1 Undervalued Energy Play

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Crude oil prices are now the highest since the "super-spike" in 2008. With the Brent benchmark inching past $125 per barrel, HSBC Chief Economist Stephen King has gone to the extent of terming oil as the new Greece. In other words, crude oil has become the new source of anxiety for investors around the globe.

Yet this doesn't come as a huge surprise. While deteriorating relations between Iran and the West are fueling supply-side fears, an improving job market in the U.S. has speculators betting on a growth in demand for crude oil -- the perfect catalysts for rising crude prices.

Given the uncertain situation, I'm going to show you an energy stock that looks like a long-term winner to me: Petroleo Brasileiro (NYSE: PBR  ) , or Petrobras to most regular investors.

Why Petrobras?
How is this company different from the others operating in the same line of business? The state-run Brazilian integrated oil and gas company has been adding reserves at a breathtaking pace, and more importantly, it's been developing these reserves at an equally fast pace.

Petrobras shot to prominence through its discovery of the Tupi oil field in the pre-salt Santos basin. Considered to be the largest oil discovery in the past 30 years in the entire Western Hemisphere, this field is estimated to hold between a massive 5 billion and 8 billion barrels of oil equivalent, or Boe. The Guara well, another discovery in the Santos Basin, is estimated to hold 2.1 billion Boe, mainly consisting of light oil and natural gas.

With the intent to make profits while crude prices are high, Petrobras has ramped up production significantly. In December, average daily production stood at 133,000 Boe, a steep increase from 71,000 Boe at the start of 2011.

Right place, right money
The waters off the Brazilian coast are rich with what's called pre-salt oil reserves. Each of the 37 wells Petrobras drilled here in 2011 have hit oil. In all, proven reserves have reached 16.4 billion Boe. Now this is where I see potential. With fears of a shortage in global crude oil supply, the Brazilian reserves are among the most exciting prospects in the exploration and production space.

Petrobras plans to spend a whopping $225 billion to develop these reserves and double its output by the end of this decade. However, it must be kept in mind that the installed capacity to dig out the resources off the Brazilian coast has yet to match up to proven reserves. And as of now, the company doesn't look capable of pulling out the hydrocarbons all by itself. But help is at hand.

Solid partnerships
(NYSE: CVX  ) and Statoil (NYSE: STO  ) have sizable stakes in these reserves and jointly look to develop them with Petrobras. Chevron holds a 37.5% stake in the Papa Terra project, operated by Petrobras in the Campos Basin. Statoil holds a 35% stake in the Pao de Acucar project, a 250 million Boe discovery, where Petrobras holds a 30% stake.

On the production side, Petrobras has enlisted the help of deepwater drilling giant SeaDrill (NYSE: SDRL  ) . With five-year charters drawn up, the oilfield services company has four of its rigs contracted until 2015.

Is the stock cheap?
Given the quantity and quality of assets, Petrobras looks pretty attractive at this point. Here's how it stacks up against its fellow integrated oil and gas counterparts:


Price-to-Earnings (TTM)


Petrobras 9.2 0.93
ExxonMobil 10.2 2.62
Chevron 8.2 1.80
Total 9.5 2.34
Statoil 17.0 1.51
ConocoPhillips 8.6 1.52

Source: S&P Capital IQ; TTM = Trailing 12 months.

On an earnings basis, the stock trades at a 14% discount to its peer -group average. If you're making a decision on this stock based only on its not-so-impressive earnings, here's why you should think again: The new CEO, Maria das Gracas Foster, has already laid out big plans for the company's lagging refining segment, which should ensure that there are no rotten eggs in the basket.

On the basis of book value, Petrobras looks the cheapest by far. The company's assets look potentially undervalued to me. This is where a long-term investor should see an opportunity.

We at The Motley Fool will help you stay up to speed on the top news and analysis on Petrobras. You can start by adding it to your Watchlist. If you like energy stocks, we have a stock idea that could knock your socks off. Read about it in The Motley Fool's special free report on the energy industry and its best prospects. It's free for a limited time.

Fool contributor Isac Simon owns no shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Statoil A, SeaDrill, ExxonMobil, Chevron, and Petrobras. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 23, 2012, at 12:38 AM, petroglyph wrote:

    As a very long term investor in PBR, I would say this is, at this moment, a very contradictory situation.

    You have stated the positives, they have found a great deal of oil sub-salt, and they are cheap. The price to book metric makes little sense in evaluating a NOC, so I disregard that. But they have found oil like no other firm in the world in recent years, no argument there.

    There are a least three weighty negatives. The company if forced by the government to sell file at a substantial discount, making the downstream business a huge loser. Second, they are forcing local content rules on PBR that may be good for Brazil's shipyards, but are a very raw deal for PBR, and by extension, it's shareholders. Third, in a dismal contrast to Lula, Dilma is making it clear she expects PBR's profitability to very much take a back seat to other national interests. And her government has the majority of shares, so there is reason to fear that Brazil will get the bread, and the shareholders will get crumbs.

    I'm still long, but feeling sheepish about it after 2 years of wretched underperformance. Don't focus on the oil reserves, watch the politics.

  • Report this Comment On March 23, 2012, at 9:10 PM, NJ7 wrote:

    I am long PBR, but also am considering petroglyph's concerns, particularly the set prices in Brazil. There are two powerful trends at work here, Brazil's strong growth as an economy (and oil consumption) as well as Petrobras reserve and production growth. The first trend will hurt Petrobras if it has to continue to import oil, but I think the risk is worth it because of the dramatic growth prospects for the company.

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