Petrobras' Fate Is in Lula's Hands

08/05/2010 1:47 pm EST


Jim Jubak

Founder and Editor,

Forget about news that Petrobras (NYSE: PBR) has made a new oil discovery off Angola with at least 500 million barrels of oil, or that it is beginning production from the Urugua offshore oil field this week.

The only discovery that counts for Petrobras shares is what price the Brazilian government will charge the company for as much as five billion barrels of deepwater reserves in the deep, deep water pre-salt deposits off Brazil’s South Atlantic coast. (Petrobras is a member of my Jubak Picks 50 portfolio.)

As part of a complex plan to finance the development of the offshore fields, such as the apparently giant Tupi field that Petrobras has discovered but now needs to put into production, the government plans to sell Petrobras five billion barrels of reserves. The company will raise the purchase price of the reserves through a stock offering.

The new reserves would then give the company assets that it could use to back the debt or equity financing it needs to develop these new fields. The cost of that has been put at $224 billion by Petrobras.

So, in essence, the price that the administration of Brazilian President Luiz Inacio Lula da Silva charges the partially state-owned oil company will determine how much Petrobras has to pay to finance this development. Estimates in the last week or so range from $5 to $6 a barrel—or about $30 billion—to $8 a barrel—or about $40 billion.

A higher price for the reserves would make it harder for Petrobras to sell stock to cover the purchase price, since investors would be getting fewer barrels of oil for their money. That would increase the number of shares Petrobras would have to issue to raise the purchase price and in turn increase the dilution suffered by existing shareholders as a result of the sale of new shares.

The government has had difficulty settling on a price, and the share sale has been repeatedly delayed. On June 22, Petrobras postponed the sale of shares until September. That pushes the offering dangerously close to the October presidential election, thereby raising the risk of more political intervention—which would make already nervous investors even more nervous.

They fear that the price for the reserves and for the stock offering will be determined not by oil field economics but by the politics of a close race to succeed President Lula. Too low a price would open Lula’s party and its presidential candidate to charges of a sweetheart deal that favors capitalists and foreign investors.

As of the first half of 2010, shares in Petrobras are the world’s second-worst-performing oil stock, behind only BP (NYSE: BP). The stock was down 27% in the first half of 2010, versus a 47% drop for BP. (Petrobras traded below $39 in New York trading late Thursday.)

Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.

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