The Oct. 27 landslide victory of Brazilian leftist presidential candidate Luiz Inacio Lula da Silva of the Workers Party (PT) over Sen. José Serra, the ruling party's candidate, at the outset was cause for concern for the oil and gas industry in Brazil.
But some industry executives and consultants interviewed by OGJ suggest that the prospect of a left-wing government's impact upon Brazil's petroleum industry may not be as grim as some have warned.
Issues of main concern for the Brazilian energy sector under a Lula government include its policies toward the prospect of price controls, simplification of the cumbersome tax structure, incentives for investments, upgrading the electricity sector, and Brazil's role as a key player on the volatile political and economic international scene.
Left vs. right not clear-cut
Given some of the campaign-trail comments made by the two presidential election runoff candidates, where they stood on the left and right ends of the political spectrum is not clear-cut.
In an interview with OGJ about possible impacts of Lula's election upon Brazil's oil and gas sectors, Jean-Paul Terra Prates, a leading Brazilian oil consultant, said, "Ironically, the promarket government candidate Sen. José Serra has shown much more governmental intervention impetus during the campaign than left-wing candidate Luiz Inacio Lula da Silva.
"It is important to remember the comments made by Serra in a press interview last April, favoring price controls over oil products. This resulted in increasing Brazil's political risk ratings and caused Petroleo Brasileiro SA (Petrobras) shares to slide. During that interview, Serra criticized pricing mechanisms for refined products used by Petrobras, following the deregulation of the markets on Jan. 1, 2002," said Prates, partner and executive director of Rio de Janeiro-based consultancy Grupo Expetro.
When Serra advocated price controls, analysts with Merrill Lynch LLC said, "Taken at face value, the comments are very unsettling in our view. They could reinforce concerns about the sustainability of the government's deregulation of industry."
Price controls
Prates pointed to other examples of interventionist suggestions by Serra during his campaign.
"Last July, due to (Serra's) weak performance in the polls, he also attacked the autonomy of the regulatory agencies. In August, the federal government buckled under political pressures and announced the return of controls on oil prices, allegedly for social reasons (OGJ Online, July 31, 2002). This negative measure was uncomfortably confirmed by Sebastiâo de Rego Barros, the director general of the National Petroleum Agency (ANP), at the opening speech of the World Petroleum Congress in September, as being temporary, to last until the elections.
"Then many investors started asking themselves if such a government would not fall into similar temptation every 2 or 4 years, when elections take place at different levels in the country," Prates said.
This unofficial price control measure is possible to implement because 96% of the fuels consumed in Brazil are produced or imported by Petrobras, Prates explained.
The governmental price control order took place not through any regulatory measure, but merely as an internal directive from the government, Petrobras's main shareholder. The government owns 33% of Petrobras equity but controls a majority of votes on the board of directors.
"In times of a plummeting real (vs. the US dollar) and increasing international oil prices, if current prices are compared to what they should be if price hikes had been allowed, this control measure has resulted in losses of around $60 million/month for Petrobras," Prates said.
Petrobras owns 11 of Brazil's 13 refineries, so the price control measure is causing the country's 2 private refineries to seek to stave off bankruptcy. Meanwhile, three other mainly petrochemicals-oriented complexes that had begun to shift their focus to production of gasoline and diesel for a hungry local market now are thinking twice about continuing production, he added.
"On the other hand, during his campaign, Lula never publicly commented on oil products price controls, neither favorably nor against. Of course this is not an assurance that he will not practice price controls. But, at least, it is an indication that he does not consider it a simple issue that he could have used in his campaign. It would certainly be easier for him to promise to control fuel prices to gain more votes—something that did not happen once during his campaign," added Prates.
Lula and FPSOs
In one area that alarmed industry watchers, Lula said during the campaign that he would cancel Petrobras's three recent contracts with foreign builders of floating production, storage, and offloading vessels, an expenditure of $1.5 billion that he wants to keep at home to generate jobs for Brazilians. During his campaign, he criticized Petrobras for ordering the FPSOs from overseas construction companies.
