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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Oil Majors Undeterred By Brazilian Turmoil

Offshore rigs

Turmoil in Brazil didn’t scare away the oil majors from the country’s latest offshore auction, demonstrating Brazil’s allure to the industry.

Brazil held an auction last week that attracted some of the largest oil companies in the world, including Chevron, ExxonMobil and Equinor (formerly Statoil). The auction comes on the heels of a crippling series of strikes that had briefly paralyzed the Brazilian economy.

Earlier this month, a strike by truckers disrupted the flow of goods across the country, leaving supermarket shelves empty and forcing the slaughter of millions of chickens because feed couldn’t reach farmers. The disruptions were motivated by the soaring cost of diesel and the situation presented a political nightmare for the Brazilian government. The solidarity with the protests from Brazil’s leading presidential candidates increased the pressure on President Michel Temer to take action. He proposed lowering and fixing the price of diesel, a move that crashed the share price of state-owned oil company Petrobras and forced the ouster of the company’s CEO, Pedro Parente.

A return to price controls spells trouble for the highly indebted oil company, and it offered reminders of the potential pitfalls for international oil companies trying to operate in Brazil.

However, the oil majors are clearly not deterred. Brazil offered up four blocks in last week’s auction, with three awarded to a consortium of companies, although all three will partner with Petrobras.

The most notable was a group including Equinor, ExxonMobil and Petroleos de Portugal, which offered three times the minimum bid for the Uirapuru block in the Santos Basin, one of the prized offshore regions off of the coast of Rio de Janeiro. The group paid a nearly $680 million signing bonus, plus 75.4 percent of profit oil – way above the minimum required. Petrobras exercised its right to be the operator on the project.

A consortium consisting of Chevron and Royal Dutch Shell won one block and another group including Petrobras and Equinor won a third. Related: The Real Reason For Higher Gas Prices

The oil majors waved away concerns about renewed political interference, even after the government announced rolling back market-based pricing for gasoline and diesel. “We didn’t really make a connection with the fuel prices and the bidding rounds. It is quite an independent process,” Anders Opedal, country manager for Equinor, told Reuters.

The auction was deemed a success as it pulled in around $800 million for the cash-strapped Brazilian government. “Competition was very high,” Brazil’s top energy regulator, Decio Oddone, said to reporters. “The Brazilian society will appropriate 90% of pre-salt proceeds.”

Temer’s government desperately needed some good news, with approval ratings in the single digits. While he has been wildly unpopular for quite some time, the sudden turmoil hitting the Brazilian economy has sparked somewhat of a crisis. Brazil’s currency suffered a spike in volatility last week, losing nearly 4 percent of its value against the dollar in a matter of days. “There is no risk of a currency crisis in Brazil,” Temer said last week, trying to reassure the markets.

The central bank was forced into action to stop the losses, and the bank’s president promised to sell reserves if the situation required it. Independent analysts see interest rate hikes as likely. “The Central Bank and the Treasury will continue offering liquidity in a coordinated way, be it in the currency market, be it in the interest rate market,” Central Bank President Ilan Goldfajn said on Friday. Related: EV Adoption Could Cost Germany 75,000 Jobs

Against this complicated political and economic backdrop, the results of the latest auction are rather impressive, and they speak to the high value that the industry puts on Brazil. “You are not seeing this in any other area of the world,” Ricardo Bedregal of IHS Markit told the New York Times.

Brazil is widely seen as one of the few areas that offer enormous potential for non-OPEC production growth, and Brazil could be the largest source of additional supply over the next five years, second only to the United States. That is exactly why companies like ExxonMobil and Shell want their piece. Shell spent more than $50 billion to purchase BP Group a few years ago, a move that was, in part, a major bet on Brazil. Exxon was late to the party but now has stakes in 25 blocks in Brazil.

Still, production from Brazil has often lagged expectations. The IEA had to lower its forecast for Brazilian output in 2018 by more than 150,000 bpd compared to last year’s estimate. Producing oil from Brazil’s pre-salt is expensive and complex, and despite its potential, it is still a gamble. “High interest for the pre-salt is leading to very risky bets,” said Juliana Miguez of Wood Mackenzie, according to the WSJ. She told the WSJ that the projects could be unprofitable if production falls short of estimates, “but based on pre-salt estimates, they are feasible.”

By Nick Cunningham of Oilprice.com

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