Earnings Call Transcript - PBR Q1 2020

Operator, Operator

Good morning, ladies and gentlemen. Welcome to Petrobras Webcast with Analysts and Investors about the First Quarter of 2020. We would like to inform you that all participants will follow the transmission by Internet as listeners. After introduction, a Q&A session will begin. You can send us questions by email, [email protected]. Today with us is Roberto Castello Branco, Chief Financial Officer, André Barreto Chiarini, Chief Logistics Officer, Carlos Alberto Pereira de Oliveira, Chief Exploration and Production Officer, Chief Digital Transformation and Innovation Officer, Roberto Ardenghy, Chief Institutional Relations Officer, Rudimar Lorenzatto, Chief Production Development Officer, as well as other Company executives. The presentation will be available on our website. And now, we will start with Petrobras CEO. Roberto, please you can begin.

Roberto Castello Branco, CEO

Thank you, Carla. It’s a pleasure to be here with you to exchange some ideas and to disclose some information about the Company. The world is dealing with three shocks. On the one hand, we have the worst public health crisis since the Spanish flu, 100 years ago, and a very severe recession, very severe and synchronized recession. All lives and livelihoods are at risk. At Petrobras, our number one priority is health, the health of our employees and the health of our Company. To deal with the health threats, we launched several measures to protect our employees, including a massive testing. Up to today, we have tested 22.5% of all employees and are using home offices, reducing personnel operations to an average level of 50% of the total labor force at operations. In order to deal with the threats to our health, we are preserving our liquidity, have withdrawn revolving credit facilities, and increased our total cash holdings up to US$15.7 billion. We cut capital expenses by almost 30%, US$3.5 billion, and are pursuing a minimum reduction of our operating costs of $2 billion. We are developing several initiatives to do that. We organized a liquidity committee that interacts with all operational areas of the Company. They are the sentinels of our resilience and recovery, because we are now dealing with not only the short-term but also accelerating the execution of the strategy that was put in place back in January 2019 in order to emerge from this severe crisis as a strong company able to generate a lot of value for shareholders. I said that we are executing several deep cuts in capital expenditure and operating costs, but we are doing this with the preservation of the safety of the Company and our commitment to sustainability. Petrobras is executing its corporate citizenship, helping Brazilian society cope with the threats arising from the COVID-19 virus. We have donated PCR tests, 3 million liters of fuels, and several other medical materials to public hospitals. We’re helping with our scientists and high-power computers to develop research related to the COVID-19 problem. Our commitment to maximize value through the increase in return of capital employed and reduction of cost of capital remains in place. We are pursuing a full review of our product portfolio. The competition for capital was enhanced in order to have stronger capital discipline in a scenario of lower oil prices as we are seeing in the future. We believe that the recovery will be slow and the price will converge to a plateau of $50 per barrel in the future. So, we have to enhance capital discipline to allocate capital in the most efficient way. Results will be shown later. Our divestment program remains intact, business as usual. Of course, we may have some delays in execution. But, the main block of assets, the refineries, the process is going ahead with some delay, of course. But, we do expect that by year-end, we will have signed sales and purchase agreements with several players. Different from 2008, when we had a global financial crisis, now we have a global economic crisis. The central banks reacted very fast to inject liquidity into the market. So, liquidity is not a problem, which facilitates the divestment program. Well, having said that, I’ll say that we are confident that with the help of our professionals, highly committed to the Company when we need, and high-skilled people combined with world-class assets, we will survive this crisis. And after that, we’ll be even stronger than we are now. We are quickly learning the lessons offered by the crisis, and these will be applied for sure in the benefit of lower costs and higher efficiency and productivity. Now, I pass to Carla to manage the conference.

Operator, Operator

Thank you, Roberto. Now, we begin our Q&A session. The first question comes from Frank McGann with Bank of America Merrill Lynch. In refining, are there any issues with the mix of products being produced with demand and some remaining strong, and for this week, how do you adjust the production late? And the second question is, what’s the current expectation for crude oil output over the next few months in the remainder of the year? Anelise, would you like to start and then, Carlos?

