Petrobras is a 'Scheme, Not a Stock'
Companies / Oil Companies Oct 21, 2014 - 11:48 AM GMTBy: Bloomberg
Jim Chanos spoke with Bloomberg Television anchor Stephanie Ruhle from the Robin Hood Investor's Conference in New York today. Chanos described Petrobras as a "scheme," saying that optimism it will benefit if Dilma Rousseff is voted out of office is unfounded: "Every time Dilma's poll numbers go up, Petrobras's stock goes down...Even if Neves wins, it doesn't change the economics" at Petrobras.
STEPHANIE RUHLE, BLOOMBERG: Jim, we will get to talk about China, but you just left the stage. You have been followed out here by attendees talking about your big idea, Petrobras. Talk to us.
JIM CHANOS, FOUNDER, KYNIKOS ASSOCIATES: Well, I guess we're going to talk about one emerging market situation first. I gave a presentation inside to the Robin Hood folks on an idea we've been involved with on and off for the last couple years, but it was timely because of the upcoming election. This Sunday the presidential election in Brazil is occurring, and Brazilian stocks have basically been - been ping pong balls moving every which way based on where people think the presidential election will fall out.
Our point was Petrobras is such a unique animal globally and it's an energy stock that it defies that kind of simple analysis. And we pointed that out --
RUHLE: Why? It is so tied to Dilma Rousseff.
CHANOS: Well it is, and that's the interesting thing. Every time Dilma's poll numbers go up, Petrobras stock goes down. And every time Neves's numbers go up, Petrobras stock goes up. The problem is it's tied to Dilma. She was the chairwoman of this company. There's been a number of investigations and - and scandals swirling the company - around the company. And we're just not sure that even if Neves wins he's going to really be feeling all warm and fuzzy toward this creature. Having said all that, the economics are just so poor at Petrobras that we really have called it a scheme, not a stock.
RUHLE: A scheme. Do you believe they misled investors back in 2010 when they did the IPO?
CHANOS: Well we did - there was a slide in our presentation where we looked at the company's projections. They keep - these five-year plans that they keep revising. And suffice it to say that if you look at it on the table, they have been a tad too optimistic down through the years by a lot.
RUHLE: But is that enough to call it a scheme?
CHANOS: Well, no. The problem is is that in fact the company is cash flowing about $25 billion, $26 billion, so-called EBITDA, and its CapEx annually is $45 billion, and another $5 billion of capitalized interest. So their - their gross cash flow is only covering half of their capital spending and capitalized interest, so they're not covering their dividend. And in fact they're having to borrow the shortfall, and they're borrowing more than $20 billion a year. This is an enormous, enormous sink hole from a financial point of view.
RUHLE: So their expectation to double output by 2020 for you, laughable.
CHANOS: Well they can double output by 2020. For the last handful of years, five years, production really hasn't increased. And we put a chart up to show the Robin Hood folk. Despite this enormous capital expenditures and the fact that their big pre-salt (ph) field is now coming online, production hasn't increased. And that's disturbing.
Now maybe it will double in the next six years, but we would argue it has to double to basically service all this new debt that they're taking on and will take on to complete the field. And in the oil and gas business, particularly in Brazil, as you know, sometimes things don't always turn out the way you think they're going to turn out. I think we can look at the Batista saga and others that - to really point out to you there are enormous risks here.
RUHLE: Batista saga, way too tied to the government. So are you saying this is just like that? Because many people think if Neves wins the stock will rally.
CHANOS: Well that's in fact what I think will be the opportunity. And that's why I thought it was timely this week that if that's what happens and if investors knee jerk run into the Bovespa and buy Petrobras because Neves wins, I think it's a great entry point on the short side in this story because it doesn't change the economies of the situation. And we pointed out today in our presentation that even - even if you gave this company Exxon's margins both upstream - and I see your eyebrows - and downstream, it would still be break even cash flow.
RUHLE: Really?
CHANOS: Yes.
RUHLE: So those of us who are saying, well, if Neves wins who's going to be in Petrobras management, you're laughing at that. You're saying -
CHANOS: My conclusion was - my conclusion is if Neves wins, this is underwater. If Dilma wins, this is really underwater.
RUHLE: You're damned, you're damned Petrobras.
CHANOS: I think it's just a matter of degrees.
