NEW YORK--(BUSINESS WIRE)--Recent scandals surrounding Petrobras' contracting practices could have a negative implication for the company's effectiveness in negotiating with equipment suppliers as its executives will likely exercise incremental caution when signing or amending contracts, according to Fitch Ratings. This issue will be most relevant for modifying specifications for floating, production, storage, and offloading (FPSOs) under construction, which could cause delays in deliveries and therefore affect long-term production growth. In the short term, recent significant production increases evidenced during 2014 will likely maintain momentum during 2015.
The Brazilian state-run energy company last week said it would not meet its Nov. 14 deadline for reporting 3Q14 earnings amid corruption allegations. The company has stated it plans to release unaudited results on Dec. 12. According to Bloomberg, PricewaterhouseCoopers last month said it would not sign off on earnings results and would alert U.S. authorities if appropriate action was not taken to probe the allegations. Some Petrobras' indentures include affirmative covenants that require the company to report unaudited quarterly financial statements within 90 days after the end of each interim fiscal quarter, excluding fourth quarter and audited financial statements for year end within 120 days after the end of each fiscal year. Failure to comply with this requirement will likely create issues for the company to access the debt capital markets, which the company relies on to fund a significant portion of its investments. Furthermore, the scandal exposed Petrobras' corporate governance weaknesses that failed to prevent its contracting practices.
We believe there are several factors that could affect production growth and most relate to execution risk. The main execution risk for increasing production relates to procuring key equipment including FPSOs, offshore drilling rigs, and pipe-laying support vessels (PLSVs). Petrobras' future credit profile relies heavily in the company's ability to grow production to bolster cash flow generation, reduce dependency on imports, and lower downstream cash losses.
Petrobras' credit quality will deteriorate if the ongoing corruption investigation results in monetary penalties or loss of assets. The company's capital structure and aggressive investment plan provides it little room to absorbs significant additional financial burdens and maintain its ratings at the current level. As of the last 12 months ended June 2014, Petrobras' leverage, as measured by total debt to EBITDA, was 5.4x, which is considered high for the rating category and above Fitch's negative rating sensitivity level of a sustained 5.0x.
Fitch incorporates in Petrobras' ratings a six months delay in FPSOs' commencement of operations; every additional six months delay reduces 2018 estimates by around 300,000 barrel of oil equivalent per day (boed). An average delay of 12 months or more in bringing new production units on-line could significantly weaken Petrobras' standalone credit quality and result in negative rating actions. As of the end of September 2014, the company had reported a 7.9% year-over-year growth in production to approximately 2.78 million boed from 2.58 million in 2013.
Additional information is available on www.fitchratings.com.
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