Brazil’s
economy
The
devil in the deep-sea oil
Unless
the government restrains itself, an oil boom risks feeding Brazil’s vices
The Economist, November 5th, 2011
·
DEEP in the
South Atlantic, a vast industrial operation is under way that Brazil’s leaders
say will turn their country into an oil power by the end of this decade. If the
ambitious plans of Petrobras, the national oil company, come to fruition, by
2020 Brazil will be producing 5m barrels per day, much of it from new offshore
fields. That might make Brazil a top-five source of oil.
Managed
wisely, this boom has the potential to do great good. Brazil’s president, Dilma
Rousseff, wants to use the oil money to pay for better education, health and
infrastructure. She also wants to use the new fields to create a world-beating
oil-services industry. But the bonanza also risks feeding some Brazilian vices:
a spendthrift and corrupt political system; an over-mighty state and
over-protected domestic market; and neglect of the virtues of saving,
investment and training.
So it is worrying that there is far more debate in Brazil
about how to spend the oil money than about how to develop the fields. If
Brazil’s economy is to benefit from oil, rather than be dominated by it, a big
chunk of the proceeds should be saved offshore and used to offset future
recessions. But the more immediate risks lie in how the oil is extracted.
The government has established a complicated legal
framework for the fields. It has vested their ownership in Pré-Sal Petróleo, a
new state body whose job is merely to collect and spend the oil money. It has
granted an operating monopoly to Petrobras (although the company can strike
production-sharing agreements with private partners). The rationale was that,
since everyone now knows where the oil is, the lion’s share of the profits
should go to the nation. But this glides over the complexity in developing
fields that lie up to 300km (190 miles) offshore, beneath 2km of water and up
to 5km of salt and rock.
To develop the new fields, and build onshore facilities
including refineries, Petrobras plans to invest $45 billion a year for the next
five years, the largest investment programme of any oil firm in the world. That
is too much, too soon, both for Petrobras and for Brazil—especially because the
government has decreed that a large proportion of the necessary equipment and
supplies be produced at home.
How
to be Norway, not Venezuela
By demanding so much local content, the government may in
fact be favouring some of the leading foreign oil-service companies. Many would
have set up in Brazil anyway; now, with less price competition from abroad,
they will find it easier to charge over the odds. Seeking to ramp up production
so fast, and relying so heavily on local supplies, also risks starving non-oil
businesses of capital and skilled labour (which is in desperately short
supply). Oil money is already helping to drive up Brazil’s currency, the real,
hurting manufacturers struggling with high taxes and poor infrastructure.
When it comes to oil, striking the right balance between
the state and the private sector, and between national content and foreign
expertise, is notoriously tricky. But it can be done. To kick-start an
oil-services industry,Norway calibrated its national-content rules
realistically in scope and duration, required foreign suppliers to work closely
with local firms and forced Statoil, its national oil company, to bid against
rivals to develop fields. Above all, it invested in training the workforce.
But Brazilians need only to look at Mexico’s Pemex to see
the politicised bloat that can follow an oil boom—or atVenezuela to see how oil
can corrupt a country. Petrobras is not Pemex. Thanks to a meritocratic
culture, and the discipline of having some of its stock traded, Petrobras is a
leader in deep-sea oil. But operating as a monopolist is a poor way to maintain
that edge. Happily, too, Brazil is not Venezuela. Its leaders can prove it by changing the rules to be
more Norwegian.
Brazil’s
oil boom
Filling
up the future
Its
remarkable offshore oil bonanza could do Brazil a lot of good. But getting the
most out of it will not be easy
Nov 5th
2011 | SÃO PAULO | from the print edition
·
GEOLOGICAL
structures of vast antiquity are more often called on to bolster the arguments
of atheists than enlisted as tokens of a deity’s existence—let alone his
nationality. But the deep Cretaceous salts which trap oil in rocks off Brazil’s
coast are “strong evidence”, in the words of President Dilma Rousseff, “that
God is Brazilian.” It is not a new conceit, but it has rarely been a more
apposite one. The pré-sal(“below the salt”) oilfields look set to
generate wealth on a scale that could transform Brazil’s economy.
Before
the pré-sal finds, which started in 2007, the country’s total
proven and probable reserves were 20 billion barrels. Conservative estimates
for the total recoverablepré-sal oil now come in at 50 billion
barrels: a little less than everything in the North Sea, all in the waters of
one country. Optimists expect three times as much. “In the pré-sal area,
our exploration has a success rate of 87%, compared with a world average of 20%
to 25% for the industry,” says Sergio Gabrielli, the president of Petrobras,
Brazil’s state-controlled oil company.
