Petroleo Brasileiro SA (NYSE: PBR) has uncovered what has been called one of the biggest oil fields in the world, but the retreat in oil prices has led to a sharp drop in the firm’s market valuation. The drop can be attributed to the fact that the majority of this oil is very expensive to get out of the ground and the company’s project assumptions of $40 a barrel oil is at risk of breaking. The big question is: How far will oil drop and will it stay low?
Oil prices hitting $147 were a clear sign of a bubble, but many are saying that $40 a barrel may be too low. So, where is the actual market equilibrium for crude oil prices? The question is difficult to answer due to the nature of the oil market - the supply side is tightly controlled and the demand side is difficult to predict. However, we know that an improvement in the economies of the world would increase the appetite for oil once more and spur prices higher.
So, assuming the current economic crisis doesn’t last forever, oil prices should eventually move higher. The big question is when this will happen. The United States is the largest consumer of oil and the current recession is expected to last for awhile. However, a rebound in oil prices only relies on an increase in spending, which some economists are expecting to see as early as the second half of 2009. So, if oil begins to turn around companies like Petrobras could prove to be quite the bargain.
Petrobras currently trades at just over 4x earnings despite holding rights to one of the largest oil reserves in the world. Its recent discoveries off the coast of Rio de Janeiro have been estimated to contain billions of barrels of high quality light crude oil. The company just recently began commercial production of Brazil’s first subsalt oil a few months ago by linking a subsalt well to an existing production platform that was lifting heavy oil from shallower depths.
Investors confident in oil’s eventual recovery and Petrobras’ impressive line-up of projects over the long-term should consider investing in long-term or LEAPS options. These let investors place bets without committing as much capital up-front, which helps multiply gains when a recovery takes place. Currently, the January 2011 $25 LEAPS are trading at just $5.00 a piece. This means that investors can obtain the rights to 100 shares of Petrobras at $25 per share anytime during the next 791 days for just $500 down!
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