Oil wealth opportunity in Brazil

By Rudy Martin | 2008-09-08

In the wake of the discovery of billions of barrels of offshore, sub-salt layer oil in the past year, the Brazilian government is weighing changes to rules governing oil exploration and production. By some Brazilian government official estimates it will cost $600 billion to develop the fields. What is PetroBras role and how will public shareholders benefit?

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Petroleo Brasileiro (NYSE:PBR), the dominant oil company in Brazil has an aggressive expansion and investment program. It plans to invest $19.5 billion (€13.22 billion) each year between 2008 and 2012, with 85% earmarked for projects in Brazil. But this excludes the investments the company will make for oil exploration projects in the pre-salt layers.

One idea recently floated is to create a structure that allows foreign investors to take the development and debt risk, while the government keeps control of the oil and gas produced.

This new program idea may make sense given the scale of the findings but scares the current exploration companies who are already feeling the effect of higher costs for finding, extracting and shipping petroleum. Fortunately, according to Mines and Energy Minister Edison Lobao, none of the existing pre-salt exploration licenses with companies such as Petrobras, BG Group (BRGYY:OTC) and ExxonMobil (XOM:NYSE), would change as a result of a new program.

The combination of more government involvement, new competitors and political speeches, have made some investors overly-concerned about PetroBras. These worries underestimate the PetroBras dominance in Brazil, with technical, refining and other scale/scope advantages.

The trend in Brazil is toward privatization NOT nationalization. PetroBras has been the key to the industrialization of Brazil. Without PetroBras investments and exploration, the country wouldn’t be in the midst of this historic moment, according to Brazil’s President Lula da Silva.

The Brazilian industrialization trend is broadly-based. Just last week, Brazil’s defense minister said the government may build a fourth airport in Sao Paulo and that it would be privately run.

Since the mid-1990’s, Brazil has undergone a series of privatization processes involving public service such as water utilities, telecommunications, financial institutions and also in transportation. The moves to privatize new airports are part of a plan to streamline Brazil’s air system, which suffers from chronic congestion and delays. Brazil will be the host for the 2014 soccer World Cup and Rio is bidding for the 2016 Olympics.

So, while the US markets are distracted with the financial services reconstruction, Brazil is just beginning one of its longest, sustainable growth periods with publicly-traded PetroBras as the primary growth engine.

Company News

•Petroleo Brasileiro (NYSE:PBR), announced that it kicked-off the production of the first oil in the pre-salt layer, in the Jubarte field, in the Campos Basin, off the southern coast of Espírito Santo State today. The first well's production potential is 18,000 barrels/day, and the main purpose of developing it is to obtain knowledge that will help the Company develop the pre-salt reserves located in Espírito Santo and in other places off the Brazilian coast. The characteristics of the light pre-salt oil (30° API) required investments of nearly $50 million in adapting the platform's process plant, in the completion of well 1-ESS-103A, and in interconnecting the well to FPSO JK (P-34). Production begins with Long Duration Test (LDT) to observe how pre-salt oil behaves, both in the reservoir and in the platform's process plant. The LDT is expected to last six months to a year. FPSO JK (P-34) has been producing oil in the Jubarte field since December 2006, in a reservoir located above the salt layer. The fact this platform is only 2.5 km away from the 1-ESS-103A exploratory well, which discovered the oil in the pre-salt, below the Jubarte Field, 1,375 meters below the water line, allowed production in the pre-salt layer in Espírito Santo to be anticipated.

•Companhia Energetica de Minas Gerais (NYSE:CIG) has raised its 2008 investment plan to BRL 2.13 billion from BRL 1.56 billion announced in December 2007. The increase is due to plans for the acquisition of transmission assets in the second half. The investment will be made in Cemig Distribuição, Cemig Geração e Transmissão and in Companhia Energética de Minas Gerais (Cemig).

• Grupo Aeroportuario del Pacifico S.A.B. de CV (NYSE:PAC) is interested in acquiring airports in Latin America and Caribbean, according to a report in Milenio. Investor relations director of GAP, Miguel Aliaga, was quoted as saying: “The area is very attractive for the company due to its geographic proximity and common language, as well as the lack of competitors.”

General News

• Brazil's central bank may raise interest rates to the highest level in two years. Currently the Selic rate stands at 13% and economists estimates call for a 50-75 basis point increases with 15% being viewed as the high water mark for rates. While recent consumer prices rose at the slowest pace in 11 months in August, the policy makers are expect to continue the tightening moves through year-end. Gross domestic product grew 5.76 percent in the 12 months ended March 31st.

• The Latin Capital Markets dropped again last week. The average Large Cap Latin Beat Universe Stock fell 3.7% last week and is now down 16% year-to-date. Stocks with losses for the week totaled 90 and gainers totaled 28. Among the few gainers were the Telecom de Chile (NYSE:CTC) the Chilean consumer wealth effect is driving subscriber growth. The worst performing stock were the steel stocks which plummeted 15% in one week as fears of a global economic slowing have dampened interest in the materials group.