Petrobras Ready to Benefit from Next Oil Price Spike

| About: Petrobras - (PBR)

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 (NYSE: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.

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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.