A Look At Petrobras’ Capital Allocation Strategy

Plummeting commodity prices over the last two years have left the entire oil and gas industry fretting about their future. The sharp plunge in commodity prices has caused oil and gas companies across the globe to cut their capital spending drastically, in order to restrict their production in the low price environment and conserve their diminishing cash flows. Following this trend, Petroleo Brasileiro Petrobras (NYSE:PBR) slashed its capital expenditure from $15 billion in 2014 to $10 billion in 2015. Since the outlook for the commodity markets continues to be uncertain, the Brazilian energy company has decided to further curtail its capital spending over the next few years. In this note we will discuss the company’s capital allocation plans for the period 2017-2021 and how the company aims to fund these expenditures. You can read our previous articles in this series where we analyzed Petrobras’ production and cost reduction strategies.

Capital Allocation Plans

As per Petrobras’ Business and Management Plan (BMP) for 2017-2021, the company expects to expand its total (Brazil and international) oil and gas output from 2.62 million barrels of oil equivalent per day (MBOED) in 2017 to 3.41 MBOED by 2021 (Read: A Look At Petrobras’ Production Strategy). In order to realize these goals, the integrated company will have to spend a substantial amount of capital to build and produce the huge amount of output. However, as the commodity markets continue to be volatile, Petrobras has reduced its capital spending budget for the next four years to $74.1 billion, as opposed to $98.4 billion spent by the company in the last four years.

Since exploration and production of oil and natural gas is Petrobras’ core business, more than 80% of this capital budget will be spent on its upstream operations. Moreover, given the company’s plans to grow its hydrocarbon production at around 7% annually over the next few years, a majority of the capital expenditure will be concentrated on completing major projects and bringing production on-stream as soon as possible. Furthermore, most of the production growth is likely to come from Petrobras’ pre-salt operations.

The company has a significant presence in the deep pre-salt water provinces, which are believed to have large accumulations of extremely high quality, and commercial value light oil. This enables Petrobras to generate much higher EBITDA per barrel compared to its onshore as well as offshore (deep and ultradeep waters) plays, making it the company’s most profitable play. Consequently, the oil and gas producer is expected to concentrate more than 65% of its capital expenditure on developing and exploring these plays over the next few years.

In addition to the upstream operations, Petrobras plans to spend around $12.5 billion on its downstream operations, primarily refining. The primary motive behind this is to reduce the company’s dependence on imports and improve its operational performance. For this, the company plans to invest in building new refineries and increase the productivity of its current refineries. At present, the integrated company has 13 refineries spread across the country, and a shale processing unit in Paraná, and produces more than two MBOED of oil products such as diesel, gasoline, naphtha, jet fuel, liquefied petroleum gas, and lubricants.

Petrobras has not only laid down an extensive capital spending plan, but has also worked out the sources of income that it aims to utilize to fund these expansion goals. In the quest to reduce the risk attached to its operations, the oil and gas company plans to enter into strategic partnerships with relevant third parties, within and outside Brazil, to facilitate and boost its cash flows. Furthermore, the integrated company targets to divest a sizeable portion of its core and non-core assets over the next few years to finance its capital spending needs. Year-to-date, the company has signed partnerships and divestment transactions worth $9.8 billion, implying that it has achieved 65% of its target for 2015-2016. Going forward, Petrobras expects to raise around $19.5 billion through its strategic partnerships and asset sales in 2017 and 2018. These proceeds will be used to augment the company’s capital expenditure over the next two years, without any new debt being issued during that period.

Our Take

Petrobras’ reduced capital spending, backed by partnerships and divestitures, appears to be a judicious move in the current low price environment. However, it could be difficult for the company to implement its growth plans, if the commodity prices do not recover as expected and the company is unable to generate the planned operational cash flows to fund its expansion needs. Besides, Petrobras’ highly levered balance sheet could be a serious cause of concern for the company as well as its investors, if the commodity markets do not rebound soon.

Stay tuned for our next article where we will discuss the company’s financial position and how it plans to improve its capital structure.

Have more questions about Petrobras (NYSE:PBR)? See the links below:

• A Look At Petrobras’ Production Strategy
• Petrobras’ Stock Plunges Due To Disappointing 3Q’16 Earnings; Company Sets An Optimistic Production Plan For Next 4 Years
• Petrobras To Post A Strong Quarter Backed By Higher Realizations And Cost Savings
• How Will Petrobras’ Leverage Move In The Next Three Years?
• How Will Petrobras’ Oil & Gas Production Move In The Next Five Years?
• How Important Is The Upstream Business For Petrobras?
• How Will Petrobras’ Revenue Move If Crude Oil Prices Rebound Over The Next Two Years?
• How Will Petrobras’ Revenue Move If Crude Oil Prices Continue To Remain Depressed Over The Next Two Years?
• Is It Time For Crude Oil Prices To Recover?
• Petrobras’ 2Q’16 Earnings Plunge On The Back Of Lower Commodity Prices
• Here’s Why We Revised Petrobras’ Price Estimate To $11 Per Share

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