Petrobras Revisited

| About: Petrobras - (PBR)

Five years ago on Seeking Alpha, when Petrobras (NYSE:PBR) was trading at 72, I issued a sell rating on it. Let's see what happened since then?

Maybe it was just a lucky guess. And everyone got hammered in the 2009 crash, right? So let's compare PBR and ExxonMobil since 2010.

Personally, I don't think much of XOM's growth prospects. CEO Rex Tillerson has admitted that the company hasn't made a dime on shale gas acquisitions, and his conventional oil & gas production is declining. Exxon's wildcat well in the Santos basin came up dry, whereas lucky Petrobras drilled more than two dozen successful pre-salt boomers.

Maybe the market is wrong-headed about "undervalued" PBR, and the Brazilian state-owned supermajor is on the cusp of becoming a whole lot superermajorer. At least that's their story, according to a recent Petrobras press release:

Average monthly oil production in the pre-salt for February 2013 has already reached 281 thousand bpd, representing a 138% increase in just 12 months. Between 2014 and 2016, another 11 new platforms will go on stream for pre-salt production: ten in Santos Basin and one in Campos Basin. This will allow oil production operated by Petrobras in the pre-salt to exceed 1 million barrels of oil per day in 2017.

Wow. 281 thousand barrels per day ... of what exactly? According to Offshore Magazine, roughly half of what Petrobras is producing from the pre-salt play is corrosive CO2 dissolved in a very high gas-oil ratio. Pre-salt oil production has been limited by how much gas the FPSOs are equipped to flare. And that's the good news. It's far from certain that anything approaching tens of billions of barrels will ever make it from ship to shore.

Kazuioshi Minami, Production Engineering Manager for the Santos Basin Operating Unit. and his team have been evaluating the potential for formation of unwanted by-products during pre-salt production, including deposition of wax, hydrates, asphaltenes and scaling. Wax analysis, using densitometry, microscopy, viscosimetry and cold finger tests, suggest significant build-up when the crude temperature drops to 19.67°C (67.4°F)... Future pre-salt projects may require counter-measures such as heated risers and periodic pigging of flowlines... Minami said that blowing down flowlines and risers after shut-downs should keep produced fluids outside the hydrate formation envelope. "The gas is pretty dry, so the risk is low for injection and export gas. We will use molecular sieves at the topsides to remove CO2 from the gas stream." [Offshore Magazine Vol 71 #10]

Hmm. Not quite what we were led to believe, that all PBR had to do was drill a bunch of wells and offload oil into waiting tankers.

There is a risk of scale build-up, Minami warned. This necessitates installation of sulfate removal units and downhole chemical injection to hinder formation water scale... Giovani Cavalcanti Nunes of E&P Petrobras, speaking on innovations in processing and topsides facilities for the pre-salt fields, said the biggest challenge had been the company's drive towards standardization of the production systems... But as Nunes pointed out, there is no prior experience of dealing with such high associated levels of CO2, or creating standard units for handling different concentrations of CO2.

He cited other pre-salt challenges such as very high salinity water as a result of carbonate scaling, and an export gas specification of 3% CO2 content. Because of the varying CO2 content, the compressors will have to be designed for a wide range of molecular weights. And if the gas pipeline linked to the various FPSOs fails, all the gas will need to be reinjected. "The reinjection pressure of 550 bar [7,977 psi] will require extra compressors," he added, "and the gas injection compressors must be able to deal with high CO2 streams and normal gas on the platform." [Ibid]

Did you catch that? A gas pipeline laid over a rocky undersea chain of mountains 200 km to the nearest platform that can pipe it ashore to PBR's money-losing thermal electric plants. Honestly, oil production is more or less a byproduct in the pre-salt. They can't produce much of anything without high pressure injection wells, geosteering, and multistage horizontal fracking like a tight shale play.

The company is still working on the ideal geometry for deviating wells through the deep salt layer, with bilateral, radial and horizontal multifractured drilling among the options under review... Another preoccupation is reservoir drainage, owing to the unusual nature of the microbial carbonates prevalent in reservoirs in this province, which are not common off Brazil or anywhere else... As for improved oil recovery in the pre-salt, Petrobras has solid waterflood experience, but with carbonates there are issues to contend with such as wettability and heterogeneities... A waterflood test next February in the Lula production pilot will hopefully clarify the picture. "Carbonate reservoirs can be very faulted and fractured." [Ibid]

Transporting the produced natural gas, on the other hand, poses a more challenging project. Three solutions have been suggested. One is to construct a natural gas pipeline that would connect Tupi with a fixed platform closer to shore at the Mexilhao field in the Santos Basin. Another gas transportation solution involved the fabrication of an LNG unit at Tupi that would allow for vessel offloading. The last proposal is to build floating gas-powered thermoelectric plants close to Tupi that would produce energy for the field, as well as supply power to shore for public consumption. [Ibid]

FLNG like Shell's uninsurable $12 billion Prelude project? or a floating electric plant? Come on, get real. Petrobras doesn't have the cash, and I doubt that Daewoo is going to vendor finance a giant floating bomb, or build it in Brazil, which is PBR's state-mandated jobs plan. Speaking of which, let's take a gander at PBR's accident-prone local workforce, compared to other oil operators:

Return on equity practically shouts at you. How about news flow?

RIO DE JANEIRO - Brazil's oil production is falling, casting doubt on what was supposed to be an oil bonanza. Imports of gasoline are rising rapidly, exposing the country to the whims of global energy markets. Even the nation's ethanol industry, once envied as a model of renewable energy, has had to import ethanol from the United States... Saddled with a nationalist mandate to buy ships, oil platforms and other equipment from lethargic Brazilian companies, the oil giant is now facing soaring debt, major projects mired in delays and older fields, once prodigious, that are yielding less oil. The undersea bounty in its grasp also remains devilishly complex to exploit. [New York Times, March 26, 2013]

Petrobras cut its production goal in a business plan published June 14 to 5.7 million barrels a day by 2020, from a previous target of 6.4 million barrels. About 80% of Brazil's oil comes from the Campos Basin, where Petrobras has been producing since 1977. Output at Roncador, which was Brazil's biggest-producing field until January, declined 8% in the past 12 months through April... Petrobras forecast that it will start having positive cash flow, excluding dividends, in 2016. [MercoPress, June 26, 2012]

Lemme think. Positive cash flow someday. Horizontal fracking five miles subsea through unstable salt. High pressure injection wells. Corrosion. And a floating power plant with a 300 km extension cord to shore, because Brazil needs electricity and it's PBR's job to generate it at a loss.

Hell yeah, buy! What could possibly go wrong?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.