Government Interference Hurting Petrobras

| About: Petrobras - (PBR)

Many investors are aware that Brazil's oil giant Petrobras (NYSE: PBR) is investing nearly $225 billion between 2010 and 2015 to develop its offshore oil fields. These vast 'pre-salt' discoveries lie below a two-kilometer deep salt layer underneath the seabed.

But Petrobras faces another difficulty in addition to the technical ones it faces in drilling for oil under such harsh conditions. That difficulty is the Brazilian government and its dictate that equipment used in new oil production fields have a 77 percent local content requirement. The requirement for older fields was for only 35 percent local content. The country simply lacks the capacity at the present time to cope with the enormous demands imposed upon it by Petrobras and other oil companies drilling in Brazil's waters.

The biggest bottleneck by far is expected to be Brazil's shipbuilding industry. Petrobras alone is ordering a fleet of new vessels. In June, it placed an order for 21 drilling ships on top of the seven already on order.

Last year, Petrobras and its partners signed two contracts for the construction of hulls for eight floating platforms (FPSOs) with Brazilian infrastructure firm Engevix Engenharia.

But the problem is that Brazil's shipyards have never built a FPSO before. The shipyards face quite a daunting task considering, according to a report from energy consultancy Wood Mackenzie, Brazil will need 100 new oil platforms over the next decade, nearly half of them for Petrobras. In addition, Wood Mackenzie says that out of the 40 shipyards in Brazil, only four of them are believed capable of building FPSOs.

The good news is that some of the biggest and best shipbuilding companies like Singapore's Keppel Corp. (OTCPK:KPELY) are setting up joint ventures with Brazilian companies. But it will take time to retool the local companies to undertake such a complex project as building a floating platform.

New shipyards are also being built in Brazil, doubling its offshore construction capacity. For example, Korean firm Hyundai Heavy is teaming up with Brazilian companies such as OSX, controlled by Brazil's richest man Eike Batista, to build new shipyards.

One question remains though...whether shipbuilding capacity can be ramped up quickly enough and at a reasonable cost.

Petrobras is already under pressure from the government to curb costs. And doubts are growing among investors whether the company can raise enough capital to fund its investments, pressuring the stock price lower in recent months.

The best long-term solution for both Petrobras and Brazil would be if the Brazilian government eases the local content requirement. The government has to realize that this will be best for the long-term success of both the oil and shipbuilding industries. It will also help their coffers. Delays in construction of FPSOs and other equipment may potentially delay the date oil fields come into production, deferring hundreds of millions of dollars in revenues for the government.

However, based on the performance of Brazilian President Dilma Rousseff to date, it is doubtful these necessary changes will be implemented.

Therefore, Petrobras is still a hold and not a buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.