Petrobras' Ills Linger
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For years, Brazilian oil giant Petroleo Brasileiro SA ADR, or Petrobras, (NYSE: PBR) was a wonderful way to play both the BRIC country of Brazil and higher oil prices. But in recent months, the Brazilian government headed by President Dilma Rousseff has increasingly interfered in the day-to-day operations of the company, making it a not-so-great investment.
Petrobras is not alone though. The same can also be said of Brazil's other premier natural resource company, Vale ADR (NYSE: VALE). Its prior CEO was forced out and a new, more government-friendly CEO, Murilo Pinto de Oliveira Ferreira, was appointed. The Brazilian government is trying to force Vale away from just concentrating on iron ore production and more toward building steel mills so that the country does not have to import so much steel.
Brazilian government interference has also hurt US-based ETF players. Vale and Petrobras stocks combined make up nearly 20% of the most popular Brazil ETF -- the iShares MSCI Brazil Index Fund (NYSEMKT: EWZ) -- putting a drag on its performance, hurting emerging market investors.
The government recently appointed a new head of Petrobras, Maria das Gracas Foster. Although she is a long-time veteran of Petrobras, she is also quite close to the Brazilian president. She made clear where her loyalties lie in her first press conference when she spent a good deal of time emphasizing the importance of the government's rather new policy of requiring that up to 65% of the content in the national oil industry must be local.
This policy will have a big effect. After all, Petrobras has the world's largest capital expenditure budget over the next five years, at $225 billion. The company has to build or buy an incredible number of ships – 250 (more than most nations' navies) as well as other equipment in order to develop the vast offshore “pre-salt” oil fields, the largest oil discovery in the Americas in decades.
This burden will likely only add to the recent poor results for the company. Fourth quarter 2011 results show the extent of the problems facing Gracas Foster. Net profit fell by more than half from the year ago period, weighed down by the poor performance of Petrobras' downstream operations. Demand for fuel in Brazil is soaring thanks to a strong economy and weaker-than-expected production of ethanol locally. That has forced Petrobras to import fuel at higher prices from other parts of the globe, including the United States, and sell it domestically at government-mandated lower prices.
Another problem facing Petrobras' CEO is the long-term one of the company's ability to increase oil production. Its production in December was 2.72 million barrels of oil a day, a lower figure than December 2010. The company has failed to meet its own internal targets for oil production for the last three years, and that is despite massive investments. Since 2003, the company's investments into oil production have risen by 280% but actual production has increased by a mere 30%.
The company issued a forecast stating it will more than double oil production to 6.4 million barrels a day by 2020. That figure is not a safe bet at all based on Petrobras' poor track record on hitting production targets. The main obstacle the company faces in meeting this lofty goal will be that pesky 65% local content requirement imposed by the government. The country simply lacks the manufacturing capacity to meet the requirement to build ships and equipment in a timely and cost-efficient manner.
What Petrobras needs is some breathing space from the government on several fronts – the 65% requirement and the price caps on domestic fuel. It remains to be seen whether Gracas Foster can use her friendship with Rousseff to gain the company some breathing space in the months and years ahead.
Petrobras' stock has moved up since the beginning of the year on the back of optimism over the global economy. But it has underperformed the Bovespa index by more than 15% in the past year. If the company does not get some breathing room from the government, look for Latin America's biggest market cap stock to continue to trail the general stock market.
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