Brazil: An Ocean Of Losses - Swimming Naked When The Tide Went Out...
Feb. 10, 2015 6:21 AM ET
Summary
- Corruption destroys the jewel of Brazil.
- Lower oil exposed a catastrophe.
- A real problem for Brazil.
- Petrobras and the price of oil in the future.
Brazil is the number one producer and exporter of cane sugar in the world. The price has moved from north of 36 cents per pound in 2011 to under 15 cents today. During the almost decade-long great commodity bull market that ended in 2011, Brazil did well. Higher prices and increasing investment capital hid underlying issues within the country. Now that the bull has turned bear, the Brazilian economy is suffering. Add to that the fact that Sao Paulo, the capital, is running out of water due to the biggest drought in decades, and that the real has dropped the most among major currencies in the past six months. This past week, a scandal of epic proportions is rocking the former star of BRIC nations. The scandal hits right at the heart, the epicenter of Brazilian business, growth, politics and economic power.
Corruption destroys the jewel of Brazil
Petrobras, the state-run oil company, was the crown jewel of Brazil as it emerged from the global economic crisis. The company, Petroleo Brasileiro S.A. (NYSE:PBR), operates as an integrated oil and gas company in Brazil, and internationally is engaged in the exploration, development and production of crude oil, natural gas liquids and natural gas for sale in the domestic and international markets. As Petrobras grew, its international segment spanned the globe, with interests in the Americas, Africa, Europe and Asia. As of December 31, 2013, the company had proved and developed oil and gas reserves of more than 7.6 billion barrels of oil equivalent and proved undeveloped reserves of almost 5 billion barrels in Brazil. Measured by 2011 revenues, Petrobras was the largest company in the Southern hemisphere by market capitalization, and the largest in Latin America by revenues. Petrobras was the tenth-largest oil and gas company in the world by revenue. At its peak valuation in 2008, the company had a market capitalization of $310 billion.
Fast-forward to 2015. As the oil price cratered, falling from over $107 per barrel in June 2014 to around the $50 level today, the company has failed to meet growth targets, not just recently but for a number of years. Investors face enormous losses.
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PBR stock has dropped from highs of over $131 per share in 2008 to close Friday, February 6, at $6.54. Its market cap stands at under $43 billion. It seemed odd that Petrobras struggled even before oil prices crashed. Now, a vast corruption scandal at Petrobras provides the aha moment. Payoffs, embezzlement, and corruption has rocked Petrobras, and last week, the CEO and five top managers resigned in disgrace as police probes pick up steam.
Lower oil exposed a catastrophe
Like many corruption cases in the past, it is easy to keep the illegal activity going as long as cash flows into an entity. Consider the case of Bernie Madoff. The 2008 financial meltdown exposed his ponzi scheme when the cash stopped flowing in and investors asked for redemptions. When the financial tide went out, the game was up for Madoff, who admitted to stealing billions in a multi-decade game of fraud and deceit. In the case of Petrobras, lower oil revenues unmasked the years of corruption and payoffs. When oil and gas revenues flowed like water, it was easy to bury the ill-gotten gains for a select few far below the surface. When the gush of earnings turned to a trickle, those improprieties became apparent, destroying the market capitalization of the once-great South American energy giant. For Brazil, the destruction of the company that once stood as the emerging market nations' crown jewel is nothing short of an economic catastrophe.
A real problem for Brazil
The situation at Petrobras comes at a very bad time for the economy of Brazil, the nation's leadership, and citizenry. Lower commodity prices and a long-term drought have weighed heavily on the country recently. Wealth destruction in Brazil's energy industry is nothing new. OGX, Eike Batista's flagship oil-producing company, went bankrupt in 2013. Last week, a judge in Rio seized Batista's assets as part of an insider trading case brought against him.
On the governmental front, the budget gap in Brazil more than doubled from 3.25% of GDP in 2013 to 6.7% in 2014. Last March, S&P cut the country's credit rating to one level above junk, and it is likely that a further downgrade is in the cards. On the political front, the scandal may present special problems for President Dilma Rousseff. Maria das Gracas Foster, the now disgraced and deposed CEO of Petrobras, was a close friend and advisor to the president. For more than a decade, the two have had a relationship, dating back to when Rousseff herself was chairperson of Petrobras.
The citizens of Brazil take great pride in their country, and the scandal at Petrobras has rocked the nation. Protesters have descended on the company's headquarters in downtown Rio de Janeiro on a daily basis. As Carnival approaches, masks of Foster's face have become popular for protestors and partiers alike. While Petrobras continues to produce record amounts of oil and gas, it is difficult to imagine that the company will continue to thrive, given the extent of the scandal. The energy business is capital-intensive. The company is likely to find itself in a tough spot when it comes to raising capital in debt or equity markets anytime soon.
Petrobras and the price of oil in the future
During the great commodity bull market that commenced over a decade ago, Petrobras became a beacon of Brazilian economic strength for the nation with rich natural resource reserves. In the wake of the global economic crisis of 2008, Brazil emerged as an emerging market powerhouse - perhaps the strongest of all the BRIC nations.
A commodity bear market, drought, and now yet another scandal exposing graft and corruption that may reach to the highest levels of business and politics in Brazil has set the country's economy back many years. Petrobras, once seen as one of the strongest energy companies in the world, will find itself a shell of what it once was. The world counted on Petrobras for energy production for years to come. Now, that energy will have to come from elsewhere. Perhaps the only positive in the Petrobras saga is for the price of oil itself. Here is a major producer that will not produce anywhere near the levels expected in the years to come due to a lack of capital.
Commodity prices have moved considerably lower over the past months. Brazil stands to be one of the biggest losers, due to their position in the world as a major producer of many raw materials. The scandal at Petrobras just adds insult to injury for the nation and its people.
When the tide rolled out for commodity prices, Brazilian corruption was exposed. Perhaps the Chinese, the biggest commodity consumers in the world, will step in with a rescue package for Petrobras and its vast portfolio of reserves. The situation presents China with yet another opportunity to buy vast commodity resources for pennies on the dollar. If this comes to pass, it may leave the Brazilians with another couple of corrupt billionaires and the Chinese with perhaps the most important natural resource of Brazil.
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