RUHLE: All right. Let's go to the other side of the world, China. We get GDP numbers tonight. People are focused. What are they going to be? Are you saying numbers shnumbers because they're all made up?
CHANOS: Well I've often said that China is the only advanced country in the world that knows its annual GDP on January 1 of that year. It's true.
RUHLE: So will you even look at that number?
CHANOS: We'll look at it of course, but - but remember, everything is managed to the number. It's sort of like the high-tech industry in 2000. You can't miss the number. And so I'm sure it will be 7 something, close to 7.5, give or take, and - and I think you really shouldn't get too excited one way or the other because with China it's all about actually how they get there and how much credit and debt are they taking on to do it.
And I think it's now sort of almost beyond a shadow of a doubt that in fact most observers think that the economic model needs reworking. And whether or not they can reform is another question.
RUHLE: All right. Let's talk about gloating for a moment. In 2010, you signed a letter to the Fed warning about the risks of QE. When you look at the market turmoil, the disastrous week many hedge fund managers, peers of your hands, are your hands on your hips and you're saying how you like me now, I told you so?
CHANOS: No, no. Gosh no. It's a little funny. You mentioned that letter -
RUHLE: Because I'd like to see you do that.
CHANOS: The - you're going to wait a long time. The - the - that letter has sort of gotten a second run recently I noticed. And look, the inflation - the risk of inflation it raised, and I signed it, was wrong. And I'm first to admit it. I was also probably the only liberal who signed that letter. It was mostly conservatives. And I was basically of the belief that monetary policy isn't going to do it, that we need fiscal policy, we need stimulus, we need infrastructure investment.
RUHLE: But do you believe the sentiment of that letter is still correct?
CHANOS: Well I think it's too early to tell, number one. It's four years. It's all a matter of judging. Inflation did go up the following year to 4 percent. Even more interestingly, those that have criticized that letter from the investment community have said they got it wrong. And I've put together as a thought exercise two portfolios as of the day of the latter. One that was an inflation portfolio, 25 percent stock market, 25 percent REITs, 25 percent gold and 25 percent cash, saying that would be basically if you thought inflation was coming you would do that versus 25 percent in government bonds if you were a deflationist, that - that things weren't going to get better as - as (inaudible).
RUHLE: All right. You've put it together. What does it look like?
CHANOS: Well guess which one turned out a lot better. The inflation portfolio did. It actually outperformed the deflation portfolio at sort of 6 percent annually to 3 percent annually. Again, what does that prove? Nothing. But I just - to point out that in fact from an investment posture maybe it wouldn't have been so bad to - to read what was in that letter.
RUHLE: All right. Right now when we're looking at this global economic I'm going to say pickle that we're in and many investors are calling for the ECB to take action, when the ECB is saying, well we're buying bonds back, and it turns out to be two-year covered bonds which are nothing, you can't possibly believe ECB is the right answer if you don't believe it's more monetary policy. What needs to be done to help Europe?
CHANOS: Yeah. I think the transmission mechanisms are broken, and that's the problem. And this has been ongoing since arguably capital went ascendent (ph) to labor in the '70s. In effect, the - the whole power of monetary policy has increasingly been diminished in the real economy and it's been increased in the financial economy.
So the central banks have said overtly that they're trying to influence asset prices as a way to transmit economic activity, as opposed to just interest rates. Interest rates aren't doing it anymore. We're all used to zero bound. We're all used to 3 percent mortgage rates. So in fact, trying to get the stock markets of the world and the assets market up hopefully will stimulate economic activity and animal spirits. It remains to be seen whether that's going to happen. And I think the signatories in the letter, certainly me, felt that the unintended consequences of this policy were really hard to judge. And that is how do stock buybacks impact this versus capital spending? Talk to IBM today.
And - and how - how possibly are we putting into our mix low volatility as being here forever and that upsets the apple cart when volatility increases? All these things get - get magnified when, as my friend Jim Grant says, someone has their finger on the scale. We just don't know because the market's not clearing. But certainly the inflationary and currency abasement aspect of that letter was wrong, and I'll be the first to admit it.
RUHLE: So was last week a positive in your mind? When you see all this blood in the water in the investment community specifically for hedge funds, yes, it's hurt professional investors, but is this all really a sign that the economy is finally doing okay and the real USA, it's a positive?
CHANOS: We hope so. We hope the real economy is doing - remember, finance exists to serve the real economy. We kind of lose sight of that sometimes.
