(Rio de Janeiro –  August 24, 2011) - Petróleo Brasileiro S.A. - Petrobras today announced its consolidated results stated in U.S. dollars, prepared in accordance with U.S. GAAP. 

Contacts: PETRÓLEO BRASILEIRO S. A. – PETROBRAS

Investor Relations Department I E-mail: petroinvest@petrobras.com.br / acionistas@petrobras.com.br

Av. República do Chile, 65 – 22nd floor, 2202 - B - 20031-912 - Rio de Janeiro, RJ I Tel.: 55 (21) 3224-1510 / 9947

This document may contain forward-looking statements about future events that are not based on historical facts and are not assurances of future results. Such forward-looking statements merely reflect the Company’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results. Such terms as “anticipate”, “believe”, “expect”, “forecast”, “intend”, “plan”, “project”, “seek”, “should”, along with similar or analogous expressions, are used to identify such forward-looking statements. Readers are cautioned that these statements are only projections and may differ materially from actual future results or events.   Readers are referred to the documents filed by the Company with the SEC, specifically the Company’s most recent Annual Report on Form 20-F, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements, including, among other things, risks relating to general economic and business conditions, including crude oil and other commodity prices, refining margins and prevailing exchange rates, uncertainties inherent in making estimates of our oil and gas reserves including recently discovered oil and gas reserves, international and Brazilian political, economic and social developments, natural disasters and accidents, receipt of governmental approvals and licenses and our ability to obtain financing.    All forward-looking statements are qualified in their entirety by this cautionary statement.   We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events or for any other reason.   

Dear shareholders and investors,

We are pleased to announce our results for the first half of 2011. We posted record net income of U.S.$13,172 million, 53.8% higher than in the same period last year, and cash generation as measured by Adjusted EBITDA of U.S.$18,959 million, a 14.3% increase compared to the first half of 2010.

Throughout the second quarter, we announced important discoveries in the Gávea exploratory well, the pre-salt areas of the Campos Basin and the cretaceous reservoirs in the Espírito Santo Basin. Ongoing exploratory operations in the pre-salt area of the Santos Basin also produced encouraging results, underlining the high production capacity of the Lula Pilot Project and the extended well test in Guará. The Lula field was responsible for the highest output from a single Petrobras well, a record of more than 36,000 barrels of oil equivalent in May.

We initiated three new extended well tests in the second quarter: Lula Nordeste in the Santos Basin, which data will contribute to the study of that area’s definitive system; Aruanã in the Campos Basin post-salt area, which will last for approximately six months; and Brava in the Marlim pre-salt field, which we expect will last two years and which data will provide input for the area’s definitive production development project.

In relation to our Refining, Transportation and Marketing segment, we used 92% of our installed primary processing capacity, which exceeded 2 million barrels per day. We continued to invest strongly in expansion and quality improvements, which will allow us to increase production of premium oil products. We expect that the expansion of our refineries will ensure that we are equipped to meet the growth in domestic demand, which increased 8.3% in the first half of 2011 compared to the first half of 2010.  

Following exhaustive analysis, we approved our 2011-2015 Business Plan in July, with total investments of U.S.$224.7 billion, virtually identical in size to the 2010-2014 Business Plan. The plan calls for higher investments in exploration and production, with an emphasis on the pre-salt discoveries and, for the first time, on the areas  covered by the Assignment Assignment; the expansion, improvement and modernization of refining facilities, most of which are scheduled for conclusion by the end of 2014; continuing investments in the gas, power and fertilizer chain; and increased production of ethanol and biofuels. We also intend to divest certain assets, as part of our ongoing determination to make the best possible use of our capital. We have also maintained our commitment not to issue additional shares in the period, as well as to maintaining the investment-grade status conferred by the leading ratings agencies.

Despite the continuing uncertainty of the global economic scenario, we have suffered no adverse impact since most of our activities are concentrated in Brazil, where the market is growing and ensuring sufficiently robust cash flow for the development of our businesses.

