Brazil creates strategic planning for pre-salt areas

Jul 08, 2010 02:00 AM

Brazil's National Congress is working its way through a slew of legislation designed to prepare the South American giant for its coming entry into the global league of major energy producers.
Though significant internal impediments remain, Brazil's political and economic evolution over the past two decades, combined with its recent fortuitous oil finds off the Atlantic Coast, are transforming the country into a geopolitical success story. To ensure Brazil stays the course, Brazilian President Luiz Inacio Lula Da Silva has already shown a willingness to spend the necessary political capital in seeing key energy reforms through before he leaves office.

The pre-salt challenge
In addition to the roughly 2.1 mm barrels of crude oil that Brazil pumps daily, the country is believed to have somewhere between 70 bn and 110 bn barrels of oil off its Atlantic coastline. This oil wealth, if realized, could give Brazil billions of dollars in oil revenues with which to increase its geopoliticalclout.
Although Brazil's economic prospects are looking bright, it must first overcome the immense challenge of actually getting the oil from beneath the ocean floor. The pre-salt oil deposits are below a layer of compressed salt that sits 1.8 miles beneath the ocean surface and another 3 miles beneath the seabed.

Brazil's Petroleo Brasileiro (Petrobras) -- which is 51 % state-owned -- has earned a reputation in the energy industry for its ability to develop skills independently and absorb knowledge and skills from the international supermajors it has worked with in joint ventures. Today, Petrobras is considered world-class in advanced exploration and deepwater drilling techniques and can drill at depths of roughly 1 mile below the ocean floor. In other words, Petrobras currently has the skills to drill roughly one-third the depth to reach the pre-salt deposits.
Though a highly competent oil firm, Petrobras will still need plenty of foreign technology and expertise to exploit the massive reserves and drill in the extreme depths of the pre-salt fields. On top of the logistical challenge of drilling for the oil 2 miles deeper than the company has proven capable of, Petrobras and its selected partners will also have to pay a high infrastructural cost to cover the pipelines, boats, shuttle stations, helicopters and other equipment to simply access the reserves sitting 150 miles from shore.

In short, Brazil will not be able to realize its oil potential on its own.
Overcoming the pre-salt challenge will require a lot of operators and a lot of investment (around $ 220 bn) just to get the project going between 2010 and 2014.

Planning ahead
Before Brazil opens the door to the foreign oil majors that are eager to tap into the pre-salt reserves, the country's lawmakers have some serious long-term planning to do.
In the course of this planning, Brazil is trying to ensure four things: that Brazil gets the funding needed to tap the oil reserves; that Petrobras is the primary operator of thefields and the state is the primary recipient of the oil windfall; that Petrobras remains a competent and efficient energy firm; and that Brazil's severe socioeconomic disparities are alleviated by the incoming oil wealth. Several bills that have circulated in Brazil's legislature recently address each of these objectives.

The most basic objective -- obtaining the funds to tap the oil wealth -- was addressed with legislation for Petrobras to finance a $ 200 bn-$ 220 bn investment plan to develop the pre-salt fields. Since the federal government technically owns the reserves, the plan calls for the government to transfer 5 bn barrels of pre-salt oil reserves to Petrobras in exchange for shares in the company, thus allowing Petrobras to sell more shares to help finance its work.
The government has also arranged for Petrobras to be the primary operator of all pre-salt oil fields and to have a minimum 30 % stake in all pre-salt joint ventures, an arrangement that is still competitive in relation to other major oil-producing states like Nigeria and Venezuela (and without the high militant and political risk). Both pieces of legislation tie into the second objective of giving the state more direct access to the oil windfall while giving Petrobras a monopoly in pre-salt production.

Since Petrobras will have its hands full operating the pre-salt fields, the state wants to ensure that the company does not lose its edge in the energy industry. To keep Petrobras from taking on the negative attributes of a state-controlled monopoly, the government wants a state-owned entity other than Petrobras to govern the energy contracts and manage the oil revenues.
This is the rationale behind a bill calling for the creation of a new energy firm -- Pre-Sal Petroleo -- that would be entirely state-owned (unlike Petrobras) to manage new projects. Pre-Sal Petroleo would also run a new contract system that allows the state to implement production-sharing agreements that would direct more of the oil windfall to the state than to the oil companies whenever the price of oil goes up.

Brazil is anticipating a new and steady inflow of petrodollars, but wants to avoid following Venezuela into a resource-extractive economic pit by glutting itself with petrodollars at the expense of its already well-diversified and industrialized economy. To this end, the National Congress approved legislation calling for the creation of a social fund that will receive 50 % of pre-salt oil revenues to support state-run socioeconomic programs.
Though social programs in Latin America are often associated with the vote-buying populist subsidies so familiar to economically-troubled countries like Venezuela and Argentina, the social fund now in the works in Brasilia is different. The primary purpose of the social fund is not to subsidize Brazil's poorer class (in fact, Brazil is quite conscious of keeping limits on public spending since its economic recovery that began in the late 1990s). Instead, the fund is designed to develop a generation of Brazilian technocrats by funding schools and programs that emphasize education in science and technology. The fund will use only the interest generated by its earnings, and 50 % of the interest will go exclusively to education.

The far more contentious socioeconomic controversy simmering in Brazil at the moment concerns the distribution of oil revenues to the states. The dividing line in the Brazilian legislature is between the oil-producing states of Sao Paulo, Rio de Janeiro and Espirito Santo (which together account for 90 % of the country's oil production and are not particularly inclined to share the bulk of the oil wealth currently distributed to them by the federal government) and the states that do not produce oil, but want their share when the pre-salt revenues start streaming in.
Rio de Janeiro has led the campaign against the oil revenue redistribution bill, rather dramatically claiming that any move to strip the state of its oil wealth will threaten Brazil's ability to host the 2014 World Cup and 2016 Summer Olympics. Politicians from the oil-deprived states meanwhile want to promise their constituents new oil money ahead of the October elections.

Some Brazilian senators attempted to strike a compromise by amending the legislation to have more of the oil revenues collected by the federal government redistributed to the oil-producing states to compensate them for their losses should a new plan be implemented to spread the oil wealth across all states.
Caught between upsetting the powerful oil states and alienating the poor north-eastern states where his party carries substantial support, da Silva has for now convinced Brazilian lawmakers to postpone this debate until after the election. This will be a hard-fought battle when the issue resurfaces, but it is notable nonetheless that Brazil has politically matured to the point where it can actually hold this debate.

Achieving political consensus
Save for the oil revenue redistribution bill, the Brazilian National Congress has passed all the necessary legislation to allow Petrobras to capitalize an investment plan to bring the pre-salt fields online, create Pre-Sal Petroleo to manage oil revenues and contracts, enhance state control over the pre-salt revenues and channel the oil funds toward socioeconomic development that will help maintain economic diversity and boost Brazilian industrialization.
These energy reforms did not come without a price, however. To see the Pre-Sal Petroleo legislation through, for example, da Silva made a bargain with the opposition and signed into law a 7.7 % pension increase that would reassign $ 888 mm (and gradually increase with time) from the federal budget.

Though da Silva was against this costly pension increase from the beginning, he was willing to incur the cost in order to see his energy vision for Brazil materialize. This is one small but notable example of the political maturity and strategic vision that Brasilia has internalized.
After decades of struggling to attain some basic internal consensus and stability, Brazil has the economic foundation and is evidently developing the political will to move into uncharted territory.

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