoming out downstream margins. [1]

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. Based on the recent earnings announcement, we have revised our price estimate for Petrobras to $21/share, which values it at 10x our 2014 full-year diluted EPS estimate of $2.1 for the company.

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Rising Upstream Production

Petrobras’ upstream production is expected to grow significantly in the coming years as it continues to develop its pre-salt reserves. 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 term “pre” 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 accounts for just around 22% of Petrobras’ total oil production, but the company plans to increase this figure to 53% by 2020. [2]

During the second quarter, Petrobras’ crude oil production grew by 2.1% y-o-y, primarily driven by the new pre-salt wells it has brought online over the past few months. The company recently announced that oil production from fields operated in the pre-salt areas of the Santos and Campos Basins offshore Brazil, which averaged just 302 MBD last year, hit a record level of 546 MBD on July 13. Petrobras plans to grow its average daily crude oil and natural gas liquids production by 6.5-8.5% y-o-y this year. However, given the progress made so far, we believe the target to be very ambitious and have factored in a 4% y-o-y increase in its total upstream production for the full year. [3]

Improving Downstream Margins

Petrobras’ downstream operations have been under considerable pressure over the past few years. According to our estimates, the company’s refining, marketing and distribution EBITDA margins in Brazil 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 realized by the company for its refined products sales in Brazil due to government regulations.

Since January 2012, Petrobras has been 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 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 focused on controlling inflation. Gasoline and diesel are heavily weighted in the country’s benchmark IPCA inflation rate.

However, we expect Petrobras’ downstream margins in Brazil to improve in the coming years as it reduces its exposure to imported fuel products, keeps the per unit refining cost in check and is allowed to take pricing measures amid rising domestic demand. During the second quarter earnings call, Petrobras announced that it expects to see a sharp decline in the amount of gasoline and diesel fuel it imports as the new RNEST refinery comes online in November this 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. In addition, Petrobras has also been able to reduce its per unit refining cost this year due to an increase in both productivity and throughput. The company’s first half refining cost stood at just $2.85 per barrel this year, compared to $3.11 in 2013. Petrobras expects its 2014 full-year average refining cost to decline by around 2% y-o-y to $3.03 per barrel. [4]

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  1. 2Q14 Financial Report (USD), []
  2. Aggregate Production From The Pre-Salt Layer Reaches 343 Million Barrels, []
  3. Petrobras’s domestic oil production rises by 2% and company sets new one-day and monthly production records in the pre-salt, []
  4. 2Q14 Webcast, []
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