Brazil’s Star, Petrobras hobbled by scandal and stagnation

Simon Romero and Landon Thomas Jr.

No company has embodied Brazil's rise like the oil giant Petrobras.

Bolstered by some of this century's largest oil discoveries, Petrobras soared into the top ranks of global energy producers. Executives at the state-controlled company boasted that it could even outstrip Apple as the world's most valuable publicly traded company. Political leaders here said Brazil was on the cusp of energy independence.

Now Petrobras is coming to symbolize something else entirely: the disarray afflicting Brazil's sluggish economy and the reassessment of growth prospects in emerging markets around the world.

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Instead of surging, Petrobras's oil production has stagnated, heightening Brazil's reliance on imported oil. Petrobras finds itself mired in corruption investigations and claims of managerial incompetence. And its debt load is exploding: Petrobras now ranks as the world's most indebted company, dependent, more or less, on United States mutual funds to finance its ambitious investment plans.

"The decline of Petrobras has been stunning, swift and painful," said Fábio Fuzetti, a partner at Antares Capital Management, a São Paulo investment firm. "This is the energy company that served as the model for others in developing countries," he said. "Now it's the example of precisely what not to do."

Despite these problems, executives at Petrobras point out that the company still has clear strengths. The company, which remains profitable over all despite mounting losses from importing fuel, is a pioneer in deep-sea exploration. And Petrobras commands coveted assets around the world, including oil and gas reserves of about 13 billion barrels.

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In a statement, a spokeswoman for Petrobas said that debt levels had climbed as the company invests in offshore oil and expanding refining capacity. "We'll have an inflection point in our debt starting in 2015, when revenue generation will surpass investment, initiating a trajectory of debt reduction," said Paula Almada, the spokeswoman.

Pointing to the tension building over Petrobras's woes, senators grilled the company's chief executive, Maria das Graças Foster, on Tuesday. She contended that losses related to a controversial Houston refinery deal were being overestimated. Defending the company's strategies, she said, "No operation is 100 percent safe."

So far foreign bondholders, who now fund a record 43 percent of the company's giant investment program, have been remarkably patient. But analysts warn that much of this largess has been driven by the global liquidity glut. If Petrobras's troubles continue to mount, it could run into resistance on international markets.

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The ills that plague Petrobras — too much debt and spending for too little return — reflect a larger concern that the golden age for Brazil, China, Russia and Turkey, once the vanguard of the emerging-market boom, is coming to an end.

"The problem with Brazil is that the days of 4 percent growth are gone," said Tony Volpon, a Latin America expert at Nomura Securities, who expects the country's economy to expand at well below 2 percent this year.

The problems at Petrobras, which is 60.5 percent owned by Brazil's government, have come into sharp relief in recent weeks as the company grapples with a simmering scandal over its acquisition of a Houston refinery, beginning in 2006 and completed years later, at an estimated cost of $1.19 billion from Astra, a Belgian oil trading company that bought the refinery for just $42.5 million in 2005.

Police here also recently arrested one of Petrobras's most powerful former executives, Paulo Roberto Costa, who led refining operations until 2012. Investigators say he was involved in a sprawling money-laundering scheme and may have received bribes related to the construction of a refinery that has ballooned in cost to $18.5 billion from $2.5 billion.

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The list goes on. Petrobras faces scrutiny over claims that its employees received $139 million in bribes from SBM Offshore, a Dutch supplier of oil rigs. Petrobras said this month that an internal audit had not found evidence of the bribes, but federal investigators are still examining the matter. Another investigation is looking into claims of gross overbilling in an $825 million contract with Odebrecht, the Brazilian construction and oil services giant.

Despite the scandals, Petrobras remains Brazil's most powerful company. Even as the company aims to invest about $220 billion over the next five years, Mr. Volpon points out that most other companies in Brazil are not following suit. On the global stage, he says, Brazilian companies, hobbled by high interest rates, inflation and an expensive currency, are becoming less competitive.

