PETROBRAS ANNOUNCES THIRD QUARTER OF 2010 RESULTS

Consolidated net income attributable to Petrobras reached U.S.$4,725 million in the third quarter of 2010 and U.S.$13,288 million in the nine-month period ended September 30, 2010.

HIGHLIGHTS

•           Consolidated net income attributable to Petrobras for the third quarter of 2010 increased 11.3% compared to the second quarter of 2010, primarily due to higher domestic sales volumes and improved net financial income.

•           Domestic oil and natural gas production for the nine-month period ended September 30,2010 increased 1.9% compared to the nine-month period ended September 30, 2009. Domestic natural gas production reached a production record of 53,773 thousand m³/day in September 2010.

•           The completion of the global public offering of our common and preferred shares (“the Global Offering”) resulted in a capital increase of U.S.$70,005 million.

•          Generation of the resources needed for the celebration of the assignment agreement (U.S.$43,868 million) and for the continuity of the Business Plan for 2010 through 2014 (U.S.$26,691 million in cash and in Brazilian treasury securities).

•          The Brazilian economy growth and lower reservoir levels, together with the improvement of logistics capacity, generated the record of natural gas thermoelectric production in September 2010 (6,252 MW in average) and natural gas sales in the third quarter of 2010 (360 thousand barrels of oil equivalent per day).

•          In October 2010 the platform-ship Cidade de Angra dos Reis started-up its production, which represents the first definitive production system in Tupi, then initiating the crude oil commercial production at the pre-salt layer of Santos Basin.

Dear Shareholders and Investors,

It is with great pride that we announce our results for the third quarter of 2010, the period in which we carried out  our biggest ever public offering of shares. The success of our Global Offering was due to the confidence of our shareholders and investors, the Company’s excellent reputation in the capital markets and our commitment to transparency and investor returns.

We allocated part of the proceeds of our public offering to pay the initial purchase price of an assignment agreement with the Brazilian federal government, which gives us the right to produce up to five billion barrels of oil equivalent in specified pre-salt areas that were not under concession. Access to these additional oil and gas volumes will allow us to improve our portfolio through sustainable production growth while simultaneously creating greater shareholder value.

As a result of the Global Offering, our net debt decreased 36.0% to U.S.$33,155 million in the nine-month period ended September 30, 2010 compared to U.S.$51,772 million in the first half of 2010. Our capital stock increased from U.S.$39,741 million on June 30, 2010 to U.S.$106,655 million on September 30, 2010. Our financial plan is based on maintaining leverage ratios within specified target levels and will enable the Company to use the proceeds of the Global Offering to become stronger and carry out its business plan. According to Platts, an energy consultancy, Petrobras is currently ranked fourth among the world’s 250 leading energy firms.

Net income grew by 28.3% year-on-year in the first nine months of 2010, sustained primarily by increased oil and gas production, higher commodity prices and higher oil product sales volumes fueled by Brazil’s economic growth. Capital expenditures in the nine-month period ended September 30, 2010 totaled U.S.$33,394 million, most of which were directed to our exploration and production segment. To maintain the integration of our businesses and maximize the resulting operational synergies, we are upgrading our existing refineries to produce cleaner fuels and constructing new ones to accompany market growth.

In October, we commemorated 57 years of successful operations. In the same month, we inaugurated the expansion of the Leopoldo Américo Miguez de Mello Research and Development Center (Cenpes), a landmark in the Company’s technological history. Latin America’s biggest R&D center, and Brazil’s leading source of patents in the last ten years, Cenpes doubled in size to become one of the world’s largest applied research institutes. This expansion, together with our partnerships with universities and research centers around the country, has made Brazil one of the best experimental centers in the world in the field of energy. Our strategy to consistently invest in research and technology has enabled us to produce oil offshore at enormous depths and led to pre-salt discoveries.

On October 22, we concluded drilling the ninth pre-salt well in the Tupi area of the Santos Basin, confirming light crude oil potential and the recovery of natural gas. October also saw the start-up of the Tupi pilot project, the first dedicated production system installed in the pre-salt area. It will produce light crude with a high commercial value and collect vital technical data for the future development of the major crude oil reserves in this region.

