Petrobras: Opportunity or Trap? 20 comments
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I never owned shares of Petrobras (PBR)—it was never in my radar and I missed out on the explosive upward trend of 2007-2008 (see chart). It was nothing less than spectacular and an obviously mistake on my part because I failed to exploit the price momentum for worrying too much about fundamentals. I had own StatOilHydro (STO) of Norway before, so I was convinced all state-owned oil companies were inefficient.
I wasn’t entirely off the mark in my assessment of the company (Petrobras’s reliance on the Brazilian government for production expenditures carries a lot of risks which include the potential for the nationalization of resources and intervention from bureaucrats) but a trend is a trend. The market was in love with Petrobras and a lot of traders made money. Now, the drop in oil prices and the recent discovery of new oil and gas deposits makes Petrobras an intriguing and complex play once again. Could this be another opportunity or just a big trap? On paper the company has a promising future—Petrobras has enough experience in deep-water offshore operations to make them profitable. Indeed, the company’s expertise and skills are huge advantages and investors are well aware of it.
Nevertheless, the biggest challenge (according to industry experts) is the Brazilian government and its political/economic agenda—will the government turn its back on free-market reforms now that oil is down more than 70% from its peak a year ago? Keep in mind that the Brazilian government owns a controlling stake (55% of voting shares) in the company and can override any management decision. Petrobras is also the country’s largest tax payer and that’s a huge asset for the state. Under this scenario, do not expect shareholder interest to prevail.
According to Morningstar, the Brazilian government already takes royalties and receives dividends from Petrobras undermining shareholder interests. Furthermore, the new oil discoveries may tempt the government to nationalize these deposits like Hugo Chavez did in Venezuela (some economists favor this move). This could severely damage Petrobras’s future because an exodus of expertise and skill would cripple the firm. Some in Brazil are also talking about making Petrobras a service provider rather than a fully integrated oil company. Unless Petrobras controls the actual production of crude I really don’t see much value in owning this company in the long term. These factors make the stock a very speculative trade.
Another issue to consider is time and money. Putting aside the huge technical difficulties of extracting oil from offshore deep-water deposits, the biggest concerns are time and money. How much is it going to cost and how long will take for production to start? Some believe production will begin 2017. So the next question is: Will oil prices be high enough to justify these expensive operations?
The current global economic crisis also created serious capital constraints for Petrobras (the company just sold $1.5 billion of 10-year bonds at a yield of 8.125 percent) and remains a big concern with investors. The bond sale was the latest effort in trying to raise enough funds for a five-year, $174.4 billion investment plan. “Petrobras faces sizable challenges both in arranging financing and relating to geology, technology, access to materials, rigs and services, staging of development, and the political environment,” Moody’s Investors Service analysts Steven Wood and Thomas Coleman wrote in a recent report.
An accurate valuation of the company is also difficult giving the precipitous drop in oil prices. What prices are analysts using? $50$, $90? or $25? Nobody is certain where prices might be in a year or two. Oil’s steep correction is not over yet and the economic slowdown is just starting to reach the four corners of the world. For Petrobras to make money, oil needs to be at $50 a barrel level. Another ten percent drop might be unavoidable now that we’re producing and driving less. Historically, recessions have caused oil to drop significantly, making a mockery of optimistic economic forecasts—this recession is no different. I expect many challenges for Petrobras.
Here is the reality: Petrobras benefited from high oil prices and made huge profits and a lot of it went to the Brazilian government. That’s great! It was good for Brazil and let’s hope Lula spent the money wisely. Brazil also made huge profits from the commodities boom but now the boom is over and the flow of capital all but evaporated with the credit crunch. Profitability has suffered and Brazil will have to issue debt to stimulate demand (read this RGE Monitor regional report). We’re going to see a role reversal where the government will be forced to pump money into Petrobras. So, don’t expect miracles from this company anytime soon. At the same time, savvy traders know that a another commodities boom will send Petrobras into the stratosphere.
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This article has 20 comments:
In addition, even if PBR were to somehow go straight from crawling to running a marathon -- the costs of developing these fields will rival the biggest oil projects ever attempted in the world.
As the article mentions, the Brazil government depends heavily on tax revenue from Petrobras. Providing the needed capital will definitely crimp the Brazilian government's revenues in the near term -- but does not necessarily guarantee increased revenue in the future. Politicians the world over don't like to pay costs now and defer benefits for the next office holder.
In addition, many Brazilian bureaucrats have made comments suggesting how the new revenues might be spent! When they find out that revenues (if any) will be years from now, and the immediate future will involve government outlays...
True, but as you yourself said it depends on the price of oil. If they are profitable with $50 oil, that means their overall operations. The deepwater stuff, especially anything thats going to be done in the future requires a price of $70-90 to be profitable. So that takes out all prospects for giant increases in production, on which the whole bubble was based.
