In this week's energy and industrials episode of Industry Focus, analysts Sean O'Reilly and Taylor Muckerman look at two Brazilian companies, Vale (NYSE:VALE) and Petrobras (NYSE:PBR), that have ratcheted down in price in the past several years. Listen in to find out why the two companies were so sought after just a few years ago, what's been doing them in, and why it's just not worth it for long-term investors to take a position in either company today.
Also, the hosts look at the most important points from OPEC's meeting this week, what Donald Trump has been saying about the energy sector, and why 2015 clocked in with the lowest level of oil finds we've seen in six decades.
A full transcript follows the video.
This podcast was recorded on June 2, 2016.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, June 2, 2016, so we're talking about energy, materials, and industrials. I'm joined today by Motley Fool analyst and Fool Canada head Taylor Muckerman, who happens to be a Mongolian food connoisseur.
Taylor Muckerman: Yes. It's been a while, but it's one of my favorites.
O'Reilly: Before we started here, you were telling me, about your ... was it a recent trip? Or is this a regular thing with you?
Muckerman: You were talking about Mongolia, and I was like, have you ever had Mongolian food? And I got to thinking, it's been a long time since I've had it and it's delicious.
O'Reilly: Does it do the sticks and stuff? What do they ... ?
Muckerman: I don't know how traditional it is, but I've been to several "Mongolian" places.
O'Reilly: This is all in D.C., obviously.
Muckerman: No ... D.C, North Carolina. Bethesda, there's one in Bethesda. You basically get all your ingredients in a bowl.
O'Reilly: It's like a Chipotle line, you were saying.
Muckerman: In terms of the ingredients laid out. But there's no one back there serving you. You just go up and fill up a bowl with all these ingredients, raw meats, vegetables, sauces. And then they have a humongous hot stone, kind of like the table we're at right now. I don't know, what would you say this is?
O'Reilly: Three and a half feet across.
Muckerman: Three and a half feet across.
O'Reilly: This is a three-and-a-half-foot circular table that were sitting at, folks.
Muckerman: It looks like the first wheel ever created. It's this huge stone, piping hot. And it's got two glorified chopsticks that are three feet long, and they dump all your food on the stone. He's tossing it around with these sticks for like a minute.
Muckerman: And with one swift movement, he swipes all your food into a new bowl.
O'Reilly: And you sit down and enjoy your meal.
Muckerman: It's fantastic.
O'Reilly: All right, I guess I know what I'm doing this weekend. Moving on to more serious matters. First up, right off the bat, I guess we have to mention the OPEC meeting that just wrapped up. I wrote a note here, "No production cap, mostly because of Iran, but Saudi pinky swore that they wouldn't flood the market with more oil." Is that the bottom line? Anything to add?
Muckerman: Pretty much. We've seen some meetings before that didn't really pan out. This might just be another one of those. Times have changed.
O'Reilly: What was it? Qatar's oil head said that $65 oil is desperately needed ASAP, though?
Muckerman: For budgetary reasons, I'm sure, yeah. Saudi Arabia is talking about cutting a bunch of subsidies, possibly.
O'Reilly: And they just announced another bond sale, did you see that -- $15 billion?
Muckerman: I did not see that.
O'Reilly: Yeah, like two days ago, they were like, "Yeah, we need another $15 billion."
Muckerman: They had the reserves, but they're probably just trying to get it while money's still cheap.
O'Reilly: Right, which is definitely the case. Anyway. We would have been remiss if we didn't mention OPEC. There you have it. We're not really macro people.
Muckerman: Saudi Arabia has a new guy in charge, the new oil minister.
O'Reilly: Oh! That's right! They got rid of that guy! When was he in charge since the '80s? What was his name?
Muckerman: I don't know; I can't remember his name.
O'Reilly: I'm going to Google this.
Muckerman: Go for it; we'll have it before the end of the show. So yeah, there's a new head, he has a different take on things. It'll be interesting to see. But as of this meeting, nothing really interesting.
O'Reilly: Little bit closer to home, or, a little bit more useful to oil investors, a recent piece on Bloomberg noted that oil finds are at a six -- that's right, six -- decade low.
Muckerman: How many years is that? Sixty?
