The Fuse

In Petrobras Debate, A Challenge to Brazil’s Resource Nationalism

by Paul Ruiz | @pmruiz | July 02, 2015

When Brazil’s immense offshore oilfields were discovered in the mid-2000s, local elected officials celebrated it as a key discovery that would turn the Latin American country into the next great energy giant. The enthusiasm about the discovery prompted a wave of resource nationalism, but eight years later, low oil prices and corruption scandals have had sweeping implications for the country’s energy sector.

Legislation is moving forward in the Brazilian Senate that would unravel Roussef’s reforms, and open Brazil’s massive pre-salt reserves to international oil companies.

In fact, against a backdrop of low public approval ratings, current president Dilma Roussef is fighting for her legacy of nationalizing Petróleo Brasileiro, or Petrobras, and cementing state control over the country’s oil reserves. Meanwhile, legislation is moving forward in the Brazilian Senate that would unravel her reforms, and open Brazil’s massive pre-salt reserves to international oil companies.

Brazil’s current struggles illustrate that although U.S. shale oil was viewed as the inevitable victim of the oil price downturn, other high-cost production may ultimately prove more vulnerable. Perhaps most importantly, low prices are not only having an impact on investment and production, but also national energy policies.

Current legislation in Brazil’s Federal Senate could relieve Petrobras of billions in development costs if a bill sponsored by José Serra of the opposition Brazilian Social Democracy Party wins approval. Serra told a committee of senators and oil and gas experts on Tuesday that the state oil giant’s participation in developing the country’s most prolific oilfields is a burden to Brazil’s economy, as its inability to finance projects has created a bottleneck in production.

Since discovering the energy potential of the pre-salt basin in 2007, international oil majors—largely more efficient and technologically-savvy than state-controlled counterparts—have been clamoring to develop Brazil’s mammoth offshore resources. Production has frozen, however, as a series of events largely related to internal mismanagement and graft at the state oil giant resulted in massive asset cutbacks and reductions in capital expenditures. Petrobras is now one of the world’s most heavily indebted companies, rendering it incapable of spending the billions it needs to realize the country’s energy potential.

In 2010, the Brazilian government passed a bill requiring Petrobras to claim a minimum 30 percent stake in new oilfield development contracts. Passed at a time of high oil prices, the measure was intended to spur development of the country’s reserves, which could contain 50 billion barrels of medium sweet crude, or nearly as much as all of the oil found in the North Sea. But the country’s worsening economic outlook—punctuated by a deepening recession, high refinery costs, and a widening corruption scheme at Petrobras—stalled development.

Reversing resource nationalism

Passage of Serra’s bill would upend the hopes and aspirations of Petrobras and Brazil as the standard bearer for resource nationalism. In 2008, Brazil created a sovereign wealth fund, only to secretly withdraw from it four years later to balance a short-term budget shortfall. An organized cartel network—consisting of corrupt government officials, oil executives, and members of Rousseff’s inner circle—skimmed upwards of $2.1 billion from government contracts at the expense of what was then one of the world’s most promising state-owned enterprises. Today, Petrobras’ targeted oil production is expected to fall through 2020, from 6.4 million barrels of oil equivalent per day (mboe) projected in 2011 to 3.7 mboe, according to the latest revision. The company is reportedly selling assets, divesting $15.1 billion next year and $42.6 billion two years from now.

Prior to the hearing Tuesday, Eunício Oliveira, leader of the center Brazilian Democratic Movement Party and pivotal voice in the debate, told Reuters Brazil that the country and economic climate had changed from when legislation was originally passed in 2010. Reportedly, some officials at Petrobras have quietly expressed support for the proposal, given the company’s recent financial struggles.

Unwinding Rousseff’s legacy

Brazil’s offshore oilfields, and Petrobras, became symbols of its economic boom of the last decade.

In Rousseff’s successful election campaign in 2008, she championed state control over the oil industry as a tool for economic progress. The country’s offshore oilfields, and Petrobras, became symbols of its economic boom of the last decade. The government asserted greater control over the economy, and in doing so, purchased ships, offshore platforms, and other equipment from struggling oil companies. It issued steep local-content requirements mandating companies to purchase or procure a minimum threshold of goods and services locally, in order to increase jobs and stimulate local economic development. The philosophy was intrinsically nationalistic, and intended to emulate the approaches that brought immense wealth to other oil-rich states, like Saudi Arabia and Norway.

“They used Petrobras to serve an economic policy that did not work. Petrobras was not on its knees, it was brought to its knees by the folly and megalomania of the government,” Serra told the committee yesterday.* At Petrobras, Rouseff introduced fuel subsidies in 2006 in a bid to keep inflation low. Since then, the country has been importing gasoline and diesel fuel to sell at a loss. Credit Suisse estimates that these subsidies will cost Brazil $14.8 billion over the next three years. Mounting credit-rating downgrades and budget constraints, though, have forced the government to end policies that lowered economy-wide prices. Brazil cut discretionary expenditures year-over-year by $22.6 billion.

The corruption scandal has incensed Brazilians, many of whom have called for the ouster of the recently reelected president. In the heat of the scandal, more than one million protesters peacefully took to the streets to demand reforms. Dilma Rouseff’s popularity now stands at 10 percent, according to recent polls. Former president Lula da Silva—still revered by many, and a stalwart ally of the president—told Brazil’s most widely-circulated paper that the government’s political weakness may give support to Serra’s bill.

Looking forward

The profitability of pre-salt ventures depends on oil prices, the direction of which is “only getting murkier,” the International Energy Agency said earlier this year. Brazil’s offshore reserves are located two miles beneath the ocean surface and three miles under a layer of compressed sea salt. The development of just one well could cost at least $200 million—33 percent more than the most expensive Gulf of Mexico project—requiring high well productivity to offset steep capital costs.

In Brazilian media, international oil major Royal Dutch Shell reportedly reaffirmed its commitment to pre-salt projects saying it would like to have the “option” of operating there. A consortium of foreign investors, including Total, Shell, and Cnooc have already been awarded production rights to the Libra oil field, although Petrobras holds the largest share at 40 percent. Chinese giants Sinopec and Cnooc are preparing bids for lucrative pre-salt sites, Bloomberg reported yesterday.

It remains unclear whether Dilma Rouseff will be able to hold together a coalition to beat back opposition legislation, but the current debate signals a likely recalibration in the country’s energy policies.

*Quote via Google Translate