Meanwhile, Petrobras, in the last five years, has sold $51 billion worth of bonds to yield-starved global investors, nearly a quarter of all corporate bonds emanating from Brazil and the most of any emerging-market company, according to data compiled by Thomson Reuters.

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But the munificence of foreign investors is not bottomless. As interest rates in the United States creep up and as Brazil's finances come under greater stress, Petrobras's top creditors — which include mutual fund giants like Pimco, Fidelity and BlackRock — may well view their exposure as too risky and begin to unload their bonds.

"It's just such a big issuer," said Gary N. Kleiman, an emerging-market investment consultant who says that a Petrobras sell-off could ignite a broader emerging-market pullback. "We are just waiting for this thing to blow up."

Citing the increasing debt load, Moody's downgraded the company's debt last October to Baa1, the third-lowest investment grade rating offered by the credit agency.

The effect on Petrobras's financing ambitions has been minimal.

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Nearly a year after setting an emerging-market record with an $11 billion bond sale, the company tapped the bond market last month for yet another monster offering. Petrobras raised $8.5 billion, the biggest corporate debt offering of the year, period.

Meanwhile, as corruption scandals ensnare Petrobras, the company is struggling to lift oil and gas production, which fell 2.2 percent in 2013 to an average of 2.55 million barrels a day. There are signs this year that Petrobras may finally be succeeding in reversing such declines; the company's oil production in Brazil climbed 0.3 percent in February from the previous month.

Perhaps Petrobras's biggest challenge is that it is not just an energy company. It is also at the heart of a fierce debate here over the extent of the Brazilian government's use of its wealth to achieve political and economic goals.

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In an effort to keep inflation from accelerating during an election year, President Dilma Rousseff's government has prevented Petrobras from raising fuel prices to meet the cost of importing refined gasoline and diesel. At the same time, domestic fuel consumption has surged since the Brazilian authorities offered incentives to car manufacturers to raise production.

The result is that Petrobras's losses in its refining, transportation and marketing operations reached $8 billion in 2013.

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Throughout the economy, examples abound of Petrobras being stretched thin by policies aimed at asserting greater state control over the oil industry, like measures requiring Petrobras to buy equipment domestically, effectively propping up inefficient industries in Brazil like shipbuilding.

Speaking at a Brazilian shipyard on Monday, Ms. Rousseff lashed out a critics of Petrobas and her government's energy policies, describing the oil giant as Brazil's "mother company." Contending that any corruption at Petrobas would be rooted out by investigators, she accused political opponents of a "smear campaign" against the company.

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Still, as these so-called local content rules make Petrobras's costs skyrocket — and increase the company's debt — energy analysts here are also growing dismayed over the crisis in Brazil's once-envied ethanol industry, which has been shuttering dozens of plants as producers fail to compete in price with Petrobras's subsidized gasoline.

Facing budgetary pressures, the authorities have also quietly stopped strengthening Brazil's sovereign wealth fund. Created in 2008 soon after Petrobras announced its major oil discoveries, the fund was viewed as a pillar of efforts to establish greater financial stability in Brazil, as commodities exporters like Norway, Chile and Canada have done.

But in an attempt to meet a budget target for the 2012 fiscal year, officials withdrew about 80 percent of the money in the fund, leaving it with just $1.3 billion. Instead of replenishing the fund with proceeds from oil exports, Petrobras has grown more dependent on importing fuel and building costly projects, forcing its debt up.

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Petrobras remains far from approaching the levels of political tension and opaque dealings that now characterize Petróleos de Venezuela, the acutely politicized oil producer owned by Venezuela's government that was once considered an industry leader and a bastion of technical expertise.

But some contend that Petrobas is also being stretched by Brasília's political ambitions. "Petrobras's woes are the result of well-defined government policies," said John Forman, a former head of the regulatory agency overseeing Brazil's oil industry. "That's where things get complicated, because changing the policies is challenging indeed."