Aiming at growth, innovation, profitability and social and environmental responsibility, we will continue to invest our funds in one of the best project portfolios and opportunities at oil and gas sector, generating returns for our shareholders and investors, as well as benefiting society as a whole.

Net Income and Consolidated Financial and Economic Indicators

(1)    Gross margin equals net operating revenues less cost of sales divided by net operating revenues.

(2)    Operating margin equals operating income divided by net operating revenues.

(3)    Net margin equals net income divided by net operating revenues.

(4)     Debt to equity ratio equals total liabilities divided by the sum of total liabilities and total shareholders’ equity.

(5)     Crude oil and NGL average sales price in Brazil includes intra-company transfers and sales to third parties.

Reconciliation between Adjusted EBITDA and Net Income

(1) Adjusted EBITDA margin equals adjusted EBITDA divided by net operating revenues.

Our adjusted EBITDA and our adjusted EBITDA margin are not U.S. GAAP measures and it is possible that they may not be comparable with indicators with the same name reported by other companies. Adjusted EBITDA should not be considered as a substitute for operational profit or as a better measure of liquidity than operational cash flow, both of which are calculated in accordance with U.S. GAAP. We provide our adjusted EBITDA and adjusted EBITDA margin to give additional information about our capacity to pay debt, carry out investments and cover working capital needs. 

The comparison between our results of operations for the nine-month period ended September 30, 2010 and for the nine-month period ended September 30, 2009 has been affected by the 17.0% increase in the value of the Real against the U.S. dollar during that period.

Net Income

Consolidated net income attributable to Petrobras increased 28.3% to U.S.$13,288 million in the nine-month period ended September 30, 2010 compared to U.S.$10,361 million in the nine-month period ended September 30, 2009, primarily due to the recovery of domestic sales volumes and increased export prices and international sales, which more than offset lower diesel and gasoline domestic prices and higher unit costs, consisting primarily of higher government participation and import costs, which were also affected by international prices. 

The upturn in sales volumes and freight costs generated increased sales expenses. The impairment charge related to the San Lorenzo refinery in Argentina and the Breitener thermoelectric power plant in Brazil; higher personnel expenses due to an increase in our workforce and pay raises generated by the 2010/2011 collective bargaining agreement; and lower tax benefits for certain incentivized activities,  also contributed to increased expenses that impacted our net income in the nine-month period ended September 30, 2010.

Financial income (expense), net amounted to a net income of U.S.$527 million in the nine-month period ended September 30,  2010, compared to a net income of U.S.$34 million in the nine-month period ended September 30, 2009, primarily as a result of lower foreign exchange losses on net monetary assets denominated in U.S. dollars.

Net income attributable to the noncontrolling interest generated a positive effect of U.S.$1,188 million in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009, due to the impact of the exchange rate variation on SPE debt expressed in U.S. dollars.

Adjusted EBITDA

Adjusted EBITDA increased 16.7% to U.S.$24,218 million in the nine-month period ended September 30, 2010, compared to U.S.$20,756 million in the nine-month period ended September 30, 2009, primarily due to higher domestic sales volumes and higher international sales prices, partially offset by increased costs and expenses associated with commodities prices and sales volumes.

ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We earn income from:

Our expenses include:

Fluctuations in our financial condition and results of operations are driven by a combination of factors, including:

Virtually all of our revenues and expenses for our Brazilian activities are denominated and payable in Reais.  When the Real strengthens relative to the U.S. dollar, as it did in the nine-month period ended September 30, 2010 (an appreciation of 17.0%) the effect is to generally increase both revenues and expenses when expressed in U.S. dollars. However, the appreciation of the Real against the U.S. dollar affects the line items discussed below in different ways.  The following comparison between our results of operations in the nine-month period ended September 30, 2010 and in the nine-month period ended September 30, 2009 was impacted by the increase in the value of the Real against the U.S. dollar during that period. 

Depreciation, Depletion and Amortization

We calculate depreciation, depletion and amortization of most of our exploration and production assets using the units of production method. Depreciation, depletion and amortization expenses increased 26.6% to U.S.$6,208 million in the nine-month period ended September 30, 2010 compared to U.S.$4,904 million in the nine-month period ended September 30, 2009, due to higher capital expenditures and increased oil and gas production.

