Striking Cash

In early May, after a spectacular share price run-up on the back of new discoveries, Petrobras found itself the world’s ninth-largest company with a market value of just over $248 billion. Still half the size of Exxon, it is now the second biggest producer in the Americas and ahead of BP and Shell.

Even so, the extent of new Petrobras discoveries remains a subject of fierce debate, thanks to some seriously badly-mishandled news flow. Harold Lima, head of Brazil's National Petroleum Agency, announced in a public forum April 14 that the company's deep-water Carioca field could hold up to 33 billion barrels of oil. Petrobras immediately announced that these were not its figures and has since confirmed only that Tupi field, part of the Carioca area, may contain up to 8 billion barrels of oil and natural gas. Still, that’s not to be sniffed at. It would boost the country's reserves by more than 50% and other finds, such as Jupiter, will increase that further.

Large, upward revisions to capital expenditure are all but certain since many of the oil discoveries are under salt layers and lie up to 10,000 metres below sea level. Heat, pressure and distance make the feasibility and economics of getting the black stuff out murky. The deepest oil lift to date is 2,700 metres recently reached last year by Anadarko Petroleum.

The technology to explore all these fields is not ready yet and it is not clear that it will be in short order, says one São Paulo-based senior investment banker. He adds that new technology is emerging fast in deep-sea drilling and, as this new technology becomes available, the existing methods they replace become much cheaper.

The burning question for Petrobras in developing these massive, deep sites is what its capex needs will be and how they can be most efficiently funded. The firm had announced that it expects to spend $112 billion through 2012, but this is a figure analysts now see as quaintly out of date. They are awaiting an upward revision, although none of them is venturing a guess on just how much until more data become available.

For now, “no-one knows; not even the President and CFO know the answers to these questions on capex,” says Ted Helms, head of investor relations at Petrobras. In September, the firm will present its five-year strategic plan, including overall spending and estimates for developing the Tupi pre-salt level finds and other fields. That will help shape estimates but even then the firm won’t have huge amounts of certainty, he underlines.

Issuance increases again
Petrobras is already stepping up debt issuance to increase production. Almir Barbassa, CFO, has announced that the company would like to sell $3.6 billion in bonds this year, compared to less than $800 million, on average, each year from 2001 through 2007.

In February, though, the firm got a shock when it tried to finance some $500 million in a re-tap of 6.125% notes of ’16 and decided to pull the deal when it realised that it had under-estimated how much it would need to pay.

The timing of the deal came at the exact inflexion point when investment grade capital markets seized up, notes Helms, pointing out that it coincided with AIG’s announcement of a $5.3 billion loss and JPMorgan’s announcement that it would acquire Bear Stearns. “We started the deal at Monday at 9am, but the first hour was just bad. We didn’t want to disrupt the market, so we pulled back and decided to wait,” he says.

Since that set-back, the firm has put great emphasis on its road show program, Helms notes. The thrust of the message in this round of presentations is that Petrobras had recently received the third agency nod to investment grade and Brazil had become much higher profile with investors overall. The firm was helped by a new wave of coverage. “Every major broker dealer now has an analyst covering us. JPMorgan was one of the last gaps and they have since initiated coverage,” says Helms.

Furthermore, local and overseas investors in Asia were finding that assets had reached fuller valuations and were looking for more attractive markets, Helms says. They also have access to better information on Brazil as the government and broker/dealers establish more commercial offices globally.

Getting the Best Price
As funding needs becomes clearer over time, there is the tricky question of how to optimize resourcing. The last few years has seen Petrobras move away from dusty lines of credit and export credit agency guarantees to become a capital markets player pure and simple.

Indeed, Petrobras had become such a stalwart that not only did it not need banks, lenders were starting to find such a creditworthy name unattractive thanks to wafer thin margins. In 2003, Petrobras was getting 400 basis points over Libor; three years ago, around 100 basis points and the figure was as low as 40-50 basis points over before the start of the global credit crisis.

The aborted trip to bond markets in February: “made Petrobras realize that it’s dangerous to rely on capital markets alone,” says one New York-based banker about the deal. They are going back to basics and realize they need to diversify funding sources and are building back relationships with commercial banks and export credit agencies (ECAs) to make sure that they have as many routes as possible to secure long-term financing, he says.

Helms says that the firm is talking to ECAs as part of its diversification strategy and to avoid over-utilizing any one market. ECAs currently represent good value, he adds. Brazil is now better rated (at level 3) and, as ECA costs of funding are based on US Treasuries, the agencies represent a more attractive source than they did three years ago, he points out.

The recent Brazil sovereign upgrade by Standard & Poor’s has seen the sovereign and Petrobras achieve their tightest ever spreads. The Republic has priced inside triple-A rated GE while Petrobras is inside some double- and tripe-A rated banks, points out Helms. That will allow the firm to plan longer tenors, although he declined to elaborate on specific plans. “We’re no longer constrained by ratings. Fund raising will be a corporate finance decision based on what makes the most sense for us,” he says. The firm is not currently considering equity issuance. Equity capital is the most expensive form of capital and the opportunity set would have to justify any issuance, says Helms.

If diversification of funding sources to drive down pricing is set to become a theme, the company also has a giant piggy bank to help meet spending, thanks to oil prices. This strong operating cash flow is a particular windfall as the firm’s models were factoring in a current oil price of around $60 per barrel for planning purposes, much lower than current realities of over $120 per barrel, points out Clarence Tong, senior vp, project finance Americas at Mizuho Corporate Bank in New York. The firm has some $7 billion in cash right now and will be able to cover a large part of investment funding needs through future operating cash flow, he notes. The firm still has recourse to the national development bank BNDES. Cash flow from online projects will help fund the development of new projects, concurs Helms, but cautions: “Who knows what the price of oil is going to be over the next five years. It’s all speculation.”

The possibility of splitting costs with partners and keeping the debt off balance sheet through project finance bonds is an attractive option, says Tong. The giant Tupi field is split between Petrobras with 55%, BG Group at 25% and Galp Energia with 10%. The most likely structure to fund expenditure would be a special purpose vehicle with bonds securitizing revenues, says the senior investment banker in São Paulo.

The final decision on how Petrobras funds itself will be based on relative cost. Public markets are a visible and straightforward benchmark to decide which structure to use, Helms concludes. LF

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