Impacts of the new coronavirus on the Oil and Gas chain

O social isolation to contain the spread of the new coronavirus, according poll taken by CNT on April 1st, will lead to a drop in transport in the month of April of 40% or more for 58% of respondents. As a consequence, diesel consumption, which accounts for 25% of transport costs, has also been suffering a drastic drop since March. The same scenario is repeated for gasoline, even more abruptly, with the drop in the circulation of passenger vehicles. Petrobras indicates a retraction of 60% in the sale of gasoline to distributors, in relation to the moment before the crisis, and of 40% in diesel.

For consumers, the most visible impact of the virus and social isolation on the sector is the price drop at pumps. The reduction in the price of a barrel of oil is largely responsible and occurred due to excess world stocks due to a drop in consumption and disputes between the largest producers.

The crisis in the oil industry, the biggest in the last 100 years, extends throughout the Oil and Gas chain, going against the good prospects and plans of the agents in this chain for 2020 in Brazil, given the strong changes that have been taking place, mainly with the opening of the market, from the sale of Petrobras assets.

Figure 1: Oil and Gas Chain. Analysis: ILOS.

Retail is the end of the Oil and Gas chain, represented by distributors and service station networks. On the other hand, there is the Exploration and Production of oil or Upstream, represented by the big oil companies and mainly by Petrobras. Connecting the two ends, there is the figure of Transpetro, responsible for transporting oil between platforms and refineries, and Refining, the link between oil and derived fuels sold by distributors.

The impact of the coronavirus on retail

Ipiranga, the 3rd largest distributor in the country, faced a 33% reduction in diesel sales and a 63% reduction in gasoline and ethanol sales in the first week of social isolation, in line with the reduction in Petrobras sales. Official data on fuel and biofuel sales for the month of March, when the first case of coronavirus was reported in the country and measures to restrict movement began to be adopted, will be released by the ANP at the end of this month, when we will then have statistics. to guide the impact.

The company, together with Raízen, the 2nd largest player, followed similar paths before the crisis, investing in the expansion of convenience stores. Ipiranga, currently with the highest percentage of service stations with convenience stores under its Ampm brand and holder of a logistics operation to serve these stores, had a plan to open another 250 stores in 2020 in order to grow with capillarity. Raízen recently carried out a joint venture with Femsa, owner of the Oxxo stores, with an original plan to open street stores in SP in 2020 and 500 stores in 3 years, and intended to open 300 Shell Select convenience stores in gas stations with Shell flag per year.

The largest distributor, BR, was privatized in July 2019 with a reduction in Petrobras' shareholding to 37,5%. With the change in management, restructuring projects are being carried out to reduce costs and increase operational efficiency. The pre-crisis focus was also on investing in new businesses, such as trading in the import and sale of derivatives and ethanol, and in financial services, with the expansion of BR Mania convenience stores, which bring in revenue from contracting services logistics and payment of royalties.

The scenario has changed and the race is now on to adjust to the new demand, to a scenario that should no longer reach the high volume levels of 2014, and to support its biggest customers, the retail service station networks. The service stations suffer even more impact in the Oil and Gas chain, as they have low working capital and tight margins. These have been pleading for support from the government and distributors to survive the crisis.

Among the claims is the request to ANP of untying the brand in the purchase of fuels. This means that gas stations of a given brand could buy from any distributor. Flag stations (eg: BR, Ipiranga and Shell) have higher costs than white flag stations because, in addition to being obliged to purchase a product from the brand's distributor, they pay royalties for using the flag. This permission had already been granted prior to the time of the truck drivers' strike and would be a mechanism for reducing the purchase price of fuel. However, the ANP understands that the suspension of the current regime, in addition to not tackling the problem of falling demand, “is structuring and requires public consultation, since, in addition to affecting economic rights, they are also primarily aimed at defending basic consumer rights”.

Resellers also claim that distributors have not passed on the price reduction for gasoline and diesel announced by Petrobras. The reflection is the practice of still high prices at the pumps, which, according to them, further damages the sale. Due to the drop in sales that spreads throughout the Oil and Gas chain, the stocks being passed on to the service stations were acquired at previously practiced prices.

On the other hand, the distributors, as a way of preserving the service station business, have granted postponement and/or installment payments and postponement of royalties in the case of flagged service stations.

Changes in Refining

Given the reduction in consumption, the volume of refined oil is changing. Petrobras claims that no refinery will stop production completely, but some processing units are being shut down due to excess inventory. According to Valor, at the end of the first half of this month, Regap (MG) was already operating at less than 1% capacity, Repar (PR) at 40% and Reman (AM) and even the largest refinery, Replan (SP), may also be affected.

The sale of the 8 Petrobras refineries, responsible for 50% of national production, was postponed. The receipt of binding proposals would take place between April and May 2020. In this way, until the interested companies take a breath to make investments in the face of the crisis, Petrobras will continue with the refining monopoly, dictating prices at the product supply poles in order to balance its inventories, thus defining the entire distribution network of the country.

The sale represents an important step in opening up the market. Raízen and Ipiranga had been showing interest in participating in the process, in order to increase the vertical integration of their operations and gain advantages over other competitors in the region of influence of these refineries. Raízen recently entered the refining market in Argentina, verticalizing its operation in the neighboring country. Around here, it is one of the most verticalized companies in the sector, as it is also a partner in ethanol plants, Logum Logística, an ethanol pipeline operator, and Rumo Logística, an important railway operator.

