PBR Petroleo Brasileiro ADR

NOTES TO THE FINANCIAL STATEMENTS

Petróleo Brasileiro S.A. (Petrobras), hereinafter referred to as “Petrobras” or “Company,” is a partially state-owned enterprise, controlled by the Brazilian Federal Government, of indefinite duration, governed by the terms and conditions under the Brazilian Corporate Law (Law 6,404 of December 15, 1976), Law 13,303 of June 30, 2016 and its Bylaws.

Petrobras’ shares are listed on the Brazilian stock exchange (B3) in the Level 2 Corporate Governance special listing segment and, therefore, the Company, its shareholders, its managers and fiscal council members are subject to provisions under its regulation (Level 2 Regulation - Regulamento de Listagem do Nível 2 de Governança Corporativa da Brasil Bolsa Balcão – B3). These Regulations shall prevail over the statutory provisions, in the event of prejudice to the rights of the recipients of public offerings provided for in the Company's Bylaws, except in certain cases, due to a specific rule. On February 13, 2020, the company had its request to be disassociated from the B3 State-Owned Governance Program, requested on January 29, 2020, answered.

The Company is dedicated to prospecting, drilling, refining, processing, trading and transporting crude oil from producing onshore and offshore oil fields and from shale or other rocks, as well as oil products, natural gas and other liquid hydrocarbons. In addition, Petrobras carries out energy related activities, such as research, development, production, transport, distribution and trading of all forms of energy, as well as other related or similar activities.

Petrobras may perform any of the activities related to its corporate purpose, directly, through its wholly-owned subsidiaries, controlled companies, alone or through joint ventures with third parties, in Brazil or abroad.

The economic activities linked to its business purpose shall be undertaken by the Company in free competition with other companies according to market conditions, in compliance with the other principles and guidelines of Laws no. 9,478/97 and 10,438/02 (oil & gas and electricity sector regulations, respectively). However, Petrobras may have its activities, provided they are in compliance with its corporate purpose, guided by the Brazilian Federal Government to contribute to the public interest that justified its creation, aiming to meet national energy policy objectives when:

I – established by law or regulation, as well as under agreements provisions with a public entity that is competent to establish such obligation, abiding with the broad publicly stated of such instruments; and

II – the cost and revenues thereof have been broken down and disseminated in a transparent manner.

In this case, the Company’s Investment Committee and Minority Shareholders Committee will evaluate and measure the difference between market conditions and the operating result or economic return of the obligation assumed by the company, in such a way that the Union compensates, for each fiscal year, the difference between market conditions and the operating result or economic return of the assumed obligation.

1.1 Highlights of the year

In a year of restrictions and uncertainties imposed by the COVID-19 pandemic, the company's quick response with a defined strategy allowed an improvement in the company's operational and financial performance, with the increase in oil and natural gas production and strong cash generation. The main strategies adopted by the company are presented in note 6.

Oil and gas production in 2020 was 2.84 million barrels of oil equivalent per day (boed), with the pre-salt representing 66% of the total (1.86 MMboed), which resulted in a record annual production. The performance mainly reflected the implementation of four platforms installed in the Búzios field, technological improvements related to combating corrosion and postponing production decline, as well as optimization of production stoppages on the platforms (note 25). In 2020, the company remained a net exporter of oil and oil products, with a balance of 743 thousand bpd.

In 2020, new reserves were incorporated due to the approval of new projects and the good performance of the reservoirs, with emphasis on the Santos Basin pre-salt, resulting in an appropriation equivalent to 101% of the year's production. This effect was dampened by the negative impact resulting from the 32% reduction in the oil price in 2020. Thus, disregarding the effect of assets sold in 2020, the replacement of reserves was 29% of that year's production. The sale of assets in 2020 is aligned with the maximization of the portfolio's value, with a focus on world-class assets in deep and ultra-deep waters, and the impact was not relevant in the total value of reserves. The 2020 reserves do not yet consider new projects to be implemented as a result of the acquisition of the Transfer of Rights Surplus. Such volumes will be incorporated after the signing of the co-participation agreements of Búzios and Itapu fields (Supplementary information on Oil and Gas Exploration and Production - unaudited).

The performance in 2020, aligned with our pillar of maximizing return on capital employed, resulted in a large operating cash generation, with a significant increase in exports (note 9) and a series of measures to reduce expenses and preserve cash in the face of uncertainty, in order to reinforce the financial strength and resilience of the company's business, in addition to receipts for the sale of assets and interests. These funds were used to reduce gross indebtedness and make investments.

In portfolio management, we highlight the sales of subsidiaries Liquigás and Petrobras Oil & Gas B.V and onshore fields and in shallow waters (note 32).

During 2020, the Company signed Expenses and Volume Equalization Agreements with its partners in the Tupi, Sépia, Atapu and Production Individualization Agreements for the Berbigão, Sururu, Albacora Leste and other fields , with an impact on other operating income (note 30).

Regarding the capital structure, the Company continues to prioritize debt reduction and financial deleveraging, through prepayment of financings in Brazil and abroad in the amount of R$ 70 billion (note 34 – Finance Debt). There was a decrease on the gross debt (Financings and Leases) translated into U.S. dollars.

