Petrobras Struggling Despite 50 Billion Barrels

Jim Brown
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You would think an oil company with dozens of new discoveries of as much as 60 billion barrels would be swimming in money. For a normal company going to the capital markets would be easy with that kind of fortune ahead.

For Petrobras the massive offshore finds has been trouble since day one. The finds will eventually make Petrobras larger than Exxon but there is a long road to that potential future. Last week a Petrobras official said the offshore finds are similar to the ones found in the North Sea decades ago. The North Sea waters off the U.K. and Norway held about 62 billion barrels.

Brazilian reserve are miles under the ocean floor and trapped under multiple layers of rock and salt that produce extremely difficult drilling conditions. The distance from shore in ultra-deep water prevents the building of pipelines so all the oil must be pumped into a floating tanker with processing capabilities to separate the oil, gas and water then the oil is pumped into another tanker for transport to shore.

This is very labor intensive because it must be done in all weather conditions with the utmost safety in mind in order to prevent oil spills.

The wells are very expensive because of the water depth, surface conditions and the layers of shifting salt that currently overlay the oil. A shift in the salt can close a well or restrict production after spending hundreds of millions to drill the wells. Each well costs more than $100 million to drill.

Instead of using existing capital to develop smaller portions of the newly named Lula fields Petrobras is planning an ambitious development scheme that will involve dozens of ultra-deepwater rigs, FPSO processing ships, tankers and a massive amount of underwater infrastructure.

The current plan is pegged at $224 billion over a five-year period. Petrobras borrowed money then they floated the largest ever secondary offering to fund the budget. As soon as the offering was completed they went back to the capital markets with a massive debt offering to raise even more money and even further dilute shareholders.

The Brazilian government, seeing a goose that was about to lay millions of golden eggs, quickly passed some bizarre laws regulating the methods used to explore and develop the oil. They required Petrobras to buy the oil from the government in advance before they ever produced it. Not only did the massive secondary actually give the government more than 50% of the shares but the government raised royalties, added the oil purchase scheme and then changed the management rules. They attempted to get their fingers into every piece of the Petrobras pie so they could milk the oil discovery for every dime.

Private investors fled the stock and have not returned. Just as Petrobras was recovering from the 2008 oil crash and recession the government meddling in Petrobras finances began and the stock has trended lower despite oil prices remaining stubbornly over $110 for seaborne light crude.

Petrobras Chart

It is not hat Petrobras does not have a lot of oil. The new discoveries will allow Petrobras to triple production by 2020 to more than 6.0 mbpd. Petrobras currently expects to produce 2.1 mbpd by year-end. The problem with Petrobras is the attempt to develop the giant field all at once and find ways to raise up to $250 billion in advance.

Most non-OPEC countries would auction the leases to independent exploration companies and then charge a royalty on everything they produced. That means the oil company like Conoco, Exxon or Shell would have to provide all the investment, equipment and technology and take all the risk. When you spread that risk and expense among 10-15 companies they each take a small piece of the pie but at least it gets baked.

The Brazilian government has soured that process by requiring Petrobras to be 51% owner and operator of any new well plus the oil produced had to be purchased in advance from the government. Lastly it puts the onus on Petrobras to come up with all the money to develop the wells. This is not the way to run an oil company.

I keep looking at Petrobras as a potential investment because hardly a week goes by that they don't announce a new discovery. Increasing production from 2.1 mbpd to 6.0 mbpd over the next nine years is going to produce a lot of cash for Petrobras. Unfortunately much of that cash will be going to the government in the form of profits, taxes, royalties and payments for the purchase of the next billion barrels of oil.

There is no upside for investors with this much government intervention. The government-controlled board has rejected two proposals for the 2011-2015 business plan saying Petrobras needed to cut costs. The new plan calls for Petrobras to raise another $47 billion by 2014 to finance the continuing development and make debt payments on the initial capital they raised.

If the government would step back and quit meddling in the management of Petrobras and quit draining the company of funds whenever possible this would be a hugely successful company. A discovery that big and this close to the U.S. market means they have a permanent buyer for the oil and a dozen companies that would be happy to explore and produce it. Unfortunately that is not the case and I can't justify buying Petrobras today. Although the stock appears to have found support at $32 I would not be surprise to see it trade down to $25. With the various stock sales they are up to nearly four billion shares outstanding and I am not sure that counts the major percentage held by the Brazilian government. It could be even worse.

On the bright side the rig companies are facing long leases despite nearly 20 rigs being built by Petrobras for future development. It will provide a long-term revenue source for the oil well service companies and those that build, supply and maintain the underwater systems. Eventually the oil produced will go a long way towards reducing the global shortfall set to begin over the next couple of years.

It is too bad investors can't participate in this company with a reasonable expectation of seeing a return on their investment. The only investor getting a return in Petrobras is the Brazilian government.

Jim Brown

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