O'Reilly: It went back to 1952, the last time the world found this low amount of oil. And it's actually rather large. It was 12.1 billion barrels of oil equivalent -- that did include gas.
Muckerman: That did include gas?
Muckerman: Yeah, barrels equivalent of oil. The mix of that was predominantly natural gas.
O'Reilly: Yeah, I'm sure. The article also noted that it definitely lends credence to the idea that we could be long-term undersupplied, because it takes five to 10 years to get all that stuff online. This is not ideal right now.
Muckerman: Yeah. We talk about the quickness that you can bring a shale oil to market, and that's just not the case with the majority of oils in the world, predominantly with the oil they found last year, leaning more heavily toward offshore, which, you're looking at at least seven years to develop, and a much higher cost per barrel that is needed as a hurdle rate to even justify getting those projects.
O'Reilly: That's just it. With all these reserves, but especially for the offshore stuff, once you find it, all your work is still ahead of you.
Muckerman: Absolutely. You have to contract the rig, you have to drill-test oils and development oils, and then you have to produce it, you have to coordinate the tankers to distribute it, get the pipelines going. It's a process, which is why seven years is the average.
O'Reilly: Yeah, five, 10, seven. Last show, you mentioned how you thought offshore is going to be increasingly important in the decades ahead. Does this, the fact that we're finding less oil than we have in six decades ... God, what was going on in 1952?
Muckerman: I wasn't here.
O'Reilly: JFK, I don't even think was a freshman Congressman. Jeez. Anyway. Does this add to the bull case for oil?
Muckerman: Not going to try to predict prices, but supply, less than demand? You would imagine that prices would go up. Definitely a longer-term play than what people are talking about in investing in oil right now, because everyone is so excited about the prospects of rising prices now. But we could see prices fall again in the near term. But long-term, if you don't have the product, then it could be a five-year chart that looks really great for long-term investors, rather than a one-year chart.
O'Reilly: Final thing in that article that jumped out at me, it noted that exploration spending in 2015 was down 45% from 2013. My reaction was actually, "That's it?"
Muckerman: Especially this year, too. You see the stats this year compared to 2013; it's going to be down even more than that. The crisis has not abated in terms of company upstream spending. That's not just for oil. You see projects with coal export terminals being shelved, you see natural gas pipelines being shelved. Two in particular in the Northeast.
O'Reilly: What was it, Kinder Morgan a few months ago actually shelved a few pipelines or something like that?
Muckerman: One of them in the Northeast, I believe, was a several-billion-dollar project. That area is really struggling when it comes to prices for natural gas, when you talk about New York and New England. They're paying, sometimes, close to 50% more than the national average just because the distribution networks aren't there. That's a little bit to do with government and environmental activists coming in and stopping that. Companies want to invest there, they're just finding it difficult, so they're abandoning or postponing a lot of these projects.
O'Reilly: Got it. Moving on -- we don't talk enough about overseas oil companies. Tyler Crowe used to always talk about Total.
Muckerman: Yeah, he's a big fan.
O'Reilly: Why does he like them so much?
Muckerman: They're diversified. Upstream, downstream, and they're pretty big into renewables. One of the more forward-thinking energy companies out there.
O'Reilly: Got it. We wanted to chat today about Brazilian commodity producers, particularly Petrobras and Vale. The chart on Petrobras alone is brutal.
O'Reilly: High of $76.60 in 2008. Just a nice downhill slide ever since.
Muckerman: It was a darling back then. Everyone was clamoring to get some.
O'Reilly: Leading up to the financial crisis, yeah.
Muckerman: Yep. Everyone was clamoring to access offshore Brazilian oil.
O'Reilly: They actually have a lot of oil -- 8.7 billion barrels of crude, 10.4 trillion cubic feet of natural gas.
Muckerman: Sounds like big numbers, and it actually is, comparatively around the world. It's not a No. 1 or No. 2 reserve holder, but it's an important factor.
O'Reilly: It's sizable, and we need it.
Muckerman: Yeah. Without it, we would be in dire straits.
O'Reilly: In 60 seconds, can you give our listeners a rundown of the plethora of corruption problems that Petrobras ... feel free to take a minute and a half, if you want.