Exploration, Including Exploratory Dry Holes

Exploration costs, including costs for exploratory dry holes, increased 12.4% to U.S.$1,342 million in the nine-month period ended September 30, 2010 compared to U.S.$1,194 million in the nine-month period ended September 30,  2009. Excluding the impact of the appreciation of the Real, exploration, including exploratory dry holes remained relatively constant in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009.

Impairment

In the nine-month period ended September 30, 2010, we recorded an impairment charge of U.S.$94 million compared to zero in the nine-month period ended September 30, 2009. This expense is related to losses on the recoverable amount of our 65% interest in the Breitener thermoelectric power plant in Manaus, Amazonas and on the recoverable amount of assets held for sale in the International segment (related to refining, transportation and marketing and distribution activities) which were written down to their fair value for the period.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 26.8% to U.S.$6,502 million in the nine-month period ended September 30, 2010 compared to U.S.$5,126 million in the nine-month period ended September 30, 2009.

Selling expenses increased 31.8% to U.S.$3,303 million in the nine-month period ended September 30, 2010 compared to U.S.$2,507 million in the nine-month period ended September 30, 2009. This increase was primarily attributable to the impact of the appreciation of the Real, to higher freight expenses due to increased sales volumes and also to higher sales expenses related to NGL reconverter ships.

General and administrative expenses increased 22.1% to U.S.$3,199 million in the nine-month period ended September 30, 2010 compared to U.S.$2,619 million in the nine-month period ended September 30, 2009. The increase in general and administrative expenses was primarily attributable to the impact of the appreciation of the Real and also to higher personnel expenses due to increased workforce and pay raises.

Research and Development Expenses

Research and development expenses increased 35.0% to U.S.$736 million in the nine-month period ended September 30, 2010 compared to U.S.$545 million in the nine-month period ended September 30, 2009. This higher expense was primarily due to increased average sales prices, which are the basis for a fixed 0.5% provision for expenses on research and development investment required by Brazilian law.

Employee Benefit Expense for Non-Active Participants

Employee benefit expense for non-active participants consists of financial costs associated with our expected pension and health care costs of retired employees. Our employee benefit expense for non-active participants increased 23.3% to U.S.$640 million in the nine-month period ended September 30, 2010 compared to U.S.$519 million in the nine-month period ended September 30, 2009. Excluding the impact of the appreciation of the Real, the employee benefit expense for non-active participants remained relatively constant in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009.

Other Operating Expenses

Other operating expenses increased 53.4% to U.S.$3,147 million in the nine-month period ended September 30,  2010 compared to U.S.$2,052 million in the nine-month period ended September 30, 2009.  A breakdown of other operating expenses by segment is included on page 28.

The most significant changes between the nine-month period ended September 30, 2010 and the nine-month period ended September 30, 2009 are described below: 

 These increases were partially offset by:

Equity in Results of Non-Consolidated Companies

Equity in results of non-consolidated companies decreased 40.9% to a gain of U.S.$220 million in the nine-month period ended September 30, 2010 compared to a gain of U.S.$372 million in the nine-month period ended September 30,  2009, primarily due to a loss from investments in the petrochemical sector.

Financial Income

We derive financial income from several sources, including interest on cash and cash equivalents. The majority of our cash equivalents are short-term Brazilian government securities, including securities indexed to the U.S. dollar. We also hold U.S. dollar deposits.

Financial income increased 12.0% to U.S.$1,479 million in the nine-month period ended September 30, 2010 compared to U.S.$1,321 million in the nine-month period ended September 30, 2009. This increase was primarily attributable to higher income on financial investments (U.S.$118 million increase). A breakdown of financial income is set forth in Note 11 of our unaudited consolidated financial statements for the nine-month period ended September 30, 2010.

Financial Expenses

Financial expenses increased 24.9% to U.S.$1,263 million in the nine-month period ended September 30, 2010 compared to U.S.$1,011 million in the nine-month period ended September 30, 2009. This increase was primarily attributable to increased financial expenses related to our debt (U.S.$1,330 million increase), partially offset by higher capitalized interest income (which resulted in a U.S.$910 million decrease in financial expenses) and by lower losses on derivative instruments (U.S.$256 million decrease). A breakdown of financial expense is set forth in Note 11 of our unaudited consolidated financial statements for the nine-month period ended September 30, 2010.

