Record 2Q Earnings Could Be Hard Act for Petrobras to Follow

SAO PAULO (Dow Jones Newswires), August 14, 2008

Record second quarter profit could prove a hard act to follow for Brazilian energy giant Petrobras (PBR) in the face of falling international oil prices and stubborn domestic inflation.

"We continue to believe that Petrobras is today more of a call on oil than anything else," said analysts at UBS bank in a research note. "And oil remains a tough customer."

Monday, Petrobras posted record quarterly profits of 8.78 billion Brazilian reals ($5.42 billion) on record revenues of BRL54.57 billion. The company, known formally as Petroleo Brasileiro SA, was favored by high international oil prices during the second quarter and a May 2 domestic price hike for oil products granted by Brazil's government.

Scenarios for the second half may not be as bright.

"One risk that threatens Petrobras' positive scenario is the possibility of changes in the regulatory environment," said analysts at Sao Paulo's Ativa brokerage in a research note. "This has generated a great deal of speculation for the company."

At issue is development of potentially huge reserves off Brazil's southeastern coast. The administration of Brazilian President Luiz Inacio Lula da Silva has given indications it will create a 100% government-owned special purpose company for the region. Although Petrobras would still have a key role in developing the reserves, most likely as a contractor, profits would belong to the new corporation.

In order to create such a company, Brazil would have to alter its 1990s Petroleum Law, which would open a broad congressional debate on all aspects of oil regulation. This alone has generated uncertainties about future Petrobras strategy and operations.

Petrobras also faces a number of other second half risks, according to analysts. These include volatile international oil prices, rising costs and the idea that Brazil's government is unlikely to grant another domestic price hike at a time of rising inflation.

International oil prices, for example, have fallen some 22% in the last month alone, hovering at about $115 per barrel.

Brazilian inflation, meanwhile, is running at 6.37%, up from 4.46% in the 2007 calendar year. President Lula has announced a "concentrated effort" to pull down the inflation rate. That effort, plus municipal elections in October, make retail fuel price hikes unlikely, according to analysts.

Meanwhile, Petrobras suffers from another problem hitting oil companies worldwide. "Lifting costs (for Petrobras) rose 14% year-on-year in the second quarter to $9.88 per barrel," noted analysts at Sao Paulo's Brascan brokerage in a research note. "This was even higher than the average 9% rise in lifting costs internationally."

Lifting cost is the amount of money a company pays to pump a barrel of crude oil from its reserves. The world's thirst for oil has brought heavy demand, and rising prices, for oil equipment and petroleum engineers. There is little prospect for an easing of lifting costs in the near future, according to analysts.

However, while Petrobras may face some cost and revenue issues in the months ahead, prospects are good for its share price. Petrobras shares took a beating in recent months because of increased risk aversion among foreign investors.

As of the close Wednesday, Petrobras shares had shed 23% of their value so far in 2008. The shares closed at BRL33.85.

Wrote UBS analysts, "We see current valuations as very appealing." Following the second quarter earnings release, UBS reiterated its buy recommendation for the company, with a target price for the share of BRL65.80.

Petrobras sold at a price-to-earnings ratio of 11 times at the end of 2007. UBS is forecasting a ratio of 8.5 times by the end of 2008. 

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