R-Squared Energy Blog

Pure Energy

Brazil Flexing Its Muscles

A couple of years ago I was thinking about the possible fates of various nations in a world in which depleting oil reserves begin to have a very strong impact on oil prices. I had visions of $100+ oil and eventually $5-10 gasoline, which would place a crushing burden on the U.S. economy.

Of course higher prices will motivate people to conserve (and will contribute to recession), and then you may find yourself in a situation in which the supply/demand balance once again tips toward excess supply (as we found ourselves in as oil approached $150/bbl). Prices fall. The economy starts to recover. What happens then? Prices rise, putting the brakes on recovery. This is what I postulated in The Long Recession. Today I saw that someone else had weighed in with the same general thesis:

Oil prices mean perpetual recession

“The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the U.S. went into recession. Right now, 4% of GDP is US$80 a barrel oil. So my current view is that if the oil price exceeds US$80, then expect the U.S. to fall back into recession,” wrote Steven Kopits, managing director for U.K.-based energy-consulting and -research firm Douglas-Westwood LLC in New York.

Long recession, perpetual recession – the idea is the same. If demand starts bumping back up against supply because economies are heating back up, it will be very tough to dig out of a recession for very long for countries that rely heavily on oil imports. Maybe we aren’t there yet. Maybe we have another cycle to go. But I see this as a very plausible scenario.

One country that I have long felt is very well-equipped to thrive as oil prices go higher is Brazil. In fact, as I was preparing to buy Petrobras last year, I debated whether to instead buy into a closed end Brazil fund called iShares MSCI Brazil Index (EWZ). My reasoning was that as oil prices climb, the Brazilian economy stands to benefit in multiple ways.

There is of course the obvious in that Brazil has very large oil reserves relative to their population size, and their oil production is on the rise. It therefore stands to see cash flow into the country increase as they begin to export oil. I would expect to see consumer spending rise, benefiting many sectors in the country. For countries that wish to replace oil with alternative energy, Brazil is a key provider there as well. There is probably nobody better at efficiently producing ethanol from sugarcane. Their location in the tropics also means they have good solar insolation, improving the prospects for solar power (as well as for biomass, since they also get ample rain). All in all, they are abundantly blessed with fossil and renewable energy.

I saw another story today from MarketWatch that emphasized some of these very points and reminded me why I selected Brazil as a country with a bright outlook as oil production worldwide depletes:

Brazil’s JBS shows a nation on the march

SAN FRANCISCO (MarketWatch) — The Brazilians are coming and they are buying, securing a firm foothold in weakened corners of U.S. agriculture. JBS S.A., the world’s biggest beef producer, just added Pilgrim’s Pride to its empire, speeding the Texas-based chicken producer’s exit from bankruptcy with an $800 million cash payment that will give JBS 64% of the company’s new stock.

JBS is not the only Brazilian outfit feeling its protein these days. The country’s economy is on a tear, much of it fueled by resurgent commodities. It posted surprisingly strong 1.9% GDP growth in the second quarter, making it the first Latin-American nation to emerge from the global recession.

Petrobras (PBR), Brazil’s state-controlled oil company, is in the thick of it. Over the past few weeks, it announced several major new deepwater oilfield discoveries, prompting talk that it might swap some of its bulging reserves for up to $25 billion worth of new shares in the company.

The new found oil wealth augments Brazil’s already booming sugar cane-based ethanol exports and vast hydroelectric supplies. Together, they have put the country in the enviable position of becoming a net energy exporter.

The article goes on to say that the Brazilian stock market is up 60% for the year.

So far, my decision to buy PBR over EWZ has proven to be the correct one. In the not quite 10 months since I bought it, the PBR is up 160%. The return from EWZ has been nothing to sneeze at though, up 117% over the exact same time period. This reiterates my belief that Brazil will be a safe haven in an oil-induced financial storm.

September 17, 2009 Posted by | Brazil, Brazilian ethanol, EWZ, investing, investment, PBR, Petrobras, recession, sugarcane ethanol | 14 Comments

Loading Up on PBR

A little over a month ago, as a result of the dramatic fall in the market capitalizations of oil companies, I opened up a brokerage account with Ameritrade to take advantage of the fire sale. Besides my ConocoPhillips (COP) stock, most of my investments are diversified in various mutual funds – often diversified into things I don’t know too much about. As I have said many times before, I am a long-term investor. Short-term volatility doesn’t impact me much; my time horizon when I buy a stock is 5-10 years out. Therefore, I see an opportunity.

Do I think oil prices will be hanging around $40 in 10 years? Absolutely not. I think the OPEC cuts will begin to bite, and they are going to be very slow to increase production again. I also think that non-OPEC production will peak soon, if it hasn’t already (and that is in fact a widely held view; the bigger question is whether worldwide production will peak – and I think it will). Right now the December 2009 WTI contract is trading above $52, so the market is expecting prices to go up from here.

So, if I am correct, and I think oil prices are headed back above $100 in the next few years, what is a long-term investor to do? If you can put up with the risk, you could buy oil futures. But I don’t like that kind of risk. Better I think is investing in energy companies, and oil field services companies. But which ones? If I didn’t already own COP, it would have been a no-brainer. The price to earnings ratio (PE) had fallen to below 4 – the lowest of any major oil company – and the dividend yield was right at 4%. It was being priced like a company in dire financial straights, when it was nothing of the sort. But I already own COP, and I don’t want to concentrate my holdings too much.

The other problem with the U.S. based oil companies is that their access to oil is drying up. So, how about a non-U.S. oil company sitting on a bunch of reserves? Saudi Aramco seems like a no-brainer, but I don’t believe there is any way to invest there. There are companies like Statoil (STO) in Norway, ENI (E) in Italy, and Petrobras (PBR) in Brazil. The one that really intrigues me is Petrobras. They are sitting on large reserves, and have made a number of new discoveries in recent years. Consumption in Brazil is very low relative to the U.S., and the EIA forecasts that they will become a net exporter in 2009. Production has been growing in recent years. Access is not a problem, since they still have room to grow even at home. I have also noted my opinion that in a post-peak world, Brazil is poised to continue to grow their energy production for many years.

I had missed the chance to buy PBR at $15 in November, and by the last week in November the price had bounced back to >$20. But with PBR trading at $21, I went ahead and put in a limit order at $17.50, hoping I hadn’t missed the bottom. On December 4th, that trade executed. The PE then was hovering around 5. (I had almost invested some on margin, but the margin rates were much too high for my liking).

Since then, the stock has risen by as much as 48%, until backing off somewhat last week. As I write this, my shares are up 34% in less than 3 weeks. Despite my long-term view, such a quick run-up has provided a great temptation to go ahead and sell. But short term capital gains are taxed at a much higher rate than are long term capital gains, so I plan to go ahead and hold for at least a year. In the interim, if shares fall again to $15, I will put more money down.

As a footnote, there was an investment that I carefully considered as an alternative: EWZ, which is a closed-end mutual fund that invests in Brazilian companies. The reason I considered this is that if you look at the low consumption in Brazil, combined with their oil reserves, you can make a very strong case that their economy has a lot of room to grow. But one of EWZ’s major holdings was Petrobras, so I figured I would just go directly with PBR, who stand to benefit quite a lot as Brazil’s economy grows.

December 23, 2008 Posted by | ConocoPhillips, COP, EWZ, investing, oil companies, PBR, Petrobras | 22 Comments