Petrobras Ready to Benefit from Next Oil Price Spike

The Tupi people are a group of indigenous people native to the Amazon rainforest of Brazil. Although their history is in some respect reminiscent of the American Indian, Tupi culture and language are still very prevalent in Brazilian culture today. It is in their honor that one of the world’s largest oil fields discovered in the past 25 years off the coast of Brazil was named.

The field itself is very impressive. After drilling three test wells, Petrobras (PBR) confirmed earlier estimates of 5-8 billion barrels of oil. Some recent reports suggest the field could hold from 30-100 billion BOE. Petrobras has not confirmed these higher estimates.

The bad news is the crude oil is beneath 7,000 feet of water and held in rocks beneath a salt layer that reaches thicknesses of up to 6,000 feet. The good news is the reward: the oil is very high quality sweet crude with a specific gravity of around 0.88 and less than 0.5 percent suffer. The boys drilling in the Caspian Sea can only dream about such high quality crude.

Such ultradeep wells encounter intense pressure and temperature. In a recent Forbes articles ("Crude Cassandra"), Matt Simmons suggested going much deeper with a drill bit might strike molten lava and unleash “the biggest volcano in the history of the world.” It’s interesting to think about such an encounter and what the results might be on the surface of the water. Luckily, none of the test wells to date have resulted in such fireworks. That said, Matt Simmons is spot-on with his oil predictions. To put things in perspective, as large an oil field as Tupi is, at 8 billion barrels it is only enough oil to supply the world’s demand for 3 months.

During the credit crunch, there were concerns Petrobras would have trouble obtaining financing to exploit Tupi. The stock dropped from over $70 to a low of under $15 in November of 2008. However, the stock has recovered nicely as credit crunch worries have subsided and financing deals have been reached with China and others. Recently PBR traded above $43/share. The PE=11.7 and the dividend yield is a scant 0.70%. But this isn’t a dividend story. Unlike US majors XOM, CVX, and COP, Petrobras is a story about strongly increasing production in an age of peak oil. That will certainly lead to increasing profits and a stock that will outperform its peers.

Monday, a story broke about GE winning a $250 million contract to supply Petrobras with 250 VectoGray subsea wellhead systems. Energy is the real future of GE. If GE would trim their fat and focus more on energy, that stock would start moving too.

Peak oil didn’t go away because of a credit induced drop in demand. Non-OPEC supply appears to have peaked in 2006 at just above 51 million barrels per day and fell below 50 million bpd in 2008. Technology is a mixed blessing as it gets more oil out faster, but accelerates reservoir decline rates. Mexico’s Cantarell field used to produce 1.5 million bpd until its peak was reached and production began its post peak decline. Pemex drilled new wells to inject nitrogen gas and this boosted production to 2.1 million bpd in 2004. Then Cantarell collapsed to 800,000 bpd. If the same were to happen to the massive Saudi Arabian Ghawar field, church is out.

On the demand side, the news isn’t good either. China’s car sales continue to set records every month. Anybody read the excellent article in the WSJ yesterday "Chasing After Crude in China"? There’s no doubt the Chinese are stockpiling oil at the expanding Aoshan Petroleum Reserve. Who can blame them – would they rather hold US treasuries or oil? People want to know why oil is trading close to $70/barrel with US inventory at 20 year highs – well, there’s your answer.

Meanwhile, the Obama administration has done absolutely nothing to reduce foreign oil imports and the US continues to consume around 25% of total world oil supplies. Energy Secretary Chu is “agnostic” about natural gas transportation, and therefore the only realistic chance the US has at significantly reducing foreign oil imports over the next 5 years has been shelved. Not to worry though, Obama will be booted out of office after one term as the US will be in another full blown oil crisis before his term is up. I say not to worry… but the next oil spike is going to make 2008 look tame by comparison. The US will be lucky to survive it without much social and economic upheaval. Apparently our elected officials in Washington either don’t care or are paid off to ignore it. After 2008’s $145/barrel oil, they can no longer confess ignorance as it was on the front page every day.