The FPSOs are destined for deepwater development projects in Brazil's prolific Campos basin.
These contracts aside, Lula has promised he would honor all other international agreements, notably those with foreign oil companies that hold exploration and production concessions and those providing products and services to the Brazilian petroleum industry.
Lula also said he backed the terms of the International Monetary Fund's recent $30 billion loan package to Brazil. (OGJ Online, Oct. 4, 2002).
Lula already is treading carefully in a juggling act designed to appease both investors and an electorate unhappy with the political establishment's handling of Brazil's beleaguered economy, the world's 11th largest.
Walter Molano, an analyst at BCP Securities Inc., Greenwich, Conn., said that even rumors of who may be included in Lula's economic team is helping to soothe investors' frayed nerves. He mentioned Henrique Meirelles, former president of global banking for Boston-based FleetBoston Financial Corp., Henri Philippe Reichstul, former president of Petrobras, and Sergio Werlang, who served as economic research director under current Central Bank Pres. Arminio Fraga.
An independent's view
Wagner Freire, a former Petrobras director of exploration and production and now president and CEO of the independent Brazilian oil and gas company Starfish Oil & Gas Co., complained to OGJ about Lula's stance on the FPSOs.
He also repudiated the bill recently approved by Rio de Janeiro's Legislative Assembly that forces oil firms to pay a tax of 18% on platforms and other offshore facilities that are built outside Brazil and brought into Rio de Janeiro state. Before the bill was passed, the tax was charged only on facilities constructed within the country. Incorporating Campos production, Rio de Janeiro state accounts for around 80% of Brazil's total oil output.
"In a globalized world, investors seek to build platforms and other equipment in any part of the world, where price and quality conditions result in good returns for their capital investment. At present, Brazil is not as competitive as, for example, Singapore for building platforms," added Freire.
The former Petrobras executive also said, "Brazil's tax structure is too complex, and the administration of President Fernando Henrique Cardoso has made it more complicated in an attempt to simplify it. We hope that Lula will have the will to 'untie the knot' of this veritable jigsaw puzzle of a tax structure."
Furthermore, Freire added, "The data provided by (ANP) to companies interested in participating in its ANP's licensing rounds are too expensive and difficult to get."
It is easier to access data from the Gulf of Mexico, he said.
Freire told OGJ that Starfish, in a consortium with Petrobras (operator) and Brazilian companies Queiroz Galvão and Coplex Petroleo do Brasil Ltda. will start producing 18,000-20,000 b/d of crude oil from Coral field in the offshore Santos basin by next November.
Rush to Brazil
The end of Petrobras's monopoly in 1997 attracted 43 foreign oil companies to Brazil.
The first licensing round conducted by ANP took place in 1999, and a fifth one is planned for 2003.
The main concerns of multinational oil companies are still related to the consistency and clarity of the regulatory framework, especially regarding the tax structure for import or domestic contracting of supplies and equipment. "These are rules that affect the most risky and relevant part of the E&P investment, so that even slight percentage variations in either federal or state taxes might turn a project nonviable," Prates said.
He also said he believes that any future government will face several potential pitfalls regarding energy reforms. For instance, the government will have to cope with Petrobras's market dominance in areas such as transportation logistics and natural gas and will have to face them with intelligence and in a nontraumatic way.
"Of course, it is also up to us, from the industry, to propose intelligent measures to avoid regressive taxation or rigid compulsory quotas. There are ways to boost domestic suppliers more directly through governmental incentives granted to local equipment and service sectors. Information flow is also fundamental, so that private oil companies be informed of domestic alternatives to their components," Prates said.
He added that there are also arguments in favor of easing the government-take burdens not only for marginal fields but also for deepwater operations that require larger investments.
International competition
Industry executives have pointed to a burdensome fiscal regime as a serious deterrent to exploration and production investment in Brazil (OGJ, July 29, 2002, p. 32).
Prates contends that, in general, the Brazilian government's fiscal and regulatory regimes are efficiently administered.
"However, we see ways of proposing some more-flexible economic policies in order to adapt for specific cases, such as the need to compete for investment before Iraq and the Caspian republics become the new 'jewels of the crown' for international investors, he said.
