China to Buy Oil Reserves

Highlights include Petroleo Brasileiro SA (PBR - Analyst Report), China Petroleum & Chemical Corp. (SNP - Analyst Report), Vale (RIO), Cosan Limited (CZZ - Analyst Report) and Gerdau SA (GGB - Analyst Report).

China Continues to Pursue Long-Term Investments in Commodities

Yesterday, leading Japanese business newspaper Nikkei informed that China is considering a plan to use part of its US$2 trillion reserves to buy oil reserves and diversify its international investments, reducing the exposure to U.S. bonds. Currently 2/3 of the Chinese reserves are denominated in U.S. dollars.

If this plan is approved, we foresee two direct consequences: (i) Oil prices should recover, leading the way to other commodity price increases, and (ii) the U.S. dollar should fall against international currencies like the Yen and the Euro, a development that would also be positive for commodities prices in general, since they are all negotiated in U.S. dollars -- thus a lower dollar would mean higher nominal prices for commodities.

However, it is not reasonable to expect a great movement in the short-term for the U.S. dollar based on this information. Just to put it into perspective, even if China decided to buy 100 million barrels of oil, it would mean around US$4 billion, or just 0.2% of the countries' reserves. Nevertheless, Prime Minister Wen Jiabao already said that Chinese purchases of U.S. bonds should be revised in the near future.

Actually, it makes a lot of sense for China to make such a move, mainly considering it has already announced its decisions. Some weeks ago, Chinese steel companies announced they would buy stakes in smaller Australian mining companies in order to guarantee future flow of raw material.

Also, some days ago Petrobras (PBR - Analyst Report) announced it has signed two Memorandums of Understanding with Chinese institutions and an export oil contract with UNIPEC Asia Co. Ltd., a subsidiary of China Petrochemical Corporation, or SINOPEC (SNP - Analyst Report), to export around 100 thousand barrels of oil per day. The amount of the deal is estimated as US$10 billion in loans for Petrobras in exchange of future oil exports.

We have been skeptical on commodities producers, since these are highly cyclical companies. However we prefer raw material producers like oil companies such as Petrobras and mining companies like CVRD (RIO) and agricultural companies like Cosan (CZZ - Analyst Report) if compared to steel producers like Gerdau (GGB - Analyst Report).

For the moment, we are keeping our Hold recommendation on both Petrobras and CVRD, our Buy recommendation on Cosan and our Sell recommendation on Gerdau, however we are following the particular case of Petrobras with great attention before the company's earnings release next week.