During the year, some actions were part of the effort to reduce the liabilities of the post-employment pension and health benefit plans, with approvals of new equation plans, negotiation of new proportions of health care plan costs, approval of a new management model for the health care plan through an association and early settlement of the Financial Commitment Term (note 19 - Post-employment benefits - Pension and health care plans).

The impacts of the pandemic and the change in our long-term view of oil prices to US $ 50 / bbl generated recognition of impairment losses in the first quarter of 2020, partially reversed in the fourth quarter of 2020, considering the economic assumptions of the Strategic Plan 2021-2025, approved in November, as well as active portfolio management and new estimates of reserve volumes and dismantling of production areas, which underpinned the recoverability tests for the year 2020 (note 27).

As a result of the collaboration and leniency agreements entered into by other companies under “Lava Jato” Operation, the Company was reimbursed at R$ 797 throughout 2020 (note 23).

Throughout 2020, Petrobras, through its strategy of active management of its liabilities and considering the specificities of each process, as well as the analysis of the cost-benefit ratio, adhered to amnesty and state remission programs for payment in cash of VAT tax debts, with the benefit of an average reduction of 49% (note 17.2), in addition to addressing possible future risks associated with the matters for which adhesions were made (note 20).

In 2020, Petrobras and two subsidiaries obtained a favorable and definitive court decision on the exclusion of VAT Tax from the calculation base of PIS and Cofins contributions, referring to undue payments made between October 2001 and August 2020. The estimate generated recognition of credits of R$ 17,588 in current assets, net gain in profit and loss of R$ 11,608 and, in 2020, the company offset part of these credits for settlement of other federal taxes, in the amount of R$ 10,372 (note 17.1).

The company's distribution of added value is as follows:

In October 2020, the revision of the Shareholder Remuneration Policy was approved in order to enable Management to propose the payment of dividends compatible with the company's cash generation, as long as the company's financial sustainability is preserved. With this change, the proposal for the fiscal year 2020, in the amount of R$ 10,272 (R$ 0.787446 per common and preferred share) will be forwarded to the 2021 Annual General Meeting (AGM) (note 36), of which R$ 5,711 through the profit sharing for the year and R$ 4,561 through the use of profit reserves.

In addition, our financial statements in U.S. dollars, which are translated based on CPC 02 - “Effects of changes in exchange rates and translation of financial statements”, equivalent to the international accounting standard IAS 21 - “Effects of changes in exchange rates” are also disclosed and filed. The table below shows the main information in millions of dollars:

The consolidated and individual (Parent Company) financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), and with the pronouncements issued by the Brazilian Accounting Pronouncements Committee (Comitê de Pronunciamentos Contábeis - CPC) and released by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM).

All relevant information related to financial statements, and only them, are presented and corresponds to the information used by the Company’s Management.

The consolidated and individual financial statements have been prepared under the historical cost convention, except when otherwise indicated. The summary of significant accounting policies used in the preparation of these financial statements is set out in their respective notes.

In preparing these financial statements, Management used judgments, estimates and assumptions that affect the application of accounting practices and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. The relevant estimates and judgments that require a higher level of judgment and complexity are disclosed in note 4.

In July 2019, after the additional sale of its interest in Petrobras Distribuidora S/A (BR) through a secondary public offering (follow on), Petrobras' interest was reduced to 37.50% of the share capital, and BR ceased to be a Petrobras controlled company. This operation was a “discontinued operation”. Thus, the consolidated statements of income and cash flows, for the comparative period, present the results and cash flows from operating, investing and financing activities in separate lines, as a net income of discontinued operations. The comparative information related to the other statements does not present such segregation, including the statement of added value, whose values ​​for 2019 were reclassified in order to provide better comparability.

The Company's Board of Directors, at a meeting held on February 24, 2021, authorized the disclosure of these financial statements.

The Brazilian corporate law requires the release of the Statement of added value as an integral part of the financial statements. This statement is presented as supplementary information under IFRS and was prepared in accordance with CPC 09 – Statement of Added Value, approved by CVM Resolution 557/08.

The purpose of the statement of added value is to present information relating to the wealth created by the Company and how it has been distributed.

The functional currency of Petrobras and all of its Brazilian subsidiaries is the Brazilian Real, which is the currency of its primary economic environment of operation. The functional currency of most of the direct controlled entities that operate in the international economic environment is the U.S. dollar.

The income statements and statement of cash flows of non-Brazilian Real functional currency subsidiaries, joint ventures and associates are translated into Brazilian Real using the monthly average exchange rates prevailing during the year. Assets and liabilities are translated into Brazilian Real at the closing rate at the date of the financial statements and the equity items are translated using the exchange rates prevailing at the dates of the transactions.

All exchange differences arising from the translation of the financial statements of non-Brazilian Real subsidiaries, joint ventures and associates are recognized as cumulative translation adjustments (CTA) within accumulated other comprehensive income in the shareholders’ equity and transferred to profit or loss in the periods at the disposal of the investments.

2.3. Order of presentation of the explanatory notes

As recommended in the Conceptual Framework for Financial Reporting CPC 00 R2 (Conceptual Framework), the expectations of users of financial statements regarding the company's returns depend on their assessment of the value, the time and the prospects for future net cash flows and their management's assessment of economic resources.

