Petrobras Scandal May Force Brazil To Sell Off Presalt Assets

There is an old cliché about Brazil that sums up the country's unmet potential. "Brazil is the country of the future…and always will be." That expression aptly describes the country's oil sector as well.

The oil and gas reserves in Brazil are immense. The 2007 discovery of vast reserves of oil located beneath a layer of salt in the Atlantic Ocean was supposed to turn Brazil into an energy superpower. Once the state-owned firm Petrobras tapped the "presalt," Brazil would more than double its oil production by 2020, targeting 5 million barrels per day. At those levels, it would be in an elite club of oil producers, likely breaking into the top five worldwide.

But in dramatic fashion, late last month Petrobras finally faced reality and overhauled its plans and projections moving forward, gutting capex by 37 percent and slashing its expected 2020 production level down to just 2.8 million barrels per day. In other words, Petrobras expects to merely keep production flat through the end of the decade.

Due to its astronomic levels of debt, Petrobras has decided to sell off some of its assets. And to ease the burden, the Brazilian Congress is looking to overhaul its laws to open up the oil and gas sector to private investment, not so dissimilar to what is going on in Mexico.

Offshore Opens Up

That provides huge opportunities that were hitherto off limits to international companies. Of course, private companies are allowed to operate in Brazil, but the state-owned firm Petrobras has been required by law to be the sole operator in the presalt and have a minimum 30 percent stake (the law, passed in 2010, leaves in place arrangements with private companies who have operatorship dating back before the law's passage). Private companies can take a stake in projects, but must yield to Petrobras.

If that changes - with legislation possibly moving forward as soon as September - the doors will swing open to international exploration companies.

There are several fields that Petrobras is considering selling its stakes in.

Sagitario (BM-S-50). The ultra-deepwater field located in the Santos Basin was discovered in 2013. Located 120 miles from the coast of Sao Paulo, Petrobras drilled a test well in 2014, confirming the presence of oil and gas. The well was drilled to a depth of over 23,000 feet, and had an API of 32 degrees, indicating a high-quality, light form of oil. Petrobras has a 60 percent stake in Sagitario with BG Group (LON: BG) holding a 20 percent stake and a joint venture between Repsol (BME: REP) and Sinopec (HKG: 0386) controlling the remaining 20 percent.

Jupiter (Block BM-S-24). Another offshore field also in the Santos Basin, the Jupiter is about 200 miles from Rio de Janeiro. Petrobras has drilled several test wells in the field. It has a strong presence of hydrocarbons. In its Apollonia well drilled last year, for example, a 313-meter, and 87-meter thick, column of oil and gas was found. Petrobras controls 80 percent of the project, with the remaining 20 percent held by a joint venture between Sinopec and Galp Energia SGPS SA (ELI: GALP), a Portuguese firm. Petrobras is looking to use a floating production, storage and offloading (FPSO) vessel at the Jupiter in order to run more well tests. "Apollonia was much better than anyone expected, and is certainly the driving force that persuaded Petrobras to fast-track more work," an unnamed source told upstreamonline.com in 2014. Some even think that the Jupiter could be more productive than the much more famous Libra field, which is also using an FPSO (Libra is run by Petrobras, along with Royal Dutch Shell (NYSE: RDS.A), Total (NYSE: TOT), PetroChina (NYSE: PTR), and CNOOC (NYSE: CEO)).

Carcara (Block BM-S-8). Located in the Santos Basin, the Carcara was discovered in 2012. Another massive column - 470 meters of pay zone with 31-degree API. Petrobras is drilling appraisal wells this year to find out the extent of the discovery. Petrobras has a 66 percent stake, along with Petrogal Brasil (Galp Energia) with 14 percent, Queiroz Galvão with 10 percent, and Barra Energia do Brasil Petróleo e Gás with the remaining 10 percent. The companies let go of other prospects - Bem-Te-Vi and Bigua - nearby in order to focus on Carcara as the potential is large.

Pao de Acucar (Block BM-C-33). An offshore field located in the Campos Basin, northeast of the Santos Basin, Pao de Acucar is also in ultra-deepwater. The Repsol-Sinopec joint venture controls 35 percent and is actually the operator on this one. Statoil (NYSE: STO) has 35 percent, and Petrobras controls the other 30 percent. Pao de Acucar is thought to have one of the thickest columns of oil and gas to have ever been discovered in Brazil, with hydrocarbon columns as thick as 500 meters. The field could hold 700 million barrels of recoverable oil and 3 trillion cubic feet of natural gas. It will pain Petrobras to sell off part of its stake in this one.

Outlook

Petrobras could divest its positions in the fields mentioned above. That provides a big opportunity for the firms involved to take larger stakes and/or become the operator. Petrobras' woes could play to the benefit of the international companies, who have been waiting a long time for a liberalization in the oil sector. That day may finally be approaching.

One of the big variables in offshore Brazil is the proposed Shell-BG merger. BG has a significant position in Brazil's offshore sector, and before Petrobras sells off and farms out some of its assets, it also has to consider the ramifications of the BG purchase. Shell and BG have stakes in the Lula and the Libra fields, two of the most promising, and both of which are operated by Petrobras. The Lula is thought to be the largest oil discovery in the western hemisphere in decades.

The Shell-BG merger, which Brazilian regulators just approved, could cut both ways. After spending $70 billion, Shell may not have much of an appetite for much more. On the other hand, Shell clearly sees its future in Brazil, so it could continue to divest elsewhere and double down in Brazil. The latter is probably more likely, as Shell has already expressed interest in becoming the operator on certain fields. That offers the shareholders of Shell-BG a huge upside, and bodes well for Petrobras as it tries to raise cash by selling off assets.

Conclusion

Up until very recently, it would have been unthinkable that Brazil would shift its energy policy towards a less nationalistic posture. Brazilians have been very proud of their natural resources, and Petrobras was seen as a national champion. That would have made divesting from productive offshore assets - assets that have been the backbone of Brazil's economic optimism over the last decade - very difficult to pull off. Any plans to sell off offshore fields would have run into a wall of public opposition.

But things have changed dramatically over the past year. The corruption scandal has tarnished Petrobras' image terribly, and the economic malaise that has descended over the country is perceived to be linked to the scandal, as well as missteps by the government. The failure of Petrobras to boost production along with its pile of debt that has ballooned in recent years, has suddenly made privatization of some oil fields more palatable. If Petrobras cannot pull off the presalt on its own, maybe private companies can help out, the thinking goes.

That offers a huge opportunity for companies already operating in Brazil. Repsol-Sinopec, the soon-to-be Shell-BG conglomerate, Galp Energia, Statoil, CNOOC, and others have a chance to scoop up assets from the bloated Petrobras. For all the problems with Petrobras and Brazil's broader economy, let's not forget that there are vast resources that lie just offshore in the Atlantic, and many companies are more than willing to take over.