Oil and Brazil

What lies beneath

Is there really an ocean of oil off Brazil?

JUST how much oil is there off the coast of Brazil? Until recently, Brazil’s oil reserves were thought to be relatively modest: about 12 billion barrels at the beginning of 2007, according to BP, or about 1% of the world’s total. But last year, Petrobras, Brazil’s partly state-owned oil firm, announced the world’s biggest oil discovery since 2000: the Tupi field, which it hopes will produce between 5 billion and 8 billion barrels. Now the head of Brazil’s National Petroleum Agency (ANP) says another nearby discovery might hold as much as 33 billion barrels, which would make it the third-largest field ever found. That alone would be enough to raise Brazil to eighth position in the global oil rankings—and there is talk of further big discoveries. But the peculiar way in which the information came to light is casting doubt on its significance.

The ANP, which regulates the oil industry in Brazil, was quick to distance itself from the remarks of its boss, Haroldo Lima. His comments were of a personal nature, it said, and were based on past reports in the media. It helpfully cited an article from a magazine, World Oil, that had mentioned the magic figure of 33 billion barrels in February. Petrobras and its partners in the field, BG of Britain and Repsol-YPF of Spain, said that they had not yet done enough tests to determine exactly how much oil it contained.

But no one dismissed the estimate as preposterous. That, plus the fact that a senior official had given any credence to such a dramatic number, caused the share prices of the three firms to jump, despite the fact that Mr Lima claims he does not even know where the stockmarket is, and certainly did not intend to influence it. At one point Repsol’s was up by 14%. The shares of Hess, an American firm which is part of a consortium looking for oil nearby, posted their biggest gain since 1981.

Both Tupi and the field mentioned by Mr Lima, Carioca-Sugar Loaf, lie far below the seabed, beneath a thick layer of salt that is some 800km long and 200km wide. José Sérgio Gabrielli, Petrobras’s boss, has hinted that there are vast reserves of oil to be found in this “pre-salt” formation. At any rate, Petrobras has struck oil every time it has drilled there. It is currently assessing the reserves of yet another nearby discovery, Jupiter, which appears to be very similar in scale to Tupi. The firm’s head of exploration says “there is practically no exploratory risk” in the area. While this does not necessarily transform Brazil into an oil power on a par with Venezuela or Saudi Arabia, as Dilma Rousseff, the chairman of Petrobras’s board and chief of staff to Brazil’s president, has excitedly proclaimed, it suggests that the volumes of oil involved are very big.

Nonetheless, the immediate impact of the “pre-salt” discoveries will be small. It will be several years at least before any of the new oil comes to market. What is more, it will be expensive to produce. The fields are all far out at sea, deep under ground that is itself far below sea level. Simply drilling the first test well at Tupi cost $240m, and costs are likely to rise, thanks to fierce inflation throughout the oil industry. As if to underscore the point, the oil price hit a new record, of $114.41 a barrel, a couple of days after Mr Lima dropped his bombshell.

Even if there is an ocean of oil off Brazil’s coast, it will not necessarily be of much benefit to big oil firms, which have struggled to gain access to promising territory for exploration of late, thanks to growing nationalism in oil-rich countries. Brazil had been a heartening exception. But after Petrobras announced the discovery at Tupi, the ANP cancelled a planned auction of rights to explore for oil in several adjacent areas. Mr Gabrielli, the boss of Petrobras, says that the state’s relatively low share of the revenues from oil production in Brazil should be increased to reflect the decreasing risks and increasing profitability of exploration.

The discoveries do suggest that the gloomiest pundits are wrong to predict that the world will soon run out of oil. It is not that there are still lots of huge oil fields out there: the number of mammoth discoveries is declining, Tupi (and perhaps Carioca-Sugar Loaf and Jupiter) notwithstanding. But the new finds do illustrate how the technology with which oil firms hunt for, extract and process fossil fuels is constantly improving. Petrobras’s recent success is only possible thanks to recent advancements in seismic surveys, drilling, and offshore platforms. Other technological developments are allowing a greater proportion of the oil found around the world to be recovered and are even expanding the definition of oil, as firms conjure liquid fuel from the solid tar-sands of Canada, for example, or from coal and natural gas. Indeed, among the shares that rose in the wake of Mr Lima’s comments were those of the firms that supply Petrobras with all its clever kit.

Democrats Pushing Obama, Clinton Toward Populism, Protectionism

April 17 (Bloomberg) -- Protectionist and populist sentiments run strong among Democrats in three states holding presidential primaries, showing why the campaigns of candidates Hillary Clinton and Barack Obama are moving in those directions.