Muckerman: The one in particularly that we're discussing today has really been going on since 2014, in terms of investigation, dubbed "the carwash scandal."
O'Reilly: Why does it have that name?
Muckerman: They're trying to scrub the government? I don't know. Anyway. You're talking about vendors overcharging Petrobras for some of the supply and the equipment.
O'Reilly: And these are vendors that the government requires Petrobras to work with, because it's partially state-owned.
Muckerman: Not partially. It's majority state-owned. There's a mandate in there that they have to use a certain amount of local vendors. Then, on top of that, they have to sell oil at a subsidized price, they have to buy internationally, sell it domestically. They're really getting screwed over on the margin side.
O'Reilly: And all of this was OK, pre-financial crisis. Oil went up there and gave $140 a high five, as I recall. So all that was OK back then, because oil was $140.
Muckerman: Well, it was on the development side, but when you have oil prices that high, and it's producing its own oil, it couldn't sell its oil to the refineries in Brazil. It had to go out and buy oil on the open market and sell it at a subsidized price to the domestic market.
O'Reilly: Oh my gosh! How is this a good idea?
Muckerman: Well, for the government, it seemed like it. For the company and investors, obviously not.
O'Reilly: Right. I'm at risk of being a stereotypical American here or something, but why not just let it do its thing, make money, and tax it heavily or something?
Muckerman: Let capitalism do its thing? I don't know why. Same thing with Vale. It's partially government-owned.
O'Reilly: Are they nearly as corrupt? What happened there?
Muckerman: I don't believe there's as much corruption, at least, that's been announced.
O'Reilly: Iron ore is just in the tank?
Muckerman: Yeah. You see the troubles of an entire country, especially the size of Brazil, being so heavily reliant on materials and ...
O'Reilly: They were doing well. Do you remember, Warren Buffett actually made a currency trade, which he never does, and he bought the Brazilian real. That was -- I'm trying to remember -- I think 2007 or something. Anyway, times change. I read something earlier, and it was like, "Petrobras' corruption scandals are probably in the past." You don't necessarily agree with that, though?
Muckerman: No. Maybe within the company, but you're already seeing new discoveries or new rumors that new officials in the government are trying to undermine the probe. You've seen the government change hands in the last couple months, after the oust of their former leader. Now, his newly appointed cabinet members are already suspected of trying to undermine this probe. I think we're still a couple years ...
O'Reilly: Do they own car washes?
Muckerman: I have no idea. I don't think there's enough water right now in Brazil ... with all the hydro-power they need, especially with the Olympics coming up, there's probably water restriction on car washes.
O'Reilly: Oh, that's right! The Olympics are there! Oh, boy.
Muckerman: Thankfully it's only in one city, so it might not be as disjointed as the World Cup was, even though that seemed to have gone off without a hitch. At least they can only concentrate on one area, rather than sending Americans on the longest route possible to try and win the World Cup.
O'Reilly: OK. So, bottom line for Foolish investors, I hear all this stuff and I'm like, "This sounds stressful. I don't need this."
Muckerman: You don't need it. If you're a long-term investor, you don't need it, you don't want it. Therefore, I wouldn't recommend investing in it.
O'Reilly: Would you take either of these names if we gave you shares?
Muckerman: Yeah, I would take them.
O'Reilly: Then you'd sell them?
Muckerman: They've been beaten up so badly. And if they're given to me, whatever. I wouldn't sell them right away. I'd probably give them a chance, but I wouldn't put any more money ...
O'Reilly: But even at what might be a bottom for iron ore and Vale and oil and Petrobras?
Muckerman: That's the thing. You're still trying to call a bottom. Oil was above $100 for most of the time since 2008, and we've seen the share price ...
O'Reilly: You're absolutely right.
Muckerman: With all the government mangling, not only in possible corruption, but also in the financials and their operations, I just don't see the benefit. The reward could be great, but it's going to be a stressful ride.
O'Reilly: OK. Last topic of the day, is Donald Trump going to make oil great again?
Muckerman: That's what he says. I don't know if he used that exact phrase, but it wouldn't surprise me. Used just very simple terms. Going to deregulate oil and other fossil fuels.
