Fitch Affirms Petrobras' IDRs at 'BBB-'; Outlook Negative
Petrobras' rating actions follows Fitch's downgrade today of Brazil's sovereign foreign and local currency IDRs to 'BBB-' from 'BBB' and the country ceiling to 'BBB' from 'BBB+'. The Rating Outlook on the sovereign is Negative. The sovereign rating downgrade reflects the country's rising government debt burden, increased challenges to fiscal consolidation and a worsening economic growth backdrop. The difficult political environment is hampering progress on the government's legislative agenda and creating a negative feedback loop for the broader economy. The Negative Outlook reflects Fitch's view that economic and fiscal underperformance is likely to persist while political uncertainty could continue weighing on broader confidence, delay a turnaround in investment and growth, and increase risks for the medium term fiscal consolidation needed for debt stabilization.
KEY RATING DRIVERS
Petrobras' ratings are supported by its strategic importance to Brazil, its leadership position in the Brazilian domestic energy market, and its recognized expertise in offshore exploration and production (E&P). Fitch's long-term IDR for Brazil is 'BBB-' with a Negative Outlook. Petrobras' ratings are tempered by its weak credit protection metrics; exposure to local political interference, and long-term vulnerability to fluctuations in international commodity prices, currency risk and domestic market revenue concentration. Petrobras' credit metrics are expected to remain weak over the next two to three years due to its high debt levels and depressed global hydrocarbon prices.
The Negative Outlook reflects the Negative Outlook for Brazil's sovereign rating.
LINKAGE TO THE SOVEREIGN
Petrobras' ratings continue to reflect its close linkage with the sovereign rating of Brazil due to the government's control of the company and its strategic importance to Brazil as its near-monopoly supplier of liquid fuels. Absent implicit and explicit government support, Petrobras' credit metrics are not consistent with other large, integrated private sector oil and gas companies that are rated investment grade. The company reported total financial debt of approximately USD134 billion. Fitch expects Petrobras' leverage to remain above 5x should the current exchange rate prevail throughout the second half of 2015 (2H15) and 2016.
Petrobras' credit linkage to the sovereign is evidenced by the lending commitments offered by Banco do Brasil and Caixa Economica Federal during 1H15 in order to bolster Petrobras' liquidity, as well as by the recent decision to increase domestic fuel prices, which remain above international levels. By law, the federal government must hold at least a majority of Petrobras' voting stock. The government currently owns 60.5% of Petrobras' voting rights, directly and indirectly, and has an overall economic stake in the company of 46%. Fitch views Petrobras' cash position as strong and sufficient to meet its short-term debt.
CASH FLOW REMAINS UNDER PRESSURE
Petrobras' cash flow generation is expected to remain under pressure from Brazilian Real depreciation and the fall in oil prices despite the recent price increase and capex reduction. The company is expected to generate enough cash flow from operations to cover capex and to depend on its access to the debt capital markets to service its upcoming maturities through refinancing. Any debt reduction over the upcoming years will depend highly on divestitures, which are uncertain and difficult to predict. The price increase is marginally positive as it demonstrates Petrobras' ability to adjust prices upwards even during periods of economic downturn in the country and declining oil prices globally. The capex reduction may somewhat ease cash flow pressure yet it still remains uncertain what its impact will be on long-term production growth.
Although the recent 6% and 4% price increases for local gasoline and diesel sales, respectively, will modestly bolster the company's cash flow generation in Real terms, it is not considered enough to offset the Real depreciation seen since the last price adjustment in November 2014. Fitch believes Petrobras' EBITDA could fall from an annualized rate of approximately USD27.9 billion for 1H15 to an annualized rate of USD23.5 billion for 2H15 at the current exchange rate of close to BRL4 per dollar and following the price increases.
Fitch believes the current price difference between domestic products and international markets is unsustainable in the long term and expects the differential to erode overtime, eliminating temporary trading gains. As a result, growing production remains strategic for Petrobras to have a strong balance sheet in the long term commensurate with an investment grade rating. Petrobras currently benefits from low international oil prices as it is a net importer. Fitch estimates that the company's current realization price for sale of liquid fuels after the recent price increase ranges between USD60/ barrels of oil equivalent (boe) and USD65/boe while WTI has ranged between USD45/bbl to USD50/bbl over the past few weeks.
