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Chevron, Transocean Face Brazil Ire

Zacks Equity Research

Seventeen executives from U.S. energy behemoth Chevron Corp. (CVX) and offshore drilling giant Transocean Ltd. (RIG) have been slapped with ‘environmental crimes’ by federal prosecutors in Brazil for an oil leak 74 miles off the coast of Rio de Janeiro in November.

The Verdict

The filing by Santos de Oliveira, a prosecutor in the oil district of Campos de Goytacazes, requires the employees – that include the chief executives of Chevron and Transocean’s Brazilian units – to each pay a $5.5 million bond with a guilty verdict bringing prison sentences for up to 31 years.

Both Chevron and Transocean have strongly disputed the charges. The former has, in fact, even labeled the allegations as ‘outrageous and without merit.’

The companies are already facing a lawsuit by a Brazilian federal prosecutor for R$20 billion ($10.6 billion) in damages. The civil suit also seeks a court injunction to stop the companies’ operations in the country. Prior to that, Chevron was slapped with a fine of R$50 million ($28 million) by the country’s environmental regulator.

The Background

Chevron has already accepted full responsibility for the spill that began at its deepwater Frade field on November 7, about 230 miles from the beaches of Rio de Janeiro. The super-major’s multibillion-dollar Frade project in partnership with Brazil’s state-run energy giant Petrobras S.A. (PBR) and a Japanese consortium, was the South American nation’s eighth most productive field in September with a daily output of 75,000 barrels of oil.

Chevron estimates put the size of the leak at approximately 2,400 barrels, or 100,800 gallons before it was plugged. The California-based giant has acknowledged that it had miscalculated the pressure and rock strength in the exploratory well.

While the leak is relatively small compared to the 2010 deepwater Horizon rig disaster in the Gulf of Mexico (GoM) – that killed 11 workers and spewed more than 200 million gallons of crude – and as claimed by Chevron, was contained within four days without any impact on wildlife or coastal areas, it has rocked the company’s credibility in Brazil.

With Brazilian officials accusing Chevron and Transocean – operator of the rig at the Frade project – of being negligent and slow in reacting to the incident apart from a lack of planning and environmental management, the firms could be in line for some legal headaches.

How the Players are Affected

Transocean, which owned and operated the Deepwater Horizon, is already struggling with its direct involvement in the GoM accident and the ensuing uncertainty regarding the company’s potential liability exposure.

However, we remain particularly concerned about Chevron and fear that the stock could experience a considerable pullback should the Brazilian prosecutors establish concrete criminal and environmental charges against the third-largest oil producer in the country behind Petrobras and Royal Dutch Shell plc (RDS.A).

To add to Chevron’s woes, a new leak was detected last week in the Frade field, prompting the company to halt operations temporarily. Brazil’s local oil regulator – Agencia Nacional do Petroleo or ANP – has formed a committee to examine the oil sheen.     

Though the area offshore Brazil is not a major part of Chevron’s upstream portfolio and accounts for just 2-3% of its global assets as against 17% for Australia and 21% for the U.S. Gulf of Mexico, in recent times the company has invested heavily in the development of deepwater fields in the South American nation.  

Brazilhas huge pre-salt reservoirs (oil deposits located in the sea bed under thick layers of salt) that lie below the Espírito Santo, Campos and Santos basins in deep and ultra-deep water. These reserves, estimated to hold upwards of 50 billion barrels, are widely thought to be the most important oil find in recent years.

As such, any decision by the authorities that impacts Chevron’s ability to further drill and explore for oil in the world's sixth largest economy will surely hurt the company’s hopes for a significant toehold in the strategically important country’s offshore riches.  

In particular, as access to new energy resources becomes more difficult, Chevron, like most of its peers, will face headwinds to replace its reserve base.  Given its large base, achieving growth in oil and natural gas production has been a challenge for the company over the last many years. With the established oil producing regions of Europe and North America well beyond their prime, the search for growth has pushed Chevron into riskier regions like Brazil.

Rating & Recommendation

Both Chevron and Transocean shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. Longer-term, we are maintaining our Neutral recommendation on the companies.

The Other Side

On the other hand, many believe that the ongoing legal saga could unnerve foreign entities seeking to cash in on Brazil's offshore oil boom and slow development of the country’s massive deep-sea pre-salt reserves. These fields are located at water depths of more than 2,000 meters, and then a further 5,000 meters below sand, rocks and salt – making exploration technologically complex, challenging and expensive.

As such, the success of these projects is heavily dependent on the technical expertise and funding from the likes of Chevron, ExxonMobil Corp. (XOM) and Anadarko Petroleum Corp. (APC).

Read the Full Research Report on CVX

Read the Full Research Report on RDS.A

Read the Full Research Report on PBR

Read the Full Research Report on XOM

Read the Full Research Report on RIG

Read the Full Research Report on APC

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