Thus, the order of the explanatory notes aligns the company's financial statements with the users' view, in addition to emphasizing the importance in terms of the company's strategic management.

Thus, after the explanatory notes that present the company and its operations, as well as the explanatory notes related to the conceptual structure applied in the preparation of the financial statements, it begins with the explanatory note on Capital Management, followed by the other notes, obeying primarily the groupings of cash flow statement activities.

The Company's accounting practices are consistent with those adopted and disclosed in the previous year. For a better understanding of the recognition and measurement basis applied in the preparation of the financial statements, these practices are presented in the respective explanatory notes that deal with the topics of their applications.

The preparation of the financial statements requires the use of estimates and judgments for certain transactions that reflect the recognition and measurement of assets, liabilities, income and expenses. The assumptions used are based on history and other factors considered relevant, and are periodically reviewed by Management. Actual results may differ from estimated values. The impacts of COVID-19 and the change in the economic environment were considered in the preparation of these financial statements and the results of the review of these assumptions, arising from COVID-19, are presented in note 6.

Information about those areas that require significant judgment or involve a higher degree of complexity in the application of the accounting policies and that could materially affect the Company’s financial condition and results of operations is set out as follows.

Oil and gas reserves are estimated based on economic, geological and engineering information, such as well logs, pressure data and drilling fluid sample data and are used as the basis for calculating unit-of-production depreciation, depletion and amortization rates, impairment testing, decommissioning costs estimates and for projections of high probable future exports subject to cash flow hedge.

These estimates require the application of judgment and are reviewed at least annually based on a re-evaluation of already available geological, reservoir or production data and new geological, reservoir or production data, as well as changes in prices and costs that are used in the estimation of reserves. Revisions can also result from significant changes in the Company’s development strategy or in the production capacity.

The Company determines its oil and gas reserves both pursuant to the U.S. Securities and Exchange Commission - SEC and the ANP/SPE (Brazilian Agency of Petroleum, Natural Gas and Biofuels / Society of Petroleum Engineers) criteria. The main differences between the two criteria are mainly associated with the use of different economic premises and the possibility of considering as reserves, under the ANP / SPE criterion, the volumes expected to be produced beyond the contractual term of concession in the fields of Brazil, according to the technical regulation of ANP reserves.

According to the definitions prescribed by the SEC, proved oil and gas reserves are those quantities of oil and gas which, by analysis of geoscientific and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs and under existing economic conditions, operating methods, and government regulation. Proved reserves are subdivided into developed and undeveloped reserves.

Proven developed reserves are those that can be expected to recover: (i) through existing wells, with existing equipment and operating methods, or in which the cost of necessary equipment is relatively lower when compared to the cost of a new well; or (ii) through the equipment and extraction infrastructure installed, in operation at the time of the reserve estimate, if the extraction is done by means that do not involve a well.

Although the Company understands that proved reserves will be produced, the timing and amount recovered can be affected by a number of factors including completion of development projects, reservoir performance, regulatory aspects and significant changes in long-term oil and gas price levels.

Other information about reserves is presented in the supplementary information about oil and natural gas exploration and production activities..

Estimates of proven reserve volumes used in the calculation of depreciation, depletion and amortization rates, in the units produced method, are prepared by specialized company professionals, in accordance with the definitions established by the SEC. Reviews of developed and undeveloped proved reserves have a prospective impact on the depreciation, depletion and amortization amounts recognized in profit or loss and the book values ​​of oil and natural gas assets.

Therefore, considering all other variables being constant, a decrease in estimated proved reserves would increase, prospectively, depreciation, depletion and amortization expense, while an increase in reserves would reduce depreciation, depletion and amortization.

Notes 25 provides more detailed information on depreciation and depletion.

For the calculation of the recoverable value of assets linked to the exploration and development of oil and natural gas production, the estimated value in use is based on proven reserves and probable reserves in accordance with the criteria established by ANP / SPE.

Further information on impairment testing is presented in note 27.

The estimate of the moment when decommissioning costs for are realized is based on the depletion period of proven reserves according to the criteria established by ANP / SPE. Revisions to reserve estimates that imply changes in the depletion period may affect the provision for dismantling areas.

The Company estimates highly probable future exports in accordance with future exports forecasted in the scope of its Strategic Plan projections, which are driven by proved and probable reserves estimates. Changes in such estimates may impact future exports forecasts and, consequently, hedge relationship designations may also be impacted.

Impairment testing involves uncertainties mainly related to its key assumptions: average Brent prices and Brazilian real/U.S. dollar average exchange rate. These assumptions are relevant to virtually all of the Company’s operating segments and a significant number of interdependent variables are derived from these key assumptions and there is a high degree of complexity in their application in determining value in use for impairment tests.

The markets for crude oil and natural gas have a history of significant price volatility and although prices can drop precipitously, industry prices over the long term tends to continue being driven by market supply and demand fundamentals.

Projections relating to the key assumptions are derived from the Business and Management Plan. These assumptions are consistent with market evidence, such as independent macro-economic forecasts, industry and experts’ evaluations. Back testing analysis and feedback process in order to continually improve forecast techniques are also performed.

