Brazil has been touted as Latin America’s budding oil powerhouse, with the International Energy Agency predicting that the country will account for one-third of global supply growth by 2035 based on an estimated tripling of current production levels. Despite this optimism, Brazil has been plagued by a combination of poor policies and bad luck that is throwing some cold water on these projections.
The centerpiece of the oil revolution was supposed to be the country’s vast pre-salt reserves, oil trapped beneath shifting and unpredictable salt layers thousands of meters below the Atlantic Ocean. According to Wagner Freier, former petroleum geologist with Petrobras, “There were a lot of government authorities saying the reserves of Brazil were 50 billion barrels, 100 billion barrels, even 240 billion barrels, more than Saudi Arabia.” Unfortunately, he says, “Lots of wells have been drilled in the pre-salt area, and the well comes up dry.” The cost of developing these pre-salt basins is increasing as well, with current estimates putting the required aggregate capital at a staggering $237 billion, making this oil some of the most expensive on the planet. Dry wells are never good for an exploration company, but it is especially unfortunate when the wells are so expensive to develop. OGX, Brazil’s second largest oil company and an early investor in pre-salt potential, found this out first hand when it was forced to file for bankruptcy in October after the majority of its exploratory wells came up dry.
Petrobras must also deal with onerous regulations placed on it by the federal government. For example, Petrobras must source its oil platforms, ships, and deepwater equipment from Brazilian firms, which has led to significant cost overruns, delays, and shortages. Add to this that Petrobras is legally required to take the lead on all pre-salt development projects and must maintain at least a thirty percent stake. This puts tremendous financial strain on the company and serves to keep out international capital and firms with expertise that could prove essential.
Petrobras has also had to purchase finished gasoline from international markets and sell it at below market prices since 2008 in an attempt to control inflation, a policy that has thus far cost the company over $20 billion. These mounting financial pressures have forced Petrobras to sell off many of its assets in the Gulf of Mexico, Peru, Columbia, and Africa. While helping ease the current financial stress, this also means that Petrobras is increasingly dependent on a shrinking number of plays, the majority of which are pre-salt. The market appears to be factoring this risk into Petrobras’ stock price, which has gone from a high of $51.33 a share in late 2009, to $31.21 in early 2012, to $13.16 now.
Brazil is currently producing approximately 300,000 barrels per day from pre-salt sources, but the country is going to need to dramatically increase this flow if it is going to cover its costs. The question is whether or not Petrobras will win the race between pre-salt production and the specter of increasingly precarious financial exposure.
By. Rory Johnston