CREDIT METRICS TO REMAIN WEAK
Fitch expects Petrobras' leverage, as measured by total debt-to-EBITDA, to remain above 5x over the medium term and for leverage to decline only if the company's divestiture program is successful. As of June 2015, the company reported total financial debt of approximately USD134 billion. As of year-end 2014, total proved reserves (1P) were approximately 13.1 billion boe and proved developed (PD) reserves were 8.4 billion boe. This translates into debt-to-proved reserves of USD10 per boe and debt-to-proved developed reserves of USD16 per boe. These metrics are also considered weak for the assigned rating.
GROWTH POTENTIAL WINDING DOWN
Petrobras production growth potential has been winding down over the past year as a result of the corruption scandal surrounding the company and forced reductions in capex from stagnant cash flow generation and low oil prices. Fitch's rating case assumes Petrobras' gross production to increase to approximately 3.1 million barrels of oil equivalent per day (boe/d) over the next two to three years and then to remain relatively flat over the ensuing two years. The company has revised its stated production targets downwards and the last business plan projected gross production to grow to 3.7 million boe/d in 2020, down from the expected 5.3 million boe/d for the same year under the previous business plan. Fitch expects the company to continue facing various challenges to achieve its targets on time, such as overcoming the impact the recent corruption scandal has had on its supply chain; complying with local content commitments; and obtaining external financing to roll over debt maturities.
During 1H15, Petrobras' production increased to approximately 2.8 million boe/d from approximately 2.6 million boe/d during 1H14 and was consistent with Fitch's expectations. Petrobras expects production to increase to approximately 2.9 million boe/d by next year as a result of the ramp-up of recent production platforms deliveries. The company enjoys a solid asset base reflected in proved oil and gas reserves of 13 billion boe under the U.S. Securities and Exchange Commission definition. In 2014, its three-year reserve replacement ratio (RRR) remained above 100% and its reserve life was approximately 15 years.
STRONG LIQUIDITY
Petrobras' strong liquidity provides some comfort in a temporary scenario of deteriorating credit metrics. As of June 2015, Petrobras maintained ample liquidity supported by approximately USD30 billion of cash and marketable securities. This liquidity compares with current finance debt of USD14.4 billion as of June 2015. The company's liquidity is also supported by its funds from operations (FFO), which is expected to be used to cover capex of approximately USD20 billion to USD25 billion per year. For the LTM ended June 2015, FFO amounted to USD22 billion. During 2015, Petrobras' FFO has benefitted relative to 2014's FFO as a result of the short-term benefits of declining global hydrocarbon prices, unlike other oil and gas producers that have suffered from the steep decrease in prices. As aforementioned, this benefit is not expected to be sustainable in the long term.
KEY ASSUMPTIONS
--Strong government support through access to financing
--Petrobras' production will continue to grow over the short term and potentially flatten over the medium term
--The company maintains a similar downstream pricing strategy as it has in the past and domestic prices converge with international prices in the medium- to long-term.
RATING SENSITIVITIES
A negative rating action could result from a downgrade of the sovereign and/or the perception of a lower linkage between Petrobras and the government.
A positive rating action on Brazil, could lead to a positive rating action on Petrobras.
Fitch has affirmed the following ratings:
Petroleo Brasileiro S.A. (Petrobras)
--Foreign currency IDR at 'BBB-'; Outlook Negative;
--Local currency IDR IDR at 'BBB-'; Outlook Negative;
--National long-term rating at 'AAA (bra)'. Outlook Negative;
--Long-term National Debentures at 'AAA (bra)'.
Petrobras International Finance Company (PIFCO)
--Foreign currency IDR at 'BBB-'; Outlook Negative;
--International debt issuance at 'BBB-'.
Petrobras Global Finance B.V. (PGF)
--Foreign currency IDR at 'BBB-'; Outlook Negative;
--International debt issuance at 'BBB-'.
Petrobras Argentina S.A.
--International debt issuance at 'BBB-'.
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