Petróleo Brasileiro S.A. - Petrobras (PBR) Q2 2007 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Petrobras Presentation and Conference Call to discuss the 2007 Strategic Plan and Business Plan and the Second Quarter 2007 Results. At this time at the conference call, all lines are in listen-only mode. Later, there will be a question and answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded. Today with us we have José Sergio Gabrielli, CEO; Mr. Almir Guilherme Barbassa, CFO and IR Officer and Mr. Celso Lucchesi, Strategy Management Director. As always, other Petrobras representatives are here. We have a simultaneous webcast on the Internet that could be accessed at the site www.petrobras.com.br/ir/english. Additionally, on the webcast registration screen, you may download and print the presentation and download the financial market reports. Also, you can send your questions to us by Internet, click on the icon "Question to the Host" anytime during this event. Before proceeding, let me mention that the forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of Petrobras management and on information currently available to the company. They involve risks, uncertainties and assumptions because they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Petrobras and could cause results to differ materially from those expressed in such forward-looking statements. Finally, let me mention that this conference call will discuss Petrobras' results prepared in accordance with Brazilian GAAP. At this moment, we are unable to discuss any issues related to U.S. GAAP results. The conference call and the presentation first will be conducted by CFO and Investor Relation Officer, Mr. Almir Barbassa. He will comment on company's operating and financial highlights and the main events during the second quarter 2007. Following that, our CEO, Mr. Gabrielli will comment upon 2020 Strategic Plan. Afterwards, we will be available for answers and any questions you may have. Mr. Barbassa, may you begin please.

Good morning ladies and gentlemen. It's our pleasure to be here with you once more to discuss the second quarter results. To start with, we have here P-52 that shall be come on stream by October this year the first oil and we'll grow in production up to the 108,000 barrels of oil per day capacity. I will give you one minute to read this disclaimer. And let's go for the results. The production, the domestic oil production, was pretty much stable between the first and second quarter of this year. We have some new, some platforms recently installed like P-34 and FPSO Capixaba and FPSO Rio de Janeiro that has a production increase, but at the same time we have some maintenance in a few platforms that kept the average production of the quarter, the second quarter little smaller than the first one. But what's important here is that in June we had a higher production when compared with May. So it seems that we are in a good trend. The oil prices for E&P was very positive in the second quarter and this is going to be one of the reasons to explain the good results we have in the quarter. The refining in Brazil performed very well. We kept the utilization of the capacity we have in Brazil, we kept about the same level we have been using the domestic oil in the volume process in Brazil. What's important here is the sales volume. We have increased in this quarter very significantly when compared with the first quarter and we had the best... better quarter than last year as well. This was mainly due to the high season demand. We had a very big season crop in Brazil and lots of diesel were used, and the economy…

[Operator Instructions]. Let me check if someone has a question here in the audience. First there.

On the reserves, do you guys foresee it necessary to support those production targets in 2012 and 2015? Now the second one is regarding debt. You said that --

Could you repeat please?

Sure. The question was regarding the production targets, what amount of crude reserves do you guys foresee to be necessary to support the 2012 and 2015 targets? The second one was regarding the incremental debt load about 8 billion, how much... how do you guys see that being loaded from now to 2012 what's the curve, and with that is the if you guys are looking to extend the maturity of your average life of your debt, thank you. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: I'm going to leave the debt question to our CFO, and I would talk a little bit about production and proven reserves. Our proven reserves production ratio is around 19 years. We are going to increase our production from the current 2.3 to 3.5 in 2012 and 4.5 in 2015. Our plan is to have a internal recovery rates... how to call it... replacement rate, the replacement ratio about one, which means that we are going to increase our reserves in the minimal and the same amount that we have produced until 2015. And we are probably, this is not our target, but this is our projection that we are going to be above 15 years of the reserve production ratio by 2018.