Monetary and Exchange Variation

Monetary and exchange variation increased to a gain of U.S.$311 million in the nine-month period ended September 30, 2010 compared to a loss of U.S.$276 million in the nine-month period ended September 30, 2009.  The gain in the nine-month period ended September 30, 2010 compared to the loss in the nine-month period ended September 30, 2009 was primarily due to lower foreign exchange losses on net monetary assets denominated in U.S. dollars.

Other Taxes

Other taxes, consisting of various taxes on financial transactions, increased 59.8% to U.S.$334 million in the nine-month period ended September 30, 2010 compared to U.S.$209 million in the nine-month period ended September 30, 2009. This increase was primarily attributable to the impact of the appreciation of the Real and also to losses on the recoverable amounts of tax credits.

Other Expenses, Net

Other expenses, net are primarily composed of gains and losses recorded on sales of fixed assets and certain other non-recurring charges. Other expenses, net increased to a gain of U.S.$40 million in the nine-month period ended September 30, 2010 compared to a loss of U.S.$36 million in the nine-month period ended September 30,  2009, primarily due to the U.S.$147 million provision for losses from the Pasadena Refinery in the United States occurred in the first quarter of 2009, partially offset by the decrease of U.S.$86 million in tax benefits with incentived activities in the nine-month period ended September 30, 2010, compared to the nine-month period ended September 30, 2009.

Income Tax (Expense) Benefit

Income before income taxes and non-controlling interest increased 14.8% to U.S.$18,663 million in the nine-month period ended September 30, 2010 compared to U.S.$16,258 million in the nine-month period ended September 30, 2009. Income tax expense increased 15.3% to U.S.$5,030 million in the nine-month period ended September 30, 2010, compared to U.S.$4,364 million in the nine-month period ended September 30, 2009, primarily due to the increase of taxable income, partially offset by the increase of the tax benefit related to the provisioning of interest on shareholders’ equity (U.S.$221 million increase). The reconciliation between the tax calculated based upon statutory tax rates to income tax expense and effective rates is set forth in Note 4 of our unaudited consolidated financial statements for the nine-month period ended September 30, 2010.

NET INCOME BY BUSINESS SEGMENT

Petrobras is an integrated energy company, with the greater part of oil and gas production in the Exploration and Production segment being sold or transferred to other business segments of the Company.

EXPLORATION AND PRODUCTION

Our Exploration and Production segment includes our exploration, development and production activities in Brazil, sales and transfers of crude oil in domestic and foreign markets, transfers of natural gas to our Gas and Power segment and sales of oil products produced at natural gas processing plants.

The increased net income from Exploration and Production in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009 was primarily due to the recovery of the international market for heavy oil in relation to light oil, since our production consists mainly of heavy oil, and a 1.6% increase in oil and NGL production.

The spread between the average domestic oil sale/transfer price and the average Brent price narrowed from US$ 8.67/bbl in the nine-month period ended September 30, 2009 to US$ 4.21/bbl in the nine-month period ended September 30, 2010.

(1)             Includes production from shale oil reserves.

(2)             Does not  include LNG. Includes reinjected gas.

(Jan-Sep/2010 x Jan-Sep/2009): Increased production from platforms P-51 in the Marlim Sul field, P-53 in the Marlim Leste field, P-54 in the Roncador field, P-34 in the Jubarte field,  the Tiro extended well test (EWT) in the SS-11 field, Tupi (FPSO-Cidade de São Vicente), FPSO-Cidade de Niterói in the Marlim Leste field, FPSO-Frade (Frade), FPSO-Cidade de Vitória (Golfinho), FPSO-Espírito Santo (Parque da Conchas) and FPSO-Cidade de Santos (Uruguá) more than offset the natural decline in crude oil and NGL production from mature fields.

Domestic natural gas production increased 3.5% to 1,962 mmcf/d in the nine-month period ended September 30,  2010 compared to 1,896 mmcf/d in the nine-month period ended September 30, 2009 due to increased production from our platforms.

