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James Saft: Petrobras' remarkable 100-year bond

 

 

Sometimes, as with a glorious sunset or a can't-look-away train wreck, the best thing to do is to stand back and bear witness.

Ladies and gentlemen, I give you the Petrobras 100-year bond.

The $2.5 billion bond, issued by subsidiary Petrobras Global Finance, was launched at a yield of 8.45 percent on Monday.

Again, Petrobras is issuing a 100-year bond.

There are three elements in that sentence, let's take them one by one.

PETROBRAS IS A 'COMPLICATED' CREDIT

First, there is Petrobras, the state-controlled oil company in the midst of a corruption scandal and in genuine need of cash.

That Petrobras is state-controlled is both its curse and saving grace. Curse, at least from a creditor's point of view, in that the company is run not to most efficiently extract, refine and market energy, but, as can be seen, as an instrument of other aims. Saving grace, so far as it goes, because Petrobras wouldn't be the credit it is without the implicit and explicit backing of the Brazilian state. For example, pump prices in Brazil are kept above global levels in part to keep cash flowing to Petrobras during its time of need.

That brings us to oil, the stuff Petrobras deals in. Not only can there be no guarantee that the 100-year distant future will feature oil as a sought-after commodity, there isn't even very much notion of what the stuff will be worth in a year's time. After all, a year ago it was worth very much more than it is today.

Before we move on fully to thinking about the idea of a 100-year bond at all, let's return to Petrobras and to the scandal. Petrobras in April took a write-down of about $17 billion to account for over-valued assets and $2 billion of bribes paid as kickbacks to executives and spread among politicians. Scores of Petrobras executives have been arrested and more than 40 leading politicians are under investigation.

The scheme is popularly called Operation Car Wash, or Operação Lava Jato in Portuguese, a term which occurs seven times in the Securities and Exchange Commission registration document for the new bond.

In that same document, Petrobras explains that investors run the risk that Brazil may impose capital controls, as it has in the past, that judgments by courts in Brazil to enforce the guarantee of Petrobras would be paid in reais, rather than in the dollars investors will fork over, and that the company faces threats to its continued ability to access capital markets. Petrobras indeed was effectively cut out of capital markets until its recent write-down.

 

ONE HUNDRED YEARS IS A LONG TIME

At this point I should probably point out that one hundred years ago coal and the horse were the dominant technologies in their respective fields. Mexico, which just issued a bond due in 2115, was in 1915 in the process of defaulting on its debts, a state of affairs which would only be fully cured in the 1940s.

It seems, at least to me, but not to the owners of the $10 billion of pledges to Petrobras' bond, to be very difficult to calculate the risks that might arise over 100 years. New technologies, new governments, laws and ways of doing business all might plausibly makes this a regrettable investment.

Mexico sold a 100-year bond issued in euros in April, one which has since lost considerable value as interest rates fluctuate. Really, judging the risks of a 100-year bond based on a month or two of market fluctuations is probably not fair, though by not fair I mean not nearly harsh enough.

BOND MATH IS SOVEREIGN

The other issue to understand is that Petrobras' 100-year bond is just that, a bond, and hence exposes buyers to very large duration risk. The longer a bond's duration, or ultimate maturity, the more its value will fluctuate as interest rates rise and fall. A bond with two years to run will rise or fall by 2 percent in value for every one percentage point move in rates. A bond with five years left will move by 5 percent in price.

A 100-year bond therefore is extremely sensitive to interest rate moves. Now bond math cuts both ways, but honestly, even at an 8.55 percent current yield the risks in global markets, where the price of money is ultimately set, are anything but one way.

We'll have one hundred years to watch this unfold, but it seems likely to someday seem a relic of a particularly rash market.

 

James Saft, Reuters Columnist. Saft's columns feature twice weekly in the International Herald Tribune and widely elsewhere. Before beginning his column, he directed all global coverage of economics and financial markets for five years at Reuters. His column won a Best in Business award in 2008 from the Society of American Business Editors and Writers. Petroleumworld does not necessarily share these views.

Editor's Note: This commentary was published by Reuters, on May 01, 2015. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft ) (Editing by James Dalgleish ) . Petroleumworld reprint this article in the interest of our readers.

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