Brazil - An Exercise in the Preposterous?

The past two weeks have been extremely frustrating. I made a commitment to do a definitive article on oil & gas valuation for Seeking Alpha and some heavy hitters in Houston.

Whether it's a single prospect, or a portfolio, or the producing assets of a listed company, oil & gas valuation is highly complex and often contentious.

This is especially true of large companies. For the past 18 months I've had a "sell" rating on Petrobras (PBR). For a while I looked like a genius, because I told clients to sell at $72 and the market agreed with me. Petrobras is now trading in the mid-40's.

I never had a price target on PBR. I do valuations.

Investors and stock analysts typically look at financial trends. If energy lags the S&P 500, then other sectors like tech and Fast Moving Consumer Goods attract buyers. If there's momentum in a particular stock, its market value can skyrocket.

Nowhere is stock speculation more intense and volatile than penny stock shares of oil & gas minnows who claim to have a big new discovery, or a permit to drill in a hot location, or private equity and a flamboyant CEO.

The incentive to exaggerate upside potential and deceive investors is huge. No one gets rich quick by telling the whole truth and nothing but the truth.

What they're after is capital, no holds barred. If they get it, anything is possible. Without it, there's no drilling, no FPSO, no private jet, no sports car, no cozy little chateau with servants.

I'm thinking in particular of a start-up that had a permit and a discovery funded by small investors. They sold the project to a Chinese major and pocketed millions, while cleverly remaining in charge of the project. Less than a year later it was obvious that the "discovery" was worthless, couldn't be developed or produced as advertised. The Chinese joint venture partner blew $1 billion in cash and walked away empty-handed.

Was it fraud or incompetence or both?

Doesn't matter. Oil projects and exploration companies sprout like daisies in the sunshine of high oil prices. That's why start-ups, mergers, farm-ins, farm-outs, and licensing new exploration blocks are an almost deafening cacophony of news chatter this year and last year and the year before.

We don't work for minnows. We don't audit them either. Plenty of other consultants exist to certify their phony 2P reserves and "unrisked resources."

It used to bother me a lot that consulting geologists and engineers took a fat fee to rubber-stamp whatever their client wanted to exaggerate or pretend about a doubtful oil project.

But that's not what bothers me most. It doesn't matter who the crooks are. Investors don't really give a damn, as long as they can buy a stock cheap and sell to a "greater fool" before the bubble pops. In a bull market, fundamental valuation is irrelevant. Momentum and gossip are operative, however short-lived a blue sky project proves to be.

What bothers me most nowadays isn't the screwy minnows. It's the alacrity with which everyone seems to have accepted and repeated the Brazilian "pre-salt" super elephant story, because so many international oil companies, investors, and shipbuilders are in it up to their necks.

For instance, Anadarko just announced a good drill stem test. BG Group is promising their shareholders a 3 billion barrel windfall that they expect as their share of Tupi in partnership with Petrobras. The lame duck Lula Government is working overtime to rewrite petroleum laws to bankroll the largest, most complex deepwater subsea completion program ever attempted.

All of it, every bit of it, is based on wishful thinking.

For example, BG's website says that over 3.5 million barrels were produced from Petrobras' Tupi Extended Well Test during the past 12 months. But they neglected to explain it isn't oil.

BG's twisted investor terminology coyly celebrated "3.5 million barrels boe gross" - an undefined soup of sour gas, formation water, CO2, wax, tar, acid, and medium heavy oil apparently pumped from Tupi at an implausibly high rate in December and January, because BG previously announced a more reasonable 1.0 million barrels from Tupi on October 28, 2009.

Think about it. It took Petrobras seven months to produce the first 1 million boe, then only 120 days to lift 2.5 million barrels more?

Rubbish. I don't believe a word of it. We're being lied to. At least one-third of that 3.5 million barrel "gross" production was foamy water dumped overboard into the South Atlantic and perhaps another third (boe) was poison gas flared into the atmosphere. Less than 1.5 million bbl ferried ashore.

Don't believe me? Ask Petrobras.

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