The Fuse

Brazil Engulfed in Political Crisis, But Oil Production Will Still Rise

by Nick Cunningham | May 24, 2017

Brazil is once again in a state of political crisis after tapes surfaced containing President Michel Temer discussing bribes to a jailed politician to keep quiet about a corruption scandal. Protests erupted after the release of the tapes, calling for the President’s impeachment.

The irony is that Temer and his colleagues led an impeachment campaign against former President Dilma Rousseff for alleged corruption. Her ouster in 2016 was connected to the massive scandal involving Petrobras, the state-owned oil company. The scheme involved construction and engineering contractors overbilling Petrobras, then skimming off funds that were ultimately kicked back to Petrobras executives as well as a long list of politicians. Rousseff herself was not accused of involvement, although members of her party were implicated. Nonetheless, the Brazilian Congress impeached her over allegedly manipulating budgetary figures.

The details are complex, but the current political crisis can be linked to the same scandal—President Temer is reportedly implicated in a tape discussing payments to Eduardo Cunha, a former speaker of the lower house who was jailed because of his involvement in the Petrobras scandal, in order to keep him quiet.

Despite Petrobras’ predicament and the explosive political crisis engulfing Brazil at the moment, Brazil is set to grow its oil production substantially over the next few years.

As for Petrobras, the scandal has done lasting damage. The state-owned oil company has been dogged by a wide-ranging multi-year investigation while simultaneously trying to navigate a once-in-a-generation meltdown in oil prices. However, despite Petrobras’ predicament and the explosive political crisis engulfing Brazil at the moment, Brazil is set to grow its oil production substantially over the next few years.

Petrobras chastened, private sector takes over

Petrobras has long been just about the only game in town for Brazil’s oil sector. For years, the mostly state-owned oil company had a monopoly over the country’s vast pre-salt oil reserves. But the corruption scandal and subsequent investigation (known as “Operation Car Wash”) plagued the company, leading to ballooning debts and stagnant oil production. Petrobras has been forced to repeatedly cut its production forecast. In 2013 the company aimed to produce 5 mbd by 2020; now Petrobras only believes it will be able to reach 2.7 mbd over that timeframe.

As debts soared, the company looked increasingly unable to carry the burden of the pre-salt ambitions. But last year’s impeachment of former President Dilma Rousseff cleared the way for a dramatic overhaul of Brazil’s oil sector. The reform scrapped the requirement that Petrobras own a 30 percent stake and operatorship in all pre-salt oil fields, essentially opening the door to private international companies. The government hopes this change will lead to higher production.

Recent reforms scrapped the requirement that Petrobras own a 30 percent stake and be the operator in all pre-salt oil fields, essentially opening the door to private international companies.

Brazil is set to hold 10 licensing rounds over the next three years. The first pre-salt offering will be in June and will focus on offshore tracts near known oil discoveries. The auction could lead to additional investments that come on top of a handful of high-profile commitments from several oil majors. Royal Dutch Shell has already said it will spend $10 billion in Brazil over the next five years, with a large portion of that total allocated to the Libra field, an 8 billion-12 billion barrel behemoth. That could allow Shell to nearly triple its Brazilian output to 800,000 barrels per day (b/d) by 2020. Other companies have also signed a rash of deals, including Total, which spent $2.2 billion to acquire a 35 percent stake in the Lapa field and a 22.5 percent stake in Berbigao and Sururu fields. Last July, Statoil took a 66 percent stake in a block within the Carcara discovery for $2.5 billion.

Petrobras still growing

Meanwhile, Petrobras is hoping to do more with less. The company’s latest business plan calls for $74 billion in spending over the next five years, which is a massive 25 percent reduction from the previous edition of its spending plan. But it isn’t all bad news for the state-owned company. Even as Petrobras will see its role diminish, it has plans to bring 19 new projects online by the end of 2021. Petrobras has had its hand in nearly every stage of the oil and gas sector, from upstream to downstream and even in related industries such as petrochemicals, electricity generation and ethanol. As it is in the process of slimming down, Petrobras will shift its emphasis toward upstream production, while also focusing on efficiency, productivity and costs.

Average lifting costs have fallen to just $8 per barrel, nearly half of the industry standard of $15 per barrel, according to the International Energy Agency (IEA). Moreover, the average time to bring an offshore project online in the Santos Basin, for example, has declined by two-thirds since 2010, to just 54 days. At the same time, the average pre-salt well is producing 25,000 barrels per day, much higher than the company originally anticipated. Despite repeatedly slashing its spending plan, Petrobras expects that these operational improvements will nonetheless allow the company to continue to grow production—the IEA projects that Petrobras will add 700,000 b/d of new output through 2022, or about two-thirds of Brazil’s total expected gains.

Natural depletion and maintenance will offset some of the gains, but the IEA projects growth of 215,000 b/d in 2017, making it one of the largest sources of non-OPEC growth this year after the U.S.

New entrants combined with growth from Petrobras will allow Brazil to boost its oil production, which is already on an upward trend. As of March 2017, Brazil was producing 2.65 million barrels per day (mbd), or 285,000 b/d higher than a year earlier. A third of the gains have come from pre-salt fields, according to the IEA. Production is set to rise further as an estimated four projects reach completion in 2017 after three came online last year. Natural depletion and maintenance will offset some of the gains, but the IEA projects growth of 215,000 b/d in 2017, making it one of the largest sources of non-OPEC growth this year after the U.S. The production gains continue over the medium-term, with output expected to rise by 1.1 mbd by 2022.

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Uncertainty ahead

Despite the success, there are a lot of hurdles standing in the way. Petrobras is still the most indebted oil company in the world with total debt sitting at a colossal $122.7 billion as of 2016. The company embarked upon a $15 billion divestment program for 2015-2016, but found the campaign difficult, struggling to find enough buyers while also running into trouble at home. A court ruling late last year has held up some sales. Petrobras is planning $21 billion worth of divestments throughout 2017-18 in order to whittle away at its debt, but again, that target could prove to be ambitious. In the interim, Petrobras has been forced to take out a $5 billion loan from the China Development Bank, which came on top of a $10 billion loan in February 2016. In exchange, Petrobras agreed to earmark 100,000 b/d of crude oil for China for ten years. In short, Petrobras’ debt problems are significant, to say the least, which could yet force the company to rein in its production ambitions.

Despite the success, there are a lot of hurdles standing in the way. Petrobras is still the most indebted oil company in the world.

The political crisis also presents a huge question mark. President Temer is now in danger of suffering the same fate as his predecessor. A lengthy impeachment process—the second in a little more than a year—would derail economic reforms. S&P Global Ratings raised the specter of another credit downgrade for Brazil because the political crisis will drag down the economy. Fortunately for Brazil, barring a return to state ownership of the pre-salt, investment from IOCs will probably rush in regardless of who controls the government. That should help Brazil post gains in oil production for years to come.

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