"We believe that the international oil and gas scene will be dramatically affected in case an invasion of Iraq results in a change of government," Prates said. "As expected, a true 'logistical corridor' would be opened for the Caspian republics' production. Iraq, Iran, Afghanistan, and Pakistan may restructure their economies, thus becoming more attractive for international oil companies," he explained.
"Brazil will be forced to adapt itself to this new competition, and even a Lula administration will recognize that with the opening of virtually all countries to private risk investment, the world's E&P scene has become a mineral rights market, which is being run by the buyers, that is, the investors. Countries that do not adapt their fiscal regimes to this specific market circumstance will fail to expand their oil industries."
Private investments
"I do not believe that Lula's administration would disregard the importance of private capital (national or foreign) to develop our energy sources," Prates said. "On the contrary, I believe the administration will positively surprise many of those who today naturally fear a left-wing victory."
Lula recognizes that the country has evolved and that many sectors are much better off with private investment than without it, the consultant said. Lula's few statements involving Petrobras or the oil sector were all related to his wish that new investments in oil and gas generate jobs in Brazil. That is no different from policies currently practiced in the UK, Norway, and Canada, Prates contends.
Petrobras role
Lula also must take care not to cripple what had been a prosperous state oil company seen as an increasingly important player on the international oil and gas scene as well as the key to the country's long hoped-for oil self-sufficiency.
Petrobras is the largest industrial company in Brazil. According to the state company, the country contains the second largest oil reserves in South America after Venezuela, with proven reserves of 8.4 billion bbl and a postulated resource pegged at 47 billion bbl still to be discovered.
Of special concern is Petrobras's refining sector, which continues to lag its upstream operations.
Petrobras refines 1.6 million b/d of crude oil to produce a slate of products for which demand continues to grow rapidly.
Naphtha and diesel are among the products Brazil will need most by 2005, say Petrobras officials.
By 2005, the gap between Brazil´s crude oil output and its capacity to refine products will grow significantly, leading the country to export crude oil and to import a number of oil products, Petrobras officials predict.
Petrobras is forecast to produce 2 million b/d of crude oil by 2005, but the company will have capacity to refine only 80% of that total.
Brazil´s need to upgrade its refineries means that the country will be importing 20% of its oil products needs by 2005, say government officials.
Currently the country imports 15% of its oil products needs, according to ANP.
Chávez vs. Lula
The alarms raised over Lula have been augmented by the recent turmoil in Venezuela, where a leftist politician came to power and quickly entered into conflict with the powerful state oil company in that country.
"There are huge differences in the personal profile of (Venezuelan) President (Hugo) Chávez and President-elect Lula," said Prates. "The Brazilian politician is a long-standing union leader, with many years of experience negotiating labor agreements within a democratic context. President Chávez has a military background, having reached the rank of lieutenant colonel and having attempted a coup d'état before being elected."
There are also significant differences between the two countries, Prates contends.
"Unlike Venezuela, Brazil is a large consumer of its own oil and gas production. Unlike Venezuela, Brazil has an important domestic industrial sector and does not depend, life-or-death, on oil exportsU. Brazil also has the right notion that its geology is not as attractive as (Venezuela's).
"So, for Brazil, it is very important to welcome the presence of private investment in the oil industry, because competition for investment in similar operating environments—for example, Angola, Nigeria, and the Caspian republics—will increase in the future.
"Also, Petrobras is not PDVSA (Venezuela's state-owned Petroleos de Venezuela SA). Petrobras has original value as a company built in Brazil and is a successful and innovative operator, especially in deep waters. PDVSA results from the expropriation of assets from foreign operators and sometimes is more important than the government of the country itself, which is certainly not the case with Petrobras," Prates said.
Some analysts have predicted that Lula instead will follow the model of socialist President Ricardo Lagos of Chile—one of the sturdiest economies in South America—who has been in power for 21/2 years and implemented promarket policies with social measures, instead of pursuing the kind of largely populist policies of Venezuela's President Chávez.
