In 2007, Brazil’s commodity economy was radically transformed with the discovery of the Subsalt Polygon off the country’s east coast. This ultra-deepwater field, roughly the size of Bangladesh, is estimated to contain at least as much oil as was found in the North Sea. This oil lies beneath about 6,600 feet of water and another 16,000 feet of sand, rock and salt.

While an energy find of that magnitude is typically a cause for optimism, in Brazil’s case it has raised some eyebrows among analysts. That’s because the government has taken an increasingly interventionist—and populist—approach to managing key sectors of its economy.

Many fear that private sector oil companies, particularly multinationals, will be hesitant to get involved in producing the recently discovered Brazilian oil fields.

Consequently, as Brazil prepares to auction off exploration and production (E&P) rights to the Libra field, one of the largest in the Subsalt Polygon, there’s some trepidation as to how much interest the bidding will attract.

In October, the Brazilian government will auction the E&P rights to the Libra field, which is expected to produce about 15 billion barrels of oil over the next 35 years. However, the government has created a new set of bidding rules specifically for the Subsalt Polygon, aimed at maximizing the government’s take of the production. The winning bidder will be the one that offers the largest share of future output to the state.

On top of that, state energy company Petroleo Brasileiro SA (NYSE: PBR), commonly known as Petrobras, will automatically own at least a 30 percent stake in the field and its production no matter who wins the bid. One upside for the winner is that Petrobras will also cover 30 percent of the production cost.

Given that rather high trade-off and government interference in key sectors of the Brazilian economy, it’s understandable that some observers doubt whether the auction will be a success. However, just three weeks ago the government’s energy regulatory body auctioned off exploration rights in frontier areas to 30 companies from 12 countries, raising USD1.4 billion for the government and showing that there’s still a great deal of interest in Brazil’s oil wealth.

There’s a lot of speculation about who will enter the bidding war in October. However, the easiest way to play the Subsalt Polygon is simply to stake a claim in Petrobras itself. An added enticement is the state-controlled oil company’s relative cheapness right now.

Petrobras had been a high flyer for several years, as its American Depository Receipts shot up from about $5 in 2003 to better than $70 in mid-2008. Shares have plummeted since the recession, though, as oil demand plunged and Petrobras fell victim to its own ambitious growth plans. Government interference in strategic sectors hasn’t helped matters.

But with the current Brazilian government high in the polls ahead of upcoming elections, government meddling is likely to abate for at least a while. Most of the government’s recent actions, such as capping electricity rates, were clearly populist measures aimed at shoring up domestic support and came at times of weak approval ratings for the government. Now that it’s firmly ensconced, the Brazilian government will probably take more of a backseat.

Meanwhile, Petrobras has embarked on an efficiency program that aims to reduce its costs by about $8 billion annually over the next few years. The goal is to bring its operational efficiency up to 88 percent—from its current level of about 73 percent—by the end of the decade.

Even as it cut costs and improves efficiency, the company is working to build out its refining capability to 1.5 million barrels of distillate per day over the next two years. That goal is largely driven by the fact that the government recently backed away from its populist price controls and actually allowed some price increases.

The greatest driver for Petrobras is the nearly tripling of Brazil’s total oil reserves over the past five years, thanks to the recent oil finds, almost all of which have been in deep water. Petrobras has been operating in those hostile environments for more than a decade and has the requisite expertise to successfully produce the Subsalt Polygon.

Consequently, while a relationship with Petrobras will be foisted onto those companies that win the contracts, it shouldn’t prove to be a detrimental one.

The company’s shares currently trade at just 0.4 times book value and revenue growth is averaging about 16 percent a year. At current levels, Petroleo Brasileiro SA shares are an excellent buy for long-term investors.

Portfolio Roundup

Shares of Gafisa Group (NYSE: GFA) slid by about 5 percent after Brazil’s central bank increased its benchmark Selic rate by 50 basis points to 8 percent. The increase is designed to slow the inflation that helped stall Brazil’s economy in the first quarter. However, given the impact the increase will have on mortgage rates—as well as on Gafisa’s own interest expense—investors haven’t taken kindly to the news.

Regardless, the company is in solid shape and faces good growth prospects. While higher interest rates will create potential headwinds for Gafisa over the short term, growing Brazilian incomes and government urban renewal programs will continue to drive earnings growth for the company.

Gafisa Group remains a buy under 5.

Banco Bradesco (NYSE: BBD) has also taken a hit, despite an initially positive reaction to news of the rate increase.

Downward pressure on the company’s shares has more to do with general concerns about the state of the Brazilian economy than the increase itself. A higher base rate will widen out Banco Bradesco’s net interest margin, fueling future earnings growth.

Banco Bradesco remains a buy under 20.