(1)             Production taxes include royalties, special government participation and rental of areas.

Lifting Costs - Excluding production taxes

(Jan-Sep/2010 x Jan-Sep/2009): Our unit lifting cost in Brazil, excluding production taxes (consisting of royalties, special government participation and rental of areas) increased 16.5% to U.S.$9.94/bbl in the nine-month period ended September 30, 2010 compared to U.S.$8.53/bbl in the nine-month period ended September 30, 2009. Excluding the impact of the appreciation of the Real, our lifting costs in Brazil increased 6.0% in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009 due to higher well interventions in Albacora Leste field, Marlim Sul field, Marlim field, Albacora field and Bicudo field and also to increased personnel expenses.

Lifting Costs - Including production taxes

(Jan-Sep/2010 x Jan-Sep/2009): Our production taxes in Brazil on a per barrel basis increased 36.5% to U.S.$14.37/bbl in the nine-month period ended September 30, 2010 compared to U.S.$10.53/bbl in the nine-month period ended September 30, 2009. This increase is attributable to a 37.7% increase in the reference price for domestic oil, which averaged U.S.$68.55 in the nine-month period ended September 30, 2010 compared to U.S.$49.78 in the nine-month period ended September 30, 2009, reflecting the Brent price on the international market and higher production taxes of the Marlim Sul and Marlim Leste fields due to higher produced volumes.

REFINING, TRANSPORTATION AND MARKETING

Our Refining, Transportation and Marketing segment includes refining, logistics, transportation, export and the purchase of crude oil, as well as the purchase and sale of oil products and ethanol. Additionally, this segment includes the petrochemical division, which includes investments in domestic petrochemical companies.

The decreased net income for our Refining, Transportation and Marketing segment in the nine-month period ended September 30, 2010 compared to the same period of 2009  was due to the higher oil acquisition/transfer costs and higher oil product import costs.

These effects were partially offset by higher domestic oil product sales volumes, an increase in the average realization price of exports and the upturn of domestic prices, where oil products are indexed to international prices, despite the reduction in the price of diesel and gasoline in June 2009. 

(1)             Includes third-party sales by our international subsidiary, Petrobras International Finance Company (PifCo) and also crude oil export volumes of Refining, Transportation and Marketing and Exploration and Production segments.

(2)             Includes exports in progress.

(Jan-Sep/2010 x Jan-Sep/2009): Higher crude oil exports are primarily attributable to higher production and to a decline in the volume of crude oil processed at certain of our distillation plants due to scheduled stoppages, primarily at the Replan Refinery, in the nine-month period ended September 30, 2010.  Higher oil product imports were due to higher demand for diesel, due to increased agricultural activity in 2010 and public infrastructure projects, and higher demand for gasoline due to lower ethanol availability in the market in the beginning of 2010.

(1)             As registered by the National Petroleum, Natural Gas and Biofuels Agency (ANP).

(Jan-Sep/2010 x Jan-Sep/2009): Refinery output in Brazil remained relatively constant in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009.

(Jan-Sep/2010 x Jan-Sep/2009): Excluding the impact of the appreciation of the Real, our refining costs in Brazil increased 22.0% in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009 due to higher personnel expenses, increased scheduled stoppages and higher third-party service costs mainly with equipment maintenance.

GAS AND POWER

Our Gas and Power segment consists principally of the purchase, sale, transportation and distribution of natural gas produced in or imported into Brazil. Additionally, this segment includes our participation in domestic natural gas transportation, natural gas distribution, thermoelectric power generation and our two domestic fertilizer plants.

The improved result for our Gas and Power segment for the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009 was due to higher natural gas sales to the non-thermoelectric segment, led by growth in the industrial sector as well as to the thermoelectric segment due to higher demand for electricity; increased fixed income from energy auctions; lower acquisition/transfer costs of natural gas reflecting international prices and also to the impact of the appreciation of the Real.

These effects were partially offset by increasing selling expenses with LNG regasification vessels.

The 25.3% increase in sales of electricity was primarily due to higher electricity reserves, thus allowing us to take advantage of market opportunities.   

The great increase in electricity output has been occurred since July and was generated by higher demand and also by low reservoir levels.           

