Brazil nuts about growth

Opinion by Energy Voice

JUST as the threat of a double-dip recession reappears across North America and Europe, Brazil is reinforcing its position as an economic powerhouse.

Last year, its gross domestic product jumped 7.5%, compared with 1.7% in the UK, and following its successful bids to host the 2014 football World Cup and 2016 Olympics it is attracting foreign interest and investment like never before.

Key to the country’s future economic prospects is its oil and gas industry.

Since 2006, Brazil has moved from being a net importer of oil to a net exporter, despite ever increasing domestic demand.

Although currently modest, that surplus is set to dramatically increase over the next few years as more developments are brought on stream and the country establishes itself as a major oil exporter. Indeed state operator Petrobras expects to increase domestic production from 2.1million barrels per day in 2010 to 3.95million bpd in 2020 – a 6.5% year-on-year increase.

Such grand plans don’t come cheap and last month Petrobras approved a $224.7billion five-year investment programme. This ambitious plan, currently the world’s largest in the oil industry, aims to help Petrobras tap into Brazil’s vast, deepwater “pre-salt” oil discoveries – estimated by the government to be at least 50billion barrels oil equivalent – which it anticipates will be the source of some 40% of the country’s oil production by 2020.

Meeting this potential promises to be challenging, not least because of local content requirements. In the context of Brazilian oil and gas licensing, local content refers to the obligations on exploration and production companies to source goods and services in country.

The logic is clear – develop know-how, build up Brazilian manufacturing and engineering and increase employment. But the policy is a complicating factor for foreign companies offering products and services to the Brazilian oil industry and risks pushing up costs for operators.

As part of the licensing process, bidders have to commit to a certain minimum level of local content in aggregate and for particular categories of goods and services (items and sub-items).

For example, in the most recent (10th) licensing round, local content percentage minimums were 40% for seismic interpretation and processing, 90% for drilling rig chartering and 100% for well-lining.

If a concessionaire fails to meet its obligations, it could be fined 60 to 100% of the non-realised local content percentage – potentially a lot of money. On the other hand, if operators do not bid a high enough local content percentage they will prejudice their chances of winning the concession.

It’s a classic Catch-22 – risk being unable to meet your obligations or miss out entirely.

Brazil desperately needs foreign investment as capacity constraints are already apparent, particularly offshore. Its local shipbuilding market is still developing, and of 40 shipyards only four are believed to be capable of building production ships (FPSOs).

While some of the biggest names in shipbuilding, like Hyundai Heavy Industries, are working with local Brazilian companies like OSX to develop more facilities capable of building such units, it will take time.

But Petrobras’s latest business plan calls for the delivery of 50 FPSOs by 2020 and it is hard to see how these demands will be met locally. Indeed, Maersk FPSOs was unable to build a $1billion vessel for use at the Statoil operated Peregrino field near Rio de Janeiro due to lack of local capacity. In the end the job went to China and Singapore. That field’s local content requirement is 35%, well short of the 77% target for all new developments.

This lack of supply is pushing up costs. Prices for many locally produced items are 20-30% higher than internationally – the so-called “Brazil cost”.

At the same time, obligations to use less experienced local contractors may also risk delaying oil production, potentially deferring hundreds of millions of dollars in revenues, and could stymie Petrobras’ ambitions.

Barclays Capital, for example, suggests that a 5% annual output increase over the next 10 years should be seen as a positive result – against the 6.5% forecast by Petrobras. Despite the restrictive nature of the local content rules, Brazil’s offshore oil and gas industry has the potential to be so lucrative that it may justify some suppliers moving production to Brazil or reconsidering their own supply options. Indeed some already have.

Oil services company Cameron has more than 1,000 employees based in Brazil, and the rewards are clear – it is due to supply Petrobras with 138 subsea “Christmas” trees this year in a contract worth $100million.

For suppliers keen to get a slice of the action and circumvent the restrictive local content rules, it seems that setting up shop in Brazil may well be the best way forward.

Penelope Warne is head of energy at CMS Cameron McKenna LLP