Bottom line: all these trends add up to a very strong case to invest in Petrobras.

Disclosure: The author owns PBR.

Comments

[longoil:]

Brazil is exemplary in what a good energy policy should look like:

1) They have a strong conventional energy base for the short term being developed through advanced technology at the Tupi fields

2) Transition energy strategy for the mid-term is covered by their huge sugar ethanol pruduction that provides fuel for over 10 million cars.

3) Brazil is a leader in long term energy strategy. Brazil is the 3rd largest hydroelectric producer (after Canada & China). Thay have have 9 nuclear reactor planned for construction before 2025. They are the leader in wind and solar installations in South America

Jun 10 06:59 AM

[yellowhoard:]

I love PBR.

Other than the reasons mentioned above, PBR will benefit from not being a US energy company.

I have no doubt that the Obama administration is going to shake down our domestic producers when prices spiral once again.

Jun 10 07:44 AM

[john s. gordon:]

and brazil has good resources of monazite (source of thorium).
> jack

Jun 10 08:38 AM

[U2Easy:]

PBR has great long term prospects and is a must hold in any portfolio with energy investments.

Michael... keep your political views to yourself... because it only dilutes the value of your writing.

Jun 10 08:57 AM

[Michael Fit...:]

longoil: yes, brazil is the polar opposite of the US: after the brazilian economy was brought to its knees by earlier energy crisis, brazil policymakers decided to wean themselves off of foreign oil with prudent energy policies. now they are in a great position to export oil. this is one reason i recently wrote an article suggesting the brazilian EWZ etf. btw, i hope u enjoy hefner's book as much as i did.

yellowhoard: i hope you are not correct re obama and windfall profits taxes. this was tried before and simply doesnt work. oil companies will protect shareholder return and reduce E&P expenditures. that means less oil produced. in an era of peak oil, that is a wrongheaded approach. that said, so is supporting "clean coal" and ignoring nat gas transportation, both of which the obama energy team is doing. so, perhaps you are right. obama and team don't have a clue about prudent energy policy other than supporting wind and solar. unfortunately, those two source generate electricity..not gasoline. obama's policies haven't reduced foreign oil imports any more than bush's did.

freya: well, the volcano reference was kinda tongue and cheek...i had never thought of it before.

U2Easy: i wish i could stay away from politics. however, the US won't solve its energy problems without political leadership. as a patriotic american, i feel it my duty to talk about it. note the earlier reply to longoil about how brazilian politicians fixed their energy problems and now they are in a great position going forward. i am trying to be constructive here, and i was just as critical of bush, so there isn't any party favoritism going on here. US energy policy is terrible - and both parties are to blame.

Jun 10 09:57 AM

[isaac the t...:]

I hold 2011 longterm options on PBR- good way to play since the risk of buying at the wrong moment is diminished, and the potential rewards are enhanced.

Jun 10 10:37 AM

[Mad Hedge F...:]

For sure. I ran into a couple of geologists from the Brazilian oil company Petrobras (PBR) who knocked my socks off when they told me about the quality of the crude they were pulling out of their new deep offshore Tupi field. They are drilling at 20,000 feet and getting 15,000 barrels a day of hot, light sweet crude blasting back in their faces under its own pressure; the kind of premium crude you normally only find in the Middle East. Overall, the company plans to boost production from 2.4 million barrels/day today to 3.6 million in five years and 5.7 million in ten years, or half of Saudi Arabia’s current production. I was unable to pin them down on the true cost of the offshore production, meekly claiming they didn’t break the figures out separately. They did admit, begrudgingly, that it is well below $40/barrel compared to the $80 offered by some industry analysts, and $9.20 for the company’s own weighted average cost. This confirms my belief that the next move in crude is up to $200, and then down to $10, as it is replaced by alternatives over time. Be sure to own PBR on the up leg.

Jun 10 10:44 AM

[Trinvester:]

good article, good stock. questions were arising as to the viability of the tupi field, but at $70 a barrel and climbing PBR is sitting on gold, or even better, light sweet crude. the real winner though will be the deep water driller that gets called up to the plate.