A plurality of Democratic primary voters in Pennsylvania, Indiana and North Carolina blames predatory lenders and mortgage- company greed for the housing crisis that may be dragging the U.S. economy into a recession. A majority in each state favors a government bailout of homeowners in danger of foreclosure, according to a Bloomberg/Los Angeles Times poll of likely Democratic voters.

Most Democratic voters in the three states also believe free trade has hurt the economy and favor tougher regulation of Wall Street.

``We've got more stuff coming in from other countries than we've got going out,'' says Louis Bixler, 63, a Logansport, Indiana, Democrat, in a follow-up interview. The retired factory worker blames the loss of trade-related jobs for economic problems including the housing crisis. ``Let's get back to, `Made in the U.S.A.','' he says.

Obama and Clinton, who are competing for the combined 406 delegates in the three states, have bashed free trade, promising to slow new agreements, renegotiate existing ones and punish China, with which the U.S. had a record $256 billion trade deficit last year.

The two candidates also advocate greater supervision of financial markets and have devised plans to assist homeowners in danger of default. Clinton, 60, has called for a moratorium on foreclosures and a five-year freeze on subprime interest rates.

`Failure of Oversight'

``There has been a regular failure of oversight'' of the financial industry, she said on March 18.

``Our free market was never meant to be a free license to take whatever you can get, however you can get it,'' Obama, 46, said in a March 27 address.

The poll of 687 Democratic primary voters in Indiana, 623 in Pennsylvania and 691 in North Carolina was conducted April 10-13, and has a margin of sampling error of plus or minus 4 percentage points. The Pennsylvania primary is April 22; the contests in North Carolina and Indiana take place May 6.

After mortgage lenders, voters in the three states faulted insufficient government regulation, as well as irresponsible borrowers, for the housing crisis.

Blaming the Lenders

``Lenders were looking for ways to make a buck in an era when many Americans were eager to grab a piece of the American dream,'' says Jennifer Simmons, a poll respondent from Raleigh, North Carolina. Asked if she thinks homeowners should be bailed out by the federal government, the 31-year-old lawyer says, ``Yes, I do.''

Democrats in all three states had a negative view of trade, with 58 percent in Indiana, 55 percent in Pennsylvania and 61 percent in North Carolina saying it has hurt the economy. At least three in 10 in each state say it hurt a lot.

In an economic speech this week, Republican candidate John McCain also sounded populist, criticizing business executives for ``extravagant salaries'' and bankers for bad decisions that contributed to the economic slowdown.

Still, McCain called free trade ``indispensable to our future prosperity'' and chided the Democrats for preaching ``economic isolationism.''

Respondents in all three states say, by margins of 2 to 1 or better, that the federal government should regulate the financial industry more aggressively. Sixty-four percent of North Carolina Democrats and 62 percent of those in Pennsylvania support a federal bailout of homeowners caught between rising mortgage payments and falling home values. Slightly more than half of those in Indiana agree.

Freeze Rates

``I don't feel that the government should bail homeowners out, but I do feel that lenders should freeze escalating interest rates, and the government should require them to do it,'' says Renee Webb, a Democrat in Fort Washington, Pennsylvania. Webb, 57, a rental property owner, says banks need more regulation because ``what's happening on Wall Street is infecting the rest of the economy.''

More than six in 10 Democratic voters in each state call their personal finances secure, though at least eight in 10 say the economy is in a recession.

A slight majority of respondents in Indiana and North Carolina say it's easy for them to pay their monthly mortgage or rent, with about a quarter saying they're having difficulty.

Paying the Bills

In Pennsylvania, four in 10 say they're having no trouble making payments and 35 percent say they are. Almost one in 10 voters in each state say paying bills is ``very difficult.''

Similarly, 55 percent of Indiana respondents and 61 percent in North Carolina say paying other monthly bills is easy, while half of Pennsylvania respondents agree. A majority of those in each state say they're not concerned about losing their jobs.

None of the states had an unemployment rate significantly different from the national average of 4.8 percent in February, according to the Labor Department. However, both North Carolina and Pennsylvania saw a jump in jobless rates over the last 12 months.

Poll respondents in all three states were split over whether the government did the right thing by helping Bear Stearns Cos. avoid bankruptcy.

