Petrobras’ Political Risk Raises Uncertainties

(Fitch, 23.Feb.2021) — The request to replace Petroleo Brasileiro S.A.’s (Petrobras, IDR BB-/Negative) CEO made by the Brazil’s Ministry of Mines and Energy is viewed by Fitch Ratings as raising uncertainties for the ethanol sector whose price dynamics are strongly correlated with Petrobras’ pricing policy.

The government influence on Petrobras’ business strategy could be a cash flow negative for Brazilian sugar and ethanol (S&E) participants, though Neutral for their ratings. Fitch understands that any potential change to Petrobras’s pricing policy that deviates from the import parity, as has previously occurred, would likely put the expected recovery of the ethanol sector at risk. Hydrous ethanol’s competitiveness as a gasoline substitute in Brazil declines when gasoline prices fall.

On 19 Feb. 2020 Brazil’s Ministry of Mines and Energy requested that Petrobras’ board of directors replace the company’s CEO. The government’s request coincides with a period of growing social pressure over domestic diesel prices, demonstrating the impact of political risk on the company’s strategy. The maintenance of Petrobras’ current import parity policy is important for the recovery of the domestic ethanol sector in 2021. In 2020, ethanol producers with little presence of sugar in the mix were the most affected by lower demand and oil price volatility that followed the outbreak of the coronavirus pandemic in Brazil.

While the Outlook is Stable for 70% of Brazilian S&E players rated by Fitch, the Outlook is Positive for the sector. The expected recovery in average oil prices combined with the relaxation of social distancing measures in Brazil should contribute to higher ethanol demand in 2021, supporting Brazilian producers’ cash flow. Companies with a large sugar presence in the product mix will fare even better as they continue to benefit from the recent spike in sugar prices and historically high levels of hedged sugar positions.

Fitch maintains that corn-based ethanol producers like FS Agrisolutions Industria de Biocombustiveis Ltda (FS, BB-/Stable) would be the most affected by a change in Petrobras’s pricing policy as ethanol represents over 70% of their revenues. Companies like Jalles Machado S.A (Jalles Machado, A+(bra)/Positive), Acucareira Quata S.A (Zilor, A-(bra)/Stable) and Usina Santo Angelo Ltda (USA, A-(bra)/Stable) could also be affected, though their ratings incorporate the relevant exposure these companies have to the sugar market. The pricing policy change could also pressure Raizen Energia S.A, Raizen Combustiveis S.A (jointly referred to here as Raizen, BBB/RWN) and Biosev S.A.’s cash flow generation (Biosev, B/RWP). The companies were placed on Rating Watch following Biosev’s acquisition by Raizen that is pending approval by the Brazilian antitrust authority, Conselho de Desenvolvimento Economico (CADE).

Ethanol’s market conditions have improved fast, and Fitch expects the well managed companies to report positive FCF and declining leverage in 2021. Fuel demand, including both hydrous ethanol and gasoline, has been recovering and ended 2020 with a 9% drop over 2019, comparing favorably with an average decline of 23% in 2Q20 over the same period of 2019. After plunging by 30% in the 2Q20 compared to 2Q19, hydrous ethanol sales improved during 2H20 and closed the year with a 15% drop compared to 2019. On 8 Feb. 2021, Petrobras announced an 8% increase in gasoline prices at the refinery to BRL2.25/l, 32% above the previous year’s price. Hydrous ethanol prices at the mill currently trade at BRL2.52/l, up 19% over a year ago.