Jun 10 10:52 AM

[harammph:]

trinvestor: Last year when the going was easy, PBR contracted practically every Deep driller in the world, I don't know if anything has changed in that regard.

Jun 10 11:01 AM

[Mmarrkk:]

Freya: the volcano thing is way out there. Simple geology tells you not to worry about volcanoes, molten lava, etc. Long way to go to get to liquid rocks down there!

Fitz: great review of PBR; and I hope you are right about O getting booted out after one term. As you know, I'd love that. Unfortunately, the damage being inflicted might be too much to overcome. But I know, 8 years of Bush...yada yada yada. We are in a hole, a deep hole, but we still only have shovels digging full speed ahead!! And not nat gas driven shovels, either!

Did you see where our great beacons of brains in Congress are going to give out vouchers for new cars/trucks if you trade in a low MPG for a higher MPG vehicle? But nothing for NGV's that I could see!

Jun 10 11:13 AM

[Michael Fit...:]

isaac: yeah, that sounds like a good play. i could really kick myself for not buying more PBR when the world was coming to end in late 2008. it was a steal. i'll have to look into longer-term options on PBR.

MadHedgeFundTrader: you bring up a good point with cost of production. that was one of my big worries last year, but this economic slowdown has in some ways has been a blessing for PBR in that they are probably getting better deals on the cost of infrastructure needed to produce deep-sea oil. you know they got a sweeter deal on those GE VectorGray units this year than they would have in 2007 or 2008. that said, i think the high-end providers of deep-sea off-shore equipment know they have a captive audience (RIG for instance). as far as oil down to $10 after another big run-up, i guess you are assuming the US has a replacement for the gasoline powered automobile. currently it isn't happening. we should be building nat gas vehicles as fast as possible imho.

freya: yeah, i saw a guy on TV last night out in california. he said there was enough geothermal potential in cali to completely supply the state's entire electric consumption. i have know idea if he is right, but if he is 80% wrong and 20% right, that is still alot of electrical generating capacity.

Trinvester: yeah, that game is RIG'd (pun intended)

harammph: as far as i know, PBR still has the orders in. the question i have is was pricing renegotiated?

Mmarrkk: well, all one has to do is visit hawaii to realize that not all molten rocks are deep - in fact, some are very near the surface. wrt the hole, you obviously know who i think dug it. where were all the republicans who are now speaking up against deficit spending and lack of regulation for the 8 years bush was in office? both parties suck, but the 8 years of bush were the worst 8 years in the history of the US: economically, evironmentally, in terms of the constitution and our basic rights and freedoms, and in terms of foreign policy. just a complete 8 year cluster from day 1. and yes! i did see the friggin clunker bill out of congrass and oh man, what a disaster. they estimate the total cost could be $4 billion (!) just to go from gasoline vehicle to gasoline vehicle! can u imagine the number of NGVs and nat gas infrastructure we could build for $4 billion??! what a mess. congress is disgusting. thanks for bringing that up, i think i'll write an article on it. hope SA publishes it - i feel like pushing the limits ;)

Jun 10 03:14 PM

[Mmarrkk:]

Fitz: saw your article on the clunker bill. Great work. I may be taking advantage of this bill if it makes it through, but I'm sure the bill will be effective the day AFTER I buy a new vehicle!!

Tried to save you some typing on the Bush years...I know what you are going to say so let's come up with a short-hand phrase you can use to make the point without all the typing...how about "Ditto"...you probably don't like that one! Anyway, next time, just say "Bush" and I'll know what you're saying! But I gave you the hole being there before Barry took office (although he was part of the Democratic majority in the Senate that did nothing too!!). That's history. My big issue is how fast the hole is being deepened!!

Now, I understand the lava in Hawaii but the geology in Hawaii and the geology in the Santos Basin off Brazil (or the Gulf of Mexico) are very different. That's why the possibility of getting molten rock in those two locations are almost nil and the chance of it in Hawaii are almost 100%! Geology! Its all about the geology!

