Brazil’s Oil Boom: Cure or Curse?

 

brazil protest neftianka
NikoNomad / Shutterstock.com

 

In 2006 it seemed as if Brazil had struck it rich. Tens of billions of recoverable oil reserves were discovered in what is now the lucrative Lula oil field, about 200 kilometers off the coast of Rio de Janeiro.

It was one of the largest oil field discoveries in the Western hemisphere for decades. The untapped hydrocarbon block was named after Brazilian president Luiz Inacio Lula da Silva. Discoveries continued as oil prices began to rise after the 2008-2009 recession. In the last four years, one in every three new oil discoveries was made in Brazil. It seemed like Petrobras, the state-controlled oil company in charge of most of the new projects, couldn’t lose.

Beyond the triumphant oil discoveries lay systemic and insidious corruption, which is only now just coming to light and tarnishing the company’s reputation, not to mention stock valuation.

Petrobras was founded in 1953 by president Getuilo Vargas, and up until recently was a viewed as a national treasure hurling the county’s economy into the 21st century. Vargas famously coined the phrase “petroleum is ours”, meaning the oil belonged to the people, not big energy companies.

vargas
Photo from Brazil’s National Petroleum Council

 

President Dilma Rousseff, herself a former energy minister, chaired the board between 2003 and 2010, and now serves as an honorary chair of the board. As chair of the board, many believe Rousseff was aware of the kickback program siphoned billions to executives and political parties third via contracts.

Once seen as a vehicle to bring Brazil out of poverty, now it has been revealed that $1.8 billion in revenue has been pocketed by top execs and politicians and the populaсу turned against Petrobras, but the president herself. Brazilians want her impeached, but her name has been cleared in any wrongdoing related to Petrobras.

While production itself isn’t impressive, the amount of reserves that Brazil sits on is significant and has huge potential for future growth.

Brazil’s oil reserves are estimated at around 14 billion barrels, making it the country with the fifteenth highest reserves. Brazil is the 12th largest oil producer in the world, but its production of oil (2.9%) and gas (0.6%) is minor. For now, they consume more than they produce, which means they still have to import oil from places like the US and Saudi Arabia.

brazil oil share graph
Neftianka

 

The bulk of oil comes from lucrative offshore deepwater projects like Lula. The Campos and Santos basins, also off the coast of Rio de Janeiro have given Petrobras the assets it needs to attract investment from the likes of Shell and China, which via its development bank, is financing $3.5 billion in loans.

If Petrobras doesn’t manage to turn a profit on the country’s oil riches, somebody else will. Although most investors are pulling out of Brazil due to scandal and distrust, the fragile situation could also provide an opportune time to invest in Latin America’s biggest economy and shiniest energy investment.

Petrobras has said it plans to increase production to 5 million barrels per day by 2018, turning it into an exporter and not an importer. It would be like the US fairy tale shale boom, except now, the buzzword is ‘pre-salt’.

Success of Salt

Much of the ‘new’ oil is located more than 2,000 meters below sea level, underneath a thick layer of salt, hence the name pre-salt oil.

Petrobras says pre-salt oil drilling is valuable at $50-52 barrel prices, which means that low oil prices will yield more investment into cheap fossil fuels and further delay renewable energy sources. Production from the pre-salt fields has hit a record 885,000 barrels per day, a more than eightfold increase since wells were opened six years ago.

oil rig brazil

Many oil and gas industry experts believe it could easily double its production. By 2018, Petrobras plans to up production to 5 million barrels per day. The US currently produces 10 million barrels per day.

In order to reach the hydrocarbons, Petrobras has had to invest in FPSO, a special type of high-tech floating rig that can cost up to $300 million per unit. By 2018, 40 new FPSOs will be up and operating, according to the Brazilian government. This estimate was made before the Petrobras scandal broke.

The oil rigs aren’t the only projects. The company has been making huge capital-intensive investments and future commitments, like the new Duque de Caxias refinery, or the unfinished Comperj plant, which Reuters reported could result in $14 billion in lost costs. The pipeline headed to the Comperj refinery is now also being reevaluated.

A lot of these projects are becoming less and less viable as the price of oil continues to slide. However, even as oil price drop, petro states like Brazil, Venezuela and Russia continue to pump more in an effort to offset losses.