DISTRIBUTION

Our Distribution segment comprises the oil product and ethanol distribution activities conducted by our majority owned subsidiary, Petrobras Distribuidora S.A., in Brazil.

The increased net income from the Distribution segment in the nine-month period ended September 30, 2010 compared to the same period of 2009 was primarily due to higher sales margins and the upturn in sales volumes. These effects were partially offset by a provision for tax contingencies.

The Distribution segment accounted for 38.7% of the national fuel distribution market in the nine-month period ended September 30, 2010, versus 38.5% in the nine-month period ended September 30, 2009.

INTERNATIONAL

The International segment comprises our activities in countries other than Brazil, which include exploration and production, refining, transportation and marketing, distribution and gas and power.

The improved result in the International segment in the nine-month period ended September 30, 2010 compared to the nine-month period ended September 30, 2009 was due to the recovery of international oil prices and higher volumes in exploration and production activities, as a result of the start-up of production in Akpo, Nigeria in March 2009.

(1)             Includes production from shale oil reserves.

(2)             Does not include LNG. Includes reinjected gas.

(3)             Non-consolidated companies in Venezuela.

(Jan-Sep/2010 x Jan-Sep/2009): International consolidated crude oil and NGL production increased 13.4% due to the start-up of production in Akpo, Nigeria in March 2009, partially offset by decreased investments in Guando, Colômbia and the decline of mature fields in the Neuquina Basin in Argentina.

International consolidated gas production decreased 2.1% as a result of the decline of mature wells in the Neuquina Basin in Argentina.

(Jan-Sep/2010 x Jan-Sep/2009): The 9.9% increase in our international lifting costs was primarily due to higher third-party services in Argentina, due to higher contractual prices and higher salaries.

(Jan-Sep/2010 x Jan-Sep/2009): Our international refinery output increased 5.8% as a result of the improved operational performance at the Pasadena Refinery in the United States due to improved operating reliability of the U.S. refinery and improved margins in Argentina. Our increased output was partially offset by a scheduled stoppage at the Nansei Sekiyu Refinery in Japan, which occurred in May and June 2010.

(Jan-Sep/2010 x Jan-Sep/2009): International refining costs decreased 17.7% in the nine-month period ended September 30,  2010 compared to the nine-month period ended September 30,  2009 due to lower maintenance and repair expenses and higher processed crude volumes at the Pasadena Refinery in the United States, which is a result of its improved operating reliability.

(1)                 Mainly composed of asphalt sales volume, due to higher consumption in infrastructure sectors.

(2)             Includes third-party sales by our international subsidiary, Petrobras International Finance Company (PifCo).

Our domestic sales volumes increased 12.5% to 2,327 mbbl/d in the nine-month period ended September 30, 2010 compared to 2,068 mbbl/d in the nine-month period ended September 30, 2009, primarily due to:

·         Diesel (increase of 9.9%) – The increase in diesel sales was primarily due to the recovery of the Brazilian economy, increased agricultural activity and growing investments in infrastructure projects.

·         Gasoline (increase of 17.9%) – The increase in gasoline sale volume was due to higher gasoline consumption in flex-fuel vehicles as a result of low ethanol supply in the beginning of 2010, a decrease in the mandatory percentage of ethanol contained in gasoline sold in Brazil in February 2010 and higher retail consumption.

·         Natural gas (increase of 28.3%) – The increase in natural gas sales was due to higher consumption in the non-thermoelectric market, which was generated by the recovery of industrial activity and also by increased power generation at gas-fired thermoelectric plants to support higher demand for electricity and guarantee hydroelectric reservoir levels during periods of low rainfall.

LIQUIDITY AND CAPITAL RESOURCES

Our principal uses of funds are for capital expenditures, dividend payments and repayment of debt. Historically, we have met these requirements with internally generated funds, short-term debt, long-term debt, project financing and sale and lease-back transactions. We believe these sources of funds, together with our strong position of cash and cash equivalents, will continue to allow us to meet our current capital requirements.