The Company’s oil price forecast model is based on a nonlinear relationship between variables reflecting market supply and demand fundamentals. This model also takes into account other relevant factors, such as historical idle capacity, industry costs, oil and gas production forecasted by specialized firms, the relationship between the oil price and the U.S. dollar exchange rate, as well as the impact of OPEC on the oil market.

The Real/U.S. dollar exchange rate projections are based on econometric models that take into account long-term assumptions involving observable inputs, such as country risk, commodity prices, interest rates and the value of the U.S. Dollar relative to a basket of foreign currencies (U.S. Dollar Index – USDX).

Changes in the economic environment can generate changes in assumptions and, consequently, the recognition of losses due to devaluation (or reversals of loss) in certain assets or CGUs, since, for example, the price of Brent directly impacts sales revenues and refining margins of the company, while the exchange rate of the US Dollar against the Real essentially impacts investments and operating expenses.

Changes in the economic and political environment may also result in higher country risk projections that would increase discount rates for impairment testing.

Reductions in the future prices of oil and natural gas, which are considered to be a long-term trend, as well as negative effects resulting from significant changes in the volume of reserves, the expected production curve, lifting costs or discount rates, as well as decisions on investments that result in the postponement or interruption of projects may be indications of the need to perform asset impairment tests.

The recoverable amount of certain assets may not substantially exceed their book values ​​and, for this reason, it is reasonably possible that impairment losses will be recognized in these assets in the coming years due to the observation of a different reality in relation to the assumptions made, as explained in note 27.

This definition involves judgments and evaluation by Management, based on its business and management model. Changes in CGUs may occur due to the review of investment, strategic or operational factors that may result in changes in the interdependencies between assets and, consequently, in the aggregation or disaggregation of assets that were part of certain CGUs, which may generate additional losses or reversals in assets recoveries. The level of asset breakdown in CGUs can reach the limit of assets being tested individually. The definitions adopted are as follows:

i) Oil or gas production field or pole: composed of a set of assets linked to the exploration and development of the production of a field or a pole (set of two or more fields) in Brazil or abroad. As of December 31, 2020, the CGUs in the Exploration and Production segment in Brazil totaled 132 fields and 30 poles. Changes in the CGUs in the E&P segment are presented in note 27. The drilling rigs are not associated with any CGU and are individually tested for recoverability..

i) Refining, transportation and marketing CGU: set of assets that comprise the refineries, terminals and pipelines, as well as the logistics assets operated by Transpetro, with the combined and centralized operation of the logistics and refining assets, with the common aim of serving the market at the lowest global cost and, above all, the preservation of the strategic value of the set of assets in the long term. The operational planning is done in a centralized way and the assets are not managed, measured or evaluated by their isolated individual economic and financial result. Refineries do not have the autonomy to choose the oil to be processed, the mix of oil products to be produced, the markets to which they are destined, which portion will be exported, which intermediaries will be received and the sales prices of the products. Operational decisions are analyzed using an integrated model of operational planning to serve the market, considering all production, import, export, logistics and inventory options and seeking to maximize the company's overall performance. The decision on new investments is not based on the individual assessment of the asset where the project will be installed, but on the additional result for the CGU as a whole. The model that supports all planning, used in the technical and economic feasibility studies of new investments in refining and logistics, seeks to allocate a certain type of oil, or mix of oil products, to define the service to markets (area of ​​influence), aiming at the best results for the integrated system. Pipelines and terminals are complementary and interdependent parts of refining assets, with the common aim of serving the market.

ii) CGU Comperj – assets related to Comperj First Refining Unit. Only the utilities module is under construction, the necessary infrastructure to meet the UPGN of the integrated route 3 project. Assets are tested separately;

iii) CGU Second Refining Unit of RNEST – assets of the second refining unit at the Abreu e Lima Refinery and associated infrastructure, tested separately;

iv) Transportation CGU: comprises assets relating to Transpetro’s fleet of vessels. In 2020, Cartola and Ataulfo ​​Alves vessels were excluded from the CGU due to the end of their operations. These vessels began to be tested separately;

v) PANAMAX CGU: comprises three Panamax class vessels under construction (EI-512, EI-513 and EI-514);

vi) Comboios - Hidrovia CGU: comprises the fleet of vessels of the Hidrovia project (transportation of ethanol along the Tietê River) that are under construction.

vii) SIX CGU: shale processing plant; and

viii) Other CGUs: assets abroad valued at the smallest identifiable group of assets that generates cash inflows independent of cash inflows from other assets or other groups of assets.

c)Gas & Power CGUs:

i) Natural gas CGU: comprises natural gas pipelines, natural gas processing plants, consolidating the purchase, transportation and treatment of natural gas segments, in order to enable the commercialization of natural gas and its liquids (LPG, NGL and ethanol). During 2020, management decided to stop the operations of UPGN Atalaia, which will be tested separately;

ii) Nitrogenated Fertilizer Units CGUs: fertilizer and nitrogen plants, tested separately.

iii) Power CGU: comprises the thermoelectric power generation plants.

iv) Termocamaçari CGU: assets of UTE Termocamaçari, tested separately due to the lack of prospects for future operations.

v) Other CGUs: assets abroad valued at the smallest identifiable group of assets that generates cash inflows independent of cash inflows from other assets or other groups of assets.

d)Biofuels CGUs:

i) Biodiesel CGU: set of assets that make up the biodiesel plants. The definition of the CGU, with joint assessment of the plants, reflects the process of planning and carrying out production, considering the conditions of the national market and the supply capacity of each plant, as well as the results achieved in auctions and the supply of raw materials; and

ii) Quixadá CGU: Quixadá-CE Biodiesel Plant, tested separately, due to the decision to close its operations.

