The Fuse

Brazil’s Offshore Sector Rebounds After Years of Disappointment

by Nick Cunningham | October 12, 2017

In late September, Brazil staged its most successful offshore oil auction on record, succeeding in attracting billions of dollars of new investment at a time when offshore drilling has slowed throughout much of the rest of the world due to low oil prices.

Brazil has struggled to reinvigorate its oil sector after failing to realize its ambitious production goals laid out about a decade ago after a series of high-profile discoveries in the pre-salt—large oil reserves located beneath a thick layer of salt in deepwater. Not only has output increased at a slow rate in recent years; a massive corruption scandal has crippled Petrobras, creating a cycle of debt, lower investment, and disappointing production results.

In late September, Brazil staged its most successful offshore oil auction on record.

Against that backdrop, the most recent offshore auction results may represent the beginning of a positive trend in an economy facing a recession and a toxic political environment. The promising results also demonstrate that Brazil’s offshore sector remains attractive even as the global oil industry has been hesitant to invest in big projects as a result of relatively low oil prices.

Brazil’s oil auction

The most notable result from the late-September auction came from ExxonMobil. The oil major agreed to pay $1.1 billion for the rights to drill in a half dozen blocks in the Campos Basin off the coast of Rio de Janeiro. Exxon will team up with Petrobras, Brazil’s partially state-owned oil company.

The entry of Exxon is significant. It was the only large oil company without a substantial foothold in Brazil, having abandoned the country years ago. One of its competitors, Royal Dutch Shell, has a much larger presence in Brazil, having acquired offshore acreage through its $50 billion purchase of BG Group. Shell has sold off assets and has undergone a multi-year divestment campaign to slim down and raise cash in the wake of low oil prices and its expensive acquisition of BG.

However, Brazil is one market from which the Anglo-Dutch oil major has not backed away. Shell said it plans on spending $10 billion over the next five years, making it Brazil’s largest foreign investor. Key to Shell’s calculation is the fact that its Brazilian assets can turn a profit with oil prices at $40 per barrel, and Brazil arguably ranks as one of the cheapest places in the world to develop new offshore projects.

Key to Shell’s calculation is the fact that its Brazilian assets can turn a profit with oil prices at $40 per barrel, and Brazil arguably ranks as one of the cheapest places in the world to develop new offshore projects.

“Everybody wants to get a piece of the pie,” Kjetil Solbraekke, senior vice president for South America at consultancy Rystad Energy, told the Wall Street Journal in an interview from April 2017. “These are probably the most prolific, high-returning oil assets available in the world.”

As the WSJ noted, the partnership of Exxon and Petrobras won the rights to a single block, C-M-346, by submitting a bid greater than five times the second-place offer from a team led by Royal Dutch Shell and Spanish oil firm Repsol. In a second block, the Exxon/Petrobras team bid 25 times higher than the runner up. The bids were so high because the blocks offer more upside with less regulatory hassle.

The auction was not a total success, however, as some tracts did not receive bids. But Brazil plans on holding another eight auctions, with highly-anticipated pre-salt offerings to be held in late October.

Turnaround for Brazil

The auction results came on the heels of a major policy overhaul in 2016 that opened up Brazil’s energy sector to private sector investment. Up until last year, Petrobras by law had to lead on all projects in Brazil’s pre-salt, and it also had to own at least a 30 percent stake in each venture. The logic was that the Brazilian government and its citizens should benefit from the exploitation of the pre-salt.

The positive auction results came on the heels of a major policy overhaul in 2016 that opened up Brazil’s energy sector to private sector investment.

Critics of those requirements argued that they drove up costs, inhibited investment, and led to disappointing production figures. Hobbled by a far-reaching corruption scandal, Petrobras felt the burden of leading as it still suffers from the largest debt pile of any oil company in the world. Austerity, for both Petrobras and Brazil, meant that the country’s oil ambitions had to be significantly altered.

With Petrobras clearly unable to go it alone in the pre-salt, calls for participation from international oil companies began to resonate. The impeachment last year of former President Dilma Rousseff ultimately paved the way for dramatic policy overhaul that allowed for private sector involvement in the pre-salt.

Offshore rebound

The September auction of offshore acreage was billed as a harbinger of Brazil’s offshore prospects following its major energy reform. In many ways, however, it is also illustrative of a global uptick in interest in offshore drilling after years of contraction.

Brazil is not the only place where the oil majors are pouring money into offshore exploration. Exxon is also spending heavily to develop its large discoveries off the coast of Guyana. In addition, like Brazil, Mexico has overhauled its energy sector, opening up offshore drilling to international firms. The initial results of Mexico’s energy reform yielded little, but interest has surged since late last year. A more speculative announcement came from Anadarko Petroleum, which said on October 5 that it plans on spending $200 million in offshore Peru. Hoping to capitalize on interest in Brazil’s massive offshore reserves, Argentina announced plans to hold an auction for resources along its Atlantic Coast, which country officials say could be an extension of Brazil’s pre-salt—although Argentina’s coast has seen very little exploration to date.

Large-scale projects, roughly speaking, can now breakeven at approximately $50-55 per barrel, after needing prices in the mid-$70s prior to the 2014 market downturn.

Offshore drilling was seen as a luxury that few could afford when oil prices crashed below $40 per barrel. But with oil firming up to above $50 per barrel, offshore investment is starting to rebound. Aiding in the sector’s recovery is the falling cost of production. A report from Wood Mackenzie earlier this year found that offshore production costs have declined by 27 percent since 2014. Large-scale projects, roughly speaking, can now breakeven at approximately $50-55 per barrel, after needing prices in the mid-$70s prior to the 2014 market downturn. But those estimates are a global average—the breakeven in Brazil’s pre-salt is even lower in many cases, giving the country hope this it is on the right track.

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