Regarding the financing of the extra $8 billion of cash, we are going to leave it to finance this plan. Petrobras has a long experience to access every different market. And but as we got the investment grade rating the capital market becomes more accessible and a deeper pocket. So, these maybe the main source but would not be for sure the only source. Month long [ph], sometime is more competitive, this is... there are situation as we buy lots of large very expensive products we may get special conditions for ECA financing. DNBS in Brazil is a good source, we saw very competitive price, so we have really very many different opportunities here. Probably the capital market is going to be the one that would be... can have the chance to present the largest growth in the set of sources we have.

Another question here.

Gabrielli, Christian Audi with Santander. A couple of questions, going back to the point of return on capital employed, you made the point that the drop from 14 to 16 part of it was your cost of capital has gone down, part of it is we have cost going up. I was wondering because that's a recurring question among investors your ability to maintain returns. So, can you talk a little bit more, elaborate a bit more in terms of... we have seen the drop here but is the trend one that should we expect a continuing downward trend or given the nature of the projects we have that maybe we don't yet see because they go beyond 2015 should we maybe expect a turnaround, but any color... additional color that you could, because I think it would be very helpful? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: As you know, if you get production color for any type of oil and gas, we are going to have a kind of hunt, of course, we will reach a peak and then go down. If you get our investment plan, they have the same type of shape, the same shape. We have investments that goes up and then reduce. When you calculate the return on capital employed, we have a cut at the end of the day. And we have these cuts sometimes in each... in some of the products in the peak of the investment without getting any results. The average time between the first indication that you have some volume and the first oil, the average time is eight years. Eight years. Which means that we have, on average, an investment period without return for eight years for big oil prices. When you take, on top of that, cost increases, the capital and the investment during these periods of great event and their path, is going up is growing. A reduce... increasing the capital without the return. Third, when you take in some of the investment that we are making is on infrastructure for your production. The result will come in 15 years. Pipeline, big transportation systems of our production areas, drilling rigs that we are buying that is going to be operating for 10 to 15 years. They are going to have the impact on our return after 2012. And our return on capital employed is calculated as an accounting measure from '08 to '12. I think that's the main reason why we have this reduction.

And so just as a follow-up, so, what's the future? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes the future. It is very hard to make an assumption about the future after 2012. As you know, we are putting targets for 2012 and forecasts for 2015. It's difficult to calculate after 2012, it is not those numbers because they are going to depend sometimes on exploratory factors, they are going to depend on the integration of the portfolio of infrastructure and production. There is some delay that we may have in the integration of the different parts of the change mainly on natural gas because natural gas necessarily you have to look at the change from the well to the market and the visibility of something after 2012, today it is not as much as we have until 2012. That's the point that we cannot have these calculations.

And just a second question, cost increases continue to put pressure in oil companies, as we've seen here it is also impacting you, can you talk in general terms, do you expect this trend it has been the case in the past five years to continue non-stop, are we reaching a point that maybe plateau, not grow as much as in the past or now should we expect the continuing cost pressures to go on? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Until two to three years ago what we saw in the past was that the increase in the cost of the supply chain would follow the increase in price of oil with two years delay. We had an increase in price of oil two years later you get the impact on the supply chain. In the last three years these delay is collapsing. Right now it's almost at the same time, it is almost contemporary. The increase in price of oil will immediately go through the supply chain. However, in some of the products, we start to see some indications that the capacity is growing and we are maybe finding in some of those products reaching the peak price and we are going to stay plateau of high price during certain time until the production would increase and then we are going to see some price reductions. But we don't forecast these right now. But we think... we don't think that is going to be forever the increase in cost. That's for sure... transfer a part of all your income from the oil companies to the suppliers.

And now we have a question from the telephone from conference call [ph].

Thank you. That question is coming from Frank McGann of Merrill Lynch. Please go ahead.

