Petrobras and the Scandal that Could Ruin Brazil’s Economy

On Wednesday February 11, an explosion happened on an oil vessel off the coast of southern Brazil that left 3 people dead and 4 injured. The rig belonged to a contractor for Petrobras, the Brazilian state-owned oil company that has had trouble staying out of the headlines recently. This incident was the most recent in a series of crises that the oil giant has had to manage of late. Currently, the company is under scrutiny for accusations of corruption, and for threatening to throw Brazil’s entire economy into recession.

The corruption scandal that lies at the center of Petrobras’ woes is perhaps the most multifaceted and complicated the nation has ever seen. But to understand the sheer magnitude of the issue, one must first appreciate the magnitude of the organization itself. Petrobras owns all of Brazil’s oil refineries, controls 21,000 miles of pipelines, and produces 90 percent of the nation’s petroleum. The company did not reach this size out of sheer luck. The company has counted on the Brazilian government’s full support since its creation 1953. Though Petrobras semi-private, the government has remained its majority owner for the entirety of its history. Though the company lost its standing as a legal monopoly over the oil industry in the 1990s, it grew significantly in share and size during the early 2000s, under president Luiz Inácio Lula da Silva and the Worker’s Party (PT). Da Silva —and later current president Dilma Rousseff — instituted a protectionist industrial policy intended to develop Petrobras and create jobs. They built new refineries and shipyards, and subsided them all with cheap government loans. Samuel Pessoa, a São Paulo University economist said simply, “The government’s plan was to make Petrobras as big as possible.” He estimates Petrobras’ operations are now responsible for around 10 percent of Brazil’s economic output.

But Petrobras’ role as a cornerstone of the Brazilian economy has proven toxic in light of the recent allegations of corruption. Police have accused over 30 Petrobras executives of accepting substantial bribes from contractors and suppliers in exchange for inflated contracts. So far, police have uncovered up to 23 billion reals ($8.4 billion US) in suspicious transactions. Even further complicating matters, the Workers Party has been implicated in the investigation. When police arrested former Petrobras refineries executive Paolo Roberto Costa, he revealed that the construction companies who won contracts from his branch diverted 3% of their profits into funds for political parties. The investigation, named Operation Car Wash, began in the early months of 2014, but all indications are that it will not end soon—the deeper police delve into this web of corruption and bribes, the more complex it becomes.

The fallout from the scandal has been momentous. Primarily, it has had a great impact on the leadership and profitability of the company itself. Petrobras announced earlier in February that it would be bringing on Almadir Beldine as its new CEO and Ivan de Souza Monteiro as CFO, both of whom served in those respective roles at Banco do Brasil. The hope was that this change would bring about more confidence from investors and stockholders, but has so far not proven effective; the company’s stock shares are down by 7 percent this month.

This is bad news for numerous other major players in Brazil’s economy because Petrobras’ relative historical stability has made it a standard for other Brazilian companies in international bond markets. As investors shy away from the oil giant, many smaller companies — including many of Petrobras’ contractors — are entirely shut out. This means that they have lost significant portions of their cash flow, as well as access to international capital to keep them afloat. As this trickle-down effect continues to happen, huge swaths of the infrastructure and energy sectors of the Brazilian economy will suffer.

Even more broadly, Petrobras’s actions have caused Brazilian currency to drop to historic lows. As of February 10, the real fell to 2.8 per US dollar for the first time in 10 years. Petrobras is but most notorious of a collection of companies whose underwhelming quarterly reports have stripped the Brazilian market from international capital. Weak international investment then led to a weak real.

The variety of issues Petrobras is facing are enough to make the recent explosion seem like a mild PR incident. But all indicates that the information revealed thus far is just the tip of the iceberg. Because of the way that Petrobras straddles Brazil’s government and economy, and because of its vital importance to both, these corruption allegations have the potential to not only throw Brazil’s economy into a recession, but significantly jeopardize the Rousseff administration. The scandal also has the potential to fundamentally change the way that public-private partnerships play out in Brazil, as well as much of the developing world. Brazil has emerged in recent years as a political leader in Latin America, and an economic leader in the global market. But the Petrobras scandal has the potential to be a significant stumbling block to its future progress.