Jun 10 04:46 PM

[Soldalma:]

One can tell all the PBR bulls cannot read Portuguese and never read a Brazilian newspaper.

There is an ongoing Parliament Commission of Inquiry (CPI) in the Brazilian congress about corruption in PBR. The papers also discuss the fight between the PMDB, the largest political party in Brazil, and the PT, Lula's party. Lula needs the support of the PMDB in next year's presidential elections (he will not be a candidate, but he supports Dilma Roussef, who by the way, has non-Hodgkins lymphoma and is undergoing chemotherapy). The PMDB is asking for directorships in PBR. One of the main figures in the PMDB, a senator, described it in an interview as a party without a program whose only objective is to extract advantages for its members. Now they are getting PBR directorships so as to milk the company. The PT was doing it before, so nothing really changes.

About the pre-salt oil, even the Minister of Social Security has laid claims for the monetary proceeds. Other claimants will appear when significant amounts of pre-salt oil start to be pumped out of the ground. There is also debate about the creation of an entity that would own the whole pre-salt oil. PBR is no longer seen as a state-owned enterprise by the leftists who abound in the political scene. Some of them are sincere believers in communism (yes, in Brazil there are many of those, and some of them are within Lula's coalition), while others use the nationalization story as a disguise for manipulations that ultimately would enrich them.

Finally, gas and diesel price manipulation has been used in the past to smooth the inflation rate. PBR lost money when prices were high in the $140s, more than made it back in the recent past, and will start losing again if the rally in oil prices continues. The press discusses this topic regularly. The rigidity of domestic gas and diesel prices goes directly against the claim that PBR is set to benefit from higher oil prices.

With many parties fighting for the spoils and the government manipulating domestic prices it is doubtful the shareholders will get much higher dividends than they are getting now. And the value of a stock is the present value of dividends. Of course, when there are news of discoveries the stock price may pop up, but buying the stock on that basis is speculation, not value investing, and should be done very cautiously.

I am bullish oil, but surely there are more attractive ways to play this trend than PBR.

Jun 11 04:45 AM

[Michael Fit...:]

Mmarrrk: thanks. i hope SA publishes it today, but i should have worked up the investment angle a bit more (they like that).

Soldalma: you're certainly correct - i don't speak portuguese and haven't read a brazilian newspaper. you're also right in that i should not have neglected the political risks in the article. i have read about most of the issues you mentioned, except for the details of the election - so thanks for that. now i'll take the other side of the debate: with respect to gas and diesel price manipulation inside brazil, this will not affect the price PBR receives for its oil exports, which will grow dramatically once tupi is tapped. wrt the dividend, i mentioned that PBR is not an investment for the dividend, which i agree there are much better oil investments if dividends are what you are looking for (BP and STO for instance). however, PBR is an oil production growth story (i.e. earnings) and that is what i think will drive the stock price. finally, i believe another tailwind will be the brazilian currency, which longterm i think will strengthen vs the US dollar. now, if brazill nationalizes PBR, or turns toward venezuela, then you're on to something. however, with the need for capital in order to make the huge investments needed to tap tupi, i'm not sure that will happen. however, it is certainly a risk - so thanks for highlighting that. here is an article that discusses the gas/diesel pricing issue as well as bidding for offshore oil:

finance.yahoo.com/news...

the political environment adds risk, but the risk/reward payoff may be a good reason to invest in PBR as its share price does not reflect its reserves nor the coming increase in production.

Jun 11 08:41 AM

[ripskii:]

Thanks for the review of PBR. One thing that has concerned me with this company is the costs estimates I've seen for producing their deep water discoveries. If oil price continues to climb that problem will be mitigated but they still have challenging and expensive issues to confront. I'm not aware of the VectoGray subsea wellhead system and would appreciate more information on that development.

Jun 11 09:51 AM

[harammph:]

Isn't anyone taking earthquakes, especially in California, into account. Hell, even Illinois has dish rattlers every so often.

Having said that Calpine(CPN?) is heavyily Geothermal in the Frisco area.