The first
shipment of pré-sal oil, 1m barrels from the Lula field
(formerly known as Tupi), set sail for Chile in May. Petrobras is producing
100,000 barrels a day from the pré-sal, a third of it from the
remarkably productive Lula test well (see map). By 2020 Petrobras expects to be
pumping 4.9m barrels each day from Brazilian fields, 40% from the pré-sal,
and exporting 1.5m: at the moment the country falls a little short of
self-sufficiency. Today Brazil is the world’s 11th-largest oil producer. By
2020 it should be in the top five.
Becoming
an oil exporter could complete the development process that began with the
conquering of hyperinflation in 1994. Because the country’s previous period of
economic development was brought to an end by the oil shocks of the 1970s,
self-sufficiency in energy looks more than usually enticing to Brazilians.
Plentiful hard currency looks good, too; it is just nine years since the
country last had to borrow from the IMF to stabilise its currency.
Petro-dollars will boost national saving—currently just 16% of GDP—creating
room for Brazil to upgrade its decrepit infrastructure. And oil would add
pleasingly to the geopolitical heft of a country keen to assert itself as a
global power.
The
possible missteps, though, are legion. Huge, technically challenging projects tend
to run late and over budget everywhere. Last year’s disaster in the Gulf of
Mexico is a grim reminder of the risks in such “ultra-deep” drilling projects.
And countries with big oil finds are prone to an ominous list of economic
ailments: capital absorption (the diversion of funds from other worthwhile
investments); Dutch disease (oil exports pushing the currency to a level that
hurts other industries); and reform fatigue (governments’ unwillingness to
tackle structural economic problems when they can see vast wealth on the
horizon).
Since
the pré-sal was discovered Brazil’s politicians have talked
much less about reforming burdensome tax and labour laws. The corrupting
tendency of oil is worrying in a country where the president has had to sack
five ministers since taking office in January over accusations of illicit
enrichment. Without a lot of care, oil might block development as much as spur
it on. In the 1970s, looking at what its oil reserves might mean for
Venezuela’s future in terms of waste, misallocated money and corruption, a
former hydrocarbons minister, Juan Pablo Pérez Alfonso, did not thank a
providential god; the country’s oil, he said, was but “the devil’s excrement”.
A key to
success in the pré-sal is Petrobras. The company’s older
offshore fields are deep enough that it already accounts for 22% of the world’s
deepwater production. The pré-sal should give it the know-how
to become the world leader in “ultra-deep” drilling, too, opening new
possibilities for it off Africa (where the geology is similar) and beyond.
A moonshot
under the ocean
But it
is an extraordinary technical challenge, and not just because of the depth, and
thus the pressure, at which the drills must operate (see diagram). New seismic techniques
are needed to see what’s going on. The salt shifts during drilling. The oil
comes out of its reservoirs very hot, and must then pass through wellheads that
are only a few degrees above freezing. It is mixed with corrosive gases.
The
dozens of floating production platforms required, which cost billions of
dollars each, will be an uncommonly long way out to sea. Lengthy pipelines will
have to be laid along the sea floor for the fields’ gas (flaring it is illegal,
as well as a waste). Oodles more platforms will be needed to act as
way-stations for helicopters ferrying personnel out and back. The distances
would also hamper the response to a disaster. Mr Gabrielli has warned that more
needs to be done to prepare for such a Deepwater-Horizon-style catastrophe, not
just by Petrobras, but by the government and armed forces, too.
Pedro
Cordeiro of Bain & Company, a consultancy, says all this makes developing
the pré-sal a national commitment comparable to that of the
Apollo programme. In terms of cost it is actually a good bit larger. Apollo
cost less than $200 billion in today’s dollars; the total bill was a few
percent of America’s annual GDP at the time. Ten years’ aggressive development
of the pré-sal could take a trillion dollars, around half of
Brazil’s 2010 GDP.
The lion’s
share of the pré-sal investment will come through Petrobras.
Last year it raised $25 billion in cash with a share offer plus the rights to 5
billion barrels of pré-sal in an oil-for-shares swap with the
government. It will be borrowing another $47 billion in the next few years, and
plans to raise $14 billion more by selling assets. It is already engaged in
nearly 700 projects costing more than $25m each, mostly to do with the pré-sal,
and it has plans for $224 billion in capital expenditure from 2011 to 2015.
This will account for a tenth of Brazil’s gross fixed-capital formation over
the next few years. Petrobras claims that exploiting the pré-sal will
make it a bigger company than Exxon Mobil well within the decade.
For most
of this year, though, the company’s share price has been falling. There are two
linked concerns: overstretch and political interference. The oil-for-shares
swap means the government now owns more of Petrobras than it did before the
share offering (48%, up from 40%). It has always held a majority of voting
shares.
