Brazil's state-run oil company, Petrobras, said on Friday that quarterly profit fell 39% from a year ago as rising exploration and administrative costs drove up spending while fuel subsidies and weak production growth hurt revenue.

The Rio de Janeiro-based company, formally known as Petroleo Brasileiro SA, said net income in the three months ended Sept. 30 was 3.40 billion reais, missing the average estimate of 5.84 billion reais ($2.68 billion) in a Reuters survey of 10 analysts.

"In addition to the impact of the break between market and domestic fuel prices at a time of strong demand, we have also had greater expenses with dry and sub-commercial wells," Chief Executive Maria das Graças Foster said in a statement accompanying the results. "We plan to reduce our debt levels over the coming months."

Petrobras is struggling under the competing goals of its controlling shareholder, the Brazilian government. As it pushes the company to boost spending and investment to create jobs and bolster oil taxes, it has also prevented Petrobras from selling gasoline and diesel at world market prices, a subsidy aimed at holding inflation in check.

With revenue and production stagnant, Petrobras has been forced to increase borrowing to finance the company's $237 billion five-year investment plan, the world's largest corporate spending program.

Total debt jumped 34% to 250.9 billion reais ($112.5 billion) in the 12 months ended Sept. 30, and the company has just agreed to pay 40% of the nearly $100 billion needed to develop the giant Libra offshore oil area.

Moody's investors service cut the company's long-term debt rating this month, citing expectations that cash flow at the company will be negative for some years.

Costs Rising

Foster assumed her post nearly two years ago with a promise to reduce costs. Costs have climbed sharply, however, eating away at revenue, while declining output from old fields and snags setting up new one have prevented sales from rising more.

Exploration expenses jumped 71% to 2.21 billion reais, driven by new production systems and the need to write off dry wells and areas that are not commercially viable.

General and administrative expenses rose 10% to 2.80 billion reais, costs related to tax preparation and accounting rose 28% to 219 million reais, and sales expenses jumped 13%.

"We have had little hope that operating results will improve this year," said Lucas Brendler, oil and gas analyst with Banco Geração Futuro in Porto Alegre, Brazil, in an interview before the results were announced.

Those costs expanded much faster than sales, which rose just 5.3% from a year earlier to 77.7 billion reais, just short of the average analyst estimate of 78.7 billion reais.

The higher costs resulted in a weaker than expected result for earnings before interest, taxes, depreciation and amortization, or EBITDA, a measure of the company's ability to generate profit from operations.

EBITDA fell 8.9% to 13.09 billion reais in the quarter, short of the 15.6 billion real average estimate.

Output rose in September and July, but Foster has said investors should not expect major increases until 2015.

The fuel subsidies imposed by the government have caused losses in the refining division to mount to more than 12 billion reais this year, the statement said.

Those losses come in large part because gasoline sold by Petrobras in Brazil's markets is 6.5% cheaper than world prices, and diesel, the country's most used fuel, is 19% lower, Foster told the GloboNews 24-hour TV network on Thursday.

That price does not include the cost of tanker freight and import taxes. Net fuel and crude imports soared 57% during the quarter to 425,000 barrels a day in the quarter from the year-earlier period.

That increase has been driven in recent quarters by a reduction of the amount of ethanol in gasoline blends, boosting demand for gasoline while crude and fuel exports fall.

Discrepancies

Not only does Petrobras sell imported fuel at a loss because of the subsidies, it forgoes additional profit from domestic operations as it uses world prices to account for its domestic crude oil production.

The gap between world and local prices exists despite a series of price increases in the past 16 months. The increase was largely swallowed up by a decline in the value of Brazil's currency. The real was 11.4% weaker in the third quarter than a year before and 9.8% weaker than in the second quarter.

Exchange-rate losses would have hurt weak third-quarter profit more had the company not used new accounting rules on imports to strip up to 70% of the exchange-rate impact from quarterly results and spread it over several years. The new rules were first used in the second quarter.

Without that change, profit would have been 824 million reais lower, according to Petrobras.