Yes, good morning. Just a question on the international side. I was wondering if you could give a little bit more color as to the drop. I assume it's because there is less coming not only from Venezuela, but perhaps an acquisition that was built into the prior numbers, but perhaps you could just give a little bit of color on that. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: On international production, first, we change some of our policies that rather than trying to get some of our reserves through acquisition, we are relying much more now on these plans on actual productivity internationally. Second, we have a change in the structure of the business in Venezuela that right now we have a mixed company in which we are shareholder and we receive dividend from this company... those companies and not... we don't share production; we get dividend. And this affects our production. And third, we have some movement on time of some of our production no longer due. The increased investment is a result of mainly from the idea that we are renting drilling rigs, two drilling rigs for our international activity. I think two, one from Columbia is back in Columbia, the other one in Gulf of Mexico, United States of America.

Okay. [Operator Instructions]. Let me check within the audience. Yes, we have another one.

I think you want to [indiscernible]. Just a question on given that you are increasing your investments in the natural gas segment, can you comment on your pricing policy here, given let's say for the thermoelectric since they don't have fixed volumes, will you charge higher prices here and do you maintain your view that natural gas prices should be aligned to fuel oil prices? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes, we have... we are trying to introduce in the natural gas market in Brazil several types of different types of contracts to allow for the flexibility in the Brazilian natural gas market. We are offering different prices for different contracts. We don't have a general pricing quality. We discuss contract by contract with each one of our purchaser. The idea is to have contracts that are firm commitments that we have to provide a certain amount of natural gas and these are going to have one price. The other type of contract is the one that we may supply certain quantity of natural gas or we may supply the alternative fuel. This is going to have a different price. The third type of contract is that we may supply or not the natural gas, and the third one is the spot market. That's the smaller one. Each one of those have different ID, different types of price. Also, we are trying to put an idea that we have in the price of gas two different components. One is the return for the infrastructure, which is fixed, pipeline and so on. The other part is the price of the molecule that should be linked to the alternative fuel. That may be fuel oil, may be diesel, may be water. This is natural gas. In the electric power generation market, it's different. In the Brazilian system, you have auction for the supply of energy for the next 2, next 3, next 5 years. There is an auction that the distributors buy energy from the generators, and we had already sold in those auctions around 2000 megawatts and also we have what is called the free market for energy that is going to be when we have access to supply our excess demand, the ones, the consumers, the big consumers that don't have a contract, they can go to this market and then the price is going to be decided. We actually don't have really one pricing policy for natural gas and energy because the market is very complex.

Hi, this is Mark McCarthy from Bear Stearns. Just following up on Frank's question, you discussed the reasons for the changes to the international targets, but they are staggering, right? They are a 30% drop from what you were working with before. I am assuming that there is an error in the table that was presented of about 230,000 barrels a day. But even with that, the drop in 2015 is 320,000 barrels a day. That's 30% or something like that. So most notably, I mean if you are now... are you not considering Venezuela? Have you pushed out the exploration success in Angola? Can you specifically address that's not... that's something material. The other question that I had is every strategic plan has some blend of cost increases and new projects. It seems to me that each new strategic plan has come with less and less detail. This strategic plan came out with no divisional breakdown of where the new projects or what really the new projects are. Can you tell us within upstream, which is 50% of the spending, what is new and can you tell us how much of the $13 billion or so of CapEx growth is attributable to that. And I know we have Celso here who is... if you are the architect, he is the engineer. If we could maybe hear from him on some of the specific numbers.

Mark, first I think the numbers really not reach to 285, but then we... I don't know exactly number, but Angola, for example, is one very clear example. Angola, for example, is a very clear case that what I was talking about. We are increasing our investment in Angola, but we are not expecting any results in the next five years because we have in exploration here.

[Question Inaudible]

No, no, no. We never had... production, we never had... 1 million, we have 500 something.

[Question Inaudible]

Oil equivalent, the oil equivalent. Okay.

[Question Inaudible]

Yes, that's true.

