Petrobras: Mixed Sentiment Despite Record Production

Brazil’s pseudo-monopoly oil company Petrobras (PBR) logged record production of 2.5 million barrels of oil equivalent [BOE] in September, up slightly from August and 7% year-over-year. And while all the oil majors are subject to the whims of crude prices lately, Petrobras has an under-leveraged balanced sheet (30% debt/equity) and attractive valuations of five times trailing earnings and forward estimates. However, as we know, in this market “good fundamentals” are a dime a dozen.

Reserves certainly aren’t the issue for Petrobras. In addition to the Tupi field find in late 2007 (estimated to be worth between 5-8 billion barrels), the recent Yara field added another 3-4 billion barrels to reserves. That’s about 10 billion barrels of new reserves, or over 200 years’ worth at current production levels. This brings us to the part that has many investors spooked about Petrobras, which is majority-owned by the Brazilian government (who also holds a roughly 40% interest in the new reserves). There are fears that the government will seek to nationalize the oil giant or massively raise taxes to increase subsidies to citizens and otherwise fill local coffers.

However, before we classify Brazil as neo-Venezuelan, we need to consider just how much it will cost to develop these new fields. Earlier this year Petrobras had allocated over $60 billion in capital spending over the next five years to develop the new fields. The company spent over $6 billion in the last quarter alone on capital expenditures. So far the company has been able to pay for this with simple operating cash flow (which is tracking at the ungodly run-rate of over $24 billion annually), but with crude oil falling over 50% from its peak, these cash flows will be crimped in coming quarters.

Due to their sheer scope, the Brazilian government needs Petrobras to help fund these projects - and they need the company’s equity to be a source of capital, something that won’t happen if investors smell a rip-off down the road when the profits start coming in from new projects.

Investment Thesis Intact

If you’re attracted to Petrobras, it’s because you believe in the long-term bullish case for oil. If you’re not behind that simple thesis, you should seek out a more integrated oil company like Exxon Mobil (XOM) or Chevron (CVX). Petrobras has some natural hedges in the form of 30,000 km of pipelines and 15 oil refineries, but by and large, profits are driven by the spread between production costs and crude prices. Despite the current deflationary environment, all the money being pumped into the global economy will eventually lead to inflation pressures, and OPEC has grown quite fond of oil above $50 and would likely cut production as far as needed to preserve those levels or higher.

Parting Thoughts

I believe that the last barrel of oil ever sold will be to someone whose level of demand was high, i.e. I believe that crude prices will remain on a long-term uptrend. There are simply too many legacy systems in the world that use or process crude, and as G7 nations evolve into alternative energy users in the future, third-world economies will just be entering their oil-consuming period.

Disclosure: Author does not hold positions in the companies mentioned.

Comments

[Pipo:]

Jim Rogers said yesterday on Bloomberg thst he was buying oil. Maybe its time to get in these oil stocks again.

jimrogers-investments..../

2008 Nov 04 01:00 PM

[Alan von Al...:]

"Reserves certainly aren’t the issue for Petrobras."

Anadarko and Exxon are currently drilling the celebrated Brazilian pre-salt prospects at the most optimal structural locations and will report sometime in the next few months whether or not it's commercially feasible to recover any light sweet oil in Tupi-Carioca. I expect the answer will be no.

2008 Nov 04 03:40 PM