An Albatross Around Petrobras' Neck

 | May 15, 2013 | 11:00 AM EDT  | Comments
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The Petrobras (PBR) bond sale was splashy, but an obscure piece of legislation in Brazil's Congress may be even more important to the oil-and-gas company and its investors.

The $11 billion bond sale, the biggest emerging-market debt deal ever, certainly deserved those headlines. Yet, as big as the offer was, it's not the last one we'll see from Petrobras. The company is looking to raise $20 billion from bond sales and bank loans this year as part of its efforts to fund a $237 billion capital-spending plan for 2013 to 2017.

That's what gives the market pause.

Petrobras already carries $74 billion in net debt. That's about 10x the debt load at Exxon Mobil (XOM). You can justify that debt load -- maybe -- by pointing to the company's extraordinary potential. Beginning in 2007, Petrobras has made a series of large discoveries in extreme deep water, pre-salt geologies in the South Atlantic. The first find alone, the Tupi block, might hold 5 billion to 8 billion barrels of reserves. In total, the company's deepwater finds could lead to a tripling of Brazil's total reserves.

But, whatever its potential, Petrobras is just not a very profitable oil company. For the trailing 12 months, the company's return on assets is an abysmal 1.84%. Its return on invested capital is just 1.95%. At Exxon Mobile, those numbers are 13.12% and 27.73%, respectively.

For a company generating those kinds of returns on investment, Petrobras' current debt load seems a very heavy burden -- and it's just the beginning.

It's for that reason that one particular Brazilian Congress bill would be so important to Petrobras and its shareholders. If passed, the bill would rescind the current legal requirement that Petrobras -- which is 54%-owned by the Brazilian government -- take a 30% stake in all new pre-salt finds and that the company must be the operating company in all those areas.

Why is this a problem?

First, it stretches Petrobras even thinner than it already is, and there's some justified worry that the company has too much on its plate as it is. Operating efficiencies in the Campos Basin, for example, fell to 71% in 2011 from 88% in 2008.

Second, it exposes Petrobras to a constant expansion of its capital budget. Any time the government auctions off a block and a foreign oil company makes a bid, Petrobras must sign on as operator and take a 30% stake. If Petrobras thinks the foreign oil company is overbidding for the block, it doesn't matter -- it has to take that 30% stake, even if it has no desire to add another extremely capital-intensive drilling project to its budget, like the very tough and expensive deepwater, pre-salt formations.

No one knows what the bill's exact prospects are. The legislation was introduced by a member of one of the leading parties in the ruling coalition, but in the fractured world of Brazilian politics, that doesn't mean the government necessarily supports the legislation.

But if Petrobras can get this albatross from around its neck, it would go a long way to controlling what has been a black hole of new projects and further debt. Petrobas' American depositary receipt closed at $18.55 Tuesday, and book value is $25.74 -- but if this legislation passes, it could ultimately help the stock close that considerable gap.

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