In July, the Board of Directors approved an advance distribution of the second portion of interest on shareholders’ equity for the 2011 fiscal year to our shareholders. The total amount is U.S.$1,668 million, equivalent to a gross amount of U.S.$0.13 per share, to be paid by the end of October.

We believe that all these results are an accurate reflection of our entrepreneurial spirit and confirm our capacity to transform challenges into achievements. We will therefore continue to invest in order to reach our goals, working harder every day to grow and exceed our limits, as well as building a new concept of an energy company. These fundamentals, together with the profitable projects we continue to develop, will generate higher returns for our investors and shareholders, while constantly increasing our strength as a company.

Net Income and Consolidated Financial and Economic Indicators

(1)    Impacted by the increase in the value of Real against U.S. dollar in the first half of 2011 compared to the first half of 2010.

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

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

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

(5)    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. See the following page for a reconciliation between Adjusted EBITDA and net income.

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

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

(8)     Capitalized expenses differ from our total consolidated investments, disclosed in Brazil under Brazilian GAAP, primarily due to geological and geophysics and scheduled stoppages expenditures.

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 first half of 2011 and for the first half of 2010 has been affected by the 10.2% increase in the value of the Real against the U.S. dollar during that period.

Net Income Overview

Net operating revenues increased 23.9% to U.S.$70,822 million for the first half of 2011 compared to U.S.$57,183 million for the first half of 2010, primarily due to an increase of 43.9% in international Brent crude price and to higher oil products prices, which increased export costs and international sales prices, domestic oil products prices and also import costs and production taxes; a 1.8% increase in total domestic and international oil and natural gas production; and higher domestic demand of oil products, mainly of gasoline, due to favorable gasoline prices as compared to ethanol prices for the period, diesel, jet fuel and natural gas.

The increase in net income was also due to:

·   Improved financial income (expense), net (U.S.$3,868 million), due to: higher foreign exchange gains on net debt denominated in U.S. dollars; higher income in financial investments (U.S.$625 million) and in marketable securities (U.S.$717 million), due to the investment of proceeds from our Global Equity Offering in the third quarter of 2010 and higher interest rates in Brazil;

·   Increased equity in results of non-consolidated companies (U.S.$371 million), primarily due to gains from investments in the petrochemical sector;

·   Higher tax benefit related to the provisioning of interest on shareholders’ equity (U.S.$439 million); and

·   Non-recurring expenses related to the corporate reorganization of the petrochemical sector in 2010 (U.S.$342 million increase).

These effects were partially offset by:

·   Higher exploration costs, including costs for exploratory dry holes (U.S.$477 million), due to higher write-off amounts of dry and economically unviable wells; and

·   Increased general and administrative expenses (U.S.$551 million), generated by higher personnel expenses due mainly to increased workforce and also to higher personnel training costs.

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 appreciates against to the U.S. dollar, as it did in the first half of 2011 (an appreciation of 10.2%) 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.  As a consequence, the following comparison between our results of operations in the first half of 2011 and in the first half of 2010 was impacted by the increase in the value of the Real against the U.S. dollar during that period. 

RESULTS OF OPERATIONS FOR THE FIRST HALF OF 2011 COMPARED TO THE FIRST HALF OF 2010

The comparison between our results of operations has been affected by the 10.2% increase in the value of the Real against the U.S. dollar in the first half of 2011 compared to the first half of 2010.

Revenues

Consolidated sales of products and services increased 24.5% to U.S.$89,056 million in the first half of 2011 compared to U.S.$71,548 million in the first half of 2010.  This increase was primarily a result of a 43.9% increase in international Brent crude price and of higher oil products prices, which increased export costs and international sales prices and domestic oil products prices; a 8.3% increase in sales volumes in the domestic market (due mainly to a 9.0% increase in oil products demand and a 7.3% increase in natural gas demand); and a 1.8% increase in total domestic and international oil and natural gas production. For more information on the domestic increase of sales volumes, see the discussion of sales volumes on page 18.

