Conflicting signals from Petrobras. On 26 Jan 09, Petrobras announced that its Board of Directors had approved the Business Plan totaling US$174.4b (an increase of 55% YoY) for the period 2009-2013. This long awaited approval came after Petrobras’ management delayed the decision twice; once in Oct 08 and another time in Dec 08 in the face of global financial crisis and plummeting oil prices. However, this joy seemed short-lived, as Petrobras announced new plans to cut 35% of Petrobras’ US$174b capex programme, according to Reuters and Upstream reports yesterday. The conflicting signals by Petrobras implied that the increased capex spending was not an indication of the easing of the tight credit markets, but rather, the strong pressure from the government of a resource-rich country to produce oil. We believe it is too early to raise hopes that Petrobras’ increased capex spendings would translate to new order momentum for both Keppel Corp (TP: S$4.48, NEUTRAL) and Sembcorp Marine (TP: S$1.75, NEUTRAL).

Nonetheless, the Singapore yards have benefitted from Petrobras through direct or indirect contracts historically. Keppel has completed five direct projects with Petrobras and seven indirect projects compared to SCM’s seven direct and one indirect project. Currently, Petrobras’ direct exposure is 16% for Keppel and 0% for SCM, while Petrobras’ indirect exposure is 6% for Keppel and 19% for SCM. Petrobras’ direct projects – a blessing or drag? While direct contracts could possibly ensure some form of contractual certainty, given the Brazilian government’s backing, the heavy reliance on local content element may possibly lead to erosion of earnings’ margins. We believe that higher operating costs in Brazil had eroded the Singapore yards’ operating margins as exemplified by two of Petrobras’ projects built at Keppel yards. This is as recent as 4Q08 when Keppel O&M’s operating margin declined to 9.3% in 4Q08 as Petrobras’ P56 FPU reached its first 20% milestone recognition.

Keppel is likely to benefit more from Petrobras. The 75/25 consortium of Keppel FELS Brasil S/A and Technip puts Keppel in a better position to benefit from Petrobras’ planned capex, in our view. Keppel BrasFELS yard, established since 2000, has good track record, given the successful completion of the many offshore units now operating in Petrobras’ Campos Basin. On the other hand, SCM partnered MacLauren Shipyard in Rio de Janeiro, Brazil only in 2008.

Still, it is not time for sector optimism as downside risks persist. We advocate that it is still too early to turn buyers on the O&M sector. With no clear indication of the easing of credit markets, we opine that any significant newbuild contract will only occur in 2H09 soonest. Our FY09 and FY10 new order estimates for Keppel stay at S$2.2b and S$2.6b respectively. New orders assumptions for SCM are S$1.7b for FY09 and S$2.0b for FY10. Downside risks persist including potential orderbook cancellations and sustained period of depressed oil price.

Share prices of Singapore Yards surged momentarily. In the face of potential order cancellations and repayment re-negotiations, news released on 26 Jan 09 pertaining to Petrobras’ increased capital expenditure provided comfort to the Singapore yards, namely Keppel Corporation (Keppel) and Sembcorp Marine (SCM). Keppel rose 2% while SCM jumped 6% on 28 Jan 09 (the first trading day after the Chinese New Year). However, we believe this to be short-lived, as Petrobras announced new plans to cut 35% of Petrobras’ US$174b capex programme, according to Reuters and Upstream reports yesterday.

Twice procrastinated but the go-ahead finally. Petrobras had previously delayed the approval to proceed with 2009-2013 capex twice. The first time was in Oct 08 at the onset of worsening global financial conditions, while the second one was in late Dec 08, when oil prices remained at depressing levels. While the implication of a repeated procrastination clearly suggests the dilemma faced by Petrobras to address short term capital expenditures with long term energy needs, the final approval to proceed implies the Brazilian government’s commitment to helping Petrobras find financial resources to fund its ambitious long-term plans.

Plan was to tap into government’s funding. US$28.6b would be spent in 2009, while US$35b to be expensed in 2010. Chief Executive Officer, Mr Jose Sergio Gabrielli unveiled the Strategic Plan just one day after the Brazilian Treasury had injected another 100b Brazilian Reais (US$43b) into the coffers of the country’s National Development Bank (BNDES). Mr Gabrielli also revealed that Petrobras was permitted to tap US$10.8b and US$4.3b out of the BNDES funding in 2009 and 2010 respectively.

But, conflicting signals announced yesterday. According to Reuters and Upstream reports yesterday, Mr Gabrielli expressed the intent to reduce 35% (or US$61b) of Petrobras’ US$174b capex programme. This was because Petrobras still had to secure US$8.9b to meet its capital spending for 2010 and refinance a US$5b bridging loan within these two years. The conflicting signals sent by Petrobras implied that the increased capex spending was not an indication of the easing of the tight credit markets, but rather, the strong pressure from the government of a resource-rich country to produce oil.

Too early to raise our hopes on Petrobras. We believe it is too early to raise hopes that Petrobras’ increased capex spendings would translate to new order momentum for both Keppel and Sembcorp Marine.