[Question Inaudible]

Yes, I know I cannot give you the details of the notes, because I don't have it right now. But what I know in general trend is that we have really an increased investment in exploration international. Angola is one big example of that. Our investment in Angola are going to increase a lot, but the results are going to come on stream maybe next five years, not less than that. Our investment in Nigeria is going to... in Nigeria, you have pretty much... we are not operators. We have to follow the operators. The cost overruns [ph] are really amazing in Nigeria, much more than anywhere else.

[Question Inaudible].

No, it's not a cost to recover, because we have participation.

[Question Inaudible]. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: No, no, no, Kabul is there. Kabul was 100,000 barrels a day. That's it. Linked to the refinery. There is no big deal in Kabul.

[Question Inaudible]. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: It's not Kabul that's the problem. The problem mainly is that we had 65% of our production in Venezuela as out of our production, because right now the consequently in Venezuela is that we have a dividend policy, not anymore the production. The investment increased, and the productions really declined, and we have also not relied any acquisition of reserves, proven reserves. We are moving our investments in our international in exploratory rigs which means that we may have nothing. But we have to rely in our knowledge.

It doesn't make a whole lot of sense to me, to be honest with you. You have 200,000 barrels a day within the next five years that's out of the plan? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: We can't now to give you the numbers right now. I don't have the number in my mind... on top of my mind.

I don't know, Celso, if you have any thoughts about this. If you can shed some light?

They are levitated, at this blue number.

The green one is wrong, right, it's 55.12... 515...

It's 515.

Right. Which is down from 740 before. So that's... the drop is 30% [Multiple Speakers]. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Certainly, there the drop is big and I think the main reason is, the delay, the changing in time and the Venezuela situation, that's what I am assuming. I don't have the numbers right; I don't have it on top of my mind. Unless, because it has... [indiscernible] [Multiple Speakers].

And just following up on which new projects have been added to E&P and how much of the $13 million goes to it? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Rigs exploration. Exploration and what we call recash [ph], which is enhanced operational recovery.

And of the $13 billion how much is attributable to it, so you have no new projects? You have higher spending... higher exploratory spending. The additional project in exploration? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: It really the exploration is not aboard in different countries at Turkey, Angola, United States then several countries in Latin America. In Brazil there are much more aggressive campaigns to... for result and see what the digest rate has trapped the concessions we have in Brazil. That's the growth and also the cost of the exploration especially training is reflected also in these numbers. Exploration is --

So exploration is now defined as a new project? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes. That always was new project? New exploration... new activities in exploration.

Okay. Do you know which ... what... of the $13 billion how much is that? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Sorry, we call new projects, the project that were not released the last direction of the plan one year ago, but exploration, in the same concession we drilled a well, you have the result, and you can forecast that the cost for evaluation $8 million. The next well, we have to review this numbers and the planning of the concession. So, new projects could mean new wells in the old concessions that we previously hidden forecast, okay. What should you do is try to get the numbers... precise numbers and then release the... I hope that's until the end of this actions.

I am trying to get the numbers here?

Okay I think we have a questions from Internet again... from conference call, sorry.

Thank you our next question is coming from Keil de Barros of Meresk [ph]. Please go ahead.

Yes. I would like to ask you about the assumptions that you made on the blend curve and could you please elaborate a bit on that?

Would you repeat again please louder?

Yes. I would like to ask you about the assumptions made on the price of oil the blend curve that you presented? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: We actually we are taking in the long run a little bit of below what is being considered in the market as the marginal cost of expansion which is the cost for the new areas of exploration of non-conventional oil and the cost... the increasing cost in the conventional oil in areas that are more difficult to introduce, to bring to production in a commercial way. This is between $35 and $40 per barrel, and we are taking $35 in the minimum level for the long run. In the short run we are increasing the price of our projections, not projections, but the numbers that we are using for our revenue calculations because the prices of the last two years were above... much above what we had in our previous plan. And we continue to be in the lower bracket of the forecast of most of the analysis worldwide. January the 1st, I think the first quarter of the distribution if I remember the cost that we have in our strategic plan of several dozens of different type assets.