Billions of state funds have – and continue to be- pumped into the company, while the payoffs are less tangible.

In 2008 at its peak, Petrobras shares were worth $70, making it Brazil’s highest-valued company. Now, the stocks are just barely afloat above $5 per share, a more than 90% percent drop.

It is the world’s third most indebted company and has more than $120 billion in debt. Petrobras is the most indebted oil company worldwide, followed by Mexico’s Pemex and Russia’s Gazprom.

The dirty politics have spilled far beyond the confines of the elite siphoning money from the oil giant. Mismanagement paired with the lowest oil prices since 2009, have meant tens of thousands of energy sector jobs have been cut.

Funds for social programs such as healthcare and education remain empty, while the debt of the state-controlled energy continues to climb.

In a recent August statement, Petrobras announced it will offer $833 million in debentures, a type of debt neither backed nor capital or collateral, on the local debt market.

Fresh Hell for Oil Prices – How Low Can They Go?

how low can they go pic neftianka

1991 by Sebastiao Salgado

If today’s Black Monday is any indication, oil and other commodities will continue to hit fresh lows as investors panic and continue to selloff global stocks.

WTI, which in early May traded at a peak of $62 per barrel, fell below $38 per barrel in spot trading on Monday. This is a nearly 39 percent drop in less than four months. Brent crude dropped to $42.38 per barrel, also a 39 percent drop.

Put simply, oil is sinking in tandem with global stocks, not to mention it was already on a downward spiral due to a major supply glut that has caused oil prices to consistently crumble in 2014 and 2015.

Some analysts say that the oil price will recover by the end of 2015, but their guess is as good as your gas station attendant’s.

As long as major economies like China continue to contract and decrease demand, the world will continue to drown in excess oil and low prices. OPEC’s decision to continue production no matter what only clogs the already over-supplied market. OPEC countries are also feeling the pain of the global selloff: The UAE’s DFM Index lost nearly 7 percent, and in the Saudi Arabia market, nearly 10 percent of value was knocked out in petrochemical stocks. Leaders in Riyadh and Dubai may decide to switch their “produce, produce, produce with no regard to over-supply” strategy, in which case they would hold an emergency OPEC meeting, and possibly shift course.

If OPEC doesn’t change their policy, US shale producers will have to cut down production, essentially losing the price standoff with Saudi Arabia. But here, the US may have the advantage: even some parts of the Bakken field in North Dakota can still be profitable at under $29 per barrel, according to Bloomberg.

Worldwide, low prices will no doubt push smaller oil companies to merge with larger conglomerates, so any smart investor will try and buy into the right mergers and acquisitions while stocks are cheap.

The US Fed and the China Question

Of course analysts are scrambling to predict if Monday’s selloff is a minor correction or if the historic collapse in the US and Chinese stock markets will continue. Now you may be thinking to yourself, what do US interest rates have to do with oil? Well, at this point, just about everything.

Oil prices could recover if the US Federal Reserve decides to prop up the US stock market with more Quantitative Easing, and loosens, instead of tightening, monetary policy. This happened in 2009 after the Fed bought nearly a trillion in Treasury securities. Since the end of QE, oil prices have been steadily sinking.

It is unlikely that cheap oil will drive the consumption needed to offset the major losses in the stock market.

And Now for the Outlandish Scenarios

A real game changer would be if a significant amount of oil starts being sold in another currency, and not dollars. China, which consumes about 12 percent of the world’s oil, could very easily set this up with Russia, the world’s biggest producer of oil. Maybe other countries that need cheap oil the most will rid themselves of the expensive dollar-traded oil. Venezuela could even start selling oil in bolivar.

Another way China could potentially shake up global markets (and therefore oil prices) would be to start buying more goods from countries with weaker currencies, such as Japan and South Korea, and less from more US and Germany, which are dollar and euro strong.

If Saudi Arabia loses control of the riyal and unpegs from the US dollar, well that is when all hell breaks lose, and you should probably stop reading this website and go unbury the gold in your backyard and cash in your bitcoins.

If neither OPEC or the US Fed influence oil prices, a road to sharp recovery is a war in the Middle East.

Take the most recent Iraq war, for example. In 2004 prices hovered at about $45, and a rally extended prices to nearly $150 and by 2008 prices had stabilized. Before that, when Iraq invaded Kuwait in August 1990, prices rose from $17 to $46 in October 1990.