Anelise Quintão Lara, Chief Officer

Yes. Thank you, Frank, for the questions. You’re right. We have some issues with the mix of products being introduced in our refineries in order to meet the difference in demand. That’s why we did some adjustments in the operational side of the refineries in order to deal with these issues. Let me give you an example. For instance, in the FCC unit, we can adjust for a certain percentage of production between gasoline and LPG. In this last week, we had an increase in LPG demand and a decrease in gasoline. So, we adjusted FCC units in all refineries in order to meet this demand. Another example concerns diesel and low fuel with low sulfur content. Sometimes we can reduce the production of diesel and increase the production of bunker low sulfur oil. This is not an easy task to do, but we can manage some of the processing at the refineries in order to use different catalysts and adjust temperature and pressure to address the difference in mix of products during this crisis.

Carlos Alberto Pereira de Oliveira, Chief Exploration and Production Officer

Hello. Regarding the expectations for crude oil output for this year and also for the next month, what we have been seeing is that production for April is still at the same level of the first quarter, a little bit less than that because of the effects of COVID-19 and the reduction of the demand for oil. However, we have been experiencing very good operational efficiency. We have reduced production due to the mothballing of the shallow water platforms and we may have some effects regarding the personnel on board, which sometimes affects platform efficiency. Nonetheless, we are still maintaining the same goal, the same target that we have for the year, namely, 2.7 million barrels of equivalent per day, plus or minus 2.5%. The current scenario presents a lot of uncertainties. It is difficult to forecast what’s going to happen. But, if we maintain the same partnership and the same efficiency that we have been achieving so far, we will keep the same goal for the year.

Operator, Operator

Thank you. Our next question comes from Rodolfo Angele from JP Morgan, regarding storage. One of the key concerns in the sector is related to the available spare capacity companies have. How is Petrobras’ current spare capacity? The second question is regarding Chinese demand and relevant export markets. We’ve been seeing some high-frequency data pointing to recovery in fuel demand there. With utilization rates for teapot refiners also increasing, how does that reflect on Chinese demand for your crude? Chiarini, would you like to start?

André Barreto Chiarini, Chief Logistics Officer

Yes. Thank you, Carla. I’ll start and then I’ll pass to Anelise to complement. So, Rodolfo, thank you for the question. I’ll start with our overall storage capacity. In addition to available storage on our FPSOs, the storage on vessels performing our offloading operations, which are in transit, and I’m not talking about any vessels hired by us for floating storage, we also have various terminals of our subsidiary Transpetro covering the country, totaling a relevant storage capacity. The nominal capacity of crude oil in our system is over 15 million cubic meters. Also, for fuel storage, we’re talking about 4.7 million cubic meters. Currently, inventory levels of both oil and fuels are under control, and we have enough spare capacity. Over the recent weeks, we have managed to reduce inventory levels of gasoline, which are currently within the range considered ideal for us. With regards to crude oil inventories, we are operating within their ideal range, and we are also monitoring both the adequate load at refineries and export volumes to operate at the lower level of such ideal range by the end of June. We have recently revised down what historically were our ideal levels of crude oil inventories so that we can generate even more cash during this crisis. We are confident that if necessary, we will have the logistics boarding capacity to set even higher records in crude oil exports, at least a 10% increase over the 1 million barrels per day record set in April. Our commercial team has been developing a long-term relationship with Shandong refineries in China where our oil has strong demand, even during the crisis because crude oils from Lula, Iracema, Sapinhoa, and Buzios fields have characteristics similar to specific Chinese oils that are experiencing a decline in production. As we’re starting to see a slow recovery in our domestic market and as we have been able to adjust the fleet and product mix of our refineries to increase production of diesel fuel oil and bunker oil, we will likely have increased export volumes of those higher value-added products, thus reducing oil exports, not due to demand or logistics constraints, but to generate higher margins. We are not foreseeing oil production cuts due to demand constraints in the short term, and we are not facing any storage capacity problems in the near term.

Anelise Quintão Lara, Chief Officer

Just a quick remark on what André said is that we don’t see any issues regarding the demand for our crude oil, especially in China. I mean, if we have more oil to export, we will be able to find a market for that. The main issue is the economics. Of course, we prefer to process this oil here in Brazil and sell it in our domestic market because of the higher margins. But, what we see now is that the demand for fuel in China is ramping up very fast, and they are eager to buy more oil from us.