Leading Economic Indicators in U.S. Rose in March (Update2)

April 17 (Bloomberg) -- The index of leading U.S. economic indicators rose in March for the first time in six months as cash poured into the banking system and the Federal Reserve lowered the benchmark interest rate.

The Conference Board's gauge increased 0.1 percent, as forecast, after falling 0.3 percent in February, the New York- based private research group said today. The measure points to the direction of the economy over the next three to six months.

The improvement is a tentative signal that the economy, after deteriorating in the first six months of 2008, may not weaken further in the second half of the year. The report indicates the Fed's rate reductions and efforts to ease the credit crisis may help mitigate the damage from the slump in subprime lending.

``We are flat to negative in the first half and we expect some of these elements of policy to kick in the second half and start to see some improvement,'' said Peter Kretzmer, a senior economist at Bank of America Corp. in New York. ``But the uncertainties surrounding that forecast are certainly increasing.''

A report from the Philadelphia Fed, issued at the same time, showed manufacturing unexpectedly contracted at a faster pace in that region as measures of new orders and shipments dropped.

Economists Forecast

Economists forecast the leading index would rise 0.1 percent, after a previously reported 0.3 percent decline in February, according to the median of 55 projections in a Bloomberg News survey. Estimates ranged from a decline of 0.3 percent to a 0.4 percent gain.

The increase in last month's index brings the decline for the last six months to a 3.3 percent annual pace. A drop of 4.5 percent or more over six months usually correlates with a recession, according to economists at the Conference Board.

``While latest data do not support the assertion that we are in a recession, growth remains weak, a situation that may continue,'' Ken Goldstein, a Conference Board economist, said in a statement.

Five of the 10 indicators in today's report contributed to the gain in the index, led by a jump in the money supply. Slower supplier deliveries, which indicate an increase in orders, and a steeper yield curve were also positive.

Credit Markets

As credit markets seized up, the Fed on March 16 gave all primary dealers in U.S. government bonds the same access to loans formerly reserved only for banks. The central bank now auctions as much as $100 billion in funds a month, making it easier to liquidate some hard-to-sell assets.

The yield curve, or the differential between the Fed's benchmark rate and the yield on the Treasury's 10-year note, also widened last month. The central bank dropped its target rate by three-quarters of a point to 2.25 percent on March 18, leading to a steeper curve.

The yield differential turned positive for the first time in February after 19 months of negative readings that subtracted from the leading index. The Fed has cut its benchmark rate by 3 percentage points since September, with two-thirds of reduction coming in the first three months of this year.

A report earlier this week indicated factory sales are improving this month, in contrast to today's Philadelphia report. The Fed Bank of New York said April 15 that its shipments index rose to 17.5, from minus 5.2 in March.

Recession Forecasts

The economy probably is in a recession, according to James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut.

Economists surveyed by Bloomberg News earlier this month projected growth in the first half of the year will come to a halt. A majority of those polled forecast the U.S. is, or will soon be, in a recession.

The Fed yesterday said economic growth slowed in nine of 12 districts since February, hurt by ``anemic'' real estate markets and a slowdown in consumer spending, according to its regional business survey known as the Beige Book.

Earlier today, the Labor Department said more Americans filed first-time jobless claims last week and the total number receiving benefits rose to the highest level in almost four years, a sign the labor market continues to weaken. The number of initial applications rose 17,000 to 372,000.

Claims were the biggest drag on the leading economic indicators index last month. They averaged 375,900 in March and subtracted 0.25 percentage point from today's gauge.

Negative Influences

Other components that subtracted from the leading measure included decline in consumer expectations, stocks and building permits.

J.C. Penney Co. Chief Executive Myron Ullman said yesterday that the company will moderate its growth plans in the next year to cope with a ``consumer environment that's very hard to predict.''

The Conference Board's coincident index, which looks at real incomes, employment, industrial production and business sales, rose 0.1 percent in March. The gauge declined in two of the prior four months. The measures are among those tracked by the National Bureau of Economic Research in determining whether a recession has begun.

PMorgan Raises $6 Billion in Hybrid Securities Sale (Update3)

April 17 (Bloomberg) -- JPMorgan Chase & Co. raised $6 billion of hybrid bonds in the bank's biggest sale of the securities, after reporting a 50 percent drop in first-quarter profit.

JPMorgan is paying annual interest of 7.9 percent, or 4.19 percentage points more than U.S. Treasuries, for 10 years on the perpetual preferred shares it sold yesterday, according to data compiled by Bloomberg. After that, the securities, which combine elements of equity and debt, will pay a floating rate of interest.