Shell gets license to drill in US Arctic

shell arctic

Image from climatedesk.org

Royal Dutch Shell has finally been granted the go-ahead by the US government to drill off the north coast of Alaska, after first drilling an exploratory well in 1991. The company estimates there is roughly 25 billion barrels of crude oil in Alaska’s Beaufort and Chukchi seas.

Alaska alone could contain up to 13% of the world’s undiscovered oil reserves, according to estimates by the US Geological Survey. Shell said it still may drill a well by the end of summer, but gave no specifics. By late September, drilling must cease.

The Anglo-Dutch company’s Arctic plans have been thwarted by nature, environmentalists, and the US government itself.

Shell has already spent some $7 billion on exploration in Alaska, most recently in 2012, where it drilled one well but due to inclement weather, it was only in use for 24 hours. Norway’s Statoil backed out of Arctic explorations after witnessing the struggles of Shell.

The Alaskan seas are considered to one of the most dangerous places in the world to drill for oil, given their remote access and icy waters. One of Shell’s rigs, the Kulluk, literally drifted ashore in September of 2012, bringing a definitive end to the failed season.

Gazprom vs. Gazprom

gazprom stock photo

Everything is just swell in Gazpromland, as long as you don’t dig too deep into the numbers and data.

Yesterday, Russia’s gas monopoly announced a first-quarter profit of 382 billion rubles (about $6 billion), lauding the 71 percent surge in profit compared to the same period in 2014. The only problem with this logic is that the “success” is calculated in Russian rubles, the world’s most volatile currency that is set for further devaluation as oil continues to slide into the abyss.

The seemingly massive jump in ruble terms actually equals a decrease in dollar value. The beleaguered ruble, which has lost 43 percent against the dollar in the last year, both helps and hinders the company. The upswing is that dollar and euro earnings account for a good chunk of the company’s revenue, and costs are mostly in rubles, and getting cheaper by the day. The downside is that the ricocheting ruble makes Gazprom investments risky.

The most talked about point in the earnings report was the company’s sharp dropoff in sales to Europe, traditionally Gazprom’s biggest client.

sales to europe gazprom

The chart shows the company’s steep sales decline to Europe, Gazprom’s key export market that relies on Russia for one-third of its energy needs. Sales to Europe dropped to 39.1 billion cubic meters (bcm) in the first three months of 2015, compared to 46.7 percent during the same period last year. That’s more than a16 percent decrease.

Sales in Europe lag for a variety of reasons, but economic slowdown has cut deepest into demand, while the rise of sustainable energy on the continent continues to play a smaller role in Gazprom’s displacement in the market. Counting on economic growth in Europe in the future quarters would be more foolhardy than the company’s expensive pipeline to China, or its recent abortion of the South Stream project, which it had already invested $4.66 billion into the $29 billion project.

Russia sits on about 25 percent of the world’s gas reserves, and with the exception of a few pesky competitors, Gazprom has a monopoly both domestic production and export abroad.

Gazprom is not only losing abroad but at home. In the first three months of 2015, it sold 80.3 bcm, 4.2 bcm less than in January-March of 2014. Independent producer Novatek and state-owned Surgutneftegas are chipping away at market share, along with a slew of other domestic producers.

domestic sales in russia gazprom

Russia is also failing to keep up with 2014 sales to former Soviet neighbors, especially Ukraine, one of Gazprom’s former bread and butter clients. Volume sales in the first quarter were down 20 percent.

sales to cis gazprom

If you want to check out the company’s full earnings report, it’s here.

Bad news for Gazprom is very evidently bad news for the Russian budget, which depends on the gas company for about 9 percent of the state’s budget. If the company doesn’t sell to its potential, the budget will face an even greater shortfall than already anticipated.

Back in 2008, when the company was valued at $360 million, Gazprom head Alexei Miller forecasted that within a decade the oil conglomerate would become the world’s largest company with a market capitalization of $1 trillion.

Now its market capitalization hovers around $51.5 billion. In the last year, stocks have lost more than 35 percent of their trading value.

In July, Russian business daily Vedomosti estimated that the company has wasted 2.4 trillion rubles (about $37.4 billion at the current exchange rate) on dead-end projects. The logic the newspaper provides is pretty rudimentary: Gazprom has a production capacity of 617 billion cubic meters, but will only produce 450 this year.

