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Saturday, September 25, 2010

Why I am not Buying Petrobras Yet?

Petrobras (PBR) just concluded a new equity offering that broke world records at $67 billion. Of that amount, some $43 billion is attributable to an oil reserves-for-equity swap with the Brazilian government where the government gave Petrobras 5 billion barrels of oil reserves. As a result, the government's stake and influence in Petrobras have increased. This exercise is a deprivatization much like the ones Putin initiated in Russia with the key resource producing companies. Besides, Petrobras is paying about $8.50 per barrel of reserves that most analysts estimate the fair value to be around $6 to $7.50 per barrel. To boot, these reserves are in deep water with many technical challenges that must be overcome before they can be produced.

I expect that government intervention in Petrobras will only intensify with the expected election of Dilma Rousseff, a statist, in the upcoming presidential elections in October. An indication of this is the existing government's pressure on Petrobras to expand its less profitable refining business to make Brazil self-sufficient in refined products. The company announced in June that it was increasings its budget for refining projects to $74 billion from $43 billion over the next five years. This is capital that can be used to develop more profitable deep water reserves.

Finally, the company will require multiples of the sum it has raised to fully develop all of these reserves in ultra deep water. Petrobras' five-year plan calls for $224 billion investment and more equity raises may be required.

Admittedly, Petrobras has one of the best growth profiles among the integrated international majors. However, the market is telling us not to be misled by the production growth. No wonder short interest in Petrobras increased 110% last week.

The stock is down about 25% year-to-date reflecting these concerns. I expect that it will gradually recover as the effects of the dilution wears off. In the meantime, I am planning to sell strangles on the stock to generate income from its near-term sideways trajectory.

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