Included in sales of products and services is the following amount that we collected on behalf of federal or state governments:

Net operating revenues increased 23.9% to U.S.$70,822 million in the first half of 2011 compared to U.S.$57,183 million in the first half of 2010 due to the increases mentioned above.

Cost of Sales (Excluding Depreciation, Depletion and Amortization)

Cost of sales in the first half of 2011 increased 31.6% to U.S.$43,038 million compared to U.S.$32,713 million in the first half of 2010. This increase was principally a result of:

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 14.6% to U.S.$4,732 million in the first half of 2011 compared to U.S.$4,130 million in the first half of 2010, due to the impact of the appreciation of the Real, to higher capital expenditures and increased oil and gas production.

Exploration, Including Exploratory Dry Holes

Exploration costs, including costs for exploratory dry holes, increased 53.5% to U.S.$1,369 million in the first half of 2011 compared to U.S.$892 million in the first half of 2010, due to the impact of the appreciation of the Real and also to higher write-off amounts of dry and economically unviable wells in the period.

Impairment

In the first half of 2011, we recorded an impairment charge of U.S.$2 million compared to U.S.$94 million in the first half of 2010. In the first half of 2010, the impairment charge amounted to U.S.$94 million and was related to losses on the recoverable amount of our 65% interest in the Breitener thermoelectric power plant in Manaus, Amazonas - Brazil 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 17.2% to U.S.$4,923 million in the first half of 2011 compared to U.S.$4,200 million in the first half of 2010.

Selling expenses increased 7.8% to U.S.$2,381 million in the first half of 2011 compared to U.S.$2,208 million in the first half of 2010. Excluding the impact of the appreciation of the Real, selling expenses remained relatively constant in the first half of 2011 compared to the first half of 2010.

General and administrative expenses increased 27.7% to U.S.$2,543 million in the first half of 2011 compared to U.S.$1,992 million in the first half of 2010. 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 mainly to increased workforce and also to higher personnel training costs.

Research and Development Expenses

Research and development expenses increased 40.4% to U.S.$629 million in the first half of 2011 compared to U.S.$448 million in the first half of 2010. This higher expense was primarily due to an increase of 43.9% in international Brent crude price and to higher oil products prices, which are the basis for a fixed 0.5% provision for expenses on research and development investment required by Brazilian law.

Other Operating Expenses

Other operating expenses decreased 21.0% to U.S.$1,689 million in the first half of 2011 compared to U.S.$2,139 million in the first half of 2010.  A breakdown of other operating expenses by segment is included on page 29.

The most significant changes between the first half of 2011 and the first half of 2010 are described below: 

These decreases were partially offset by:

Equity in Results of Non-Consolidated Companies

Equity in results of non-consolidated companies increased to a gain of U.S.$343 million in the first half of 2011 compared to a loss of U.S.$28 million in the first half of 2010, primarily due to gains from investments in the petrochemical sector, due to higher sales volume and to the foreign exchange gains on net debt denominated in U.S. dollars.

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 132.4% to U.S.$2,147 million in the first half of 2011 compared to U.S.$924 million in the first half of 2010. This increase was primarily attributable to higher income in financial investments (U.S.$625 million) and in marketable securities (U.S.$717 million) due to the investment of proceeds from our Global Equity Offering and higher interest rates in Brazil. A breakdown of financial income is set forth in Note 11 of our unaudited consolidated financial statements for the six-month period ended June 30, 2011.

Financial Expenses

Financial expenses decreased 49.1% to U.S.$418 million in the first half of 2011 compared to U.S.$822 million in the first half of 2010. This decrease was primarily attributable to higher capitalized interest income (which  resulted in a U.S.$1,112 million decrease in financial expenses), partially offset by increased financial expenses related to our debt (U.S.$648 million) and to higher losses on derivative instruments (U.S.$92 million). A breakdown of financial expenses is set forth in Note 11 of our unaudited consolidated financial statements for the six-month period ended June 30, 2011.