Financing Strategy

On June 18, 2010, our Board of Directors approved our Business Plan for 2010 through 2014, providing for planned  investments totaling U.S.$224 billion for the period.  We will continue our policy of extending the term of our debt maturity profile. We intend to fund our financial needs by issuing equity in addition to raising debt capital through a variety of medium and long-term financing arrangements, including the issuance of bonds in the international capital markets, supplier financing, project financing and bank financing.   

Government Regulation

The Brazilian Ministry of Planning, Budget and Management controls the total amount of medium and long-term debt that we and our Brazilian subsidiaries can incur through the annual budget approval process (Plano de Dispêndio Global, or PDG). Before issuing medium and long-term debt, we and our Brazilian subsidiaries must also obtain the approval of the National Treasury Secretariat.

All of our foreign currency denominated debt, as well as the foreign currency denominated debt of our Brazilian subsidiaries, require registration with the Central Bank. The issuance of debt by our international subsidiaries, however, is not subject to registration with the Central Bank or approval by the National Treasury Secretariat. In addition, all issuances of medium and long-term notes and debentures require the approval of our board of directors. Borrowings that exceed the approved budgeted amount for any year also require approval of the Brazilian Senate.

Sources of Funds

Our Cash Flow

On September 30, 2010, we had cash and cash equivalents of U.S.$27,451 million compared to U.S.$16,169 million at December 31, 2009.

Operating activities provided net cash flows of U.S.$18,633 million in the nine-month period ended September 30, 2010 compared to U.S.$18,005 million in the prior-year period. Cash generated by operating activities was mainly affected by net operating revenues, which increased U.S.$22,395 million during the nine-month period ended September 30,  2010 compared to the nine-month period ended September 30,  2009.

Net cash used in investing activities increased to U.S.$42,185 million in the nine-month period ended September 30, 2010 compared to U.S.$25,522 million in the nine-month period ended September 30, 2009. This increase was due primarily to capital expenditures mainly related to our exploration and production projects in Brazil (U.S.$6,088 million), to the modernization of  our refineries (U.S.$3,576 million) and also to the total cash of U.S.$10,439 million raised from the Global Offering.

Net cash provided by financing activities was U.S.$33,952 million in the nine-month period ended September 30, 2010 compared to net cash provided by financing activities of U.S.$14,624 million in the nine-month period ended September 30, 2009. This increase was primarily due to the capital increase of U.S.$27,472 million generated by the Global Offering at the initial closing on September 29, 2010.

Our net debt decreased 19.1% to U.S.$33,155 million as of September 30, 2010 compared to U.S.$40,963 million as of December 31, 2009, due to the increase of cash raised by the Global Offering mentioned above.

(1)     Our net debt is not computed in accordance with U.S. GAAP and should not be considered in isolation or as a substitute for total long-term debt calculated in accordance with U.S. GAAP.  Our calculation of net debt may not be comparable to the calculation of net debt by other companies. Management believes that net debt is an appropriate supplemental measure that helps investors assess our liquidity and assists management in targeting leverage improvements. Please see the table above for a reconciliation of net debt to total long-term debt.

(2)     Petrobras’ shareholders’ equity includes adjustments in the amount of U.S.$1,680 million (loss) on September 30, 2010 and U.S.$1,646 million (loss) on December 31, 2009, related to “Post-retirement benefit reserves adjustments, net of tax - pension and health care costs”.

(3)     Total capitalization is calculated as Petrobras’ shareholders’ equity plus short-term debt, total long-term debt and total capital lease obligations.

(4)    During the third quarter of 2010, Petrobras invested a portion of the resources raised from the Global Offering (see note 19 of our unaudited consolidated financial statements for the nine-month period ended September 30, 2010) primarily in Brazilian Treasury Securities with original maturity of more than three months.

Total Short-Term Debt

Our outstanding short-term debt serves mainly to support our working capital and our imports of crude oil and oil products, and is provided almost entirely by international banks. On September 30, 2010, our total short-term debt amounted to U.S.$12,521 million compared to U.S.$8,553 million on December 31, 2009.

Total Long-Term Debt

Our outstanding long-term debt consists primarily of securities issued in the international capital markets, debentures issued in the domestic capital markets, amounts outstanding under facilities guaranteed by export credit agencies and multilateral agencies, loans from the BNDES and other financial institutions and project financings. Our total long-term debt amounted to U.S.$54,131 million on September 30, 2010 compared to U.S.$48,149 million on December 31, 2009. See Note 10 of our unaudited consolidated financial statements as of September 30, 2010.