Further information on impairment of assets is presented in note 27.

The actuarial obligations and costs related to defined benefit pension and health care post-retirement plans are computed based on several economic and demographic assumptions, of which the most significant are:

These and other estimates are reviewed annually and may differ from actual results due to changing market and financial conditions, as well as actual results of actuarial assumptions.

The sensitivity analysis of discount rates and changes in medical costs as well as additional information about actuarial assumptions are set out in note 19.

The Company is defendant in arbitrations and in legal and administrative proceedings involving civil, tax, labor and environmental issues arising from the normal course of its business, and makes use of estimates to recognize the amounts and the probability of outflow of resources, based on reports and technical assessments from legal advisors and on the management’s assessment.

These estimates are performed individually, or aggregated if there are cases with similar characteristics, primarily considering factors such as assessment of the plaintiff’s demands, consistency of the existing evidence, jurisprudence on similar cases and doctrine on the subject. Specifically for actions of outsourced employees, the Company estimates the expected loss based on a statistical procedure, due to the number of actions with similar characteristics.

Arbitral, legal and administrative decisions against the Company, new jurisprudence and changes on the existing evidences can result in changes regarding the probability of outflow of resources and on the estimated amounts, according to the assessment of the legal basis.

Note 20 provides further detailed information about contingencies and legal proceedings.

The Company has legal obligations to remove equipment and restore onshore and offshore areas at the end of operations, the latter being the most significant. Estimates of costs for future environmental cleanup and remediation activities are based on current information about costs and expected plans for remediation. The accounting recognition of these obligations must be at present value, using a risk-free discount rate, adjusted to the company's credit risk. Due to the long periods until the abandonment date, variations in the discount rate, however small they may be, can cause large variations in the recognized amount.

These estimates require performing complex calculations that involve significant judgment since: i) the obligations are long-term; ii)the contracts and regulations contain subjective definitions of the removal and remediation practices and criteria involved when the events actually occur; and iii) technologies and asset removal costs are constantly changing, along with environmental and safety regulations.

The Company is constantly conducting studies to incorporate technologies and procedures to optimize the process of abandonment, considering industry best practices. However, the timing and amounts of future cash flows are subject to significant uncertainty.

Note 21 provides further detailed information about the decommissioning provisions.

The Company makes judgments to determine the recognition and the amount of deferred taxes in the financial statements. Deferred tax assets are recognized if it is probable that future taxable profits will exist. The determination of the recognition of deferred tax assets requires the use of estimates contained in the Strategic Plan for the Petrobras Group, which is annually approved by the Board of Directors. This plan contains the main assumptions that support the measurement of future taxable profits, which are: i) brent oil price; ii) exchange rate; iii) net financial result.

Changes in deferred tax assets and liabilities are presented in note 17.

The calculation of “highly probable future exports” is based on the exports provided for in the current Strategic Plan, representing a portion of the projected values ​​for export revenue. The value estimated as highly probable is obtained considering the future uncertainty about the price of oil, oil production and demand for products in a model of optimization of the company's operations and investments, in addition to respecting the historical profile of exported volume in relation to total oil production. The values ​​of future exports are recalculated for each change of premise in the projection of the Strategic Plan (PE). The methodology used for its calculation and the respective parameters are reassessed at least once a year.

Other information and sensitivity analysis of cash flow hedge accounting involving the Company’s future exports is disclosed in note 38.

As described in note 23, in the third quarter of 2014, the Company developed an estimation methodology and wrote off R$ 6,194 of capitalized costs representing the estimated amounts that Petrobras had overpaid for the acquisition of property, plant and equipment.

The Company has continuously monitored the results of the Lava Jato investigation and the availability of other information related to the scheme of improper payments. In preparing the financial statements for the year ended December 31, 2020, the Company has not identified any additional information that would impact the adopted calculation methodology and consequently require additional write-offs.

The provision for expected credit losses (PCE) for financial assets is based on assumptions of default risk, determination of the occurrence or not of a significant increase in credit risk, a recovery factor, among others. To this end, the company uses judgments on these premises, in addition to information on late payments and assessments of the financial instrument based on external risk classifications and internal assessment methodologies.

The company uses incremental rates on company loans to discount cash flows from lease payments whose implied rates cannot be determined immediately. Incremental rates are estimated based on corporate funding rates (obtained from the yields - yields - of securities issued by Petrobras), which take into account the company's risk-free rate and credit risk premium, adjusted to reflect the specific conditions and characteristics of the lease, such as the risk of the country's economic environment, the impact of guarantees, the currency, the term and the start date of each contract.

