There’s an altogether new feel about Petrobrás these days, and it’s not because the monolithic headquarters building in Rio de Janeiro has just had a facelift.


In the olden days – that is, until March 1999 – the Brazilian government-controlled oil group was the epitome of a faceless state bureaucracy: secretive, complacent, mired in political intrigue and more concerned with the long-term ambition of making Brazil self-sufficient in oil production than with efficiency and profitability.

Its former president, Joel Rennó, ran Petróleos Brasileiros almost as if it were a personal fiefdom and had the clout to brush off questions and criticism. But aside from its intimidating exterior, Petrobrás has always had a reputation for technical excellence, especially in deep-water exploration and production.

Putting that expertise to better use – and turning Petrobrás into a profitable, competitive oil group as well as a technically excellent one – was the goal the company’s new management installed a year ago.

Its freedom of movement remains limited, however: Petrobrás is still under state control, and although the treasury plans to sell a 34% stake in July, reducing its majority holding to the legal minimum to retain control of 50% of voting stock plus one, full privatization remains politically unthinkable.

The company’s new management has taken as much control as it can and, so far, industry watchers are impressed, as are investors, though doubts remain. The company’s strategic plans include ambitious targets for investment, production and revenues. Delays are common in the industry, and Petrobrás, has been particularly susceptible to hold-ups on both the operational and the financial sides.

Analysts predict, furthermore, the company will have trouble raising the cash it needs to meet its spending plans.

A Sharper Image
One indication of the cultural change at Petrobrás was its public reaction to a disastrous oil spill earlier this year in Rio de Janeiro’s Guanabara Bay. Damage to the environment and the local fishing industry was severe. The spill should have been stopped sooner it resulted from a burst pipeline that went unnoticed for four hours.

In the past, Petrobrás would have denied any blame and battened down the hatches. This time, it quickly disclosed the reasons for the spill, accepted the blame, paid fines imposed by local and federal agencies and offered compensation to fishermen and others. But Petrobrás hasn’t turned into a fairy godmother overnight; weeks after the spill, fishermen were complaining that the compensation offer had been cut after the story left the headlines.

Nevertheless, the incident gave a striking demonstration of a new, more open attitude at the company. Nevertheless, the incident gave a striking demonstration of a new, more open attitude at the company. Ronnie Moreira, the new finance director and a former senior executive at the São Paulo office of ABN AMRO, the Dutch bank, is a prime example of the new culture. As one investment banker in Rio puts it: “The thing about Ronnie is that he’s a normal human being, not one of the old Petrobrás types. You feel you can talk to him like a real person and get a straight answer.”

It’s an impression confirmed on meeting him.

He almost bounds across his office in enthusiastic greeting before perching on the edge of a sofa, eager to talk. But his openness is more than a matter of personal style. He says that opening the company up to greater scrutiny by introducing greater transparency in its financial account, is the biggest reason behind a boost to investor confidence that has helped the company more than double its market capitalization since last October to $26.8 billion.

“We’re constantly surprising the market,” says Moreira. “We’ve put a lot of effort into things like investor relations, which is all about building market value through transparency and access.”

Incredible as it may seem for a company the size of Petrobrás – which for many years was the most traded stock on the São Paulo stock exchange – the very existence of an investor relations department is an innovation brought in by the new management. Until last year, the accounting department handled investor relations.

Another organizational change is that specific departments now deal with project finance – an area that will be crucial to meeting the company’s investment plans – and with risk management. The latter deals with all financial risk, and with insurance.

“This kind of structure just didn’t exist before,” Moreira says. “I don’t really want to comment on the way things were, but they certainly weren’t the way they should be.”

In spite of these organizational changes, Petrobrás has hired just eight people in the past year: Philippe Reichstul, the new president, plus Ronnie Moreira, two other senior staff and four personal assistants and press people.

Indeed, Moreira and Reichstul have no prior experience in the oil business. Reichstul first made a name for himself in Brasilia in the early 1980s when he was in charge of controlling the finances of the federal government’s corporations – including Petrobrás. He later went into banking as a partner in a São Paulo investment bank part-owned by American Express.

Because it’s a government-controlled company, Petrobrás must run complicated competitive examinations for any new appointments. In fact apart from the new management team, it hasn’t made any new hires for the past eight years, and staff numbers have fallen through attrition and early retirement from 53,000 to 35,000 over that period. Retaining staff continues to be a major problem: the oil industry is full of former Petrobrás employees, highly trained technicians who have jumped ship for the higher salaries available in the private sector.

The company is now preparing to fill the personnel gaps. It will soon hire 200 staff and aims to hire 1,000 people a year, just to keep staff numbers stable.

Moreira’s main concern going forward, however, is with financial administration.

“The big focus is on profitability,” he says of which may sound obvious, but for Petrobrás is something new. “Cutting financial costs is a big part of that. When I arrived we were borrowing over six months at Libor plus 4.5% a year. We’ve just borrowed $6 million for 12 months at Libor plus 1.25% a year.”