Operator, Operator

The next question comes from Bruno Montanari with Morgan Stanley. As we are now some two months into the crisis, can you comment on key lessons learned, and how those might contribute to Petrobras emerging from this situation even stronger? Has the crisis accelerated any measures that we’re considering to be implemented to make the Company more efficient? And the second question, as the Company materially increases exports in an oversupplied oil market with higher transportation costs, how does the netback of exports compare with the netback of sales on the domestic market for refineries? Roberto, would you like to start?

Roberto Castello Branco, CEO

Yes. I’ll respond to the first question. Thank you, Bruno, for the question. Well, first of all, we learned the most obvious lessons. We will be able in the future to reduce travel expenses. There’s no need for many travels. Home office is being very successful. We have adapted well to home office. So, in the post-COVID-19 period, we see it as very feasible to have 50% of our personnel in corporate activities working from home. That would save costs and allow us to close several buildings, providing us with significant savings. We also learned that home office has been very productive. We have worked very intensely in this mode. Another lesson learned during the crisis is that teamwork was reinforced with an integration of corporate and business areas, which has been great. Several ideas have been raised to cut costs and increase efficiency. This integration has been highly productive for us. This is a shortlist of lessons learned. Another lesson was shown in the increase of exports, particularly in April, when we reached an all-time high level for crude oil exports. This was made possible due to the stronger integration between logistics and marketing. We are acquiring much more flexibility with domestic and national markets. This includes not only logistics and marketing but also refining and oil production. The integration of these areas added much more efficiency, and we’ve been able to discover new horizons in our ability to market and sell oil and fuels. I believe this will have significant potential to contribute to value generation over time. Every crisis has two sides, a negative one and a positive one. We think we are enjoying good lessons and extracting benefits from the positive side of the crisis. I will pass now to Anelise.

Anelise Quintão Lara, Chief Officer

Yes. Hi, Bruno. Just a quick comment on your question about the netbacks of exports compared with the netbacks of sales to our domestic refineries. Of course, the netbacks of our domestic sales are higher than the netback of our export. But, it has been like that since 2016 when Petrobras adopted import parity prices for gasoline and diesel. It is an important pillar of our strategy to keep our Company healthy. Keeping that, having import parity prices for our products in Brazil, we secure better netbacks for margins. This approach also holds during this crisis when the import parity prices decreased. Some people were skeptical that we would follow this reduction in price, but we did. In the first quarter, you see a reduction in gasoline and diesel in Brazil around 60%. Not all this price reduction went to our vendors, but from Petrobras refineries, we enacted significant reductions in both gasoline and diesel, adhering to the import parity price.

Operator, Operator

The next question comes from Luiz Carvalho regarding our pricing policy. So, oil dropped almost 70%, and Petrobras was able to pass through refineries close to 50%. However, pump prices dropped only 10%. Additionally, foreign exchange rates depreciated significantly recently. The question is, how much of a challenge will it be to follow oil prices rebound and foreign exchange valuation?

Roberto Castello Branco, CEO

Well, Luiz, it’s a frequent question. One of the most frequently asked questions. Experience tells investors and analysts that we are following international prices. We have no problem in doing so. Of course, during a period -- we are an oil producer, not an oil trading company. If we follow international prices at every moment, we’d have to put someone in front of a Bloomberg screen adjusting prices instantly. There’s no purpose in that. Our pricing policy is to adjust to international prices after observing trends. It’s much more than just having a clock to adjust every minute. During the severe drop in fuel prices, we are not driven solely by oil prices, but also by fuel prices due to their crack spread, which can be highly positive or negative. In a downward trend, we tend to have prices higher than international prices for some days; conversely, in an upward trend, we tend to have our prices lower than international prices for some days. But we follow them. You will see an upward trend in gasoline prices taking place since April 22, and we have made two price increases, one of 12% and another of 10%. If another price increase is needed, we will go ahead with that. There is no problem at all.