Uncertainties over income tax treatments represent the risks that the tax authority does not accept a certain tax treatment applied by the Company. The Company estimates the probability of acceptance of an uncertain tax treatment by the tax authority based on technical assessments by its legal advisors, considering precedent jurisprudence applicable to current tax legislation, which may be impacted mainly by changes in tax rules or court decisions which may affect the analysis of the fundamentals of uncertainty.

The main standards issued by the IASB that have not yet come into force and have not been adopted by the company before December 31, 2020.

Petrobras and its subsidiaries have debts indexed to Libor, the value of which corresponds to approximately 32% of their total financial indebtedness.

In order to be prepared for the transition of the IBORs, the company is monitoring the authorities' statements, as well as the measures that have been adopted, aiming at the adaptation of the various financial instruments to the new benchmarks.

In this way, Petrobras anticipates regulatory and financial market changes, in addition to preparing to make any adjustments to contracts, processes and systems that may be necessary.

As for the amendments and regulations listed above, which will come into effect as of January 1, 2022, the company is evaluating the effects of the initial application on its consolidated financial statements.

The CPC issues pronouncements and interpretations considered to be analogous to IFRS, issued by the IASB. The IFRS amendments contained in item 5.1 were not issued by the CPC until December 31, 2020.

6.1 Context

In January 2020, China reported having identified a new variant of coronavirus, causing the disease COVID-19, which was spreading quickly in its population. On March 11, 2020, COVID-19 was a declared a pandemic by the World Health Organization (WHO). Social isolation measures arising from this pandemic affected the global economic environment, reducing the demand for oil and its oil products and triggering a shock in the oil and gas industry.

In early April, member countries and non-members of the Organization of Petroleum Exporting Countries and their allies (OPEC +) announced a new agreement whereby the combined production of the participants would be reduced by 9.7 MM bpd (barrels of oil day) for the months of May and June, after oil prices, in March and April, showed a sharp reduction in quotations, reaching the lowest price of the year in mid-April (US$ 19.33/bpd). In July 2020, at a new meeting, OPEC decided not to change the planned schedule for implementing the combined production cuts, maintaining for July the reduction of 9.7 MM bpd (barrels of oil day) and 7.7 MM bpd as of August, remaining at this level until December 2020. On December 3, 2020, the entity decided that the member countries of the organization increase their production by 500 thousand barrels per day per month starting in January 2021. In addition, successive and gradual increases in oil production may occur in the months later. With the new agreement, the production cut will be 7.2 million bpd from January 2021.

The adversity in the global scenario caused the company to revise its top metric of indebtedness contained in the Strategic Plan 2020-2024, replacing the indicator of net debt / EBITDA by the indicator of gross debt. The approved gross debt target for 2020 was US$ 87 billion, the same level as that of 2019, being overtaken in the third quarter of 2020, mainly by prepaying loans and repurchasing and redeeming securities in the international capital market.

Aware of the global crisis, the company also revised some key assumptions such as price, exchange rate and demand, because the short, medium and long term planning scenarios for these assumptions were no longer compatible with those approved in the Strategic Plan 2020-2024, reflecting directly in the financial statements of the first quarter of 2020.

The regular monitoring of projections of its reference price assumptions throughout 2020, in view of realized prices and the external environment, signaled changes in market conditions, such as the recovery in the price of Brent oil and the strong devaluation of the Real against the Dollar , leading the company to incorporate in its Strategic Plan 2021-2025, approved in November 2020, a review of the short and medium term trajectory, but maintaining the convergence of Brent oil price to US$ 50 per barrel in the long term, such as the projections made for the preparation of the financial statements for the first three quarters of 2020.

The company, in line with the recommendations of the WHO and the Ministry of Health, announced measures to preserve the health of its employees and support in the prevention of contagion in its operational and administrative areas, including work in the home office, for all activities that can be carried out remotely, temporary change of work shifts in face-to-face operations aiming to reduce the number of professionals circulating, strict cleaning of workplaces, distribution of face protection masks, massive testing, tracking of suspected and confirmed cases, pre-shipment isolation , pre-shipment health monitoring and before shifts start, health assessment with body temperature measurement and pre-shipment testing for oil platforms and periodically at land units, in addition to health monitoring, access to telemedicine services for employees, continuous risk assessment and cooperation with society.

The Brazilian governmental authorities, in turn, implemented a series of measures to face the collateral economic effects imposed by the current pandemic, highlighting: Federal Government measures - (i) PIS and Cofins and Social Security-Companies’ Contribution - had the due amounts of competencies from March to May 2020 deferred for collection in August, October and November 2020, respectively; (ii) FGTS - had the collection of the amounts from March to May deferred in six equal installments to be paid from July to December 2020; (iii) System S - 50% reduction in rates from April to June 2020; and (iv) IOF Credit - reduction from 3% to zero in certain operations carried out from April to November and the second half of December 2020; and State of Pernambuco - (v) VAT tax rate on import of fuel (from April to December 2020) - deferral of up to 30 days.

