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By Robert Rapier on Dec 23, 2008 with no responses

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.