O'Reilly: What do you think about what he said about OPEC? Did you hear that?
Muckerman: Exactly? ... No.
O'Reilly: He was like, "If OPEC did what they do in the world in this country, they'd be in jail," and, "Oh, they set the price of oil," which I actually don't necessarily agree with, especially in the market today.
Muckerman: Yeah. Again, he's leaning on old truths.
O'Reilly: That was true in the '70s and '80s, not today.
Muckerman: It was even true 10 years ago. Even as far back as a few years ago, because you saw what happened in 2014. They tried to use their old mechanisms, and oil producers in the U.S. Some of them are going bankrupt, but those probably shouldn't have been in business anyway. I think he's just leaning on those old truths to where OPEC doesn't have nearly the power that it used to. As you've seen with the meetings over the past year or so that have resulted in ...
Muckerman: ... next to nothing in terms of market movements. They can't get on the same page right now. There's some disagreement, and rightfully so, within those ranks.
O'Reilly: Trump's obviously pro-fracking, which, I think everybody is.
Muckerman: Pro-fracking, pro-coal. Not everyone. But there's more pro-frackers than there are pro-coal miners.
O'Reilly: That was the point I found most interesting, the pro-coal. Is that even a good idea, given that there's so much natural gas in this country?
Muckerman: I don't think it's a good idea, because other countries are shunning coal.
O'Reilly: Yeah, and he's like, "We're still sending coal to China," and I'm like, "That's not quite true still."
Muckerman: Some experts have suggested that China's carbon emissions peaked last year. They're two years ahead of their carbon emissions reduction goals.
O'Reilly: Who would have bet on that?
Muckerman: Not me. They're also scheduled to build out the biggest array of solar power this year in the world. The biggest purchaser of coal is turning a cold shoulder to it. Our coal users in the United States are turning a cold shoulder to it. I think that's a talking point, and I wouldn't recommend investing based on that. At least in terms of coal. At the Fool in general, we don't recommend investing based on elections, because these things take time to play out.
O'Reilly: And then it's a coin flip.
Muckerman: And then it's a coin flip. If you invested in healthcare, trying to play the Affordable Care Act, that took seven years to get through, and we're still years away from finding out exactly how it's going to impact various sectors within the healthcare industry. We don't necessarily agree with investing based on election cycles. That being said, oil probably wouldn't do terribly if Trump was the president. But he keeps talking about reducing our reliance on international oil.
O'Reilly: He kept hitting the energy independence talking point!
Muckerman: Yeah. We still only produce 50% of the oil we need. I doubt we'll ever produce all the oil we need until demand comes down.
O'Reilly: Right. He basically intimated that we could produce 15, 16 million barrels a day in this country, and I was like ...
Muckerman: Yeah ...
O'Reilly: To our listeners who aren't watching the video, the look on Taylor's face is pretty ...
Muckerman: He oversimplifies things. Considering we were producing around 9.5, now we're below 9, and falling. And clearly we're not rediscovering enough to produce 15 or 16 million barrels. Unless some countries just completely dry up and we have to, I doubt that will ever happen.
O'Reilly: Got it. Before we head out, any interesting oil stock or materials stock stories you're reading this week?
Muckerman: I'm trying to grasp the impact of the wildfires in Canada. Companies are starting to bring production back online. But we're talking about billions of dollars of lost revenue as the results of the shutdowns they had to put in place. It's just another one of those things that makes the energy markets entirely impossible to predict. I was listening to a Motley Fool Asset Management monthly report, and Bill Mann, our portfolio manager down there, was basically saying, "Oil is one of the more hotly analyzed commodities in the world, right up there next to gold, and no one saw this coming. So how is an individual investor supposed to see this coming?" If you're a trader, maybe you can make some money off it. But if you're an investor, find great companies.
O'Reilly: Bottom line, look for companies that thrive and generate cash. Cool. Thanks for your thoughts, Taylor.
O'Reilly: Catch you later. I'm going to get some Mongolian barbecue later.
Muckerman: I might have to join you now that I remembered it.
O'Reilly: That is it for us, folks. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at email@example.com. Once again, that's firstname.lastname@example.org. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell stocks based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly. Thanks for listening, and Fool on!