The Best Way to Invest in Brazil’s Oil Boom

Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In 2006, a remarkable discovery was made in the seas off the coast of Brazil’s southeastern tip.  Energy explorers searching for new deposits of ‘black gold’ found the world’s first major oil field below the pre-salt layer – a mineral patch found in the ocean between South America and Africa. 

Named for one of the most influential ethnicities of the country, the Tupi Field is a 650-square mile area resting below 6,600 feet of water and 16,000 feet of salt rock.  The oil giant Petroleo Brasileiro SA Petrobras (NYSE: PBR), which is primarily owned by the Brazilian government, holds a controlling interest in the fields in the region. With 6.5 billion barrels of proven reserves, Tupi holds enough oil to meet global demand for three months, though this unearthing was only the start of Brazil’s oil windfall.

One year later, the Carioca-Sugar Loaf field was discovered in the Santos Basin – the same area as the Tupi Field.  The Carioca-Sugar Loaf is one of the largest and deepest oil fields in the world; it is estimated to contain upwards of 30 billion barrels at 30,000 feet below sea level.  While this presents a mechanical challenge to drillers, Petrobras has committed $225 billion to develop the field over the next five years.  Moreover, the Iara Oil Field, which was discovered in 2008, is expected to hold an additional 3 to 4 billion barrels of oil, though these estimates have not been confirmed. 

Altogether, these three discoveries nearly triple the size of Brazil’s oil reserves, placing the nation on par with the United States and Saudi Arabia in terms of crude deposits.

Already the world’s 20th largest petro company in terms of proven reserves, Petrobras owns approximately 65 percent of the 40 billion-plus barrels mentioned above.  These finds increase the company’s reserve total threefold, pushing it into the global top ten, ahead of well-known names like ExxonMobil (NYSE: XOM)Chevron (NYSE: CVX)BP PLC (NYSE: BP), the Chinese PetroChina and the Russian Gazprom.  Due to its close relationship with the Brazilian government, Petrobras is in the best position to benefit from the country’s oil boom.

With drilling and production costs expected to average $40 a barrel, Petrobras is sitting on more than $1 trillion of oil profits; and that’s assuming that prices remain depressed at $80 a barrel.  Now, costs are inherently higher in the Santos Basin region due to depth – Exxon and Chevron pay around $10 a barrel – though the sheer size of the deepwater deposits warrant investors’ optimism. 

In fact, Petrobras has already been growing its top line at an exceptional rate since the recession, as its 3-year average revenue growth (7.3%) is superior to the industry average (1.6%), and competitors like XOM (0.6%), CVX (-2.4%), and BP (1.7%).  While PBR has had difficulties translating this to the bottom line – earnings have declined by almost 20 percent over the same period – much of this can be attributed to increased research and development expenses. In 2011 alone, these outlays increased from $993 million to $4.08 billion, as the company cited a need for innovative solutions to its upcoming projects.  PBR is partnering with International Business MachinesGeneral Electric, and Schlumberger Ltd to develop a more cost-effective way to drill through the thick layer of salt that separates its oil from the ocean.

Shares of Petrobras look to be undervalued at the moment -- the company sports a P/E ratio (7.1X) that is below the industry average (8.1X) and its own 10-year historical average (11.2X).  Moreover, the company’s earnings multiple is also below XOM (10.3X), CVX (7.6X), and PTR (11.8X).  Over the past decade, Petrobras’ earnings have historically traded at a 34 percent discount to the S&P’s average.  Inexplicably, they are cheaper this year, trading at a 50 percent discount.  Coming off the heels of a better than expected earnings release last month, analysts are expecting PBR to end 2012 with an EPS of $2.72, while reaching $3.13 a share in 2013.  Assuming consensus holds, fairly valued shares of Petrobras should eclipse $25 by next summer.  The stock currently trades in the $19 range, making a return north of 30 percent a real possibility.

Going forward, Petrobras is insulated from the geopolitical shocks in the Middle East that have left others in the oil industry on shaky ground; this is perhaps the greatest reason to consider the company in your portfolio.  Brazil’s economy has quadrupled in size since the start of the 21st century, and currently ranks as the world’s sixth largest with $2.4 trillion in GDP.  GDP per capita, or standard of living, has grown from $7,400 in 2000 to over $11,000 this past year.  These gains have a pronounced effect on domestic oil usage, as Brazilians continually have more Reals to spend on consumption. 

From a global perspective, oil demand grew by 310.25 million barrels in 2011, and is expected to grow by nearly 800 million barrels over the next two years.  Since May, oil prices have fallen by over 20 percent, though most of this movement looks to be a result of disappointing economic data and fears of a double-dip recession.  Over the long term, oil is still a bullish commodity, and expected to rise above $115 a barrel by 2013.

Driven by the recent discoveries of immense crude oil reserves off the coast of Brazil, Petrobras will continue to emerge as a major player in the global oil industry over the next decade.  Due to the relative stability of the Brazilian region, and PBR’s own persistent undervaluation, now looks like the best time to take a long position. WealthLift’s Sentiment Index rates Petrobras as a strong buy, with nearly 100 percent of investors placing an overperform rating on the stock.

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Fool blogger Jake Mann does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron and Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.

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