Problematic Petrobras

Todd Shriber
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Here is an interesting trivia question that might win you a free drink next time you find yourself having a compelling conversation about energy stocks: Following BP's hemorrhaging of roughly $70 billion in market value in the wake of the Gulf of Mexico oil spill, which major integrated oil company has endured the second-largest haircut to its market cap this year? That dubious distinction would go to Petrobras, Brazil's state-run oil company.

Through the first half of this year, Petrobras shares were down 27%, which isn't bad when measured against the nearly 50% tumble for BP (BP), but a 27% drop is downright atrocious when measured against declines of 16% and 10%, respectively, for Exxon Mobil (XOM) and Royal Dutch Shell (RDS-A). BP's share price destruction is basically a self-inflicted wound because exploding oil rigs and massive oil spills are avoidable scenarios.

Petrobras's share-price cascade is not entirely the company's fault. This was a $72 stock in 2008 when oil was trading near record levels. Despite their best efforts, no oil company can really control oil prices, so giving Petrobras a pass for slack performance while oil prices tumbled as the global financial crisis set in is not unreasonable. Fast-forward to 2010 and it can be argued that Petrobras (PBR) is shooting itself in the foot. That is not to say that this stock will not reclaim its lost glory someday.

It very well could, especially if global oil demand drags prices higher in the coming years. The bull case for Petrobras centers around Brazil's vast offshore oil reserves, including the Tupi field, but even that scenario presents some risk. While the Gulf spill apparently has not deterred Brazil's offshore drilling ambitions, drilling in Brazil's pre-salt regions is going to cost a lot more cash than exploring in traditional oil fields.

To acquire some pre-salt oil from Brazil's government, Petrobras is looking at swapping up to or maybe more than $40 billion for 5 billion barrels of oil. The company also plans to issue $25 billion worth of new stock to minority shareholders to raise cash for its exploration budget, which through 2014 will be by far the largest of any major integrated oil company in the world. Shareholders authorized a capital increase for the company of $85 billion, but assuming Petrobras issues ''just'' $65 billion in new shares that will still be the largest secondary offering by U.S.-listed company...ever.

As if a massive dilution of shareholders is not bad enough, the oil-for-stock swap is caught up in a political maelstrom that has damaged the company's credibility. The offering has been delayed and delayed again and if Petrobras cannot commence the offering before Brazil's October elections, it is safe to say you will be able to buy this stock at a better price than where it currently trades.

Petrorbras is the largest company in Latin America, but that title may not last long as Bloomberg News reported earlier this month that iron ore giant Vale (VALE) could overtake Petrobras at some point. Worse yet, money managers view Brazilian equities as overvalued when compared against other emerging markets and interest rates are rising in Brazil. Is there long-term potential for Petrobras? Probably. For now, passing on Petrobras might be the preferred course of action.