Petrobras to Snap Up Galp Stake? - Analyst Blog

Brazil's state-run energy giant Petroleo Brasileiro S.A. (PBR), or Petrobras S.A., has confirmed that it is evaluating the purchase of Italian oil major Eni SpA's (E) 33.34% stake in Portugal's Galp Energia. However, the company has not given out any other details rather it added that no binding agreement had yet been reached between the parties. The transaction is estimated to cost approximately €3.5 billion ($4.69 billion) to Petrobras, according to people familiar with the situation.

Galp is already in partnership with the Brazilian group regarding exploration and production in offshore fields, including the Lula and Cernambi pre-salt reservoirs in the country's Santos Basin, which together hold  8.3 billion barrels of recoverable reserves. 

Brazil has huge pre-salt reservoirs (oil deposits located in the sea bed under thick layers of salt) that lie below the Espírito Santo, Campos and Santos basins in deep and ultra-deep water. These reserves, estimated to hold 50 billion barrels, are widely thought to be the most important oil findings in recent years. Petrobras is the operator in most of these exploration areas, and has interests in them within a wide range of 20% to 100%.

The company plans to develop the deep pre-salt layers as part of its strategic initiative to ramp up production from the current 2.5 million barrels of oil equivalent per day (MMBOE/d) to 3.9 MMBOE/d in 2014 and 5.4 MMBOE/d in 2020.

As such, the Galp stake buy, if agreed upon, is likely to expand Petrobras' deepwater exploration capabilities by bringing natural synergies for the firm. Additionally, Petrobras would get access to Galp's refineries, thereby allowing it to process its crude exports in Portugal and sell the gasoline in Europe.

Headquartered in Rio de Janeiro, Petrobras is the largest integrated energy firm in Brazil and the third-biggest oil company in the world by market value behind ExxonMobil (XOM) and PetroChina Co. Ltd (PTR). The company's activities include: the exploration, exploitation and production of oil from reservoir wells, shale and other rocks, and in the refining, processing, trade and transport of oil and oil products, natural gas and other fluid hydrocarbons, in addition to other energy-related activities.

Petrobras ADRs currently retain a Zacks #3 Rank, which translates into a short-term 'Hold' rating. We are also maintaining our long-term 'Neutral' recommendation on the stock.

We believe that continued demand growth in Brazil (expected to outperform developed countries in the next few years), together with all the new investments and acquisitions, will fuel Petrobras' medium-term earnings outlook. Additionally, we expect the company to benefit from its expertise in deep-water operations, its recent major discoveries (that could double its resource base) and the growing domestic refined products market.

However, we remain concerned with the significant increase in the level of its downstream investment in the face of a bearish refining margin outlook. Investor skepticism regarding the company's huge investment requirements, as well as the possibility of heightened state interference and earnings dilution following the $70 billion share sale also remain near-term headwinds, in our view.