Stretching Tenors
Exchanging expensive short-term debt for long-term instruments is a major concern. The first success involved the sale and lease back of a petroleum platform last July, when Petrobrás raised $200 million over 15 years through foreign insurance companies and pension funds.


In February, the company agreed on a $239 million loan, also over 15 years, to pay for five years’ operating costs of a Dutch exploration vessel, the Noble Paul Wolff. HSBC led a syndicate of banks with KBC Santander as a partner while NCM, the Dutch export credit agency, provided insurance against Brazilian country risk. Senter, part of the Dutch Treasury, is subsidizing interest on the loan at rates expected to be about 8% a year.

Next up will be more debt issues, probably in April, when Petrobrás hopes to raise $1 billion.

“We’re looking for a minimum of five years, maybe as much as 20,” Moreira says. “We want to achieve the longest period and the lowest cost we can. We expect to launch first in the US and Europe, but we’ll probably try another issue later in Japan.”

The money will go towards Cia. Petrolífera Marlim, a special-purpose company set up to raise project finance for the Marlim oil field. This and similar projects will be essential if the company is to meet its spending target of $33 billion through 2005, or about $6 billion a year. The company needs to invest more as the government liberalizes the Brazilian oil and gas industries and opens them to foreign companies. However, Petrobrás is likely to face an uphill struggle meeting that goal “No, I don’t think they’ll manage it,” says Márcio Brito of BBA Icatu in Rio de Janeiro. “It’s not impossible, but it’s very ambitious.

Clearly they have the off-balance sheet operations, but they’re trying to double their historical investment rate and they are still subject to government spending limits.

Project finance won’t do on its own.”

Because Petrobrás is a government-controlled company, its balance sheet is part of the government’s consolidated budget. Recently, the finance ministry and the treasury have put severe limits on borrowing. That means Petrobrás must concentrate on rolling over existing debt, lengthening tenors and lowering spreads, and issuing.

As to spending, the government agrees to a budget with the company each year. Last year, it set a limit of R$2.3 billion – about $1.3 billion. If that level stays the same, making up the difference through project finance alone will be a very tough order.

“We’re aware of the market’s concerns,” Moreira says, “and that’s why we’re taking things a step at a time. But all our plans were worked out on a very conservative basis, on the assumption that the price of oil would remain at $15 a barrel. We’re confident we can meet our targets.” The price of oil rose to $30 a barrel at the end of last year before recently easing to about $25.

As well as spending $33 billion, of which about 70% will go, into exploration and production, Petrobras’s targets include increasing revenues at a rate of 4.9% between 1999 and 2005 to bring annual turnover to $35 billion, including $4.4 billion from overseas operations. Return on equity is targeted at 12%. This goal has almost been met: ROE rose to 11% last year from 7% in 1998.

As well as spending $33 billion, of which about 70% will go into exploration and production, Petrobras’s targets include increasing revenues at a rate of 4.9% between 1999 and 2005 to bring annual turnover to $35 billion, including $4.4 billion from overseas operations. Return on equity is targeted at 12%. This goal has almost been met: ROE rose to 11% last year from 7% in 1998.

Financial analysts say that the massive investments Petrobrás plans for its upstream business are likely to substantially increase the company’s future profitability. Flemings, the investment bank, estimates Petrobrás’s weighted average cost of capital at about 16% over the next six years. In comparison, it forecasts the company’s return on invested capital at 43%. The large gap between the cost and return on capital indicates a potentially large gain in profitability in the years ahead, assuming that oil prices hover around $16 per barrel through 2005.

ADR Delays
One goal the company almost certainly won’t meet is its plan to launch a second level American Depository Receipt by the middle of this year. The delays are due to the effort required to make the company’s financial statements consistent with standard US accounting practices.


Under the 1953 law that created Petrobras, the company gained a legal monopoly over almost every aspect of the oil industry. The government was also required to have an absolute majority of voting stock.

Furthermore, foreigners were banned from holding any voting stock in Petrobrás, which listed on the Sao Paulo and Rio de Janeiro stock exchanges.

The government amended the constitution in 1995 to end the company’s monopoly. In April 1999, it abolished the ban on foreign ownership of ordinary stock. However, Brasilia is still required to retain a majority of voting stock in Petrobras. In fact, the government has always had much more than the minimum to maintain control.

The Brazilian government now holds 84% of the ordinary shares plus 9.2% of the preferred, or non-voting stock. It plans to sell the 34% “excess” ordinary shares as well as its preferred shares later this year in a local and international secondary share offering.

Even more complicated will be getting rid of constructs peculiar to Petrobrás, such as the so-called DNC account (named after the precursor of Brazil’s National Petroleum Agency). This is the account through which Petrobrás and the government exchange money according to variations in international prices for petroleum derivatives in relation to domestic prices, which are fixed in advance (formerly, by the DNC). Analysts say Petrobrás is working hard on the problem, but say the very best that can be expected is an ADR launch during the third quarter.

There’s no doubting the new management’s daring in changing its accounting practices.

Last October it announced a series of accounting changes that had the effect of wiping $5 billion, or 25 per cent, off the company’s book value. One would have expected the share price to fall accordingly; instead, it went up by about the same amount.