The
government’s role does not stop there. In the 1990s Petrobras was
part-privatised and the system for allocating oil concessions was liberalised:
concessions were to be sold at auctions in which any company, Brazilian or
foreign, could bid equally. For the pré-sal, that model has been
torn up. A new state enterprise, Pré-Sal Petróleo, will own all pré-sal deposits
and can veto projects it deems not in the national interest. Future pré-sal concessions
will be auctioned to consortia which must include Petrobras as their operator,
with a stake of at least 30%. Once a consortium has pumped enough to cover its
costs, what remains must be shared with the state: winning bids will usually be
those that hand over more of this “profit oil”.
The oil is
ours
Luiz Inácio
Lula da Silva, Brazil’s president at the time, justified these 2010 changes on
the basis that “you offer risk-sharing contracts when there is risk. In the
case of the pré-sal, we are sure.” This is a bit blithe. Mr
Gabrielli has recently started emphasising the distinction between “exploration
risk”, which seems low for the pré-sal, and “development risk”,
which is high. And it is not obvious that a winning recipe needed more than
tweaking. Brazil taxes oil relatively lightly. If the government felt it was
underselling a close-to-sure thing it could have raised taxes on companies
operating in the pré-sal. That would be a lot simpler than
cost-plus calculations, which Norman Gall of the Fernand Braudel Institute, a
São Paulo think-tank, expects to cause endless legal disputes. Adriano Pires, a
Brazil-based energy consultant, says the changes to the regime have fed a
perception of regulatory risk. He points to Lula’s worrying resurrection of a
slogan from state-monopoly days: “The oil is ours.”
Compared
with lumbering state-run oil firms like Mexico’s Pemex and Venezuela’s PDVSA,
treated as cash cows and employers of last resort, partially privatised
Petrobras is fit and strong.Colombia’s Ecopetrol is already following the
Petrobras model, having placed some of its shares in the stockmarket, and
Mexican politicians talk of similar steps. But navigating Brazil’s mixed
economy is never easy, for companies or their leaders. Earlier this year a
posse of shareholders cobbled together by the government ousted Roger Agnelli,
president of the privatised mining company Vale, who had laid off workers in
the credit crunch against Lula’s wishes and showed an excessive zeal for
investment abroad.
So far
Mr Gabrielli has handled such tensions rather niftily. But minority
shareholders complain that the government is forcing the company to make
uneconomic decisions. There are doubts as to whether it needs four new
refineries when there is excess capacity abroad, and if so whether it makes
sense to put two of them in the north-east, which pleases politicians but does
not best serve markets. Then there is the purchase of supertankers from
Brazilian yards with costs almost twice those of South Korea’s. The government,
concerned about inflation, regularly stops Petrobras from putting up petrol
prices in line with rising world prices. Mr Pires calculates it has lost at
least 9 billion reais ($4 billion) in the past eight years as a result.
Such
tricks may end up weakening the firm’s capacity to use its development
expertise elsewhere. “By letting in competitors and letting Petrobras go
abroad, [Brazil] created a real national champion,” says Sarah Ladislaw of the
Centre for Strategic and International Studies, a think-tank. She thinks
Petrobras’s recent decision to pull out of projects in Cuba, citing domestic
commitments, may be evidence of overstretch. “Folks respect Petrobras and don’t
want to see it pull back internationally to be hamstrung at home.”
Perhaps the
biggest challenge for Petrobras will come from the strict local-content
requirements the government is imposing on pré-salprojects. The
government intends to make these progressively more demanding, applying them to
the entire supply chain. By 2017 they may reach as high as 95% for some parts
of it. The oil-and-gas supply chain, broadly defined, accounts for 10% of
Brazil’s economy now. By 2020 its share should grow to 25%, say analysts.
Jobs for
the boys from Brazil
The
policy is meant to stop foreign suppliers from gouging Petrobras and its
partners as they buy hardware by the $100 billion. It is also meant to
stimulate domestic industry. “This is a very important demand pull on the
Brazilian economy,” says Mr Gabrielli. “We think it will respond.” If it does,
the benefits will be not only in quantity, but quality: a study by IPEA, a
government-funded think-tank, found that Petrobras’s domestic suppliers were
more technologically advanced and productive than the average Brazilian firm, and
paid higher wages and more taxes.
New
oil-and-gas service companies are already springing into being, providing
everything from undersea electrical cabling to industrial quantities of popcorn
(light, cheap and biodegradable, it can be thrown overboard to simulate the
evolution of oil spills). A high-tech hub is forming around Cenpes, Petrobras’s
research centre in Rio de Janeiro: leading service firms, including Baker
Hughes, GE and Schlumberger, are building laboratories close by. The area will
be the southern hemisphere’s largest research complex, says Petrobras. In the
state of São Paulo, the port city of Santos will be transformed into a
managerial hub, with bases for fleets of helicopters and support ships.
