Problematic Petrobras Plaguing Brazil ETFs
In all the hullabaloo that punctuated last week's market action, somewhat unnoticed was the fact that Petrobras (NYSE: PBR), Brazil's state-run oil company, delayed its first-quarter earnings report. The report, which was originally scheduled for Friday May 11, is now expected out on Tuesday May 15.
Petrobras said an unidentified scheduling conflict caused the change. Taking the company at its word, maybe this is no big deal. What is a big deal is the seemingly never-ending decline in the shares and the impact that has on numerous Brazil and Latin America ETFs.
Simply put, over the past two years, Petrobras is the worst-performing major oil stock in the world despite most global investors now knowing that Brazil's pre-salt oil fields could, by some estimates, yield 50 billion barrels of oil in the coming years.
Putting Petrobras' glum two-year run into context, the stock has lost more than 55% since the days following the Gulf of Mexico oil spill in April 2010. BP (NYSE: BP), public enemy number one in the largest spill in U.S. history, is down "just" 32% in that time.
The woes of Petrobras have been compounded today as the stock has touched a new 52-week low. When the U.S.-traded shares peaked below $20 earlier today, that was the first time the stock had been below that psychologically important level since late 2008 and the stock's woes are part of the reason why the iShares MSCI Brazil Index Fund (NYSE: EWZ) has had its own troubles lately.
As Benzinga reported last week, as the third-largest emerging markets ETF overall and the largest-country specific fund (excluding funds tracking the S&P 500) at the end of April. When that story was published, EWZ had about $8 billion in assets under management compared to $13.2 billion at the end of April 2011. Today, the ETF is below the $8 billion AUM mark.
Another reason EWZ and Petrobras have turned into risky bets is Brazil's nationalist tendencies when it comes to its oil riches. Recent legal moves against Chevron (NYSE: CVX) and Transocean (NYSE: RIG) may give Western oil companies pause about doing business in Brazil. Even if the absurd lawsuits levied against Chevron and Transocean by Brazilian authorities related to the companies' roles in a November 2011 spill off Brazil's coastline don't dissuade Western oil firms from doing business there, these companies now face heightened political risk in Latin America's largest economy.
Political risk is already something Western oil companies must contend with South America. Argentina recently sounded that message loud and clear.
Now, some governments in South America are using more subtle tactics to keep a larger slice of their oil revenue, which could lead to problems for Western majors looking to do business in the region.
"It is this change in tactics that I believe has been misunderstood by foreign energy companies operating in the region, and is seen as a distinct but refined elevation in the degree of country risk facing foreign investors," independent analyst Caiman Valores recently wrote.
In a an interview with Benzinga, Colombia-based Valores said "I believe that the degree of risk in Brazil for foreign investors is far higher than many believe and that under the current government it is increasing."
While Valores was somewhat bullish on Vale (NYSE: VALE), the world's largest iron ore producer and another 11.5% of EWZ's weight, he acknowledged that stock could be adversely impacted by a slowing Chinese economy. He was also modestly bullish on Banco Santander Brazil (NYSE: BSBR), which accounts for 1.3% of EWZ's weight.
"For Brazil I would recommend a risk premium of around 6% to 8% on top of the risk free rate of return and the generally accepted equity risk premium of 4% to 6%," Valores said.
Unfortunately for Brazil bulls, neither EWZ nor Petrobras seem capable of generating positive returns let alone accompanying risk premium at the moment.
Valore likes Ecopetrol (NYSE: EC), Colombia's state-controlled oil giant, citing the company's rising earnings, improved infrastructure and recently lifted production outlook. The shares have almost 40% since we recommend the stock in late 2011.
Ecopetrol is the largest holding in the Global X FTSE Colombia 20 ETF (NYSE: GXG) and that is certainly one reason why GXG is one of the best Latin America ETFs year-to-date while Petrobras explains why EWZ is one of the worst.
Other ETFs with large weights to Petrobras to be aware: iShares MSCI Emerging Markets Latin America Index Fund (NYSE: EEML), the iShares S&P Latin America 40 Index Fund (NYSE: ILF), the SPDR S&P Emerging Latin America ETF (NYSE: GML) and the Guggenheim BRIC ETF (NYSE: EEB).
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