The offering by the third-biggest U.S. bank comes a month after it agreed to buy Bear Stearns Cos., keeping the investment bank from going bankrupt. Even though JPMorgan's profit declined, the bank's capital ratios remain higher than some of its competitors.

``We'll see more of these transactions and we'll see more mergers and acquisitions, which is what JPMorgan is positioning for,'' said Antony Gifford, a fund manager who oversees $4 billion in North American equities at Henderson Global Investors in London. He doesn't own JPMorgan stock.

JPMorgan has posted about $10 billion of writedowns and losses since the beginning of last year, reducing the Tier 1 capital ratio that regulators monitor to assess a bank's ability to absorb loan losses to 8.3 percent from 8.4 percent. That compares with 7.5 percent at Wachovia Corp. and 7.1 percent at Citigroup Inc. as of Dec. 31.

Capital Reserves

Hybrid securities count toward capital reserves, helping banks shore up their finances after writedowns. They typically allow issuers to defer interest payments without defaulting, and credit-rating companies usually consider the bulk of the money raised as equity, meaning only a portion is counted as debt on an issuer's balance sheet.

Lehman Brothers Holdings Inc., the fourth-largest securities firm, sold $4 billion of preferred shares on April 1 that pay annual interest at 7.25 percent and are convertible to stock. JPMorgan's securities aren't convertible.

At 7.9 percent, JPMorgan is paying less than New York-based Citigroup and Charlotte, North Carolina-based Bank of America Corp. for its hybrid debt.

Citigroup, which has reported subprime losses of $24 billion and raised more than $30 billion in capital since November, is paying 8.13 percent for preferred stock it sold in January. Bank of America, the second-largest U.S. bank behind Citigroup, is paying 8 percent on perpetual preferred shares sold the same month.

Joseph Evangelisti, spokesman for JPMorgan, declined to comment.

Fixed to Floating

JPMorgan's securities have no fixed maturity. If the bank decides not to call the debt after 10 years, the interest payments will switch to a floating rate at 347 basis points more than the three-month London interbank offered rate, a borrowing benchmark that's currently 2.82 percent.

The securities are expected to be rated A1, the fifth level of investment grade, by Moody's Investors Service, and a step lower at A by Standard & Poor's, according to Bloomberg data. The ratings are each two steps lower than the grades of the holding company.

JPMorgan, which got financial support from the Federal Reserve for its takeover of New York-based Bear Stearns, raised its offer price last month to $10 a share from $2 a share initially.

``You've got a string of consolidation going on and banks have to meet the additional capital the acquisitions require,'' said Tobias Grun, who helps manage $28 billion of debt as a credit analyst at Gartmore Investment Management Plc in London.

Merrill Posts Loss on Mortgage Writedowns, Cuts Jobs (Update6)

April 17 (Bloomberg) -- Merrill Lynch & Co. posted its third straight quarterly loss and said it will cut about 3,000 more jobs after the credit seizure forced the investment bank to write down at least $6.5 billion of debt.

The first-quarter net loss of $1.96 billion, or $2.19 a share, compared with earnings of $2.16 billion, or $2.26, a year earlier, the third-biggest U.S. securities firm by market value said today in a statement. Analysts had predicted a loss of $1.72 billion, based on estimates compiled by Bloomberg. Merrill rose in New York trading.

Chief Executive Officer John Thain said today he expects ``more difficult'' months ahead. Since taking the job in December, he has sold more than $12 billion of equity to bolster capital and overhauled risk-management after the company booked more than $20 billion of credit-market losses. Merrill's stock has fallen 50 percent in the past 12 months, trailing larger New York-based rivals Goldman Sachs Group Inc. and Morgan Stanley.

``The current environment is still tough,'' said Rose Grant, managing director in the investment-advisory division of Boston-based Eastern Bank Corp., which owns about 66,000 Merrill shares. ``People are still reluctant to buy certain types of assets, and I don't think we'll see the end of that until later this year.''

Merrill gained 87 cents, or 2 percent, to $45.76 at 10:19 a.m. in New York Stock Exchange composite trading, after falling as low as $43.23 earlier today.

`Deteriorating Conditions'

The first-quarter writedowns included $2.6 billion to account for the plummeting value of mortgage-related bonds including collateralized debt obligations. Merrill also reduced the value of bond insurance contracts by $3 billion, and lowered the value of leveraged loans by $925 million.