Operator, Operator

Our next question comes from Pedro Medeiros with Citi. Can you give more color on costs and expenses savings expectations for 2020? That’s the first question. Andrea, please? And then, Petrobras has been successfully narrowing the selling discounts of oil exports relative to the Brent in the last quarters. Can you discuss how the selling spread of Brazil oil exports behaved relatively to the Brent throughout the second quarter?

Andrea Almeida, Chief Financial Officer

Hello, Pedro, thanks for the question. We announced an additional $2 billion reduction in operating expenses. This is not everything we’re doing, but it’s what we are able to announce at this time. This includes various items such as the mothballing of the drilling rigs and the postponement of contracts where we are negotiating to postpone some payments. We started discussions on postponing payments and we will return to the table for a review of our portfolio. We will focus on negotiating with major suppliers. After reviewing the overall portfolio, we might identify further opportunities for cost reductions related to some of our contracts. We continue to seek adjustments in our health system and overall structure to reduce personnel costs. We will be implementing additional measures. But up to now, we have the overall figure embedded in the additional $2 billion that we announced.

Anelise Quintão Lara, Chief Officer

Regarding the second question, Pedro, you are right; we are selling our oil relative to Brent at good margins next quarter. However, this margin has been reduced. In the first quarter, it was lower than in the last quarter of 2019 because of the volatility of oil prices in the market, which also affects our oil premium. The surplus of oil in the market is also a concern. In my opinion, you will see the same behavior in the second quarter, with high volatility of oil prices impacting our margins, but still maintaining positive margins, especially because of the quality of our oil.

Roberto Castello Branco, CEO

Just a brief remark related to what Andrea said; our CapEx cuts for 2020 will not affect the start-up of the production system in the short term.

Operator, Operator

Thank you. We just received a question from Christian Audi with Santander. You had originally planned to reduce production by 200,000 barrels a day. But given the rise in export demand, should we understand that the original 200K cut will no longer be needed? Chiarini, would you like to start? We also have another question from Christian Audi to Andrea. Could you please comment on the hedge accounting for the exports contracted for April to December? What level of exports are already contracted for this period and what products are involved?

André Barreto Chiarini, Chief Logistics Officer

Okay. Thank you, Carla. Yes. We do not expect to have further cuts due to demand constraints in oil production. We are experiencing a very volatile and complex market dynamic these days. Our teams are continuously monitoring and reassessing production levels and domestic sales to define our export targets, which can vary over time. But, we are not expecting oil production cuts due to demand constraints in the short term.

Andrea Almeida, Chief Financial Officer

Regarding hedge accounting, it’s important to note that we had an impact on our results connected to hedge accounts. To explain briefly, we do have hedge accounting in relation to future exports that are hedged against our U.S. dollar debt. Whenever we have a significant price reduction, like we had recently, the forecast of the value of our future exports will be reduced. Therefore, we will have a larger export value protecting our debt in U.S. dollars. What we use to forecast exports includes leveraging past experiences to show that we will have volumes along with the adjusted prices for the overall portfolio. We expect exports to continue the way we have seen. Again, as China has been a crucial market, after seeing higher exports as demand increased, but we cannot force forecasts. We must rely on historical data.

Operator, Operator

Thank you. Our next question comes from André Hachem with Itau. In the last crisis, Petrobras took the opportunity to review several contracts. However, when looking at the current status of suppliers in the industry today, as an example, rig services, many of them have not yet recovered from the last crisis. In this regard, is there still room for further contract revisions? Is there anything that can be done regarding FPSO leases? Rudimar, would you like to start?

Rudimar Lorenzatto, Chief Production Development Officer

Yes. André, Petrobras' procurement area along with technical teams is currently negotiating with suppliers. We have made progress in some areas and are planning new methods for negotiations to adapt current contracts to the new market conditions we are encountering. Rigs and leased FPSOs are considered strategic services, and we are studying in detail to define new objectives and negotiation strategies.

Operator, Operator

Thank you. Our next question comes from Bruno Amorim with Goldman Sachs. What’s the current level of utilization of the Petrobras storage facility, both oil and fuel? Is utilization still going up, or has it started to fall, given the recent pickup in demand in oil prices? There is also a second question. Given the strong depreciation of the BRL, can you please remind us of the impact of the 10% depreciation of the BRL on your upstream EBITDA per barrel in U.S. terms, all else equal? So, maybe Chiarini, would you like to start with the storage capacity?