Okay. Thank you.

Okay, you have a question here in the audience.

Christian Audi, again, with Santander. Gabrielli three question, in terms of production when we look at the 2015 target there was a small drop in domestic gas production. I was wondering versus what the target was in the last plan if you could explain what changed there. And secondly, if you could give us an update as we look out 2010 and '11 any updates on 2.55, 2.57, 2.56 and the very last is when we look at discoveries. I know there is no news in terms of pre-solds you continue to do the testing. Am I correct to assume that this plan, from an infrastructure point of view, does not incorporate anything at all related to pre-sold? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes, you're right. In this plan we are not incorporating any big changes that we may have to face if we have factors and that results at that. 3.65 to 3.67 we are redesigning the process of bidding. We have already some offers in the new model and we are facing all as to very high price. We are in discussions. We're for sure we assume that they have at least one year delay for 3.65 and 3.57. We are trying to anticipate the 3.56 to get the production out of the 3.56 to cover part of the production of 3.65 and 3.67. In 2012, I don't have the specific number but I guess that is result of somewhat delays on the first gas of Santos, probably that's going to see impact in 2012. But I am not sure. I don't have the specifics but I assume. I know that we have some delays in the first gas in Santos and then this probably would affect 2012.

And so just as a follow up, how concerned are you in that 2010, 2011 period of really having, from an oil production growth point of view, a pretty flattish sequential growth if we can really get 56 accelerated? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: No, because there no... P-65, P-67 would affect 2011, not 2010, end of 2011, I think. There is no impact on 2010. And if we can get P-56, then we are going to have the production of P-56 at the end of 2011. Once we head on 2010 and on the previous plan, I don't think that there is big change in the previous plan. I don't think there is any big change while the platforms are coming on stream in 2010. To have the platforms... the previous one. I don't think they are a big change for 2010. That's the best --

[Question Inaudible] José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: 40K. The difference is 40,000. No new.

[Question Inaudible] José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes, 2010 we have only P-57 here, Jubarte Phase II, that's delayed, indefinite delay.

[Question Inaudible]. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Yes.

Almir, you have been the moneyman at Petrobras for a long time. You have got now more than $100 billion to spend, and in two years time, that number has gone up double. About... I can't remember... maybe a year ago for the first time you outlined a 5% buyback program by Petrobras. Buyback shares of the preferreds. The discount of the preferreds is now for some reason a staggering 15% and yet there is no mention of this $100 billion plan of an idea to buy back some stock, why?

Yes, we approved the $2 billion buyback, share buyback at the end of last year and it prevails for one year. So we have till the end of the year to see what to do.

[Question Inaudible].

No, no. It's not a question. It is a time of implementation we have for such a program. Reviewing this according to the new plan, we are going to have more expenditure and the reason we had to do share buyback was the availability of cash. As you saw, we are going to need an extra $8 billion of cash to support this new plan. So we have to consider altogether if we are going to implement or not. The chances are lower at this moment. Costs have increased. We are going to spend $10 billion more due to the costs. Since last year, since we released the plan of 7/11, now in the plan 8/12 is an extra $10 billion. And the project for the equity return is about the same, although the loss has reduced 2 percentage points. Our capital cost has decreased, so they pay to the equity... the return to the equity is kept and our average return has been very high. Of course, this plan is based on very conservative price. As we go to the real world selling oil price $60 or $78 a barrel, we are make much more money investing in new projects than buying back. So I believe for the average is better to keep growing and producing more.

Last year I asked you the funny question which came first, the oil price change or the CapEx change. I work out a little bit of math to make sure that when you make your oil price adjustments, everything balances out. So you are saying really that there is no room in the budget, right? But arguably, if you change the oil price by $1, you'd pay for the whole buyback program. And arguably, working with $35 Brent long term or even with your curve, you said it yourself, it's very conservative. So to me, if you are realizing a lower return on equity... return on capital, might not that be an opportunity to take some of the equity capital off the table?

