Brazil is cleaning up its act, the national oil company, Petrobras, and its contractors are being dragged through a car wash. The country, the company and the industry will be better for it but in the process famous and respected companies will become casualties; some have already suffered, but investors will want to know how to predict who will be next in the firing line. Skip to the last paragraph if that is all you want to know.
Operação Lava Jato, or Operation Car Wash, is the name for the investigation into bribery and corruption in Petrobras. It started quite a while ago, the operation was actually launched by the Brazilian Federal Police back in July 2009; about a year after Petrobras was elected the leading ethical oil and gas company by Geneva-based Covalence, how clueless were they?
At the start, the investigation was focused on illegal money brokers and the first phase was named “Car Wash” because the money brokers used petrol stations for their money laundering activities. But the name stuck even when the focus of the investigation expanded to include corruption at Petrobras after the police noticed that Paulo Roberto Costa, the former head of Petrobras's refining and supply department, had been given a Range Rover by the black-market money changer Alberto Youssef. Range Rovers aren't cheap especially in Brazil ($595,000 Reals is over £100,000 in sterling)
The Car Wash investigation really came out into the open in March 2014, when Costa was arrested. Now, what happened next was interesting: Brazil had a new law on its books, the Organized Crime Law of 2013 (Law 12.850), this law formalised agreements which we might call plea bargains, but which in Brazil are known as delação premiada, or a ‘rewarded accusation’. As long as the accused tells the truth, and it has to be the whole truth, prosecutors can ask the judge to grant a full judicial pardon, reduce the collaborator’s sentence by up to two-thirds, or substitute prison with a lesser penalty, lots more on this here and here.
With his future secured, Costa sang like a canary as have quite a number of the protagonists in this affair. In November 2014 police arrested eighteen more people and in December 2014 prosecutors formally charged another thirty-six people, most of them from Brazilian engineering firms such as OAS, Camargo Correa, UTC Engenharia, Galvao Engenharia, Mendes Junior, Sanko and Engevix. By the end of last year Petrobras had banned twenty-three suppliers cited in the investigation from bidding on tenders; but that is all under review as eliminating virtually all contractors from bid lists makes awarding contracts hard and might even be illegal.
The investigation continued on, with most of the impact being felt within the Brazilian business community as respected names, such as Marcelo Odebrecht and Otavio Azevedo, heads of Construtora Norberto Odebrecht and Andrade Gutierrez respectively, were dragged into the net. The complexity of the schemes is breathtaking, take a look at this diagram which was prepared by the Brazilian magazine Veja and translated by the Petrobribes site, it explains why the process is so slow and painstaking.
But now, like a Tsunami wave quietly rippling across the ocean, the fallout from Operation Car Wash is beginning to be felt on the shores of Asia, the USA and Europe. When the Tsunami hits it will be devastating. First to be called to account was SBM Offshore, they have settled with the Dutch authorities by paying a fine of $240 million, that story is very long and very complex and told particularly well in this article, but it is far from clear that their troubles in Brazil have been resolved as yet, a settlement with the Brazilian authorities is almost inevitable, but whether it will be as much as the $1.7 billion that has been mooted is questionable.
Now respected global companies such as Ensco plc, Maersk, Keppel FELS, Rolls-Royce, Saipem, Samsung, Sembcorp Marine, Sevan Marine, Skanska, Techint (the steelmaker Tenaris), TMT Shipping, Toshiba, Transocean and Vantage Drilling have all been mentioned in dispatches from Brasilia; and these are not the kind of despatches you want to be mentioned in. Most companies have said little, some have denied involvement or pointed to former directors or predecessor companies, but it seems likely that this is not the end of the list, nor of the story. The consequences for the companies involved are hard to predict but those with long term contracts for expensive equipment are most at risk. Vantage has just had a long term contract for the Titanium Explorer cancelled by Petrobras, and now their very existence is in doubt as the contract represented 61% of the company's backlog. Their bonds are trading at a big discount.
The investigation rumbles on, this very week Brazilian police made the 19th round of arrests, so we know this story is not yet over. Corruption seems to have been completely endemic within Petrobras, and the owners of Petrobras lost out because of it. Since the principal owner of Petrobras is the Brazilian State then it really is the case that it is the people of Brazil who have lost out to corruption; and they ought to look with some pride at the work that the police and prosecutors are doing to clean up the mess, root out the wrong-doers, and seek recompense from those who benefited from inflated contracts and the bribes themselves.
However, the companies that paid the bribes will now have to pay the piper, when the Brazilian authorities come knocking on their door. So, investors should be busy checking just how much work their favourite contracting companies secured in Brazil in recent years. It is surely possible that some contractors who have enjoyed great success in, say the Brazilian deepwater market, did so fair and square, but a prudent investor might not want to take the risk of holding stock in those companies that touted a close relationship to Petrobras or who relied on Petrobras for a lot of business. Maybe it is time to leave the beach before the Tsunami hits.
Updated 26/9/2015 to add Transocean to the list