In February this year, Brazilian oil production fell to two
million barrels per day--that is 8.5% down year-on-year and 26%
down from the 2010 peak of 2.7 million. Over the same period, one
of the country's major independent explorers, OGX Petroleo e Gas
Participacoes SA (OGXPY), has lost 95% of its market value. The
twin falls from grace are not unrelated and both require the same
solution: outside help.
Much that troubles Brazilian oil--nationalist procurement
regulations and technical challenge--is captured by the OGX saga.
Publicly-listed in 2008, but controlled by billionaire Eike
Batista's EBX Group, the company's share price tumbled from 28
Brazilian reals in 2010 to about 1.5 by April 24, mainly driven by
investor concern that the company cannot meet its commitments.
Financial problems at OGX are immediate: the result of a culture
of over-promising and under-delivering. Past analyses of the
company's prospects were based on its own data, which proved
optimistic. Independent audits have given analysts more
clarity.
Interest expenses are expected to reach $360 million this year,
according to Factset consensus, while capital expenditure is
forecast to be $1.25 billion. That is uncomfortably close to the
company's $1.7 billion cash balance and leaves zero room for the
operational flexibility OGX so obviously needs.
The situation is also a headache for Mr. Batista, given that OGX
has the option to require him to purchase $1 billion of stock at
BRL6.30 ($3.14) per share. Batista's cash will help, and as the
ultimate owner he should be paying for OGX's folly, but it is his
leadership that has led OGX to its current situation. From a value
perspective, outside investment and expertise would be better.
Beyond Mr. Batista's equity injection, the company should also
bullet-proof its balance sheet by pursuing asset disposals and a
stake sale.
Reports this week suggest Russia's OAO Lukoil (LKOH.RS) is in
negotiations with OGX to take a 40% stake, although Lukoil denies
this. Either way, OGX needs to sell something and if the Russian
major isn't buying a stake, one of its rivals should. Statoil A/S
(STO), for example, is an active acquirer in Brazil, despite
subdued oil and gas deal activity in the country.
Of 20 corporate and asset deals in Brazil in 2012 recorded by
Derrick Petroleum, an oil industry M&A database, 25% of the
"buyers" were actually the Brazilian government re-taking control
of relinquished licenses. There have been no deals this year, but
there will be a license auction in May.
The rationale for an OGX deal, however, is compelling. According
to market consensus, capital spending and interest expenses at OGX
will peak this year, then tail off while revenues begin to multiply
by 2014 as long-delayed projects finally bear fruit. Sales of
around $500 million are expected this year and are forecast to grow
to $4.9 billion through 2017, by which time analysts believe net
income should top $1.5 billion.
That's the future. Right now OGX needs investors--preferably one
large investor--to buy into the story, and those potential
investors hold the best bargaining chips. Last year, robustly high
oil prices would have kept the deal ball firmly in OGX's court--but
a combination of lower oil prices, even lower base-case
assumptions, and service industry cost inflation, means the
valuation will be conservative.
OGX only has 16,800 barrels of (unreliable) daily production, a
lot of undeveloped prospects, net debts of $2.3 billion, and its
market value, which is around $2.4 billion. Major partners looking
to expand in Brazil, meanwhile, have the alternative of bidding for
a baggage-free license from the Brazilian government next month. A
40% stake in OGX might therefore be worth about $1 billion, not
including debt. That is a far cry from OGX's heady days as a $30
billion company. But combined with Batista's money and potentially
armed with proceeds from the potential sale (to Malaysia's Petronas
Bhd.) of a 40% stake in the Tubarao Martelo field that is due to
come on stream at the end of this year, OGX would be sufficiently
capitalized to hit operational targets and even take part in next
month's auction.
Energy discoveries often prompt civic leaders to make
superlative-laden announcements. When Brazil was lauded as the new
Saudi Arabia a few years ago, the superlatives seemed believable.
Yet despite the scale of oil discoveries, things haven't yet turned
out that way. Brazilian politicians and companies aren't yet up to
the job and should work hard to attract outside investment, from
which domestic capability will flow.
(Mike Weir writes for Dow Jones Banking Intelligence on energy,
resources and infrastructure. An established journalist, he studied
history and politics at the University of Strathclyde and economics
at the University of London. His email address is
mike.weir@dowjones.com and he can be reached on +44 207 842
9442)
This article first appeared on DJ Banking Intelligence, our
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