Petrobras presented a loss of R$21.6 billion for the year 2014, mainly due to an asset impairment charge of R$44.6 billion, a write-down of improperly capitalized additional spending within the scope of the Federal Police’s “Operação Lava Jato” anti-corruption probe (R$6.2 billion), a provision for losses from power sector receivables (R$4.5 billion), write-downs related to the construction of the Premium I and II refineries (R$2.8 billion), and a provision for the Program to Encourage Voluntary Severance (PIDV) (R$2.4 billion).

In the third quarter of 2014, a loss of R$5.3 billion was made. The difference in relation to the R$3.1 billion net earnings reported on January 27, 2015 reflects the write-down of improperly capitalized additional spending within the scope of Operação Lava Jato (R$6.2 billion), as well as an extra R$1.6 billion provision for losses from power sector receivables.

· The R$26.6 billion loss in the fourth quarter of 2014 reflected the asset impairment. Most of this loss was related to refining activities, due to project planning problems, the use of a discount rate with a higher risk premium, the postponement of expected cash inflow and lower economic growth. In exploration and production, the impairment resulted from the decline in oil prices.
   
· As an operational highlight, Petrobras’ oil and natural gas production (in Brazil and abroad) grew by 5% in relation to 2013, reaching an average of 2.669 million barrels of oil equivalent per day (boed) in 2014. Pre-salt production contributed 381,000 bpd during the year, with record daily oil production of 713,000 barrels achieved on December 21.
   
· During the year, four new platforms came on line and 87 new wells were interconnected in Brazil.
   
· In refining, total production of oil products in 2014 was 2.170 million bpd, up 2% from 2013. The first part of the RNEST refinery began operating in November.
   
· Investments totaled R$87.1 billion in 2014, down 17% from 2013.
   
·The company ended the year with R$68.9 billion in cash.

“Operação Lava Jato” and its consequences for Petrobras

I) Write-down arising from “Operação Lava Jato”

In the third quarter of 2014, the company recognized a write-down of R$6.2 billion of capitalized spending, corresponding to additional sums paid to acquire fixed assets.

According to statements obtained within the scope of the “Operação Lava Jato” investigations - made public as of October 2014 - construction companies, suppliers and other parties involved organized themselves into a cartel, which between 2004 and April 2012 systematically imposed additional spending in the acquisition of fixed assets by Petrobras.

Petrobras believes that such additional spending should not be included in its fixed assets. However, the company is unable to identify the specific amounts of each payment made or the periods when such additional payments occurred.

As a result, Petrobras developed a methodology to estimate the total sum of additional spending incurred to determine the value of the write-downs to be made. These write-downs therefore reflect the total overvaluation of its assets arising from the additional spending in question. This methodology is composed of the following steps:

(1) Identification of the contract counterparty: All the companies cited as members of the cartel were listed and, based on this information, the companies and business groups involved were individually investigated;

(2) Identification of the period: It was concluded that the period was from 2004 to April 2012;

(3) Identification of the contracts: We investigated all the contracts signed with the counterparts from step 1 during the period described in step 2, including contract addenda signed between 2004 and April 2012. Following this, the respective fixed assets were identified;

(4) Identification of the payments: The total value of the contracts in step 3 was calculated;

(5) Application of a fixed percentage: A percentage of 3%, as indicated in the statements, was applied to the total value of the contracts in step 4 to estimate the contracts’ additional spending.

In the case of sums charged by companies outside the cartel’s scope, to write down improperly capitalized additional spending Petrobras considered the specific amounts of improper payments or the percentage of contracts cited in the statements, given that this spending was also used by these companies to finance improper payments.

The company has not yet recovered any sum related to the improper payments and is unable to reliably estimate any recoverable amount at this moment. The investigations are still under way, but the company is
taking the necessary legal measures with the Brazilian authorities to seek compensation for the losses suffered, including those related to its reputation.

Petrobras has carefully considered all the available information and does not believe that further information arising from the investigations may significantly impact or change the methodology used. Nevertheless, the company will continuously monitor the investigations to obtain additional information and it will evaluate its potential impact on the adjustments made.

II) Company’s response to issues uncovered in the investigation under way

Petrobras does not tolerate corruption or illegal business practices among its suppliers or the involvement of its employees in such practices. The company has been undertaking a series of initiatives to advance the investigation of the irregularities and to enhance its corporate governance system. The main measures taken include the following:

· Establishment of several Internal Investigation Commissions and reporting of discoveries to the Brazilian authorities;

· Hiring of two law firms to conduct an independent internal investigation;

· Full cooperation with the Federal Police, Federal Public Prosecution Ministry, the judiciary and other Brazilian authorities, such as the Federal Audit Court and the Office of the Comptroller General;

· Establishment of commissions to analyze the application of sanctions against suppliers and construction companies and the imposition of precautionary blacklisting of business groups cited as members of the cartel;

· Adoption of measures to enhance its governance and risk control and management, as documented in standards and minutes of meetings of the Executive Board and Board of Directors;

· Creation of the position of Director of Governance, Risk and Compliance, whose mission is to ensure procedural compliance and mitigate risks in the company’s activities, including fraud and corruption risks. The Board of Directors has approved João Adalberto Elek Junior’s nomination for this position;

· Formation of an independent Special Committee to liaise between the Board of Directors and the independent law firms. This committee is chaired by Ellen Gracie Northfleet, a retired Minister of the Supreme Federal Court, and composed of Andreas Pohlmann, Chief Compliance Officer of Siemens AG from 2007 to 2010, and Petrobras’ Director of Governance, Risk and Compliance, João Adalberto Elek Junior.

