Petrobras’ recent launch of a notional $2.5 billion worth of 100-year bonds has been viewed as evidence that investors, particularly those with long-term commitments such as pension funds and insurers, are desperate for yield.
And so desperate, apparently, that they are willing to overlook Petrobras’ “Car Wash” scandal which has exposed material weaknesses in the company’s internal controls and led to investigation of corruption and bribery. Petrobras has estimated the resulting write-down to be roughly $17 billion.
But for all the focus on the company’s short-term problems, little is said of the risks it will face over the 100-year bond maturation period. Chief among those risks are new climate regulations and low-carbon technologies. A low-carbon transition implies, in turn, lower oil demand and therefore lower prices.
Moreover, issuance of a 100-year bond gives a new meaning to the phrase long-term investment. It stands in stark contrast to recent shareholder efforts to bring into focus the capital expenditure plans of the sector (see 2015 shareholder resolutions) in relation to long term energy and climate scenarios.
Applying century-long maturation to a corporate bond also makes a mockery of the maximum three-year horizon applied by ratings agencies when assessing the creditworthiness of a bond. For example, bonds issued by some oil sands operators over several decades have appeared increasingly questionable if low oil prices persist.
This is not just about whether Petrobras can make it through the ‘car wash’ – it is whether it will subsequently rust away and be replaced by electric vehicles on the other side.
In the bond’s prospectus and Petrobras’ annual report (both filed with the Security and Exchange Commission), Petrobras discusses the Car Wash scandal at length, acknowledging that the company has yet to put it in the rear-view mirror. Its risk factor disclosure—required disclosure of the investment risks—provides several warnings to this effect.
For pension funds and insurers keen on matching long-term yield with long-term obligations, ensuring that those yields will be there is important. In turn, those investors rely on regulators to ensure market transparency, which starts with a meaningful discussion of the material risks.
Perhaps Petrobras has examined the risks and concluded that little will change—but arriving at such a view would be difficult to fathom. Shell’s CEO Ben Van Beurden recently predicted that the world economy would be “zero-carbon” by the end of the century and that Shell would likely receive a “very large segment” of its earnings from renewable power. Policy-makers are even more ambitious, having proposed net-zero emissions by the middle of the century. And, the G7 just announced the goals of (1) decarbonising the energy sector of G7 countries by 2050, (2) reducing global emissions 40-70% from 2010 levels by 2050 and (3) total decarbonisation of the global economy by 2100. The announcement shows that governments are following through on old emission promises and that the long-term glide path to decarbonize requires significant action now. Even if investors might rationally discount the tail end payments of a 100-year bond, it is clear that an energy transition will hit long before then.
Nor do the financial data favour Petrobras in such a carbon-constrained world, which still plans an immense $140 billion exploration and production capex spend in its current 5-year program. Our analysis (using Rystad data as of June 2015) indicates that half of this upstream spending to 2018 requires the current oil price of around $60 just to breakeven.
It appears, therefore, that a climate-safe energy transition poses a material risk to a century bond and meaningful disclosure would recognize that risk acknowledge the trend. After all, both the discussion of material risks and the analysis of material trends are required disclosures under SEC regulations.
Despite that, the prospectus makes not a single reference to climate change. Petrobras’ annual report merely states that “as new laws and regulations relating to climate change, including carbon controls, become applicable to us, it is possible that our capital expenditures and investments for compliance with such laws and regulations and industry standards will increase substantially in the future.” Such references fail to capture the scope or urgency of the problem—if such measures have a significant impact on demand for its products, this will challenge the company’s whole business model.
Petrobras’ management missed a second opportunity to consider the issue under “Item 5” of the annual report, which mandates disclosure of “any known trends, uncertainties, demands, commitments or events that are reasonably likely to have a material affect on” the. We might ascribe Petrobras’ lack of disclosure to the general human aversion to unpleasant truths, but that is why we have micro-prudential regulation—to force companies to discuss material risks.
Where the International Energy Agency is now warning that this is the year significant emissions reduction progress must be made, can Petrobras be confident that efforts to address climate change are not material to its business nor a trend that must be discussed with its investors? If not, regulators must ask why there are no disclosures of these risks and trends.