As a result of the abrupt reduction on the demand and prices of oil and fuel, the Company adopted a set of measures aiming at reducing costs, postponing cash outflows and optimizing its working capital, in order to ensure its financial strength and resilience of its businesses. The main measures are:

Due to the structural reduction in the demand for natural gas in the entire Brazilian market due to the pandemic and the consequent declaration of Force Majeure by its customers (local natural gas distributors), Petrobras notified Force Majeure in the contracts for the purchase of natural gas related to the Manati field (GSA) and the purchase of Bolivian imported natural gas with YPFB (GSA Bolivia), as provided for in the contract. With this, the company mitigated the effects of the Force Majeure on this contract (GSA) and reduced potential controversies, as well as avoided payments related to the take-or-pay obligation. From September 2020, with the resumption of consumption in the non-thermoelectric market, for contracts that no longer met the legal and contractual requirements for the characterization of the Force Majeure, their normal supply conditions were resumed;

Despite the challenging context imposed by COVID-19, the company achieved the following results in the year ended December 31, 2020: (i) increase in the average production of oil, NGL and natural gas; (ii) reaching monthly production records in Búzios; (iii) record exports of oil and fuel oil with low sulfur content; (iv) record production and sale of low-sulfur S-10 diesel; (v) production of new gasoline with higher octane; and (vi) reduction in dollar indebtedness, in addition to improved risk perception, with the issue of 10-year bonds with the lowest yield in Petrobras' history.

As a consequence of the implementation of the measures described above and of the results achieved, the company believes that it has adequate resources to continue its operations in the short term and, therefore, the going concern assumption was applied in the preparation of these financial statements.

6.3Effects on financial statements

The impacts of COVID-19 and the change in the economic environment were considered in the preparation of these financial statements. Information on the relevant estimates and judgments, which require a high level of judgment and complexity in their applications and which may materially affect the company's financial situation and results, are disclosed in note 4.

The result of the review of the premises, whether the review is applied to the financial statements of the first quarter of 2020, such as that resulting from the Strategic Plan 2021-2025, approved in November 2020, and others arising from COVID-19, are presented below:

The company's capital management aims to return its capital structure to adequate levels, aiming at the continuity of its business and the increase in value for shareholders and investors. The company's main sources of funds have been its operating cash generation and divestments.

One of the five pillars of the 2021-2025 Strategic Plan is the reduction of the cost of capital through debt management and with a trajectory of reduced leverage. The financial strategy also aims to mitigate risks by actively managing liabilities, maximizing shareholder return and optimizing working capital.

Gross debt (composed of financial debt and lease liabilities, current and non-current) is one of the main metrics for the company, allowing Petrobras to monitor its indebtedness, which management considers essential to increase competitiveness with peers, reducing our cost of capital. The company's goal for 2021 is to reduce gross indebtedness to US$ 67 billion and the Shareholder Remuneration Policy states that, if gross indebtedness is less than US$ 60 billion, the amount planned for 2022, the company may distribute to its shareholders 60% of the difference between operating cash flow and investments in capital goods, according to note 36.

In 2020, the company reduced its gross debt by US$ 11,583 million, ending the year with US$ 75,538 million and US$ 12,370 million in cash, exceeding the target of US$ 87.1 billion. In addition, it reduced net debt by US$ 15,693 million, reaching US$ 63,168 million and extended the average debt maturity from 10.8 years in 2019 to 11.71 years in 2020. However, gross and net debt in Reais increased 12% and 3%, respectively, due to the devaluation of the Real against the dollar, as shown in the following table:

The strong generation of operating cash of R$ 148,106 (US$ 28,890 million) was fundamental to the reduction of indebtedness in the year, in addition to the divestments of R$ 10,212 (US$ 1,997 million).

These measures are not defined according to international accounting standards - IFRS and should not be considered in isolation or as a substitute for the metrics of income, indebtedness and operating cash flow under IFRS, nor be a basis for comparison with other companies' indicators.

Include cash at bank and in hand, available bank deposits and highly liquid short-term investments, maturing in up to three months, counting from the date of the original contract, readily convertible into a known cash amount and with an insignificant risk of change in value.

Short-term financial investments in Brazil primarily consist of investments in funds holding Brazilian Federal Government Bonds that can be redeemed immediately, as well as reverse repurchase agreements that mature within three months as of the date of their acquisition. Short-term financial investments abroad comprise time deposits that mature in three months or less from the date of their acquisition, highly-liquid automatic investment accounts, interest checking accounts and other short-term fixed income instruments.

The main funds generated were substantially provided by cash from operating activities of R$ 148,106, proceeds from divestments of R$ 10,212 and a set of measures to reduce cash outflows and preserve cash in this scenario of uncertainty of the pandemic, in order to reinforce its financial strength and resilience of the company’s businesses. The exchange rate effect on the balances of cash and cash equivalents resulting from investments abroad was R$ 8,323.

The main use of these funds in the period ended December 31, 2020 were for debt service obligations, net of proceeds from financing through the offering of securities in the international market, including pre-payment of debts in the national and international banking market, repurchase and redemption of securities in the international capital market and lease payments totaling R$ 94,659 and realization of investments in the amount of R$ 35,286.

Accounting Policy

They represent cash at bank and in hand, bank deposits available and short-term investments with high liquidity, maturing in up to three months, counting from the date of the original contract, readily convertible into a known amount of cash and with an insignificant risk of change in value.