Jun 13 12:53 AM

[harammph:]

oops "heavily"

Jun 13 12:55 AM

[Alan von Al...:]

It baffles me how anyone can buy PBR on future pre-salt production. An extended well test of RJS-646 began May 1, 2009, and Petrobras has been utterly silent -- no news, not a peep -- after ten weeks. Brazilian offshore production other than shallow Campos declined from an average of 86 million bpd in 2008 to 54 million bpd in May 2009. I don't care what anybody said to anybody on an airplane.

Fitz, you should take profits on PBR. I don't own the stock or any short position at present, but I'm tempted to buy leap puts at 10.

Jun 18 11:16 PM

[Soldalma:]

Michael,

I have several problems with your arguments:

1) Finance theory states that the value of a stock is the discounted value of dividends. If the prospects for dividend payments by PBR are not good then the shares are overvalued. Of course if one wants to buy for other reasons like "oil production growth" that is fine, but that is not my investment philosophy (I don't want to run the risk of not finding a "greater sucker").

2) You stated that "the price PBR receives for its oil exports ... will grow dramatically once tupi is tapped." Oil prices are determined by international supply and demand and not by Tupi's level of production.

3) I never said that PBR was going to be nationalized. The chance of that happening is remote. What I said is that politicians will milk PBR in a variety of ways. This is already happening and will continue to happen.

4) If the Brazilian currency appreciates, as you expect, PBR's profitability will suffer. International oil prices are quoted in US dollars and are not affected by the USD/BRL rate. So the value of PBR's export revenues would not be affected. On the other hand, PBR's production costs would increase when measured in USD.


On Jun 11 08:41 AM Michael Fitzsimmons wrote:

> Mmarrrk: thanks. i hope SA publishes it today, but i should have
> worked up the investment angle a bit more (they like that).
>
> Soldalma: you're certainly correct - i don't speak portuguese and
> haven't read a brazilian newspaper. you're also right in that i should
> not have neglected the political risks in the article. i have read
> about most of the issues you mentioned, except for the details of
> the election - so thanks for that. now i'll take the other side of
> the debate: with respect to gas and diesel price manipulation inside
> brazil, this will not affect the price PBR receives for its oil exports,
> which will grow dramatically once tupi is tapped. wrt the dividend,
> i mentioned that PBR is not an investment for the dividend, which
> i agree there are much better oil investments if dividends are what
> you are looking for (BP and STO for instance). however, PBR is an
> oil production growth story (i.e. earnings) and that is what i think
> will drive the stock price. finally, i believe another tailwind will
> be the brazilian currency, which longterm i think will strengthen
> vs the US dollar. now, if brazill nationalizes PBR, or turns toward
> venezuela, then you're on to something. however, with the need for
> capital in order to make the huge investments needed to tap tupi,
> i'm not sure that will happen. however, it is certainly a risk -
> so thanks for highlighting that. here is an article that discusses
> the gas/diesel pricing issue as well as bidding for offshore oil:
>
>
> finance.yahoo.com/news...
>
>
> the political environment adds risk, but the risk/reward payoff may
> be a good reason to invest in PBR as its share price does not reflect
> its reserves nor the coming increase in production.

Jul 09 03:12 PM

[Michael Fit...:]

soldalma: it's been a long time since i wrote this, and i am not going to read back through things but, with respect to your comments:

1) i don't remember making dividend growth a main reason for buying PBR. it is a production growth story, not a dividend story.
2) i was obviously referring to the revenue growth anticipated from tapping tupi. this is regardless of the day-to-day price of oil, which, i also contend will continue to go up in the peak oil years ahead
3) yeah, and under Bush the government took over the US insurance, mortgage, financial, and banking sectors. so, it can happen anywhere, including the good ole USA. see my earlier article (somewhere on here) where i contend that US investors continue to miss a major trend in risk assessment: viewing the risk of investing in US equities given our oil crisis, debt, and dependence on foreign oil in an age of peak oil.
4) say what you will, i will continue to like foreign energy assets as a way to hedge against what i believe will be a huge decline in the US dollar as well as a huge increase in the price of oil in the years to come.

Jul 15 02:42 PM