The hopes for Petrobras (ticker: PBR) investors and Brazil’s pro-business advocates were dashed on October 27, 2014, with the announcement of Dilma Rousseff winning a second term as the country’s president. The challenger, Aecio Neves, fell just short of unseating Rousseff, losing by roughly 3.2% of the vote. Many news outlets and energy analyst reports claimed a victory by Neves would be the best interest for Brazil’s economy. Potential beneficiaries of a Neves win would have included oil giant Petrobras, an $85 billion company, the largest in Brazil.
Rousseff’s History with Petrobras
Rousseff is credited with boosting income for Brazil’s lower class, but she has done so at the expense of the country’s economy. Petrobras has fared among the worst. PBR’s debt in its Q2’14 release was $140 billion – double the amount from year end-2010, when President Rouseff began her first term. A note from Raymond James on October 7, 2014, says PBR’s profits have also been constricted from the government’s fuel price policy, which requires PBR to sell fuel at a 10% to 15% discount to its citizens. At the current pace, the downstream segment is on track to lose $22.5 billion since 2013.
The ballooning debt and stagnant growth of PBR led to accusations of corruption earlier in the year. Conspiracies and rumors were popular talking points in the presidential debates leading up to the election, with Neves condemning his opponent’s handling of the massive oil company. Reports surfaced claiming Rousseff’s administration was receiving kickbacks from Petrobras to fund the re-election campaign. Other accusations included offshore workers receiving $139 million in bribes for a drilling contract and suspicious discrepancies in project costs. A refinery in northeast Brazil, originally estimated at a development cost of $2.7 billion, is now expected to run $17 billion. The biggest blunder was a $1.18 billion price tag for a refinery in Pasadena, California, which was nearly 28 times the amount the original owner paid.
The President spoke of narrowing the economic and political gap in her acceptance speech, saying she “wants to be a much better president than [she had] been until now.”
The left-leaning Rousseff has focused largely on limiting Brazil’s poverty divide in her first term. She expanded government welfare programs and ultimately lifted more than 40 million Brazilians from the poverty level, in a structure that has become known as the “Brazilian model.” Despite having the seventh-largest economy in the world, Brazil also has a huge divide in wealth; about 40% of the country’s 200 million households earn less than $700 per month.
Rousseff’s victory marks the fourth straight term for the Worker’s Party, which will have held the top seat in the Brazilian government for 16 years once Rousseff’s second term ends. She will not be up for re-election in 2018. However, the spread between her party and the opposition has narrowed. The win against Neves was much closer than many originally anticipated and Rousseff’s party lost seats in both houses of Congress, possibly complicating her future policies.
The repercussions from Rousseff’s victory were felt in the markets. Brazil’s equity index dropped as much as 6% before rallying to close at 2.5% below its opening price. Petrobras felt the brunt of the drop, with shares falling the most in six years and reaching its lowest value since March 2014. Shares of PBR were the world’s most volatile stock in the days leading up to the election, according to information from Bloomberg. The Brazil real fell to 2.52 per U.S. dollar, its lowest level since April 2005.
Analysts reflected the bearish effect of the incumbent’s victory. Fitch Ratings implied it could downgrade credit ratings in the wake of a Rousseff win, saying “Clearer signals of reduced state involvement in the private sector during her second term would be important to improving business confidence and reviving investments.”
Such an example is the government’s enforcement of lower fuel costs in order to relieve inflation, which increased to 6.75% in recent months. A note from Banco Santander SA, a Spain-based banking group, said PBR earnings will continue to be modest unless the government uses more sustainable fuel price increases.
Arthur Carvalho, an economist with Morgan Stanley, says Brazil will eventually reach a point where a radical decision on policy must be made. “If the administration avoids the hard choices, sovereign downgrades will arrive at some point over the next 18 months, creating a new set of challenges for Brazil,” he said.
Two more difficult long-term scenarios to consider; the price of Brent crude is dropping (Goldman Sachs placed its long-term Brent forecast at $90 today) and PBR’s largest projects are in expensive deepwater regions. Morgan Stanley believes costs for the deepwater activities may be as high as $75 to $100 per barrel, leaving PBR little room for profit, even without the government mandated discount.
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