Brazilian state-run oil company Petrobras (PBR 5.71%) issued $8.5 billion in bonds this week as part of an effort to fund its $220 billion, multi-year offshore drilling expansion plan. Last May, the company sold an additional $11 billion in bonds, then the all-time largest bond sale by an emerging-market company. Petrobras currently is the most indebted publicly traded oil company, with $114 billion in debt.
Concerns for Petrobras investors: debt, inflation politics, and taxes
The Brazilian oil company's high level of debt presents the threat of default. According to Bloomberg two months ago, the creditworthiness of Petrobras was deteriorating, as the cost to protect against non-payment of the company's bonds increased. Petrobras also had to pay more for access to capital in its most recent bond offering than it did in its bond offering last year.
Part of the concern for investors are the Brazilian government's anti-inflation policies, which keep fuel prices in Brazil artificially low (below international market prices). Because Petrobras hasn't been producing enough oil to meet domestic demand, it has been selling gasoline imports below cost. By subsidizing local consumption, Petrobras has not been able to finance its expansion plans without taking on more debt.
Low inflation politics are unlikely to change anytime soon in Brazil. Brazil underwent a period of economic crisis in the 1980s and 1990s when inflation sky-rocketed out of control; today keeping inflation low is a political necessity in Brazil. The government has allowed Petrobras to slowly raise the price of fuel, which was last raised in November, but prices have yet to converge with international markets.
A final concern for investors are the claims filed by federal tax authorities against Petrobras from October to January, stating the company owed more than $3 billion in taxes. According to Petrobras, the chances of losses from the tax dispute are "possible but not probable." For a company with limited financial breathing room, an additional multi-billion dollar liability could threaten its expansion plan.
More attractive: Petrobras bonds or equity?
Analysts have argued that Petrobras bonds present an attractive way to gain exposure to the company -- especially given the high yields of the most recent bond offering -- with less risk. Still, the share price of Petrobras recently hit an eight-year low, which means that increased profitability in the future could yield high returns for shareholders with faith in the company.
Will Petrobras' big bet on pre-salt pay off?
The potential value of an investment in Petrobras will depend, in large part, on its ability to extract the estimated 40-60 billion barrels of oil off the Atlantic coast of Brazil. The so-called "pre-salt" reserve discovered in 2007 reaches almost 500 miles in length, more than 200 miles off the coast of Brazil. The reserves are called "pre-salt" because they are located beneath miles of water, rock, and salt. Petrobras has already invested billions in infrastructure and research and development to be able to extract the reserves.
Increased output and profitability associated with the massive investment it has made are expected in the long-term. The company recently announced that it found oil in two wells in the Santos Basin, which could be commercially viable later this year. However, analysts have cautioned that even if the pre-salt wells start producing this year the gains will only displace losses from natural declines in Petrobras' other oil fields in the near-term.
Petrobras: The Foolish takeaway
With real increases in output from Petrobras' ambitious investments not expected by some until 2017, it may be best for investors to keep an eye on the company, but not commit to a substantial investment in the near-term. If all goes according to plan, Petrobras estimates that by 2020 the company will produce 5.7 million barrels per day, which is 44% more than it produced in 2013. Additionally, the Brazilian government may make domestic fuel subsidy policy changes that could make the company more attractive to investors.