BR, unable to participate in the offer due to its 37,5% stake in Petrobras, also viewed the sale positively, as an opportunity to renegotiate the price policy for the purchase of fuel. Currently, even though it is the largest player, it does not have any price benefit in the purchase of fuel due to its volume.

It is believed that Petrobras' divestment movement will resume after the pandemic passes, which will bring greater economic stability to the country. When the divestment plan is put into practice, there will be a resumption of activity in the sector, with the possible entry of new players, mainly Chinese, in the Oil and Gas chain. The expectation is the generation of competition and new investments in infrastructure for the flow of production, currently dependent on the Transpetro pipeline network.

Divestments in Transpetro

Petrobras' logistics company will carry out several cuts and divestments, according to memorandum released at the beginning of April, totaling R$507 MM in 2020. The postponement of maintenance of tanks and installations is among them, as well as the return of buildings, suspension of services and renegotiation of contracts.

Transpetro is currently the manager of several assets: pipelines for the flow of oil production; pipelines for moving derivatives from refineries to distributor bases; waterway and land terminals for storing oil and derivatives; in addition to having a fleet of 50 ships and supplying fuel to regions where the production of local refineries is not enough to meet demand, such as the North and Northeast regions and the state of Espírito Santo.

In the post Covid-19 scenario, the privatization of part or all of Transpetro may be discussed. Many holding employees who were working at Transpetro have returned to Petrobras and part of the pipelines operated by Transpetro are already being contemplated in the offer to sell refineries.

Reduction in oil production

China, where the new coronavirus pandemic began, is one of the biggest importers of oil. Due to the reduction in demand for fuel, OPEC countries and allies made a deal to limit oil production in order to maintain the price of the commodity. Russia, however, initially refused to follow suit, leading to a dispute with Saudi Arabia, which resulted in increased production by both countries. After 34 days of dispute between the two countries, the price war ended when the main producers agreed to cut production in May and June by 10MM barrels per day. However, the imbroglio resulted in an even sharper drop in the price of a barrel.

Figure 2: History of the daily price of Brent oil. Source: Investing.com. Analysis: ILOS.

The first case of Covid-19 was reported in China on 31/12/2019. As can be seen in the chart below, after that date, the price of a barrel has fallen sharply, fluctuating between US$22 and US$35 since March, when the quarantine in Brazil began.

Figure 3: Daily quotation of Brent oil in 2020. Source: Investing.com. Analysis: ILOS.

The drastic reduction in consumption means that stocks are not consumed at the usual rate, generating excess supply and global overstock. If the reduction in production does not accompany the drop in demand, there will not be enough tankage to store all production.
The excess oil produced and not consumed is being stored in record volumes in oil tankers, at a daily cost of US$350 per vessel, as additional tankage to those already sold out on land.

This week, we saw the price of the American WTI barrel for the May contract, which expired on April 21, retreat more than 300% the day before, ending at a negative price for the 1st time in history. Traders were waiving their contracts to avoid delivering produced oil, i.e. paying not to deliver. This was because WTI grade oil needs to be delivered and stored in Cushing City, Oklahoma, USA, where there is little or no available capacity. They then started buying contracts maturing in June, in the range of US$20 a barrel. The same does not happen with Brent, the most traded oil and a market benchmark, as the oil can be delivered offshore wherever there is storage capacity, thus not limiting the production outflow operation.

So that the price of a barrel does not fall even more, harming oil companies worldwide, and the maximum oil storage capacity is not reached, the solution is to reduce production.

Along these lines, Petrobras announced a production cut of 200 barrels/day at the end of March and published new cuts on April 1, such as shutdown of production fields, postponement of cash disbursements, cost reduction, etc., as a measure to preserve the company. Current stoppages already reach 62 units.

According with a report by Brasil Energia, initially, in the offshore operation, Petrobras decided to prioritize negotiations with companies that provide FPSO, rig and support vessel supply services. Actions to contain costs involve partial payment deferral, stoppage of some units, reduction of daily rates and even temporary suspension of contracts. The actions aim to relieve the company's cash in 2020.

It is prudent for companies to consider the historical average barrel price, in the range of US$42, as well as the government in estimating royalties and public sector shares. In addition, it is healthy to resume reforms, privatizations and other actions to stimulate greater competition and the search for efficiency in the market in a post-crisis scenario.

Beyond infrastructure and logistics: the impact from a health perspective

Companies in the Oil and Gas chain are already known for their strong safety, environment and health policies. The product and the operation itself involve a certain degree of danger and damage to the environment and health. However, with the risk of contagion by the new coronavirus, especially in environments that require confinement such as platforms, some measures have been taken to protect professionals in this industry:

• Employees who perform administrative functions are working from home. Ipiranga, for example, highlighted that it is hiring psychologists to support employees in the new work format.

• At boarding scales on Petrobras platforms increased from 21 to 28 days with 14 days off. In this way, offshore workers remain housed in a hotel for 7 days, in quarantine, before boarding, and those who show characteristic symptoms of Covid-19 will be prevented from boarding, in order to reduce the chance of contamination on board.

• Some units also had their staff reduced preventively