Monetary and Exchange Variation

Monetary and exchange variation increased to a gain of U.S.$1,460 million in the first half of 2011 compared to a loss of U.S.$781 million in the first half of 2010.  The gain in the first half of 2011 compared to the loss in the first half of 2010 was primarily due to higher foreign exchange gains on net debt denominated in U.S. dollars.

Other Taxes

Other taxes, consisting of various taxes on financial transactions, increased 1.9% to U.S.$215 million in the first half of 2011 compared to U.S.$211 million in the first half of 2010, remaining relatively constant during the period.

Income Tax (Expense) Benefit

Income before income taxes and non-controlling interest increased 52.4% to U.S.$17,757 million in the first half of 2011 compared to U.S.$11,649 million in the first half of 2010. Income tax expense increased 37.2% to U.S.$4,181 million in the first half of 2011, compared to U.S.$3,047 million in the first half of 2010, due primarily 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.$439 million) and by the increase of the tax benefit related to foreign income (U.S.$449 million).The reconciliation between the tax calculated based upon statutory tax rates to income tax expense and effective rates is set forth in Note 3 of our unaudited consolidated financial statements for the six-month period ended June 30, 2011.

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. We provide below financial information from our different business segments and related operating information.

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 52.3% increase in net income from Exploration and Production for the first half of 2011 compared to the first half of 2010 was primarily due to a 38.4% increase in average domestic oil and NGL prices and to the 1.7% increase in oil and NGL production.

These effects were partially offset by increased expenses from government participation charges and higher exploration costs, mainly geological and geophysical expenses, and due to write-off amounts related to dry holes or economically unviable wells.

The spread between the average domestic oil sale/transfer price and the average Brent price rose from U.S.$ 3.92/bbl in the first half of 2010 to U.S.$9.67/bbl in the first half of 2011, reflecting the recovery of the international market for heavy oil in relation to light oil. This increase was partially offset by the 10.2% increase in the value of the Real against the U.S. dollar in the first half of 2011 compared to the first half of 2010.

Other information relevant for this segment:

(1)             Includes production from shale oil reserves.

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

(Jan-Jun/2011 x Jan-Jun/2010): Increased production in the Marlim Leste, Cachalote/Baleia Franca and Jubarte fields, the Lula Pilot and the Tiro, Sidon, Guará, Lula Nordeste and Aruanã EWTs more than offset the natural decline in crude oil and NGL production from mature fields.

Domestic natural gas production increased 7.4% to 2,088 mmcf/d in the first half of 2011 compared to 1,944 mmcf/d in the first half of 2010 due to increased production from our fields.

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

Lifting Costs - Excluding production taxes

(Jan-Jun/2011 x Jan-Jun/2010): Our unit lifting costs in Brazil, excluding production taxes (consisting of royalties, special government participation charges and rental of areas) increased 27.7% to U.S.$12.26/bbl in the first half of 2011 compared to U.S.$9.60/bbl in the first half of 2010. Excluding the impact of the appreciation of the Real, our unit lifting costs in Brazil increased 20% in the first half of 2011 compared to the first half of 2010 due to a higher number of well interventions and maintenances in the Campos Basin fields, necessary to contain the production decline of mature fields and to prevent deterioration of our margins, captured with the processing of domestic oil. Also contributed the salary increse granted by the Collective Bargaining Agreement 2011/2010, partially offset by a 2% increase in production.

