Big Oil’s Big Problems: Inflation, Corruption, and Geopolitical Tension
It’s been a rough couple of months for Petrobras (NYSE:PBR), Brazil’s state-run oil and gas giant. Shares listed on the New York Stock Exchange are down nearly 23 percent this year to date as the company and its investors digest a mountain of bearish news ranging from an underwhelming year-end report to an ongoing investigation into possible bribery.
The big blow came early in December when the Brazilian government, which controls both fuel prices in the country as well as a voting majority in Petrobras, announced an underwhelming increase for the price of fuel. Petrobras has lost more than 30 billion Brazilian reals ($12.77 billion) over the past two years because it has resisted increasing fuel prices in an effort to fight domestic inflation, which is currently running at about 5.7 percent compared to a target rate of 4.5 percent.
The state has kept fuel prices low over the past few years despite the fact that oil prices have doubled since hitting a trough below $50 per barrel in the wake of the 2008 financial crisis. This policy, although a firm strategy in the face of rampant inflation, has eroded the oil company’s earnings because the firm has essentially been selling fuel at a discount.
Credit Suisse analyst Vinicius Canheu captured the significance of the underwhelming price increase – 4 percent for gasoline and 8 percent for diesel — when, days after the announcement, he downgraded the stock from Buy straight to Sell.
More underwhelming news came at the end of February, when Petrobras reported that total domestic and international oil and gas production fell 2 percent in 2013 to 2.54 million barrels per day and consolidated net income for the year increased just 1 percent to $11.09 billion. EBITDA was up 6 percent, but investors were unimpressed by the gain.
A regulatory filing disclosed in March revealed that the company’s audit committee advised Petrobras to cut its enormous mountain of debt ($114 billion at the end of 2013) before selling $8.5 billion in bonds, advice that the company appears to have ignored. Petrobras currently bears a debt-to-EBITDA ratio of about 3.5, well above the audit committee’s target of 2.5.
The icing on the cake is an ongoing investigation into allegations of bribery within the company. Petrobras launched an internal review following allegations that company officials accepted nearly $140 million worth of bribes from SBM Offshore, a Dutch-based supplier of offshore oil platforms. The internal review is expected to wrap up by the end of March, but the issue has attracted a lot of outside attention, in part because 2014 is an election year in Brazil. The country’s Congress has voted to investigate the investigations alongside the Brazilian Federal Police.
Petrobras CEO Maria das Gracas Silva Foster had only this to say in the company’s 2013 annual report:
“I would like to notice that in the second half of 2013 we implemented the Corruption Prevention Program, reaffirming the commitment of the Petrobras Executive Board and of its employees with ethics and transparency at our organization. The program complies with both national and international initiatives against fraud and corruption, as well as with the laws of the countries where Petrobras operates, with positive impacts in the relations with all its stakeholders.”
At the end of the day, the bribery investigation is just another headwind in the storm that is blowing through the energy industry. Petrobras was not alone in reporting underwhelming production data for 2013, it’s not alone in suffering from oil price sensitivity to geopolitical tension, and it’s not alone in its year-to-date decline on the stock chart.
Shares of American oil supermajors Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) are both down since the beginning of the year, falling 5.4 percent and 7.3 percent, respectively. Exxon Mobil reported a 1.8 percent year-over-year decline in fourth-quarter oil equivalent production and has suffered alongside the rest because of geopolitical tension in Ukraine and elsewhere. Chevron faces many of the same headwinds and is mired in its own international legal dispute, which also involves possible corruption.
But as a group, the industry is rolling through a massive restructuring and development phase. Exxon Mobil reported record capital expenditures of $42.5 billion in 2013 and is looking to launch production at a record ten major projects this year, adding 300,000 barrels of oil equivalent per day of net capacity to its portfolio. Chevron has received positive commentary from analysts at Credit Suisse who argue that Chevron’s “shale portfolio will become an important addition to its conventional portfolio (Tengiz, deepwater Gulf of Mexico), driving reinvestment returns higher beyond 2017. CVX could generate $50bn of cashflow in 4 years’ time, almost as much as XOM today.”
Petrobras has its own massive investment strategy, but financing the plan has been a particular burden for the already beleaguered company. Petrobras wants to spend $221 billion through 2018 on new and existing projects, but the company is bogged down by debt, inflation, and high costs. The company doesn’t expect to generate positive cash flow until 2016.
Critics of the Brazilian government argue that because the state has forced Petrobras to subsidize domestic diesel and gasoline consumption, the company’s balance sheet is unduly burdened. But despite the criticism, the Brazilian government will likely prevent Petrobras from increasing fuel prices in the near future because the country’s inflation is running faster than anticipated.
Inflation has made the Brazilian real weaker against the U.S. dollar. A weaker Brazilian real means imports are more expensive, and, as a result, the company’s expenses are greater. As analysts told the Wall Street Journal, approximately 60 percent of the oil producer’s costs are linked to the U.S. dollar, including a great deal of its debt, while the majority of its revenues are in Brazilian reals.