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Brazil’s Energy Dilemma

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In a tricky balancing act, Brazil aims to enable both sides of the energy industry to develop harmoniously.

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In early September, Brazil's Petrobras and two foreign consortium partners -- Repsol and British Gas -- announced a major new oil and gas discovery in the country's Santos Basin. Industry analysts reckon that the site could contain up to two billion barrels of recoverable resources. It's yet one more piece of welcome news during an oil bonanza for Brazil, which is helping the Latin American country to potentially double its current production of oil to 3.8 million barrels a day, transforming it into an energy powerhouse.

But the Santos Basin and a string of other discoveries of vast offshore oil deposits along Brazil's coast have sparked a host of thorny policy debates about the state's role in the country's oil and gas sector and the hefty, multi-year investments needed to develop the industry fully. Concerns are also growing over whether the increasing importance of oil and gas in the Brazilian economy will detract from renewable and alternative fuel programs that the government has been developing in recent years.

Yet experts agree that oil and gas are providing a wealth of economic opportunities at a critical juncture in the Latin American country's development. “Brazil aspires to become Latin America’s economic leader and its engine of growth, and one of the foundations of that leadership, without a doubt, will be energy," says Xavier Mena, professor of economics at EsadeBusiness School, in Barcelona. "A substantial part of the country’s growth will be sustained by petroleum.” It's one of the reasons why he rates Brazil as the having the greatest economic potential among all the BRIC countries.

WHEN OPPORTUNITY KNOCKS

With the latest discoveries, Brazil will have reserves of some 100 billion barrels, according to some estimates, making the country one of the largest producers in the world, on par with Venezuela and Saudi Arabia and surpassing Libya and Nigeria. But even before September's find, President Luiz Inácio Lula da Silva was stoking nationalism as he pledged to take control of various new hydrocarbon deposits. Through Petrobras, the state-controlled oil and gas company, the government plans to control the fields discovered two years ago, and in the case of partnerships with foreign companies, Petrobras will have a minimum 30 percent stake. Adopting a similar model used in Norway, the aim is to channel profits from these fields into a fund aiding the country's economic development, including programs for reducing poverty, improving health care and education, and undertaking research in science and technology.

But in its bid to replicate the growth of other oil-producing powerhouses, will Brazil struggle with an over-reliance on the sector as many of its predecessors have? According to Anita Kon, professor of economics at the Catholic Pontifical University of Sao Paulo (USP), Brazil does not run that risk because its “industries and services [are] quite diversified, as are its agribusiness and mineral exports.” Javier Carrillo, professor of economics at Madrid's IE Business School, agrees, noting that “like many of the countries that belong to OPEC [Organization of Petroleum Exporting Countries], Brazil will funnel the revenue that it gets from oil into other sectors.” For his part, Lula announced that the country will not confine itself solely to exporting crude oil, but will also focus on oil derivatives.

In many respects, he has had his work cut out for himself to prove his critics wrong. “Many people had doubts about Brazil when Lula, a leftist, came to power in 2003. But over time, he has shown that his economic policy is very orthodox,” says Mena. Investment in renewable energy sources has become the watchword of his policy, but he has also kept the newly discovered deposits in his sights.

What Lula's government and Petrobras want to avoid is repeating what happened in Mexico's oil and gas sector, according to Mena. “The nationalization of the Mexican oil companies under [President] Lázaro Cardenas [in 1938] was the first case that was done unilaterally, cancelling [the government’s] concessions to foreign companies, rather than providing them [with any] compensation," he explains. "However, because of this, [the state-owned petroleum company] Pemex and the Mexican government have been unable to cope with the huge investments required to explore the deep coastal layers [of the Gulf of Mexico].”

LONG-TERM PROSPECTS

Much remains to be done before the recent discoveries can be developed. Because of the depth at which the deposits lie (in an area referred to as pre-salt, because they lie deep beneath a shifting layer of salt in the Atlantic), extraction will be complicated and require vast investment. According to Kon, “Creating wealth from this sector is a very complex [challenge]," and it could take as long as 10 to 15 years before the infrastructure to extract the deposits is up and running and the country reaps any benefits from the deposits.

As she explains, “Meanwhile, the world will already have structured its energy consumption to include renewable energy. In addition, the energy production of many countries will not be based on oil.” She advocates redirecting the requisite investments involved -- an estimated 210 billion euros over the next 10 years -- to the development of renewable energy. Not everyone agrees. Carrillo, for example, reckons investing in oil and gas should continue. “Hydrocarbons will be recognized as the principal energy source for a long time,” he asserts.

For Brazil's pre-salt discoveries to be profitable, the price of oil will have to be at least US$70 a barrel, says Mena. "When the [global economic] crisis arrived, it led to a contraction in demand and the price of petroleum went down as a result."Right now, the price per barrel is around US$71. Carrillo predicts that when consumption revives in the U.S. and China, the price of a barrel will exceed $100 by a wide margin.

Also potentially working in Brazil’s favor to become a major oil exporter is its relative political and economic stability. As Carrillo sees it, “It seems very unlikely that Lula will decide to nationalize the country’s natural resources, since he has achieved a great deal of regulatory stability.” Although Lula will not run for re-election next year, none of the candidates appears to be a strong opponent of hydrocarbon exploration. However, Mena says that Marina Silva, the Green Party candidate and former minister of the environment, is gaining popular support. Silva has been critical of the way in which Brazil’s resources have been allocated, and has raised concerns about the environmental problems that any further exploration might create.

GOING GREEN

Regardless of who wins the election, hydrocarbon policies won't be the only area of government focus. The country's burgeoning alternative energy industry will also deserve attention. Indeed, Brazil is now one of the world’s largest producers of ethanol produced from sugar cane, and many of the country's cars run on this energy source. This year, Brazil'sbiofuel production is expected to reach a record high of nearly 29 billion liters (or 7.7 billion gallons).

This is not the only area in which the country is at the vanguard. Some 70 percent of its electricity output comes from hydroelectric sources. For this reason, Carrillo does not believe that the discovery of new oil and gas deposits will hamper Brazil’s "clean energies" policy. “The installed capacity of renewable energy and biofuels makes it very unlikely that oil will play the role that alternative fuels have played so far," he says. "Doing that would compromise multimillion-dollar investments.”

To this end, Lula has announced a new law that will make it illegal to plant sugar cane in protected regions, such as the Amazon rain forest. Nevertheless, environmental groups have expressed concerns about future activity in the country’s oil sector. As Carrillo notes, Brazil is not subject to any limitations concerning its emissions of carbon dioxide -- such as those imposed by the Kyoto Protocol -- because of its status as a developing country. But activities involved in the extraction and refining of crude oil from the pre-salt area represent a challenge for the Lula government, which openly defends environmentalism.

It is a tricky balancing act. As Brazil continues with its plans to exploit the deposits, the government is insisting that a portion of the future revenues generated from these fields go towards projects protecting the environment. Petrobras, for its part, is already investing in projects to develop environmentally friendly technology. Whether Lula's legacy will enable both sides of the energy industry to develop harmoniously remains to be seen, but given the potential benefits to the country, many believe it's worth a try.

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

 

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