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Morningstar | Petrobras Appears to Have Righted the Ship with Production Set to Grow and Debt Levels to Fall

Petrobras appears to have righted the ship and is now sailing in the right direction. Ultimately, it aims to arrive in stronger financial shape with a much smaller debt load through a combination of lower capital expenditures, reduced operating expenses, growth in production, and divestments.By reducing spending in areas that have proved to be value-destructive, such as refining, Petrobras has reduced its capital spending to about $17 billion per year ($84.1 billion, 2019-23). This is a fraction of the $45 billion Petrobras was spending before 2014, meaning it can deliver free cash flow at much lower oil prices. In fact, Petrobras has now generated free cash flow for 16 consecutive quarters.Despite the reduced spending, cost improvements along with industry deflation mean Petrobras won’t be sacrificing growth, but will be doing more with less. Efficiency gains in the presalt reservoirs have shortened well construction times while reducing the number of wells needed to fill FPSO capacity.Beginning this year, Petrobras expects to increase domestic oil production at a 5% CAGR through 2023. While the company has a long track record of missing production growth targets, there is a clear line of sight on new project startups during the next five years that gives us some confidence the target can be met. With growing production, earnings and cash flow should improve, as cost reductions and the addition of low-cost presalt volumes could lower portfolio operating cost to $10/barrel through 2021.Although the government hasn't ceased intervention, revisions to domestic product pricing will ensure closer tracking of international prices and avoid the large losses of the past, when government-controlled prices meant Petrobras subsidized the domestic market when oil prices were high. The new system will likely prevent the large profits realized when oil prices fell, but will bring more stability to the segment. The culmination of these efforts, along with a $27 billion divestment plan by 2023, is to reduce debt to below 1.5 times EBITDA by year-end 2020. We think Petrobras is on the right track, and that this target is achievable.