On Feb 06 05:00 PM Michael Fitzsimmons wrote:
> the current economic crisis actually helps keep petrobras and the
> brazilian government at arms length. petrobras needs capital to tap
> the huge oil deposits it has found. lula and the government know
> this capital needs to come from investors who would recoil if the
> brazilian gov. completely nationalized the company. your question
> about the price of oil in 2017 being high enough to make petrobras'
> production worth the cost? the answer is "absolutely". at the depletion
> rates currently being experienced in mexico, alaska, the north sea,
> and saudi's biggest reservoirs, combined with the reduction in oil
> production and infrastructure due to the current economic climate,
> the next oil spike leave 2008's high of $145 in the dust. petrobras'
> oil discoveries are the most significant on the planet in the last
> decade. if XOM thought they could buy PBR today, they certainly would.
> PBR at $30 a share is a steal. it was even more of a steal when it
> traded at $20/share during the market "turmoil". PBR will get funding.
> PBR will tap their resources. oil will be higher in the near future...and
> so will PBR's stock price.
On Feb 06 01:47 PM User 352398 wrote:
> You missed one key issue here. In the next four years why US stops
> exploring for off shore oil, the market especially India and China
> triple their demand for oil we will see prices way over $50.. This
> stock is well positioned for a good long term run.
Where is the dogma? I presented facts...The free-market system is not in question here--crooks and greedy bankers are. The free market always exposes these crooks---in socialist systems we never know about it until they collapse entirely or run to the IMF for rescue. I think we need to call things what they are. We need more regulation and less speculation. That being said I'll take my chances in a free market system any day before I put my money in a socialist state or nationalize operation. But this is not the argument. I'm simply trying to explore this company's potential once we get out of this crisis.
On Feb 06 10:05 AM Amvet wrote:
> Max, your major interest seems to be economic dogma. At this point,
> after the free market idiots have ruined the world economy, stop
> the preaching about a company being bad because it is government
> owned. Be thankful that free market Madoff doesn´t control it.
On Feb 06 12:25 PM kotika98 wrote:
> "Petrobras has enough experience in deep-water offshore operations
> to make them profitable"
>
> True, but as you yourself said it depends on the price of oil. If
> they are profitable with $50 oil, that means their overall operations.
> The deepwater stuff, especially anything thats going to be done in
> the future requires a price of $70-90 to be profitable. So that takes
> out all prospects for giant increases in production, on which the
> whole bubble was based.
On Feb 06 09:36 AM sligoo wrote:
> Good analysis of PETROBRAS, but what about their international partners?
> They will want their share of any production notwithstanding the
> politics.
For anyone interested in Uranium an ABC News article yesterday reported Sweden’s Government is planning to overturn a 30-year-old decision to phase out nuclear power, and will lift a ban on building new reactors instituted in 1980. You can read the article at www.abc.net.au/news/st....
I have been following the Swedish nuclear story for some time, as has the world. I consider this development important as it is the result of a multi-year, hard government debate in a very social-conscious country that places the safety of its citizens in high regard.
Sweden currently operates 10 nuclear reactors that supply about 50% of its electricity. Its coalition government leaders are reported as saying new reactors are needed to help fight climate change and secure the nation’s energy supply.
Yes, the Center Party has now joined the rest of the Alliance in that position. But, the overwhelming majority of Swedes do not want new nuclear power plants.
This latest step is more an effort to keep the current plants running. They had been scheduled for shutdown by 2020. Sweden's need for energy has caused this shift in the Alliance thinking. Should the Social Democrats come to power again in 2010 it is almost certain no new plants will be constructed. Even if the Alliance wins the 2010 vote it is unlikely new plants will be constructed because of the strong anti-nuclear sentiment in Sweden.
On Feb 06 08:49 PM Max Zeledon wrote:
> That's a very good point!
On Feb 06 01:47 PM User 352398 wrote:
> You missed one key issue here. In the next four years why US stops
> exploring for off shore oil, the market especially India and China
> triple their demand for oil we will see prices way over $50.. This
> stock is well positioned for a good long term run.
Deep-water sand is easy, almost routine, compared to tight high pressure subsalt carbonates. Expect PBR to crash in 2010 when Exxon backs out and Petrobras hasn't produced anything at BM-S-11 because there are no commercially viable Tupi or Carioca "reserves," just bad geology and make believe political mismanagement.
Oh, by the way, did you notice Campos is in decline?
Disclosure: no position long or short.
Thus, I think Petrobus does have a very promising future. The downside risks are the royalties and dividends given to the government of Brazil and maybe nationalization.
On Feb 06 09:36 AM sligoo wrote:
> Good analysis of PETROBRAS, but what about their international partners?
> They will want their share of any production notwithstanding the
> politics.