Integrated oil companies need to find more oil, but there is a big difference between expensive oil and cost effective oil. Growth at any price is a poor strategy. Recent numbers make some of Brazil's fields look very questionable.
Brazil 101
Petroleo Brasileiro (PBR 0.45%) offers a great and exciting growth story. Significant oil finds near the major cities of Rio de Janeiro and Sao Paulo coupled with preferential access to the Brazilian government should make for hefty profits. The problem is that Brazil's offshore fields are very expensive to drill and the government does not always act in Petrobras' best interests. In the recent Libra auction the consortium of Petrobras, Total (TTE -0.44%), and Royal Dutch Shell (RDS.A), CNPC and CNOOC agreed to terms whereby the government will receive 41.65% of all profit-oil.
Limited profits
With the Brazilian government requiring a $6.9 billion bonus from the consortium, Libra's overall return on investment is estimated to be 9% to 15%. This is very small considering that under a traditional bid the field would have had an ROI around 23%. With hefty government bonuses there is little room for error. Temporary production setbacks could seriously decrease the field's economics.
Investors in Petrobras should not be especially surprised. The company's overall ROI is just 4.9%. Government-controlled refined product prices have kept the firm's downstream operations posting losses while its upstream production has fallen from 2,110 thousand barrels of oil per day (mbpd) in January 2012 to 1,979 mbpd in September 2013.
The Petrobras expects its production to grow in Q4 2013 thanks to more drilling, but there are still fundamental problems. The company is majority owned by the Brazilian government, and the government's main responsibility is the development of Brazil and keeping the people happy. Putting a lid on gas prices and forcing losses on Petrobras is a common government policy to achieve increased social stability.
The bulls see Petrobras' growing production and low price to earnings ratio around 8.5, but in the long run corporate governance concerns to point low ROI and low returns.
Look at other oil majors
Total and Shell are partners in the recent Libra auction, and it is best to look at these companies in spite of Brazil. Total has an ROI of 9.6% and Libra's conservatively estimated ROI of 9% is not too attractive. Total is replacing reserves, but it is doing so at a very high price.
There are reasons to buy Total, but it is best to look at its growth prospects outside of Brazil. From its Surmount 2 project in the Canadian oil sands to the Yamal LNG project in Russia, the company hopes to see a big boost to its upstream production by 2020.
Royal Dutch Shell is in a similar position to Total. Libra may actually bring down the company's overall ROI of 10.1%. In 2013 Shell's upstream production has only headed downward. It needs to replace falling production even it means lower returns and less cash flow. In the next year the company may put $15 billion in assets up for sale to try and to help offset high capital expenditures.
While Shell and Total have similar ROI's and profit margins, Total's smaller upstream production gives the company more leeway to grow production and revenue. If you are looking for growth and are dying to have some exposure to Brazil, Total looks like the better option.
The other side of the coin
ExxonMobil (XOM -0.57%) is a big oil producer and it gobbles billions of dollars to find more reserves, but it has a more tempered approach in Brazil. In 2012 it decided to leave its claims in the Santos Basin. ExxonMobil had even found oil in two of the three wells it drilled, but it decided that the economics were just too unattractive. The company recently acquired two blocks in Brazil, but if the blocks prove to have low profitability it will probably dump these as well.
ExxonMobil has an ROI of 19.9%. Buying into Libra with an estimated ROI between 9% and 15% would have been a big step down. Instead, it is ramping up production in America's Permian Basin and the Canadian Kearl expansion project. The falling WTI-Brent spread has taken a big hit to ExxonMobil's downstream earnings, but the company is working to profitability expand upstream production.
Final thoughts
New oil fields are being brought online in Brazil and it is better to stick with foreign firms like Total or ExxonMobil rather than Petrobras. Thanks to Brasilia's majority ownership in Petrobras, the company's bottom line can easily be forgotten in the name of public fuel subsidies and bigger government payouts.