Lifting Costs - Including production taxes

(Jan-Jun/2011 x Jan-Jun/2010): Our unit lifting costs in Brazil, including production taxes, increased 35.8% to U.S.$32.75/bbl in the first half of 2011 compared to U.S.$24.12/bbl in the first half of 2010. Excluding the impact of the appreciation of the Real, our unit lifting costs in Brazil, including production taxes, increased 32% in the first half of 2011 compared to the first half of 2010, primarily attributable to a 42.1% increase in the reference price for domestic oil, which averaged U.S.$97.86/bbl in the first half of 2011 compared to U.S.$68.88/bbl in the first half of 2010, reflecting higher international oil benchmark prices upon which such taxes and charges are based.

REFINING, TRANSPORTATION AND MARKETING

Our Refining, Transportation and Marketing (RTM) segment includes refining, logistics, transportation, exportation 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 comprises investments in domestic petrochemical companies. Our RTM segment purchases crude oil from our E&P segment, as well as imports oil to blend with our domestic oil. Additionally, our RTM segment purchases oil products in the international markets to meet demand for such products from the domestic market that exceed its refining output. RTM acquires crude oil and oil products at the international price, either from our E&P or from the international markets. It sells products in Brazil at a price that we expect will equal international prices in the long run, but for gasoline, diesel and residential LPG can lag the international markets. Depending on the impact of this lag effect, our RTM segment’s earnings may differ from international refining margins.

The decrease in net income for our Refining, Transportation and Marketing segment in the first half of 2011 compared to the same period of 2010 was due to the higher oil acquisition/transfer costs and higher oil product imports.

These effects were partially offset by higher average price realization of exports, higher domestic prices, where oil products are indexed to international prices and increased net income from the petrochemical sector.

Other information relevant for this segment:

(1)             Includes crude oil export volumes of Refining, Transportation and Marketing and Exploration and Production segments.

(2)             Includes exports in progress.

(Jan-Jun/2011 x Jan-Jun/2010):  We imported higher volumes of oil products, mainly diesel, as a result of increased economic activity, which increased the demand. We also increased crude oil imports to complement our fuel oil and gasoil production, since domestic supply was reduced due to the scheduled stoppages at a crude oil product pipeline.

We decreased crude oil exports so as to replenish our inventories in the beginning of 2011. Crude oil exports were higher in the first half of 2010 due to the decline in the volumes of crude oil processed caused by the scheduled stoppage at the Replan Refinery.

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

(Jan-Jun/2011 x Jan-Jun/2010): Refinery output in Brazil increased 4.9% in the first half of 2011 compared to the first half of 2010 due to lower scheduled stoppages at distillation plants.

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 local gas companies, thermoelectric power generation and our two domestic fertilizer plants.

The increase in net income for our Gas and Power segment for the first half of 2011 compared to the first half of 2010 was due to the 7.3% increase in natural gas domestic sales volumes, led by growth in the industrial sector and increased demand for power generation; lower acquisition/transfer costs of domestic natural gas reflecting international prices and the appreciation of the Real against the US dollar; increased fixed revenue from energy auctions; increased fertilizer sales, reflecting the growth in demand and higher prices of agricultural commodities and the absence of losses related to impairment expenses, which were recorded in the first quarter of 2010, contributed to improved results.

Other information relevant for this segment:

(1)             Weekly weighed prices per output level (light, medium and heavy), number of hours and submarket capacity.

(Jan-Jun/2011 x Jan-Jun/2010): The 3.1% increase in imports of natural gas volumes from Bolivia was primarily a result of increased industrial consumption.

The decrease in sales of electricity was attributable to the lower volumes available for sale to the free market, which resulted from the reallocation of a part of this energy to energy auctions subject to market regulation.

The 4.5% increase in electricity output was attributable to the decision of the Operador Nacional do Sistema Elétrico (National Electricity System Operator – ONS) to increase thermoelectric power generation to supplement Brazil’s hydroelectric power plants.

The 1.2% decrease of the settlement price of differences (price of power at spot market) was due to the higher rainfall levels in 2011.

BIOFUEL

The Brazilian biofuel sector is undergoing consolidation and as a result, we have not been able to achieve more favorable operational margins with current sales volumes and the price levels practiced at auctions.

