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Global Risk Insights

Global Risk Insights

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Corruption Scandal Threatens Brazilian Oil Developments

Petrobras looked like a model for transparency in the energy sector and, with a recent discovery of large offshore deposits, was poised to make Brazil a regional energy superpower. However, a corruption scandal clouds the company, leaving the future of Brazil’s pre-salts in doubt.

Brazil’s pre-salt deposits are the largest deep-water oil reservoirs globally with unparalleled revenue potential for operators with the adequate technological capacity. But foreign operators interested in developing pre-salt blocks are subject to a special set of rules in accordance with the Brazilian government’s “Three Systems Model”.

Besides mandatory local content, any block must be jointly developed with Petrobras, which requires a minimum 30 percent stake in any joint partnership, as well as compulsory reinvestment of a portion of E&P profits into R&D.

Related: This Energy Heavyweight's Auditors Just Refused To Sign

Given the risks associated with waiving ownership rights and direct government involvement in E&P contracts, the corruption allegations involving key decision-making levels within Petrobras will certainly increase the reputational risks for existing partners, and will likely hamper the execution of future projects.

In recent months, more than two-dozen Petrobras executives have been arrested on money laundering and corruption charges, linked to the allocation of construction contracts and kickbacks to individuals belonging to the main political parties. Proceedings have followed from the U.S. State Department and the Securities and Exchange Commission, as well as several class-action lawsuits from investors. This comes at a time where Petrobras faces mounting debt of over US $139billion, and it has lost more than half of its stock value in the last three months.

Adding to the complex scenario associated to pre-salt projects, there are broader risks within the country’s oil and gas industry. The sector suffers from infrastructure bottlenecks and key decision-making positions are filled with political appointees exposed to asymmetric pressures. Projects still face informal administrative obstacles and are both subject to a multitude of regulatory stakeholders and an influential environmental lobby.

Evidence uncovered by recent on-going investigations indicate the chronic failure of state institutions in overseeing the funding of contracts, the inability of regulatory bodies to properly investigate allegations, as well as political meddling in the review process in Brazil.

This apparent breakdown of governance mechanisms at all levels will have a greater impact on pre-salt projects due to the presence of third party bodies in downstream and upstream operations, and could potentially have far-reaching implications for the execution and immediate development of these offshore deposits.

Related: Four More Years Of Pain For Petrobras

It will take some time until the full extent of the crisis is fully revealed. More arrests are expected in the coming months. Meanwhile U.S. authorities are closely reviewing compliance of FCPA guidelines on current contracts, which will only add more uncertainty for investors over the next few months. As current and potential entrants re-assess their reputational damage and risk exposure, they are expected to delay any expansion of existing projects.

It is still unclear whether Rousseff’s government will adopt the necessary measures to strengthen transparency and accountability within the sector, as she has previously voiced opposition to giving away control of the country’s valuable energy deposits and further liberalizing the sector.

However, as long as the conditions exist for collusion between oil and gas sector executives and public officials, considerable risks remain. Given that a number of offshore deep wells could become commercially unviable as the price of oil dips below $50, the deepening of this crisis will likely darken the prospects of pre-salts deposits for the foreseeable future.

By Sergio Rojas

Source - http://globalriskinsights.com/ 

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