Petroleo Brasileiro (NYSE: PBR), or Petrobras, is in a jam.  This huge secondary offering of shares has run into snag after snag.  Brazilian politics is also in the mix.  The deal was first said to be in the range of $50 to $60 billion and we had a late-July or early-August time frame expectation.  Then the deal was cut down to $25 billion and delayed.  We are in August and the deal could still come as soon as September, but now there is talk that the Petrobras offering may not come until after Brazilian elections.  The plot is thickening.

At issue is that Petrobras is effectively under the government and effectively under labor here.  The voting shares from real outside public investors have a very weak hold here.

Reuters quoted two officials in Brazil talking about the delays due to negotiations on financial terms of the oil for stock trade that will be taking place, and it further noted that President Luiz Inacio Lula da Silva is gathering information.

More importantly, yesterday came word out of the company with its daily production reports of 2.581 million barrels of oil equivalents per day that chief regulator is reviewing the government oil swap.

Is it politics or is it a murky share structure?  Either way, there is a real lack of clarity over how this process in determining a fair oil price will be and over what sort of time frame it will occur.  Petrobras will be taking control of 5 billion barrels of oil in the swap, assuming the whole amount is swapped.  Keep in mind that this is not easy to get to.  It is in deep water tracts, and the BP fiasco has definitely given some pause here.  Much of the oil here is down over 6,000 feet underwater.  The Deepwater Horizon was at roughly 5,000 feet per our notes we kept although we would use that as a rough figure.  Either way, we now know that drilling this deep is not without risk.  It is far more costly than drilling on land or in shallow water.  Then there is said to be more than 15,000 feet to get to the oil through sand, rock and salt.

A Brazilian media outlet, the Estado De Sao Paulo newspaper, clouded the issue yesterday with a report that a government audit is valuing the oil at $10.00 to $12.00 per barrel.  We have been reading over and over about a $5.00 to $7.00 value and some are calling for as high as $8.00.

So do some simple math here.  $25 billion is the stock offering as of today.  5 billion barrels.  Assuming all of the oil rights are bought, this should be $5.00 per barrel.  That means that at $7.00 that Petrobras will have to jam down more stock to buyers or it will have to sell debt too.  In short, you either will get dilution upon dilution or you will get added leverage on top of dilution.

The capital structure is listed below from Petrobras as of JULY 31, 2010:

CAPITAL STRUCTURE	Shares	Percent
COMMON SHARES	5,073,347,344	100
Federal Government	2,818,751,784	55.6%
BNDESPar	98,457,000	1.9%
ADR Level 3	1,257,461,868	24.8%
FMP – FGTS Petrobras	172,241,963	3.4%
Foreigners (RES, No 2689 C,M,N)	250,888,214	4.9%
Other entities	475,546,515	9.4%
PREFERRED SHARES	3,700,729,396	100
BNDESPar	574,047,334	15.5%
ADR level 3 and rule 144 -A	1,268,137,718	34.3%
Foreigners (RES, No 2689 C,M,N)	511,130,107	13.8%
Other entities	1,347,141,237	36.4%
TOTAL CAPITAL STOCK	8,774,076,740	100
Federal Government	2,818,751,784	32.1%
BNDESPar	672,504,334	7.7%
ADR (Common)	1,257,461,868	14.3%
ADR (Preferred)	1,268,137,718	14.5%
FMP – FGTS Petrobras	172,241,963	2%
Foreigners (RES, No 2689 C,M,N)	762,018,321	8.7%
Other entities	1,822,960,752	20.7%

And here is a pie chart showing it better for the voting percentages:

The official stance from Petrobras is that it is too soon to talk about the exact terms of the swap agreement.  We are talking about a great nation that is up and coming, but we are also talking about a nation where it has been tricky to operate in the past for many businesses.  Things are great today, but there used to be a saying about Brazil that many can’t get out of their head: Brazil is the most economically promising of all third world countries, and it will always be that way.

Petrobras ADRs are down almost 1% at $34.22 this morning, but shares were at $35.94 on Wednesday and $36.68 on Tuesday.  Its 52-week trading range is $31.21 to $53.46.  This secondary offering represents a giant overhang for Petrobras.  The public minority shareholders effectively have little say here as well.  The company better get this straightened up soon, or else the investing public is going to consider spending their investment dollars on something more transparent.

JON C. OGG

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