Nevertheless,
forcing Petrobras and its partners to buy Brazilian, and international
companies to locate themselves there, will push up costs and cause delays.
According to Booz & Company, a consultancy, Brazilian suppliers to the oil
and gas industry charge 10-40% more than world prices. Part of the problem is a
scarcity of staff. Brazil’s labour market is already so tight that employers
complain about a “labour blackout”. Petrobras itself is unlikely to suffer: it
gets hundreds of applicants for each job. But its suppliers will struggle.
According to
a wide-ranging study of the pré-sal’s impact by Mr Gall, most
workers starting courses at Prominp, a government-funded trainer for the oil
and gas industry, needed remedial Portuguese and arithmetic lessons before they
could read manuals or carry out simple calculations. Many dropped out and quite
a few who finished their training were still of too low a standard to work in
the industry. When Aker Solutions, a Norwegian oil-services company, explained
weak results in August, it cited an overspend in Brazil caused by “too many
inexperienced people”.
The
attempt to stimulate supply-chain industries is in part a way to offset the
Dutch-disease damage of high exchange rates. Some of the inconvenient strength
of the currency is down to high real interest rates which attract footloose
foreign capital. But soaring commodity exports are another factor (see chart).
Brazil is the world’s largest, or second-largest, exporter of iron ore,
soyabeans, sugar, ethanol, coffee, poultry and beef. The commodity boom has led
to a big improvement in Brazil’s terms of trade—and hard times for Brazilian
industry. Imports, mostly of manufactured goods, have grown even faster than
exports, and the country’s trade balance is now negative. Though the economy
grew by 7.5% in 2010, and is forecast to grow by more than 3% this year,
industrial output, long flat, is starting to fall.
Local-content
rules for the oil industry may help, but are of little comfort to, say,
dressmakers, who are unlikely to become part of Petrobras’s supply chain. And
they may have unintended consequences beyond reducing the oil industry’s
efficiency. Less spending outside Brazil by Petrobras and friends will reduce
demand for foreign currency—thus pushing the real higher than it would be
otherwise.
One way to
counter Dutch disease is to raise productivity in the rest of the economy.
Brazil is planning a fund to invest a good part of pré-salrevenues
along these lines. Its aims, as yet ill-defined, include education, culture,
science and technology, environmental sustainability and poverty eradication.
Bain & Company, asked by Brazil’s national development bank to analyse the
lessons of similar funds in Norway, Chile and elsewhere, said such spending
could be worthwhile, provided clear targets were set and the money was
professionally managed (not something the government’s penchant for appointing
placemen makes likely). It also recommended spending on the sort of
infrastructure that would benefit other industries and help to lower the cost
of exports, such as roads and ports. With 60% of all of Brazil’s industrial
investment currently in the oil and gas industry, according to the National
Petroleum Industry Organisation, a trade body, that could be a welcome fillip.
But the
sovereign fund may end up with little to invest in anything. A ferocious battle
is being waged in Congress between the coastal states, which have in the past
received most of the royalties from offshore oil, and the rest, which want a
share. Until a solution is found, in the supreme court if need be, there can be
no new pré-sal auctions. The answer will probably involve the
federal share shrinking, which will be bad for the fund and its chances of
strategic investment. State revenues, whichever the state, will go straight
into current spending.
Still
going Dutch
Made
in Brazil
Tony Volpon
of Nomura Securities, an investment bank, points to the disturbing possibility
thatBrazil could already be suffering from the Dutch disease associated with
success in the pré-sa l—without yet enjoying any of the
benefits. “Brazil’s growing current-account deficit is similar to big
investments in a company with present negative cashflows, but excellent
earnings prospects,” he says. Most of the assets Brazilians hold abroad are
low-yielding, such as treasury bonds; foreigners’ assets in Brazil earn much
more. For a commodity exporter like Brazil, those growth expectations can only
be met by large current-account surpluses.
Running the
numbers, Mr Volpon reckons that the current strength of the real implies
Brazil’s trade balance switching to surplus in a few years and then increasing
by 20% or so year on year. Only thepré-sal, he thinks, can possibly
justify such high expectations. If Petrobras disappoints by not producing oil
quickly enough, it will find it difficult to go on attracting the foreign cash
Brazil, and Petrobras, need. In consolation, though, the real would fall,
providing a natural remedy for Dutch disease, and giving the rest of the
economy time to breathe.
Mr
Gabrielli, whose company plunges drill bits into the bowels of the Earth with a
precision measured in centimetres, seems confident of steering a course that
threads its way between the dangers of damaging haste and disappointing delay.
For him, the providence invoked by Ms Rousseff lies not only in where the oil
was found, but also when. “God hid it until Brazil was strong enough to cope,”
he says with a laugh. It will soon become clear whether Mr Gabrielli is right.
