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The Better Bet in the Oil Patch
08/25/2009 9:56 am EST
Two state-controlled petroleum giants confront very different challenges. One faces political pressure that could kill its cash flow; the other grapples with aging oil fields.
On the surface, it's a no-brainer.
Petrobras is sitting on new deep-sea finds in the South Atlantic that probably will double the company's oil reserves.
StatoilHydro's production is concentrated in the huge, but declining fields of the Norwegian continental shelf.
Why would you even consider putting money anywhere other than Petrobras?
Because, as any geologist will tell you, a promising surface formation can be deceptive. You really can't tell what you've got until you drill deep. So let's break out the drill bits on these two stocks, shall we?
You may know the basic Petrobras story: It's one of the fastest-growing oil companies in the world. In this year's first quarter, production climbed 6% from the first quarter of 2008. It hit a record 2,059,000 barrels a day on May 5.
But that's nothing compared with what might be coming. The company has discovered what may be huge reserves of oil and gas in the South Atlantic. The fields could someday rank among the largest in the world. The Tupi field alone, discovered in 2007, could hold 5 billion to 8 billion barrels of oil. With that one field, Brazil would move ahead of Canada and Mexico in the ranks of the world's oil powers.
And even if the early reports are inflated with understandable hyperbole, Petrobras is still one of the few oil companies in the world with the potential to increase production every year for the next ten years.
And you probably know about the geological and business risks to this story. All three of the megafields that Petrobras may have discovered—Tupi in 2007, Jupiter in 2008, and Iguacu in 2009—are under 15,000 to 20,000 feet of sea water. And a layer of sediment. And a layer of salt. That geology will push current drilling technology to its limits. It also makes it extremely difficult to figure out how much oil is actually down there and recoverable. And it pushes out real production volumes from the fields to 2015 to 2017. Because drilling will be such a challenge, this will be expensive oil to produce.
Petrobras' long-term business plan calls for investing $174 billion over the next five years in developing its resources. The company says it has $30 billion in hand, including $10 billion from China's Sinopec in exchange for 200,000 barrels of oil a day for ten years.
Petroleum and Politics Don't Mix
But you may not have focused on the political risks. The politicians in Brasilia, Brazil's capital, may yet take a good part of the rewards away from Petrobras. The company was totally state-owned until 1997, and the government still holds about 56% of the company's stock.
That means politicians have considerable say over its direction. And they've become more willing to exercise that authority as the company has grown richer and more powerful.
The danger comes from two directions. First, there is simple political disruption from the opposition to President Luiz Inácio Lula da Silva's government. Currently, this takes the form of charges that the company evaded taxes and overpaid on contracts as a way to reward the president's political allies. An 11-member Senate committee, led by one of the president's allies, is investigating. I don't think the charges are a serious long-term threat to Petrobras or the value of investors' holding in the company, however.
Second, there are efforts to limit Petrobras' ability to profit from those deep-sea discoveries. I take this danger much more seriously.
A government committee is now putting together a legal framework to govern who owns the so-far unassigned rights in what is called the subsalt area, where the oil lays. This isn't exactly a minor issue. Those unassigned rights make up 62% of the total.
One plan, which has substantial support, would vest control of all these unassigned rights in a new company—totally owned by the government—that could partner with any oil company, including Petrobras, in the exploration and production of oil from the subsalt deposits.
The creation of a new company that controlled 62% of the subsalt rights could be a huge deal or no big deal, depending on how the government decided to split up the revenue. Too big a share to the new company, and Petrobras not only would be much less profitable than now projected, but also might not have enough cash flow to finance the development of these deposits.
It's enough to make me nervous. Brazil is still a very poor country. Cash from this oil would be of great use in improving education, health care, or the country's infrastructure. The government will be tempted to raid these projected cash flows even before they materialize.
We know what a mess a national oil company can become if politicians milk the cash cow dry. In Mexico, where Pemex is the source of the majority of the national budget, oil production is in collapse because the company has underinvested in its own fields for decades. Production is now projected to fall to 2.6 million barrels of oil a day this year, according to energy minister Georgina Kessell. On July 30, the company cut its forecast to 2.65 million barrels a day from an earlier estimate of 2.8 million.
NEXT: The Case for StatoilHydro |pagebreak|
Less Government, but Less Oil, too?
The risk-reward profile is very different for Norway's StatoilHydro.
Yes, this is also an oil company that is majority-owned by its national government. The government's stake is set to increase to 67% as a result of the company's merger with Norsk Hydro.
But the legal framework for that ownership is significantly different. The government has no operational control over StatoilHydro. And the government has decided to bank its share of the revenue it collects from Statoil into a national "when the oil runs out" fund. Norway is a relatively rich country with a small population, so its politicians face much less pressure to milk the cow dry.
Although I'd say that the political risk of owning StatoilHydro is less than that of owning Petrobras, the production risk is higher. The company's existing fields are aging. That requires the company to spend big bucks on advanced recovery techniques that keep the oil flowing from older wells, which comes at a price. There's still plenty of oil and natural gas to be found on the Norwegian continental shelf, but it's likely to be found in smaller pools that are more expensive to exploit.
That's forced the company to move in three directions to increase production:
- First, it has been buying reserves in other countries. For example, StatoilHydro was one of the companies that bailed out Chesapeake Energy from its cash flow squeeze by buying natural gas assets in the United States. (See my Aug. 21 post "Natural gas pains" for how to invest in
US natural gas companies.) In its deal with Chesapeake Energy, StatoilHydro
bought into the Marcellus gas shale region.
- Second, the company is increasingly shifting its
production mix toward natural gas—the production of which is still climbing in
its offshore fields—and away from oil. That plays to one of StatoilHydro's
strengths: It owns the largest offshore natural gas pipeline system in the
world. It also capitalizes on increasing worries in Europe about overreliance
on natural gas supplies from Russia's Gazprom. StatoilHydro is the number two
supplier of natural gas in Europe.
- Third, StatoilHydro is pushing north into the Arctic waters it shares with Russia. (So far, at least, Russia regards Statoil as a useful partner because the company can provide the extreme-weather drilling technology Russia needs to explore its share of these waters.)
Because of its extreme weather, the area is relatively underexplored, even though many guesstimates say this sector of the continental shelf is rich in oil and gas. (The gradual disappearance of the Arctic ice pack is an environmental disaster, but it will make life easier for oil companies exploring these seas.) StatoilHydro has already found oil at the Obesum well in the Barents Sea.
How do I add up these risks and rewards?
I think it's worth owning Petrobras for its roll-the-dice upside. If the company can dodge political disaster, it will come out a huge winner.
I think shares of StatoilHydro are less risky and a bargain because investors in general are undervaluing the company's natural gas pipeline infrastructure and the prospects for new discoveries in the Arctic.
Which you buy depends on the risk you want to take and what else you own in your portfolio.
I own shares of both, but I own about three times as much of StatoilHydro as I do of Petrobras.
At the time of publication, Jim Jubak didn't own or control shares of any other company mentioned in this column.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.
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