André Barreto Chiarini, Chief Logistics Officer

As I mentioned before, inventory levels of both oil and fuels are under control. We have enough spare space, and we’ve been adjusting production to meet internal market and export demands appropriately. We don’t see any issues regarding storage in the near term. In fact, inventory levels have been decreasing; gasoline inventory levels have been declining over the last weeks, and oil inventory levels are also going down, especially by the end of June. But they remain perfectly under control, and there are no concerns regarding that at this time.

Andrea Almeida, Chief Financial Officer

Following up on the impact of the real-dollar on our EBITDA, after the adjustments we made, we have around $200 million positive impact on EBITDA resulting from a change in the real-dollar exchange rate. We expect that further depreciation of the real, which we have observed, will continue to positively impact our results in the next quarter.

Operator, Operator

The next question comes from Lilyanna Yang with HSBC. Please give us some color on demand for fuel, gasoline, diesel in April and May. Is demand in Brazil recovering fast? Any estimates for the second quarter, third quarter, and fourth quarter in terms of demand? Please, Anelise, go ahead.

Anelise Quintão Lara, Chief Officer

Hi, Lilyanna. In terms of demand for fuels, we saw a significant impact in the first weeks of April, with diesel down around 50%, gasoline down 65%, and jet fuel down 90%. Now in May, we are observing a recovery, especially in gasoline but also diesel is improving, as well as other products. Our main concern is jet fuel; we don’t believe that it could recover as quickly due to restrictions on international flights worldwide, not just in Brazil. This will likely affect jet fuel demand throughout the year. However, diesel, gasoline, naphtha, and other oil products are showing signs of near-complete recovery by the third and fourth quarters.

Operator, Operator

Thank you. Our next question comes from Vicente Falanga with Bradesco. How are the conversations with local groups about the sale of refineries going? With the exchange rates at six, does this impact the transactions? Anelise, would you like to start?

Anelise Quintão Lara, Chief Officer

We are talking with different players interested in our refineries, both local and international ones. The interest continues, and we don’t see any indication from players that they will back out. This is a positive sign. We may need to postpone the binding offers because of the crisis, but we hope that by the third or fourth quarter of this year, we could have the binding offers presented so we can proceed with negotiations with the first player and sign a contract in the first quarter of 2021.

Operator, Operator

Thank you, Anelise. Now, it’s our last question. Our last question comes from Barbara Halberstadt with JP Morgan. This is for Andrea. What’s the plan regarding the debt level in your liability management plans for the year? Is there any risk of covenant breaches?

Andrea Almeida, Chief Financial Officer

Thanks for the question. Regarding the debt level, we announced our goal for the year to end with $87 billion of total debt. If we can do better, we will look for ways to improve. This is our target for the year. In the medium and long term, we maintain the $60 billion debt level that we believe Petrobras should sustain to be prepared for market volatility, including the scenario we are experiencing right now. Regarding liability management, we will be looking for opportunities—this is always the case. Our current focus is on liquidity, but if opportunities arise in the market to extend debt terms and roll some of the debt, we will pursue those opportunities. As for covenants, we only have debt with MBS that comes with a financial covenant. The net debt to EBITDA ratio is 5.5, and we don’t believe we are going to reach that point. However, we have all documents ready to ask for a waiver if necessary.

Operator, Operator

Thank you, all. At this time, our Q&A session is over. If you have any further questions, please send us an email to our Investor Relations team. And now, Roberto will make his final remarks. Please, Roberto, go ahead.

Roberto Castello Branco, CEO

Thank you, Carla. I’d like to thank you for your interest and attention during our video conference. As I said before, we are very confident in the survival and emergence of Petrobras as a stronger Company. During a crisis, courage and optimism are key. Our main allies in this process are highly committed, highly skilled people. Combining this with our world-class assets, I’m sure that Petrobras will continue to generate significant value for shareholders. Thank you. I hope to see you all soon in another opportunity.

Operator, Operator

Thank you. Ladies and gentlemen, the audio of this webcast will be available on the Petrobras website. Thank you very much for your interest, and have a great day.

Roberto Castello Branco, CEO

Stay safe.