Brazil is Set to Become a Top Oil Producer

by Tony D'Altorio

Brazil is Set to Become a Top Oil Producer

by Tony D'Altorio, Investment U Research

Friday, February 11, 2011

Brazil has a sunken treasure off its shores... though not the type Jack Sparrow might seek.

Instead, it is stashed beneath miles of water, rock and layers of salt beneath the ocean's floor. And these so-called "pre-salt" oil fields make for the biggest oil discovery in the Americas since the 1970s.

Brazil's oil regulator estimates they contain about 50 billion barrels of oil equivalent. That's more than enough to turn Brazil into one of the world's top oil producers in this upcoming decade.

However, making use of that potential looks challenging going forward. Both Brazil and its national oil company, Petrobras ADR (NYSE: PBR) will have their hands full...

Petrobras' Big Challenge in a Big Country

Brazil is Latin America's largest economy. And according to the World Bank, it ranks eighth globally.

Petrobras is already a big part of that.

Its capital expenditures currently accounts for around 2% of Brazilian GDP. And its overall supply chain makes up a total of 7-8% of GDP.

The pre-salt fields have enormous implications for the country. So Brazil regards Petrobras' exploration and development in this area as a national endeavor.

Petrobras has ambitious capital expenditure plans set to grow it rapidly, especially compared to the larger economy. The company wants to invest $224 billion into developing these fields by 2014.

That includes a huge amount of new equipment, such as 28 drilling ships, equal to a third of today's global fleet. The project also requires 146 additional supply ships, 8 FPSOs and 72 large oil tankers.

By the time it buys all of that, Petrobras will have more ships than most nations' navies!

Yet it does really need all of them due to the depth and remoteness of the fields. For example, rather than pipe oil to the coast, it will store it on floating platforms before taking it to shore in tankers.

Then there are the five new oil refineries Petrobras has planned for its 50% increase in refinery output. Its current refineries are running at full capacity even while Brazilian demand just keeps going up.

Petrobras' ultimate goal is to double the country's domestic oil production. That would take it from about 2 million barrels of oil a day to roughly 4 million barrels by 2020.

Financing Difficulties and What Might Come of Them

However, financing this $224 billion investment may prove almost as difficult as engineering it.

If oil prices stay at $80 a barrel, Petrobras says it can raise $155 billion of the $224 billion it needs in capital expenditure from internal operations alone. And it already has a $25-$28 billion in cash.

Most of that comes from the world record $70 billion stock offering it made last year. Another portion comes from its $6 billion bond offering several weeks ago, the largest in Brazil's corporate history.

That leaves $30-$40 billion. Petrobras says it can finance that with further debt offerings in the next four years, but that hasn't appeased everybody...

Some investors think the company's huge fund-raising efforts could push its net debt-to-equity ratio - now at 18% - beyond its internal 35% limit. Exceeding that could harm its investment grade rating.

Fortunately, a closer look shows little reason to worry in that department.

Yes, Petrobras' net debt as a ratio of earnings before interest, taxes, depreciation and amortization is expected to rise from 0.9%. But that's only to 1.4 times in a few years, well below its 2.5 internal limit.

Others doubt whether the Brazilian market can handle such large debt-raising plans. But based on its recent growth pattern, that shouldn't be a problem.

Dealogic shows Brazilian companies issuing $47 billion of debt in 2010, a $17 billion hike from 2009.

In fact, the sheer size of Petrobras' bond offerings could comprise up to a third of each year's issuance. While that might stifle competition, the oil giant's importance to the country means the bonds will get sold in Brazil regardless.

With the financial markets so strong right now, Petrobras has a good shot of raising what it needs. But any upsets in the global capital markets or oil prices could force it to rethink its ambitious plans.

And if that happens, investors had better hope the company has a viable Plan B to put in place quickly.

Good investing,

Tony D'Altorio

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