Brazil Energy Giant Buys $1.24 Billion of Pain in Texas

Petroleo Brasileiro SA, Brazil’s state-owned energy company, formulated a strategy in 1999 to go global:

1. Buy a stake in a Texas oil refinery.

2. Modify the facility so it could process the heavy crude produced in Brazil.

3. Export crude to the U.S.

4. Tally profits.

The plan unraveled. Petrobras didn’t get a good deal on the refinery, Chief Executive Officer Maria das Gracas Foster told the Brazilian Senate June 11. The company’s squabbles with its partner sidetracked the plant modification, pinching profit for years, according to court documents and interviews with consultants, bankers and analysts. At least four federal investigations in Brazil are currently looking into the deal and the decisions of officials including President Dilma Rousseff, the Petrobras chairman at the time of the purchase.

Petrobras, in a statement to Bloomberg News, said that taking the initial stake in the Pasadena, Texas, refinery “offered good investment potential” in 2006. Not making the planned modifications hurt its financial performance, the company said. Petrobras told Bloomberg News that it’s cooperating with the investigations and conducting its own internal review.

Biggest Discovery

Petrobras, the world’s eighth-largest energy company by market capitalization, hasn’t benefited from the biggest oil discoveries this century made off Brazil’s coast. Last year, the international refining unit lost $7.9 billion. Government policy forces the Rio de Janeiro-based company to sell fuel for less than it costs to produce as a check against inflation and to protect consumers. In the last five years, 43 percent of its market value has been erased.

Another Petrobras refinery, under construction in Brazil, was budgeted at $2.5 billion and is expected to cost $18.5 billion, according to a regulatory filing.

The oil business was booming in 2006, the year Petrobras bought a 50 percent interest in Pasadena Refining System Inc., the second-smallest facility on the Houston Ship Channel, from Transcor Astra Group SA for $415.8 million.

Boom Times

The price of crude had risen fourfold in the previous four years as developing countries began to import more fuel for their growing economies and the Iraq War took 1 million barrels off the market.

Brazil and Petrobras were also enjoying boom times. Oil production from the offshore Campos Basin was putting Brazil in a position to become a significant exporter. Petrobras figured the Pasadena refinery could be a foothold in the U.S. where the company would process its own heavy crude.

Astra, a closely held company based in Belgium, had bought the refinery in January 2005 for $42.5 million, meaning that its investment rose almost 20-fold in value in about a year, based on the amount Petrobras paid.

Refining oil overseas offered Petrobras the promise of profitable margins. Building from scratch was expensive, however, so the company shopped for existing refineries that it could buy or take a stake in.

Refineries make money by converting crude oil into more expensive refined fuels, like gasoline and diesel. The cheaper the crude, the bigger the profit margin.

In 2006, the heavy crude from Latin America was about $13 a barrel cheaper than lighter crudes common in the U.S. The problem was, the Pasadena facility, located just outside the Houston city limits, was designed to refine lighter crude.

Facility Retrofit

Petrobras and Astra said at the time of the sale that they planned to retrofit the plant. That way it could devote at least 70 percent of its 100,000-barrel-a-day capacity to heavy crude.

Petrobras and Astra quarreled over details. Astra said in court papers that Petrobras agreed to supply oil for the refinery at prices that would allow the business a guaranteed after-tax return of at least 6.9 percent every year for 15 years. Petrobras reneged on the agreement by insisting that the capacity of the refinery be doubled and that the guaranteed rate of return, as well as the obligation to supply crude, didn’t apply to that expansion, Astra lawyers said in federal court papers filed in Houston.

Petrobras said in court documents that the expansion of the refinery’s capacity was only a proposal.

In 2007 and 2008, Petrobras agreed to pay $700 million for Astra’s half stake and another $87.7 million for Astra’s interest in their joint trading business, court records show.

Validity Disputed

A few months after the agreements, Petrobras disputed their validity. It argued in part that officials at its U.S. unit negotiated the buyout independent of the company’s Rio headquarters and therefore the parent shouldn’t be bound by the deal, court records show.

Legal maneuvers prolonged the dispute another four years. Astra finally exercised an option to force the sale. In 2012, Petrobras agreed to pay Astra $820.5 million for its half of the refinery, bringing the total price tag to $1.24 billion, a 3,000 percent premium over what Astra had paid for it in 2005. The price was finalized after an international arbitration panel found that Petrobras should pay for certain debts that had accumulated during the litigation. Petrobras continues to own the plant.