Marketable securities classified as fair value through profit or loss refer mainly to investments in Brazilian Federal Government Bonds. These financial investments have maturities of more than three months and are mostly classified as current assets due to their maturity or the expectation of their realization in the short term.

Accounting Policy

They are initially measured at fair value and subsequently according to their respective classifications:

Amortized cost: cash flows that constitute the receipt, on specified dates, of principal and interest on the principal amount outstanding and the business model aims to maintain the asset in order to receive its contractual cash flows. Interest income is calculated using the effective interest method.

Fair value through other comprehensive income: securities in which the company has irrevocably elected due to subsequent changes in the fair value of the investment in other comprehensive income;

Fair value through profit or loss: all other securities.

As an integrated energy company, revenues from contracts with customers derive from different products sold according to our operating segments, taking into consideration specific characteristics of the markets where it operates. For additional information about the operating segments of the Company, its activities and its respective products sold, see note 13.

The determination of transaction prices derives from methodologies and policies based on the parameters of these markets, reflecting operating risks, level of market share, changes in exchange rates and international commodity prices, including Brent oil prices, oil products such as diesel and gasoline, and the Henry Hub Index.

Revenues from sales are recognized at the moment the control is transferred to the client, that occurs upon product delivery or when the service is provided. Billing takes place in periods very close to the delivery and rendering of services, therefore, significant changes in transaction prices are not expected to be recognized in revenue from periods after the satisfaction of the performance obligation, except for some exports in which final price formation occurs after the transfer of control of the products and is subject to variation in the value of the commodity. Sales are made on short receipt terms, so there are no financing components.

In addition, the company acts as an agent mainly in the biofuels business, where there is no control of the biodiesel sold to the distributors at any time during the sale operation. Agency revenues in 2020 totaled R$ 192 (R$ 183 in 2019).

Reduction of sales revenues in the domestic market, mainly by:

- jet fuel, due to the restrictions imposed by the pandemic;

- diesel, due to increased sales by importers and restrictions on the transportation of passengers and cargo due to the pandemic, partially offset by commercial actions carried out in 2020;

- gasoline, due to the restrictions on mobility imposed by the pandemic, and the loss of market share, partially offset by commercial actions carried out in 2020; and

- effects partially offset by higher volumes of naphtha, due to the reduction in direct imports from Braskem, and LPG, due to social isolation, increasing residential consumption of the derivative, and lower temperatures, promoting greater consumption.

The higher export revenue reflects the higher volumes of oil exports, due in large part to the greater oil production in Brazil and the retraction of the domestic market, as well as higher volumes of oil products, mainly low sulfur fuel oil. These effects were partially offset by lower prices, following the reduction in international prices.

The reduction in sales revenue abroad mainly reflects the sale of distribution companies in Paraguay and the Pasadena Refinery and the lower volumes sold due to the impact of the pandemic, as well as the lower prices realized, due to the devaluation of international prices.

With the reduction of participation in the share capital of Petrobras Distribuidora - BR, which occurred on July 25, 2019, the company is no longer consolidated. Sales to Petrobras Distribuidora - BR represent more than 10% of the company's total sales, mainly impacting the Refining, Transport and Marketing (RTM) segment.

The company has sales contracts for products or services in force and signed until December 31, 2020, with terms greater than 1 year, where there is established a quantity of goods or services for sales in the next years with their respective payment terms.

The following are the remaining amounts of these contracts at the end of 2020 based on their quantities of goods and services for future sales, as well as prices on the base date of December 31, 2020 or practiced in recent sales when they reflect the information more directly observable:

Revenues will be recognized through transfers of goods and services to the respective customers, their values ​​and period of recognition being subject to future demands, variations in the value of commodities, exchange rates and other market factors.

The table above does not include information on contracts with customers with a duration of less than one year, such as sales in the spot market, as well as estimated amounts of variable payments that are restricted, in addition to contracts that only establish general terms and conditions (Master Agreements), for which volumes and prices will only be defined in subsequent contracts.

Additionally, electricity revenues are substantially due to demands for the generation of thermoelectric energy as required by the National System Operator (ONS), which are impacted by hydrological conditions in Brazil. Thus, the amounts shown in the table above represent mainly fixed amounts receivable due to the availability promised to customers in these operations.

As of December 31, 2020, the company has R$ 356 (R$ 514 in 2019) in advances related mainly to take and ship or pay contracts, to be offset against future sales of natural gas or the non-exercise of the right by customer, classified as other accounts and expenses payable in current liabilities.

Accounting policy

The Company evaluates contracts with customers that will be subject to revenue recognition and identifies the distinct goods and services promised in each of them.

Performance obligations are promises to transfer to the customer goods or services (or a bundle of goods or services) that are distinct, or series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

Revenues are measured based on the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. Transaction prices are based on contractually stated prices, reflecting the Company's pricing methodologies and policies based on market parameters.

When transferring a good, that is, when the customer obtains its control, the company satisfies the performance obligation and recognizes the respective revenue, which usually occurs at a point in time upon delivery.

10.1.       Cost of sales

Cost of sales of R$ 148,107, R$ 32,033 less than in 2019 (R$ 180,140), with emphasis on the following factors:

10.2.       Selling expenses