Petrobras: Government Mandated Operation Model is a Misfit

Government mandate to operate all pre-salt fields is model at odds with Petrobras’ stakeholders’ interests, including those of government.

Petrobras is a Brazilian integrated oil and gas company.  It is failing to accomplish its objectives because of a mismatch between the company’s operational and business models.  The factors that drive this mismatch aPetrobras Stock vs IBOVre the company’s history and ownership structure. Petrobras as it is shaped today today is largely the result of the monopoly status it held in Brazil that lasted from the company’s founding in 1953 to 1997 (Wikipedia, 2015).  Today, the Brazilian government owns 50.3% of shares in the company and controls the board (Petrobras, 2015).  Although these elements have provided the company with a dominant position in the local petroleum sector, near-free access to rich petroleum reserves, and the opportunity to achieve many technological firsts, the company has struggled to produce results that match those of its peers. As a result, since 2012 the company has underperformed the local IBOV market index by 30% in addition to the company hugely missing its own production targets.

BUSINESS MODEL

A business model is defined by the relationship the organization has with its stakeholders.  Petrobras has adopted a business model that is a hybrid between a national oil company and a private oil company in that it serves both the interests of the Brazilian government and its private shareholders. On one hand, the company explores, develops, refines, and markets petroleum and petroleum distillates for profit while on the other hand using profits to subsidize fuel costs to the Brazilian public, as part of a government program to combat inflation (The Economist, 2012).   Although sometimes in agreement, the mismatch between the interests of these two important stakeholders for Petrobras results in frequent misalignment between its business model and its operation model.  As a result of this mismatch (mainly due to the subsidies and huge capital investments in pre-salt field development), Petrobras’ net debt has soared since 2005 and currently stands at six times EBITDA and 0.63 of its total enterprise value (CapitalIQ, 2015).  In response, Petrobras’ management announced plans in 2015 to cut capital investments by 37% and unlock about $60Bn of capital though asset divestments and businesses restructuring in the next two years (Petrobras, 2015).

 

OPERATION MODEL

An operation model is the offshoot of the business model that defines the processes a company puts in place to service the interests of its stakeholders. Given the size of Petrobras, in this post, I will focus on only one aspect of the operation model that is incongruent with Petrobras’ business model described above.

The discovery of Brazil’s pre-salt is one of the most remarkable success stories of the last decade.  A whopping 30% of all liquid petroleum resources discovered in the world in the last 10 years has been in the Brazilian pre-salt (WoodMackenzie, 2015). In hopes of capturing as much of this opportunity for itself as possible, the Brazilian government enacted legislation in 2010 forcing Petrobras to operate all fields that lie in a zone delineated as the pre-sal area  (map) going forward. By legal definition, that also means that Petrobras must take a 30% working interest stake in every field it operates (WoodMackenzie, 2015).  This legislation, which is a direct manipulation of the company’s operation model, has impeded the company’s ability to carry out its business model in the following two ways:

First, forcing Petrobras to operate and take a stake in all pre-salt fields means the company will be involved in deals despite having bid on them or not meaning it cannot enforce disciplined ROI controls that are required by its private investors.  Also, the company is unable to accurately forecast its own capital needs and is at risk of becoming involved in deals it had no part in negotiating.  Given the company’s increasingly dire leverage situation, Petrobras has aggressively lobbied the government against issuing any new licenses (and repealing thPetrobras Production Targetse 2010 legislation) in the Brazilian pre-salt area out of fear it will become involved in deals it cannot afford.

Second, by forcibly involving Petrobras in all pre-salt field exploration and developments, the Brazilian government has handed Petrobras a monopoly over the development of pre-salt development technology.  International oil companies have responded with a diminished interest in
Brazilian E&P, given they will not be able to operate the fields they invest in.  As a result, Petrobras has become increasingly overwhelmed by the responsibility of meeting the governments national oil production targets, which, importantly, is correlated to the amount of subsidies Petrobras has to provide.   Consequently, Petrobras has struggled to handle the amount of projects on its plate and has repeatedly, almost predictably, fallen very short of every one of its production targets since 2010 (WoodMackenzie, 2015).

 

Works Cited

CapitalIQ. (2015, 12 7). Petróleo Brasileiro S.A. – Petrobras (BOVESPA:PETR4). Retrieved 12 7, 2015, from CapitalIQ: https://www.capitaliq.com/CIQDotNet/Financial/KeyStats.aspx?CompanyId=409268&fromSearchProfiles=true

Petrobras. (2015, June 29). Business and Management Plan 2015-2019. Retrieved December 7, 2015, from Petrobras Investor Relations: http://www.investidorpetrobras.com.br/en/presentations/business-management-plan

Petrobras. (2015, 12). Petrobras Capital Ownership Composition. Retrieved 12 1, 2015, from Petrobras: http://www.investidorpetrobras.com.br/en/corporate-governance/capital-ownership

The Economist. (2012, 11 17). The perils of Petrobras.

Wikipedia. (2015, 12 7). Petrobras. Retrieved 12 7, 2015, from Wikipedia: https://en.wikipedia.org/wiki/Petrobras

WoodMackenzie. (2015). Pragmatism in Brazil could reveal pre-salt opportunities. WoodMackenzie. WoodMackenzie.

WoodMackenzie. (2015). The Technical and Infrastructural Challenges of Developing Brazi’s Pre-salt. WoodMackenzie.

 

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3 thoughts on “Petrobras: Government Mandated Operation Model is a Misfit

  1. Nice article Anas.
    Clearly shows how Government interventions which are not aligned with the long term goals of the country’s standing in an industry, can hamper rather than develop the industry.
    Providing a monopoly to Pterobras would also diminish newer and advanced technologies from being used, this would have been the case if the competitive landscape would have been maintained. Ultimately this lack of competitiveness in extracting and distributing this huge resource, due to the policies, will impact the price of the oil and ultimately the consumer.
    In addition instead of this being a joint venture, mandating actions for the venture by the Government does not allow the company to meet its business goals of providing returns to all its share holders.

  2. Wow Anas this was so interesting. I always knew them as giants in the industry but had no idea that the government had such a strong influence on them. The policy sounds pretty extreme… I wonder how much say Petrobras management and the other shareholders had when the legislation was first enforced in 2010?

  3. Anas, thanks for an article of an inefficient model, without alignment of operational and business models. Government involvement can drive projects that are initially NPV negative, but are better for long-term growth and national success/power. However, involvement can also create inefficient monopolies and a system of throwing good money after bad as you have shown. I draw parallels to the US alternative energy subsidies, driving long-term benefit through supporting projects that may never be NPV positive or NPV negative for a long time, longer than the life of the company if it functioned non-subsidized. This will be an interesting case to see how it plays out. Thanks again for the article!

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