Impairment tests

The company has also carried out impairment tests for certain assets. These tests generated losses recognized in the fourth quarter of the year.

The losses amounted to R$44.6 billion. The main assets impacted were as follows:

· Refining assets in Brazil (R$31 billion): The second part of the Abreu e Lima Refinery (RNEST) and the Rio de Janeiro Petrochemicals Complex (COMPERJ) were evaluated separately from the company’s overall set of cash-generating refineries, given that these projects/assets have been postponed. This postponement was motivated by cash preservation measures and problems in the supply chain. The losses resulted from problems in planning the projects, use of a discount rate with a higher risk premium, the postponement of expected cash inflow and lower economic growth;

· Exploration and production assets (R$10 billion): Due to the revision of assumptions arising from the fall in oil prices;

· Petrochemical assets (R$3 billion): Due to the reduction in demand and margins.

R$21.6 billion loss in the year 2014 – This loss mainly resulted from the asset impairment charge (R$44.6 billion), the write-down of improperly capitalized additional spending within the scope of Operação Lava Jato (R$6.2 billion), the provision for losses from power sector receivables (R$4.5 billion), write-downs related to the construction of the Premium I and II refineries (R$2.8 billion) and the provision for the Program to Encourage Voluntary Severance (PIDV) (R$2.4 billion).

Gross earnings rose by 15% in relation to 2013, reaching R$80.4 billion, reflecting increased demand and higher prices from the sale of oil products in the domestic market resulting from the diesel and gasoline price rises in 2013 and 2014. Higher power and natural gas prices also contributed to the growth in gross earnings.

Operating cash flow as measured by adjusted EBITDA amounted to R$59.1 billion in 2014, down 6% from 2013.

The company’s net financial income was minus R$3.9 billion, R$2.3 billion better than in 2013, notably due to a reduction in exchange rate losses, arising from lower passive exposure in dollars and the extension of hedge accounting.

Oil and natural gas production – In 2014, Petrobras’ total production in Brazil and abroad reached an average daily level of 2.669 million barrels of oil equivalent (boed), up 5.1% from 2013.

Oil and natural gas production in Brazil reached an average of 2.460 million boed, up 6% from 2013. This increase was driven by the start-up of the platforms P-58 (Parque das Baleias), P-62 (Roncador), FPSO Cidade de Mangaratiba (Iracema Sul area) and FPSO Cidade de Ilhabela (Sapinhoá), as well as the ramp-up of P-63 (Papa-Terra), P-55 (Roncador), FPSO Cidade de Itajaí (Baúna), FPSO Cidade de Paraty (Lula NE) and FPSO Cidade de São Paulo (Sapinhoá).

In 2014, 87 new wells were interconnected: 61 production wells and 26 injection wells. The number of wells interconnected in the year was 71% higher than in 2013.

Regarding pre-salt production, Petrobras maintained its excellent performance, reaching an average daily figure of 381,000 bpd in 2014. On December 21, we achieved another daily oil production record in this layer, of 713,000 barrels.

The company’s production outside Brazil was 209,000 boed, down 5% from 2013, due to the sale of international assets. The production lost through the sale of assets was partially offset by growing output in the Cascade and Chinook fields, in the United States.

Oil product output – Petrobras’ production of oil products in Brazil reached 2.170 million barrels per day in 2014, up 2% from 2013. The daily processed volume also rose by 2%, due to the refineries’ strong operational performance. The refineries’ utilization factor remained high, at 98% for the year. Of the total volume of crude processed, 82% came from Brazilian fields.

Sale of oil products – In 2014, oil product sales in the domestic market amounted to 2.4 million barrels per day, up 3% from the previous year. Highlights:

· Gasoline (+5%): Growth of the vehicle fleet associated with gasoline’s price advantage in relation to ethanol in many states. These factors were partially offset by the increase in the share of ethanol blended into gasoline, from 20% to 25%;

· Diesel (+2%): Higher consumption in infrastructure projects, growth of the light diesel-powered vehicle fleet, and higher consumption by thermal power plants;

· Fuel oil (+21%): Larger deliveries to thermal power plants.

Oil products and oil balance of trade – Petrobras’ ran a trade deficit (relative to the Brazilian economy) of 415,000 barrels per day, up 4% from 2013.

The increase in oil product imports to meet domestic demand and lower exports of fuel oil, which was diverted to feed Brazilian thermal power plants, were the main factors behind the rise in net Brazilian imports this year.

The trade deficit in crude was lower in 2014 than in 2013, due to higher domestic oil production. In addition, Brazilian output accounted for a higher share of processed crude.

Product prices – The average price of oil products in the domestic market, in Brazilian reais (for the distributors), rose by 8% in relation to 2013, mainly reflecting the increases in gasoline and diesel prices that occurred in 2013 and 2014.

The price of Brent crude fell 9% in dollars (from US$108.66 per barrel in 2013 to US$98.99 in 2014). However, due to the real’s average devaluation of 9%, the oil price calculated in reais only declined by 1%.

Investments – Petrobras invested R$87.1 billion in 2014, down 17% from 2013. The focus of investment was exploration and production in Brazil, especially production development projects.

The main reduction in investment occurred in the downstream segment, due to the completion of projects to modernize existing refineries and the first phase of the Abreu e Lima Refinery (RNEST).

Indebtedness – As of December 31, 2014, Petrobras’ net indebtedness was 27% higher than on December 31, 2013. The main factor behind this rise was the impact of exchange rate devaluation on loans and new debt issues. The company’s net debt / adjusted EBITDA ratio ended the period at 4.77 times, while leverage was 48%.