Yes, there is --

Especially when the discount is at 16%.

Yes, I am not saying that we are not going to buy some share back, but because we have... we still have some chance to improve the return on equity by increasing our debt. Our leverage is very... is below our target. Our target was to be between 25% and 35% in the leverage. We are below 20%. So there is room there to increase that and, in this way, we can improve even further the return on equity. So, but there is an important change here is the extra expenditure we are going to have in the next five years.

In general numbers, we have around 4% of the company we are paying as dividends or payout 4%, around 4% plus between 7%, 8% of growth per year. We are saying to our shareholders that we are giving back to shareholders in terms of value 4% in dividend plus 8% growth per year plus the reduction of capital cost, which gives more return to the shareholders.

Okay. The last question here.

Just two final questions Gabrielli. Ethanol, you made it clear that you're strategy is not to be a producer but rather to facilitate domestic producers and participate on the logistics and infrastructure. I was just curious why not pursue the production side of things where the rationale is there. And then lastly, on the distribution side, you have very aggressive targets for BR's market share really jumping a lot over a period of five years. Is there any... could you elaborate a little bit? Is there any major strategy change because that's a big jump? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: No, we are not planning acquisition in the BR side. No acquisition. There is only organic growth. We had already an acquisition on... it was only a part of the pyramid in the northeast of Brazil... northeast of Brazil. On the ethanol, the Brazilian ethanol market, producing market, is very consolidated in Brazil. There are more than 300 producers, private producers, more than 300 right now. We have probably around more double this number of producers of ethanol in Brazil. Petrobras is not a producer of ethanol. We have never produced it, never know... we haven't had one with smaller experience in production of ethanol, but we have right now mainly with the Japanese trading companies some structures that we are trying to get up to the production that we call a bio-energetic complex. There are new producers dedicated to ethanol more than to sugar that are going to produce mainly to the exports markets and not to the domestic market. And that's going to be linked to long term supply contracts. Petrobras may have, in those types of projects, a small share participation to guarantee the long-term contracts but not as a operational partner of the production. On the biodiesel it's different because biodiesel is a market that's being due right now, a very infant type of market.

Okay you have another question from conference call.

Thank you. Our next question is coming from Gustavo Gattass of UBS Pactual. Please go ahead.

Hi. Just wanted to follow-up on, I think it was Christian's question regarding, in fact that nothing is there. I was wondering here in the event that things go wrong disgusting, in the event that you have some sort of positive news on the exploration side on this one. I know it may be too early but can you give us an idea of how you would actually see on the strategic plan shifting to accommodate a shift towards that sort of production or is that something that's probably going to be even beyond the next CapEx plan that we are going to be seeing next year. And if you do have any updates on that field or even cash at held [ph] could you actually share them with us? José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: The presold is not in our plan because the numbers in that we have are not final. And we are not considering any of the facility that we need to develop, and any of the new technology that we have to apply. This has... will require a completely different, probably if the numbers are confirmed completely different solution and production plan. It's not in our current strategic plan.

Okay. No further questions. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: I cannot say things going to affect, because we don't know, we don't know.

Okay. Thank you.

Okay no further questions in the audience as well. Okay, I request to Mr. Gabrielli for closing remarks. José Sergio Gabrielli de Azevedo - President and Chief Executive Officer: Well, I will plans... I am trying to get the numbers that Mark McCarthy asked and they could not get us numbers but I'll send to you... to anybody that wants to know. I would thank you for your attention. I hope that we can respond all your questions and I know that we are going to have more and more questions which is very good. But we are now open to continue release of all the information that we may have for your enlightenment. Thank you.

That does conclude today's teleconference. You may disconnect your lines at this time.