Astra CEO Thomas Exl said the company declined to comment. A lawyer who represented Astra during the litigation with Petrobras also declined to comment.

Reckless Mismanagement

Brazil’s Congress, its federal police and its federal prosecutor are looking into the Pasadena deal. A prosecutor in Brazil’s national audit office has finished an investigation and the audit office is preparing a separate report. Their findings could lead to charges against Petrobras officials of “gestão temerária,” or reckless mismanagement, according to prosecutor Marinus Marsico, who works in the audit office.

Rousseff said in a March statement that the Petrobras board she headed in 2006 approved the initial stake in the Texas refinery without knowledge of the option that allowed Astra to force the sale of its remaining share to Petrobras.

Jose Sergio Gabrielli, Petrobras's CEO at the time, told lawmakers on May 20 that the Texas refinery deal wasn’t Rousseff’s responsibility because the board hadn’t been briefed on the option.

Comparable deals at the time show that Petrobras overpaid. The average purchase price of all U.S. refinery sales in 2006 was near 100 percent of replacement cost, said Michael Leger, president of Turner, Mason & Co., a Dallas consulting firm that advises in refinery transactions. After the recession, prices began to drop, and by 2010 the average refinery purchase was 12 percent of replacement cost, he said.

Replacement Cost

By comparison, Petrobras paid about 100 percent to 150 percent of replacement cost for Pasadena. That’s based on the roughly $800 million to $1.28 billion it would have cost to replace it at the time of the latest transaction, excluding certain infrastructure items like tank farms and pipeline hookups, according to Russell Heinen, a Houston-based analytics specialist at consulting firm IHS whose focus area includes refining.

“The timing was certainly poor,” Leger said.

The Pasadena plant has been a drag on Petrobras’s business. International refining costs, including those at Pasadena, rose 33 percent to $1.73 a barrel in 2006, the year the company bought a piece of the facility. By 2008, they topped $5 a barrel, mainly because of technical problems at the plant, the company said in its financial results for those periods. After Petrobras stabilized maintenance work at Pasadena in 2013, costs eased to $4.06 a barrel.

Market Value

Foster said April 15 that while the company has had offers to buy the refinery, the board doesn’t recommend selling. The market value of the refinery and affiliated properties is $222.2 million, according to county tax assessor records. That’s less than one-fifth what Petrobras paid.

The Pasadena plant wouldn’t be of interest to Royal Dutch Shell Plc, which operates four oil refineries on the U.S. Gulf Coast, John Abbott, the company’s downstream director, said in a May 16 phone interview.

Since the turn of the century, many Gulf Coast refineries, including Royal Dutch Shell’s Deer Park, Texas, plant and Exxon Mobil Corp.’s Baytown, Texas, facility, have invested in equipment upgrades to allow them to process the cheaper heavy crude.

That was the promise that Petrobras was hoping to tap into at Pasadena.

Hurt Profits

Failing to upgrade meant lost profit opportunities. In 2011, for example, the refinery imported about 78,000 barrels of lighter crude a day from West Africa. If it had been able to replace those barrels with heavier oil from places such as Brazil, Mexico and Venezuela, it would have saved $355 million.

The premium paid for the refinery and the decision not to overhaul limited the profits Pasadena could realize for about five years. It wasn’t until 2011 that oil produced in the U.S., as measured by West Texas Intermediate trades in New York, started to get cheaper than Brent crude, the benchmark in Europe, Africa and the Middle East, as improved use of horizontal drilling and hydraulic fracturing, also called fracking, pulled oil from dense shale rock in North Dakota and Texas that had mostly been inaccessible.

The U.S. recession that lasted from December 2007 to June 2009 may have ruined Petrobras’s chance to upgrade Pasadena at a price that made sense.

Postponed Upgrades

“Many refinery companies delayed or postponed investments they had previously announced when the economy went south,” said Jim Watson, a specialist in refinery and chemical plant valuations at energy consulting firm Pearson Watson Millican & Co. in Dallas.

Petrobras said in its statement to Bloomberg News that not modifying the plant hurt its investment. Petrobras preferred shares have dropped 43 percent since June 17, 2009, in Sao Paulo trading.

“After 2008, with the changed conditions providing small margins, owning 100 percent of the Pasadena refinery, without the modifications to process heavy oil, yielded a low return on the capital invested,” the company said.

Following years of losses, the Pasadena refinery posted a profit of $63.8 million in the first quarter of 2014, the company said in its statement to Bloomberg News.

“It would’ve been a good project if the revamp had been done,” Foster, the CEO, told Brazilian lawmakers last week.

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