China to Stake Claim off Brazil’s Coast

Bottom line: China likely to stake a claim off Brazil’s coast through Libra pre-salt auction, but at a potentially high environmental cost for Brazil.

Analysis: Given the small field of potential bidders (just 11 companies were approved to participate in Brazil’s 21 October auction of the Libra pre-salt oil field), China will almost certainly be a participant in the winning consortium. In one respect, it may make for a perfect marriage: Chinese companies have cash to spend but little technical experience in ultra-deep pre-salt extraction while Petrobras (the mandatory operator) has the expertise but is wonting for capital. With a $6.8 billion mandatory signing bonus and costly exploration and development in the forecast, most analysts suspect it could take nearly 20 years before the winner of the October auction starts making a profit.

Yet the risks relating to such deep-water wells are not solely financial – they are also environmental. The Brazil China relationship could quickly sour if the eagerness of Chinese investors leads to an oil spill.  Although spills can happen to any oil company, including US and European majors, recent environmental problems involving China’s state-owned companies give cause for additional concern. Just six weeks ago, in August, the government of Chad shut down China National Petroleum Corp (CNPC) operations because of a large oil spill in a southern forest. More troubling is that fact that inspectors there alleged that some of the spillage was an intentional way to cut costs and that CNPC was entirely unprepared to do any sort of remediation.

Even in its own territory, Chinese operators are notoriously opaque when it comes to acknowledging such mishaps: in 2011 it took months for officials to admit the extent of a massive spill in the Bohai Sea (and weeks to get the leak under control). Ultimately, the China National Off-Shore Oil Corp. (CNOOC) puts the blame for the largest spill in China ever on its co-operator, ConocoPhillips China. In 2010, pipelines running to a CNPC storage facility exploded, leading to an oil spill in the Yellow Sea. Again, officials initially denied any environmental impact, and even today, government estimates of how much oil was spilled (1,500 tons) is approximately 50 times less than what outside estimates allege. That lack of transparency and accountability may be another concern for Brazil, which has strict environmental impact regulations in place.

Recommendation: Brazil is clearly a bit wary of the Asian giants: it said it would only accept a joint bid from CNPC and CNOOC because of concerns that those companies could manipulate the process if they split up to bid with other groups. So China does look like a strong possibility for a winner in 2013, we only hope Brazil has no reason to regret it.