Petrobras’s Biggest Oil Discovery Brings Cost Concerns

Investors in Petroleo Brasileiro SA, the world’s most indebted oil company, aren’t celebrating Brazil’s biggest-ever crude discovery.

Since regulators doubled estimates for the Libra field to as much as 12 billion barrels on May 23, the state-run company’s shares fell 5.3 percent in New York, the worst performance among 15 peers tracked by Bloomberg. The new estimates make the oil prospect Brazil’s largest as the country prepares to bring in partners to start production.

For Petrobras, more oil means more investments and debt for a company that already has the world’s second-biggest spending plan and is stretched for staff and equipment. The Rio de Janeiro-based producer will pay a multi-billion-dollar signing bonus for Libra at a time it sacrifices revenue from fuel sales as part of a government policy to curb inflation. Petrobras has sold imported gasoline and diesel at a loss since late 2010.

“They haven’t got a shortage of reserves, so another new find isn’t going to move the needle,” Nick Robinson, the head of Brazilian equities at Aberdeen Asset Management, which has about $15 billion in Latin American shares including Petrobras, said by telephone. “The big issue for Petrobras is cash flow generation.”

Little Control

Petrobras has the financial and human resources to develop new areas of the so-called pre-salt region that holds Libra, the company said in an e-mailed reply to questions. The company has increased gasoline prices 14.9 percent and diesel prices 21.9 percent in the past year to narrow the discount to international prices, it said.

The government probably will set its signing bonus at about 20 billion reais ($9.4 billion) and Petrobras will pay at least 30 percent, said Adriano Pires, the head of the Brazilian Center for Infrastructure, a consulting firm in Rio de Janeiro.

Petrobras, which the government controls through a majority of voting shares, has little control over how much it will profit from Libra since terms will be determined by the winning bidder for a 70 percent stake to be auctioned in October. The Energy and Mines Ministry declined to comment on the size of the bonus.

The Nov. 8, 2007 announcement of billions of barrels of high-quality oil locked below a layer of salt in the deep waters of the Santos basin drove up Petrobras’s stock 49 percent to a record 52.51 reais on May 21, 2008. The stock tumbled 63 percent since then as fuel price caps, rising investments and equipment shortages discouraged investors, even as production from the so-called pre-salt region beat the company’s forecasts.

‘Different Environment’

“It’s a different environment,” said Eric Conrads, who manages about $750 million of Latin American stocks at ING Investment Management in New York. “At that time you were looking at growth, you were looking at a production explosion, new potential. Emerging markets and Brazil were hot.”

Petrobras’s capital expenditure this year will be $42.9 billion, the most after PetroChina Co. among major oil producers, according to estimates tracked by Bloomberg. Petrobras plans to invest 98 billion reais this year. It is the most indebted publicly-traded oil company at $97 billion, according to data compiled by Bloomberg.

Libra holds 8 billion to 12 billion barrels in recoverable reserves, topping the 6.5 billion at Lula, Brazil’s hitherto biggest discovery, also located in deep waters of the southern Atlantic, Magda Chambriard, the head of Brazil’s oil regulator, told reporters May 23.

Profit Sharing

Libra will cost Petrobras $34 billion over the life of the project to cover its minimum 30 percent stake, equal to 79 percent of its investments last year, Banco Santander SA analysts Christian Audi and Vicente Falanga Neto said in a note to clients.

Under a so-called profit-sharing model, the winning bidder will be determined by how much profit it pledges to the government. This puts Petrobras at a disadvantage to other international producers who can borrow at cheaper rates, Santander said. The greater the demand for Libra means Petrobras will have to forfeit a larger portion of the production to the state, said Jerry Kepes, a partner at Washington-based PFC Energy, an energy strategist to companies and governments.

“The last thing they would like to see is a bunch of foreign companies coming in and bidding the government take up and their returns down,” Kepes said by telephone. “For Petrobras that’s a problem.”

‘Slip Back’

Petrobras will probably rework its business plan to replace less profitable projects with Libra, said Iain Reid, an analyst at Jefferies Group LLC in London.

“They will rank this against other opportunities, and the opportunities which are less economic, potentially, could slip back a bit,” Reid said by telephone. “Any sensible company, which has a big and potentially commercial asset, isn’t going to just leave it sitting there.”

Bidding will be competitive among large oil companies including Total SA, BP Plc and Royal Dutch Shell Plc, said Pedro Dittrich, a partner in charge of oil and gas at Sao Paulo-based TozziniFreire Advogados.

“The Chinese companies are highly expected, as well as others from the East,” Dittrich said in an e-mailed reply to questions. “It is likely that Petrobras’s partners at the Libra prospect are currently its partners in other projects.”

Some companies may be willing to pay an even higher bonus of about $15 billion considering the success at nearby Lula and the successful drilling results at Libra, said Cleveland Jones, a geology professor at Rio de Janeiro State University.

‘Short-Term Problems’

Authorities probably will set a high signing bonus to boost revenue during a year when economic growth is trailing government and economist expectations, said Pires. Brazil’s economy has posted growth below analyst forecasts for five straight quarters. The economy expanded 0.55 percent in the first quarter, less than the 0.9 percent median forecast of analysts polled by Bloomberg.

Petrobras was down 0.5 percent in Sao Paulo this year through yesterday, less than the 13 percent drop in Brazil’s benchmark stock index. The Brazilian company, whose shares rose 0.2 percent to 19.46 reais today, trades at 7.9 times estimated profit compared with a peer average of 11.78.

The government has a track record of using Petrobras to help meet economic goals including inflation, Pires said. Fuel subsidies reduced Petrobras’s profit last year to the lowest in eight years. Brazil targets inflation of 4.5 percent plus or minus two percentage points. Annual inflation in April was 6.49 percent.

“The government wasn’t thinking about Petrobras when it set up the pre-salt auction,” Pires said by telephone. “It’s worried about short-term problems like the primary surplus.”

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