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Brazil: New Oil Company?

Will Brazil create a new state oil company that will undermine Petrobras? Three experts share their insights.

Inter-American Dialogue 

In the wake of the discovery of potentially tens of billions of barrels of offshore, sub-salt oil in the past year, the Brazilian government is weighing changes to rules governing oil exploration and production, as well as the possible creation of a new state-run oil company to manage production from Brazil's sub-salt reserves. What will the government do? What place will there be for private investment in oil exploration and production in Brazil?

Georges Landau, Head of Prismax Consultoria in Brazil: Nobody knows for sure what the government will do, because it is itself perplexed. Lula formed an inter-ministerial committee to come up with recommendations by September 7 (Brazil's Independence Day), after reviewing the legislation of other major petroleum-exporting countries, but from the president's statements he has already pre-judged the issue: he favors the positions taken within the committee by Dilma Rousseff (chief of the office of the president) and Edison Lobao (minister of mines and energy), who wish to create a 100 percent state-owned enterprise to manage the vast pre-salt deposits of oil and gas. This would by-pass Petrobras (which has the technology and could—in combination with the BNDES national development bank—raise the enormous financial resources required for successful E&P in the pre-salt layer) but whose participation is not desired by the government because the company has a high proportion of its capital in private, and indeed foreign hands. This reveals the administration's statist proclivities, tinged with xenophobia. Petrobras, heretofore an icon of Brazilian national pride, is understandably incensed, as is the petroleum industry, which sees in this posture a reversal of the liberal policies, reflected in the 1997 Petroleum Law, that account for Petrobras' unquestioned prowess in the global oil and gas industry, in partnership with Brazilian and international oil companies. A related issue with which the government is grappling is how to allocate the foreseeable zillion-dollar proceeds from production in the pre-salt layer. On that, too, it is considering the wildest ideas, but has not settled on any of them. In either case, the issues have to be submitted to Congress for its deliberation, and a battle royal can be expected at that time.

Roger Tissot, independent energy consultant: The pre-salt oil discoveries in offshore Brazil are perhaps the most important petroleum discoveries in the world in the last 20 years, and have the capacity to transform Brazil into a significant oil supplier. Not surprisingly, Brazil is dealing with the challenges of how best to manage the expected revenue while avoiding the 'curse of oil.' President Lula has suggested that oil revenues from the pre-salt could be used to pay the social debt by allocating these revenues to education. This is a very tempting offer, particularly in a country which still suffers from large levels of poverty and illiteracy despite significant gains in recent years .... On the other hand, adopting a 'Norwegian' stabilization fund, another idea suggested for the pre-salt revenues, could help Brazil to avoid the risk of a 'Dutch disease' while allowing an 'orderly' entry of the windfall revenues into the local economy ... The role of Petrobras has also been questioned. One idea is to create a new national oil company in charge of operating the pre-salt blocks. To deny the right to operate these huge fields could be perceived as a letdown to all the workers and investors who were willing to take risks and worked very hard for these successes. Brazil, and Lula's administration, are thus at a crossroads. If Lula chooses the easy, populist answer of capturing all the rent and using it for social spending, he would secure future electoral successes for his party but at the risk of sending his country backward on a 'rentist model.' By adopting the stabilization fund, he is at risk of upsetting his loyal base, which has supported him despite years of belt tightening and only recently has started to feel the rewards of policy discipline. Many would argue, when, if not now, would Brazil get serious about reducing poverty (education being a key policy toward poverty reduction)? Finally, by creating a new corporation Lula could alienate many of the shareholders who invested in Petrobras. I think a middle-ground Brazilian model could be adopted. First, Petrobras is right at focusing on an aggressive expansion of its refineries, suggesting that the company's focus is not to be a large exporter of oil but a large supplier of value-added petroleum products. That strategy ensures a consolidation of Brazil's industrial development. As such, Petrobras should be the one in charge of developing the pre-salt fields. The stabilization fund should be implemented, and instead of Norway the Chilean copper fund may be of interest, allowing the government to maintain a certain level of fiscal spending according to the price of oil. This would secure a more stable income, improving long-term budget strategies while allowing the strengthening of education programs.

Erasto Almeida, Latin America Research Associate at the Eurasia Group: The government appears headed to propose changes to Brazil's 1997 Petroleum Law, probably to introduce a production-sharing agreement (PSA) framework for the new pre-salt province, but the sector will most likely remain open and attractive to private investment. There are certainly downside risks for both international oil companies and Petrobras. The government clearly wants to increase taxes on the sector—including from existing concessions in the pre-salt shelf—and greater operational controls. In the past two weeks, President Lula has adopted a more nationalistic tone and emphasized that future oil revenues should be used to address Brazil's education and health needs, showing that oil reform may become a key campaign issue in the presidential elections of 2010. Not only will this politicize the issue, but the government's priority for oil reform increases the likelihood that Congress will approve it. That said, there are good reasons to believe that the final outcome will be moderate. First, the main driver of reform is extracting greater revenues from the oil sector, so the government has a large incentive to develop the new reserves. The government is well aware of the large financial and technological challenges involved and the importance of private investment to overcome them, so any new PSA framework will probably keep terms attractive for investors. Second, a very tight calendar for approval of new legislation in Congress before the end of Lula's mandate may well lead the government to opt for conducting adjustments within the existing model, which is flexible enough to allow for a significantly larger government take. Finally, Congress will act as a moderating force in any new legislation.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.


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