Russia’s Ministry of Economic Development has the number pegged even lower, at 414 bcm.

However, the bigger obstacle ahead for Gazprom isn’t what will happen next quarter, but rather in the long term: when cars run on hydrogen cells and not hydrocarbons, or when China develops to a point where it starts thinking about its environment and puts a pinch on its oil addiction.

And last but not least, let’s not forget about Gazprom’s tiff with the European Commission, which has formally launched an anti-trust case against the gas monopoly for being just that, a gas monopoly in Europe. If found guilty, Gazprom could face a fine of up to 10 percent of global yearly revenue. In 2013 was $164.62 billion, so the EU could hit the company with a more than $16 billion fine. So the one positive is that if Gazprom crashes and burns this year, it owes the EU less money.

Louise Dickson

The Caspian Sea: Where Russian, Iranian, EU, and US Gas Interests Collide  

oil end of the world copyThe Trans-Caspian pipeline project is still showing some signs of life. Earlier this year, European Commission Vice President Maros Sefcovic paid a visit to the capital of Turkmenistan, Ashgabat. The native Slovak, who is in charge of the Commission’s Energy Union, said that the EU will start receiving Turkmen gas in 2019. The move comes as Europe continues reduce its Russian gas purchases in a snub to Moscow’s actions in Crimea and eastern Ukraine.

Home to the world’s fourth-largest reserves of natural gas, Turkmenistan has the potential to become one of Europe’s main suppliers via Turkey.

In 2015, the landlocked ex-Soviet states plans to increase gas production to 83.3 billion cubic meters (bcm) per year, and boost exports to 48 billion cubic meters of gas compared to the estimated 45.1 bcm of gas in 2014. China currently gulps up about 30 bcm, and Russia roughly 11 bcm, and Iran is the third largest importer of Turkmen gas.

Controversial From the Start

If it is to be built, the pipeline will deliver Turkmen gas under the Caspian see to Azerbaijan, where it will be transported through Georgia and Turkey to the EU. The project, first proposed in 1996, has gone nowhere, as Caspian Sea powerhouse border countries Russia and Iran prohibit any development.

trans capsian pipeline copy

Map from Natural Gas Asia showing the proposed Trans-Caspian gas pipeline

Sluggish progress on the pipeline may be warranted, as many critics believe the project could be a financial and political mess. A project aimed at ousting Russia from the EU market will not receive a warm welcome from the Kremlin. A major proponent of the project, the US, has no obvious upstream stakes in the project, which has also drawn skepticism.

But who is going to front the $5 billion to build the 300-kilometer pipeline that could trigger a regional conflict? If the project isn’t built with Russia’s blessing, Moscow has the military capability to shut it down.

Russia has established energy ties with Turkey by promising them a version of the South Stream, but Turkey is simultaneously developing relations with Turkmenistan, and in 2014 agreed on increasing natural gas to Turkey, but left details on the actual route murky, as not to rile neighboring Russia.

There are serious doubts whether the project is even meant to come to fruition, or is simply just rhetoric to stir up relations with Russia and its Caspian neighbors.

Russia strongly opposes the project, as currently Gazprom, the world’s largest producer of natural gas, buys gas from Turkmenistan on the cheap and either sells it within Russia or abroad for profit. Russia

The energy relationship between Gazprom and Turkmenistan is shaky at best. On Friday, July 24, Russia’s Gazprom launched a formal case against Turkmenistan’s Turkmengaz at the international arbitration court in Stockholm over supply contract pricing.

A Black Hole of Water

Iran and Russia, which enjoyed exclusive access to the Caspian Sea until the fall of the USSR, continue to undermine progress by raising either environmental concerns (though many doubt their sincerity for nature) or legal disputes over Caspian maritime boundaries. Since no current agreement exists on the jurisdiction of the bottom of the Caspian Sea, no pipes can be laid without consensus from all five members.

Since the collapse of the Soviet Union, each individual country has put forth its own vision on how to divide the waters, each of course, in their own favor. But for now, in terms of international law, the Caspian Sea is a sort of black hole.

Russia, Azerbaijan, Iran, Kazakhstan and Turkmenistan are oil-rich. Leaders from the five nations meet annually at the ‘Caspian Summit’, which has only brought about bilateral accords, and no general consensus of the shores.