Another decision that impressed markets followed the 30% devaluation of Brazil’s currency in early 1999. Because Petrobrás’s debts and income are all dollar-linked, the company suffered heavily, losing about $5 billion as the real plummeted in value.

Instead of spreading the loss over four years, as Brazilian law allows, it decided to write down the entire loss in the first quarter.

“It was a conservative decision, we thought it best to handle it that way,” Moreira says. “The devaluation was a major issue, we decided to deal with it up front and get it out of the way.”

As he knows, it’s the kind of talk the markets like to hear.

Keeping the Accountants At Bay
Petrobras puts project finance to work to gain investment autonomy.

Since the Brazilian government owns a controlling stake in Petrobrás, the company is not free to decide how much it will spend each year. Furthermore, its ambitious investment plans exceed recent limits set by the government. One way of getting around these limits is to use off-balance sheet finance.

Cia. Petrolífera Marlim (CPM) is the first of what Petrobrás hopes will be a series of special-purpose companies set up to finance specific projects. It consists of a group of equity holders led by BNDESPar, the investment arm of Brazil’s development bank, and ABN AMRO, the Netherlands banking group. Their contribution consists of $200 million in equity. CPM’s assets will then raise a further $1.3 billion in debt in the global financial markets.

CPM will then join Petrobrás in a joint venture, to which Petrobrás will contribute a further $3.4 billion to finance exploration in the Marlim offshore oilfield. Revenues from the consortium, which will operate the field, will be used to pay CPM’s investors a fixed rate of return. Depending on the amount of oil produced at the field, this will vary between a minimum of 2% and a maximum of 30% of the field’s revenues.

Analysts say risk for investors is limited by a requirement that Petrobrás cover any shortfall in CPM’s obligations, as well as any shortfalls caused by currency fluctuations.

CPM’s obligations include servicing its debts, paying taxes and delivering a return to equity holders.

Petrobras Finance Director Ronnie Moreira says Petrobrás will soon raise another $5.5 billion in four similar operations that together, he describes as “the biggest project finance operation in the world.”

The deals will pay for operations at four more offshore fields: Albacora, Barracuda/Caratinga, Cabiunas, and EVM.

Cabiunas is likely to be the first of these deals Petrobras closes. Half the funds are expected to come from Japan Bank for International Cooperation, with 10% to be raised as equity and the remainder from BNDESPar and commercial banks. Other deals are likely to have different partners and a different mix of funding.

Once these deals are concluded, Petrobrás will devise a similar vehicle to cover production at its giant Roncador offshore property. Given the size of this project, which is likely to need about $2 billion in financing, Moreira has decided to deal with the other, smaller operations first.

Moreira says the money raised through project finance deals will provide a big chunk of the $33 billion Petrobrás plans to spend in the next five years. But analysts are less convinced that Petrobrás can rely so heavily on off-balance sheet finance.

One problem is that, in the end, all the projects are underwritten by Petrobrás. The risk of running into trouble becomes greater as the amounts of money Petrobrás raises increase. Another problem is simply the huge amounts of money involved – the Marlim project has only raised about half the debt needed, although market conditions are improving.

The projects have also suffered delays. The original plan was to have concluded at least four projects by the end of last year. But Petrobras must hope that with the Marlim project nearing completion, the others should now move ahead more easily.

Losing Track
Nearly a year ago, the Brazilian government scrapped a rule banning foreigners from holding voting stock in Petrobrás. The decision was part of Brasília’s campaign to open the country’s capital markets to outside investors and prepare for a future block sale of a 34% equity stake in the company.

However, Damian Fraser, Latin American strategist at Warburg Dillon Read, recently discovered that the widely reported change had not prompted Morgan Stanley Capital International, which compiles the world’s leading equity investment benchmarks, to modify its indices. MSCI only includes stock in its indices that foreign investors are able to hold and so had always excluded Petrobrás voting stock, known as ON’s, from its Latin American and Brazilian indices.

MSCI has yet to adjust its index following the new regulations. This means that Petrobrás still receives a 3.5% weighting in the MSCI Latin America Free index. Fraser says the correct figure should be 8.0%. Its 10% weight in the MSCI Brazil Free index should go to 23% and Brazil’s weighting in the MSCI Latin America index ought to rise to 34.6% from 33.6%.

Warburg is recommending its clients to start accumulating ON stock ahead of a possible adjustment in the index, which would require fund managers who benchmark off the MSCI indices to adjust their portfolios by buying Petrobrás ON shares. Fraser comments: “assume that there is $75 billion of Latin American and global emerging markets dedicated equity money roughly benchmarked against MSCI, and that all investors are currently neutral Petrobrás and want to remain neutral. Then the re-rating from 3.5% to 8.0% implies an inflow of $3.4 billion into Petrobrás [shares].”

More remarkable still is that it has taken so long for investors and analysts as well as MSCI and Petrobrás to realize the oversight.

Neither Petrobrás nor MSCI responded to LatinFinance’s requests for clarification.