Off Balance Sheet Arrangements

As of September 30, 2010, there were no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Capital Increase

On September 23, 2010, our board of directors approved the Global Offering, which increased our share capital from U.S.$39,741 million to U.S.$106,655 million as of September 29, 2010 through the issuance of 2,293,907,960 common shares and 1,788,515,136 preferred shares, with the same rights as our existing shares.

At the initial closing of the Global Offering on September 29, 2010, Petrobras raised U.S.$67,467 million, of which U.S.$39,768 million consisted of Brazilian Treasury Securities and the remaining U.S.$27,699 million consisted of cash. All of the Brazilian Treasury Securities and part of the cash we raised in the Global Offering were used to pay for the initial purchase price of the assignment agreement with the Brazilian federal government (see Note 14 of our unaudited consolidated financial statements for the nine-month period ended September 30, 2010).

As a result of the issuance, Petrobras' total issued share capital as of September 30, 2010 was comprised of 7,367,255,304 common shares and 5,489,244,532 preferred shares.

On October 1, 2010, our board of directors approved the issuance of 75,198,838 additional common shares and 112,798,256 additional preferred shares, pursuant to options granted to the underwriters to purchase additional shares. These additional shares were issued under the same terms as the Global Offering, Petrobras raised U.S.$3,091 million  as a result of the exercise of the underwriters’ over-allotment options, increasing the total proceeds from the Global Offering to U.S.$70,005 million. As of October 1, 2010, Petrobras’ total issued share capital was comprised of 7,442,454,142 common shares and 5,602,042,788 preferred shares.

The direct costs incurred by Petrobras as a result of the Global Offering, in the amount of U.S.$234 million, net of taxes, were recorded in shareholders’ equity.

Dividends and Interest on Shareholders’ Equity

a) Related to 2009 results

The General Shareholders’ Meeting of April 22, 2010 approved dividends relating to the year ended December 31, 2009 in the amount of U.S.$4,560 million to common and preferred shares, without distinction, restated in accordance with the SELIC rate  from  December  31, 2009 until the date of payment on April 30, 2010.

Interest on shareholders’ equity in the total amount of U.S.$3,912 million is included in these dividends and was distributed as follows:

·   On June 24, 2009, in the amount of U.S.$1,347 million, which was made available to shareholders on November 30, 2009, based on the share position of July 3, 2009.

·   On September 21, 2009, in the amount of U.S.$964 million, which was made available to shareholders on December 21, 2009, based on the share position of September 30, 2009.

·   On December 17, 2009, in the amount of U.S.$1,002 million, which was made available to shareholders on December 29, 2009, based on the share position of December 18, 2009.

·   On February 26, 2010, the final portion of interest on shareholders’ equity, which was made available to shareholders on April 30, 2010, based on the shareholding position as of April 22, 2010, in the amount of U.S.$599 million, together with the dividends of U.S.$648 million.

b) Interest on shareholders' equity – fiscal year 2010

The Company’s board of directors approved distributions to shareholders in the form of interest on shareholders’ equity, in advance of the close of the 2010 fiscal years, as contemplated by the Brazilian Corporate Law, as follows:

·   On May 14, 2010, in the amount of U.S.$977 million which was made available to shareholders on May 31, 2010, based on the shareholding position on May 21, 2010.

·   On July 16, 2010, in the amount of US$986 million, which was made available to shareholders on August 31, 2010, based on the shareholding position on July 30, 2010.

·  On October 22, 2010,  in the amount of US$1,074 million, to be made available not later than December 31, 2010, based on the shareholding position on November 1°, 2010.

Advance payments of interest on shareholders’ equity will be counted toward the remuneration that will be distributed upon the close of the 2010 fiscal year. The amount will be updated according to the SELIC rate from the date of payment until the end of the aforementioned fiscal year.

The interest on shareholders’ equity is subject to income tax at the rate of 15%, except for shareholders that are declared immune or exempt.

Income Statement

(in millions of U.S. dollars, except for share and per share data)