Our Biofuel segment comprises the production of biodiesel and byproducts, and purchases and sales of vegetable oils and ethanol.

The decrease in net income in the Biofuel segment in the first half 2011 compared to the same period of 2010 was primarily due to increases in costs for acquisition and transportation of raw-material for biodiesel production, expenses related to the implementation of new projects and higher operating expenses, reflecting the expansion of our business.

These effects were partially offset by the increase of biodiesel sales volumes and our acquisitions of companies in the ethanol industry.

DISTRIBUTION

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

Excluding currency effects the decrease in net income from the Distribution segment in the first half of 2011 compared to the same period of 2010 was mainly due to increased costs related to commercial services, provision for doubtful accounts and personnel expenses.

These effects were offset by the 7.0% increase on sales volumes, despite a reduction in marketing margins.

The segment accounted for a 39.0% of the national fuel distribution market in the first half of 2011, compared to 38.7% in the first half of 2010.

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 first half of 2011 compared to the first half of 2010 was due primarily to the recovery of commodities prices in the international market.

Other information relevant for this segment:

(1)             Includes production from shale oil reserves.

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

(3)             Non-consolidated companies in Venezuela.

(Jan-Jun/2011 x Jan-Jun/2010): International consolidated crude oil and NGL production decreased 8.3% mainly due to the institution of production taxes charged in crude oil barrels in the Agbami field in Nigeria since March 2011, and also to the cancellation of production agreements in Ecuador.

International consolidated natural gas production remained constant in the first half of 2011 compared to the first half of 2010.

(Jan-Jun/2011 x Jan-Jun/2010): The 22.3% increase in our international lifting costs was primarily due to higher costs of third-party services and materials in Argentina, higher contractual prices and increased well interventions.

(Jan-Jun/2011 x Jan-Jun/2010): Our international refinery output decreased 6.0% as a result of the sale of the San Lorenzo Refinery in Argentina and also of the scheduled stoppage in the U.S. fluid catalytic cracking unit in Pasadena Refinery between March 2011 and May 2011.

(Jan-Jun/2011 x Jan-Jun/2010): International refining costs increased 50.1% in the first half of 2011 compared to the first half of 2010 due to scheduled stoppage expenses incurred in the U.S. fluid catalytic cracking unit in Pasadena Refinery between March 2011 and May 2011 and also to a reduction in volumes of processed feedstock.

(1)     Mainly composed of asphalt sales volumes, due to higher demand from infrastructure projects.

Our domestic sales volumes increased 8.3% to 2,422 mbbl/d in the first half of 2011 compared to 2,236 mbbl/d in the first half of 2010, primarily due to:

·         Diesel (increase of 8.6%) – The increase in diesel sales was primarily due to growth in the Brazilian economy, to increased activity in the agricultural sector and to the loss of domestic market share of our competitors.

·         Gasoline (increase of 17.3%) – The increase in gasoline sales volumes was due to competitive gasoline prices compared to ethanol prices in most Brazilian federal states, to an increase in the fleet of vehicles and to a loss of domestic market share of our competitors.

·         Jet fuel (increase of 16.7%) – The increase in jet fuel sales was due to growth in the Brazilian economy and to the 10.2% appreciation of the Real which boosted supply and demand of domestic and international flights.

·         Natural gas (increase of 7.3%) – The increase in natural gas sales was a result of industrial growth and increased demand for thermoelectric power.

The 18.6% decrease in fuel oil sales was due to a partial transition to natural gas at thermoelectric power plants and in the industrial sector.

Our international sales volumes decreased 12.3% to 1,194 mbbl/d in the first half of 2011 compared to 1,362 mbbl/d  in the first half of 2010, primarily due to:

·         Exports (decrease of 11.8%) – We decreased our exports to replenish our domestic crude oil inventories in 2011. We also decreased crude oil exports in the first half of 2011 because of the recovery in the volumes of crude oil processing capacity in the Replan Refinery, which in the first half of 2010 had been reduced due to a scheduled stoppage and led us to increase volumes of crude oil exports.