The markdowns reflected in Merrill's net loss exclude a $3.1 billion drop in the value of securities held in the firm's U.S. banks. Those declines were classified as ``other comprehensive income,'' an accounting category for securities that Merrill expects to keep until they pay off at maturity.

Moody's Investors Service today said it may cut Merrill's credit rating for the second time in six months, citing ``deteriorating conditions in the mortgage market'' and the potential for $6 billion of writedowns in addition to those announced in the past three quarters. Last October, Merrill's rating was lowered one level to A1, the fifth-highest of 10 investment-grade ratings.

Revenue Declines

Merrill's credit-default swaps have climbed to 172 basis points from 131 basis points at the end of November, according to prices from Phoenix Partners Group and CMA Datavision. At the current price, the swaps are trading as if the firm had a Moody's credit ranking of Baa3, the lowest investment-grade rating, according to the ratings firm's credit strategy group.

Credit-default swaps, contracts to protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements.

Merrill's total revenue fell 69 percent to $2.9 billion in the first three months of 2008 from a year earlier. That included a 40 percent drop in investment-banking fees. The company's brokerage, the world's biggest with a network of 16,660 financial advisers, was the only major division to post a gain. Revenue in the unit increased 7 percent to $3.3 billion.

Fixed-income trading revenue was negative $3.38 billion and equity-trading revenue was $1.88 billion, down from $2.39 billion a year earlier. Debt underwriting generated $231 million in revenue, down 61 percent, while stock underwriting revenue dropped 45 percent to $199 million.

Investor Demands

``Merrill Lynch has to show profitability,'' said Ken Crawford, senior portfolio manager at Argent Capital Management in St. Louis, which owns about 160,000 Merrill shares. ``They can't have negative return-on-equity quarters and expect to make investors happy.''

Merrill's first-quarter loss contrasts with earnings at Goldman, Morgan Stanley and Lehman Brothers Holdings Inc. Even Bear Stearns Cos. eked out a profit of $115 million. A cash shortage forced Bear Stearns to sell itself last month to JPMorgan Chase & Co. for $10 a share. Bear Stearns traded at $158 as recently as last April.

The investment-banking business is grappling with a plunge in fees from advising companies on mergers and stock and bond sales, as CEOs and corporate treasurers hunker down for a recession. Thain also has had to weather the departures of more than a dozen senior executives and traders.

The job cuts announced today are in addition to about 1,000 previously announced. The company eliminated about 650 positions at its San Jose, California-based subprime mortgage lender, First Franklin, and shed others by selling Merrill Lynch Capital, a lender to medium-size companies.

O'Neal's Legacy

Merrill will record a $350 million charge in the second quarter related to the reductions, which will save an estimated $800 million a year, the firm said.

``I don't think anybody would tell you that we'll see earnings and returns from the brokers that will match those of 2006 for years to come,'' said Thomas Jalics, an analyst at National City Bank in Cleveland who helps manage $34 billion.

Under former CEO Stan O'Neal, Merrill paid $1.3 billion for First Franklin in late 2006, just as the U.S. housing market peaked. First Franklin's workforce has been cut to 80 from 2,300.

Thain, 52, said at an April 10 press conference in Beijing that Merrill was ``well positioned in a difficult market.'' The company's stock has fallen 28 percent since Thain became CEO Dec. 1, and yields on its bonds have widened to 3 percentage points over market benchmarks from 2.1 percentage points.

`Very Deliberate'

He joined Merrill from NYSE Euronext, where he was CEO since 2004. Before that, he worked for 25 years at Goldman Sachs. In January, Thain said he wanted to liquidate the firm's CDOs, possibly by selling them to hedge funds and other investors that are pooling money to buy securities at distressed prices. Thain also has said he plans to shut down the structured-finance division that created the CDOs.

At the Beijing press conference, Thain said he used his first two months to shore up Merrill's capital and funding. ``In the last two months, I've been more focused on strategy, getting to know people in various parts of the world,'' he said.

``Thain is a very deliberate thinker,'' said William Fitzpatrick, a bank analyst at Optique Capital Management in Racine, Wisconsin, which oversees $1.7 billion and does not own Merrill shares. ``It doesn't surprise me he's taking his time to get his arms around what exactly he wants to do.''

Merrill owns 49.8 percent of BlackRock Inc., the biggest publicly traded U.S. fund company, whose stock has climbed 25 percent this year. Thain has called BlackRock a ``core strategic asset.'' He also has said he has no plans to sell the firm's passive 20 percent stake in Bloomberg LP, the parent of Bloomberg News.