RUHLE: But has it for the last five years?
CHANOS: No. I certainly don't think it has, or not enough. And so we hope that employment picks up and GDP picks up and nominal growth picks up. I think all those things are good for people around the globe. Whether or not we get it because we're so dependent on the central bankers to do it for us as opposed to making hard decisions on fiscal policy and tax policy, well that's a different question. And that's what I worry about.
RUHLE: Who's dependent on central bankers though, the investment community or Americans?
CHANOS: Well I think - I think the investment community is, and I think that's the problem. I think the central bank policy is more about fostering productive asset markets and financial asset markets and not having them go down than worrying about what's happening on Main Street. And I think that's a big failing.
RUHLE: Do you think if the heroin is taken away, QE finishes and hedge funds continue to struggle in this volatile environment, do you think we're going to see consolidation?
CHANOS: Well I think hedge funds have a lot of other issues.
RUHLE: Like what?
CHANOS: Well I think one of the worries I have is that hedge funds more recently, you sort of get half of the upside and all of the downside. And --
RUHLE: Hold on. Hedge as an investor, you get half of the upside and all of the downside.
CHANOS: It seems like that - it seems like -
RUHLE: (Inaudible) they get 2 and 20 if it rains or shines.
CHANOS: And also - and also it seems that at - at - after the market's had a big run, hedge funds reduce their hedges, they get more correlated to the market as it goes up, and so on the way up you underperform and - and then at the top most hedge funds are correlating 80 to 90 percent with the market, so you're getting almost all the downside on the way back down. And that certainly happened in '07 and '08 and I'm worried it's going to happen come the next decline that hedge funds aren't going to - they will go down but still hurt you pretty badly.
RUHLE: Then is the right answer that some of these funds should shut down? There's so much criticism around hedge fund fees, and clearly in a market like this we're seeing who warrants them and who doesn't.
CHANOS: Well look. I run a hedge fund, so I think that - that - that it depends, like anything, on the fund, the manager, the fee structure. But I also sit on investment committees, Stephanie, and so I evaluate them. And I've got to think that anybody charging 2 and 20, 2 percent management fee and 20 percent of the profits that is correlating simply to the stock market had better look for another line of work.
RUHLE: All right. Hedge funds make me think of the ultra 1 percent. You have been critical in the past of the art market, saying we are sitting on a bubble. Where do you stand now?
CHANOS: Well I was in London last week and I spoke to a Bloomberg reporter Friday night about it. We've been short Sotheby's. We were public on that. And I think that - that the art market is an interesting microcosm of all (inaudible).
RUHLE: The super rich?
CHANOS: - about it in that - that it's socially acceptable conspicuous consumption.
RUHLE: One more time?
CHANOS: Socially acceptable conspicuous consumption. I think it's a market that studies have shown correlates more with income inequality than general economic growth. And I think that's an interesting part that a lot of people don't realize about the art market, that the richer the rich get the better the art market does. The art market didn't do so hot in the '60s and '70s when all incomes were going up. It did really well in the last10 years and in the late '80s, for example. So you have to be a little careful with art. I think art is wonderful. If you love a piece of art, buy it. Enjoy it. Put it up on your wall. But to use it as a financial investment or barometer I think is a little scary.
RUHLE: It doesn't make you change your tune on Sotheby's when you see a guy like Dan Loeb get in the game?
CHANOS: Look, Dan's an old friend and I think that he's going to do the best he can. I just think that this is a company tied to the art market. And - and that's the problem with it, and he and I disagree about that.
RUHLE: All right. Before we go, what's the one thing you're most concerned about right now? When you wake up in the morning and you're looking at your Bloomberg screen's, what's the biggest - what's the most important number that our viewers can look at and say Jim Chanos is watching X?
CHANOS: I think that certainly - certainly when I wakeup in the morning, we keep an eye on China because I think it is - it is the engine for global growth whether or not you believe the numbers or not. I think it is the largest credit bubble going on in the globe right now and one of the largest in history. It's an economic experiment that I think is completely untethered from reality, and I think it'll have implications for both economics, finance and national security going forward.
RUHLE: Jim, thank you so much. Always great to get your thoughts. Even better that it's at a place as special as Robin Hood.
CHANOS: My pleasure, Stephanie.
RUHLE: Jim Chanos, the one and only.
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