LIQUIDITY AND CAPITAL RESOURCES

Our principal uses of funds are for capital expenditures, dividend payments and repayment of debt. In 2008, 2009 and 2010, we met these requirements with internally generated funds, short-term debt, long-term debt and cash generated by capital increase. 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 July 22, 2011, our Board of Directors approved our Business Plan for 2011 through 2015, providing for planned investments totaling U.S.$224.7 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 making use of the financing capacity at the domestic market, 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.   

The funds raised in our Global Offering in September 2010 will be used for the investments foreseen by our Business Plan mentioned above.

The Business Plan for 2011 was amended and approved by the Board of Directors, providing for revised planned investments in the amount of U.S.$51.9 billion for the year.

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. 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 June 30, 2011, we had cash and cash equivalents of U.S.$21,689 million compared to U.S.$17,633 million at December 31, 2010.

Operating activities provided net cash flows of U.S.$18,391 million in the first half of 2011 compared to U.S.$13,241 million in the first half of 2010. Cash generated by operating activities was mainly affected by net operating revenues, which increased U.S.$13,639 million during the first half of 2011 compared to the first half of 2010.

Net cash used in investing activities decreased to U.S.$18,918 million in the first half of 2011 compared to U.S.$21,435 million in the first half of 2010.  In the first half of 2011, we invested a total of U.S.$20,206 million, of which U.S$9,149 million in exploration and production projects in Brazil and U.S.$8,049 million in the modernization of  our refineries.

Net cash provided by financing activities was U.S.$3,893 million in the first half of 2011 compared to net cash provided by financing activities of U.S.$5,453 million in the first half of 2010. This decrease was primarily due to the payment of interest on shareholders’ equity  (U.S.$2,953 million) and to the payment of dividends (U.S.$923 million), partially offset by the funds raised by PifCo through the issuance of Global Notes (U.S.$6,000 million) and by financings obtained by PNBV from financial institutions abroad (U.S.$2,650 million) in the first half of 2011.

Our net debt increased 18.2% to U.S.$43,382 million as of June 30, 2011 compared to U.S.$36,701 million as of December 31, 2010, primarily due to the funds raised by PifCo through the issuance of Global Notes and to financings obtained abroad by PNBV mentioned above, partially offset by an increase in cash generated in the period.

The financial leverage level (net debt divided by the sum of net debt and total shareholders’ equity) increased to 17.4% on June 30, 2011, compared to 16.7% on December 31, 2010, remaining at a favorable level and below the maximum limit established by the Company of 35%.

(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)     Total shareholders’ equity includes adjustments in the amount of U.S.$2,901 million (loss) on June 30, 2011 and U.S.$2,719 million (loss) on December 31, 2010, related to “Post-retirement benefit reserves adjustments, net of tax - pension and health care costs”.

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

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 June 30, 2011, our total short-term debt amounted to U.S.$10,232 million compared to U.S.$8,960 million on December 31, 2010.

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.$70,529 million on June 30, 2011 compared to U.S.$60,471 million on December 31, 2010. See Note 10 of our unaudited consolidated financial statements as of June 30, 2011.

Off Balance Sheet Arrangements

As of June 30, 2011, 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.

Uses of Funds

Capital Expenditures

We invested a total of U.S.$20,206 million in the first half of 2011, a 4.2% increase compared to our investments of U.S.$19,387 million in the first half of 2010. Our investments in the first half of 2011 were primarily directed toward increasing production, modernizing our refineries, expanding our pipeline transportation and distribution systems and increasing biofuels production. Of the total capital expenditures in the first half of 2011, U.S.$9,149 million was invested in exploration and development projects in Brazil, including investments financed through project financing.