H​ow Brazil’s oil industry is working to recover from commodity crash, scandal

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The boom-bust oil-driven cycle in Alberta looks benign compared to that of Brazil, where that country’s commodity-driven economy saw growth in its gross domestic product plunge from a high of 10.1 per cent in the first quarter of 1995 to a low of negative 5.8 per cent in the fourth quarter of 2016—but now there are some signs its economy is on the mend.

Brazil is also trying to mend its relationship with outside investors, including actions to open up its up oil and gas industry to international service providers and producers other than state-owned Petrobras.

When oil and gas prices were on an upward trajectory, Petrobras, 64 per cent owned by the government or its entities, was a cash cow. In 2010, for instance, it paid royalties as high as 10 per cent, “participation charges” as high as 40 per cent on projects it was developing, and other sales and taxes adding up to about 35 per cent of its total revenue.

The company also paid dividends to the government and was required to offer 85 per cent of the value of its contracts to Brazilian companies. Overall, its payments represented more than 10 per cent of total government revenue.

Then the oil crash came, along with the strangely named “Operation Car Wash” scandal, the greatest corruption scandal ever seen in a democracy. The numbers are staggering, with up to three per cent of the value of every contract with Petrobras diverted to bribes, adding up to US$2 billion.

So far, 179 people have been charged in connection with the scandal, with sentences totalling over 1,000 years in prison. The controversy led to the 2016 impeachment of Brazilian president Dilma Rousseff, and thousands of contractor and Petrobras jobs have been lost.

The scandal, along with the oil price shock, led to Petrobras writing down US$15 billion in 2015. The company is US$150 billion in debt and its shares, listed on the New York Stock Exchange and bourses, declined by 85 per cent at one point. (They’ve since recovered about 30 per cent of their value.)

The company’s new chief executive officer, Pedro Parente, recently announced a five-year recovery plan that revolves around getting the company’s finances in order. That will be done by cutting already-reduced capital expenses by 25 per cent to US$74 billion in 2017, and divesting about US$36 billion in non-core assets.

Pre-salt

While Petrobras has been guilty of mismanagement—it paid $1 billion for a U.S. refinery observers say was probably worth $50 million, for example—the company has discovered what may be one of the world’s largest deep offshore oil and gas reserves.

The so-called pre-salt layer in the Brazilian continental shelf has as much as 50 billion barrels of reserves, almost four times the country’s current reserves of about 14 billion barrels. The pre-salt extends 800 kilometres along the country’s coast, with the total area covering 122,000 square kilometres. The company has spent US$225 billion developing the pre-salt fields 300 kilometres offshore in ultra-deep waters. Special drilling equipment had to be developed. The ultimate prizes are huge.

In December Petrobras announced it had reached the milestone of one billion barrels produced from its pre-salt assets, just six years after the first production system went on-stream.

Concessions have been granted to about one-quarter of the pre-salt area. Norway’s Statoil and partners, including Spain’s Repsol and China’s Sinopec, along with Petrobras, drilled a well at 6,230 meters in 2016 that yielded 4,000 barrels of oil and 16 mmcf of gas.

Royal Dutch Shell is the largest private sector participant in Brazil, following its US$52-billion takeover of BG Group, long a major player in the country. It already produces 7.56 per cent of Brazil’s output of three million bbls/d and plans to be a major player in the pre-salt.

The biggest news of late was the move by Brazil’s congress to remove the exclusive Petrobras rights to the pre-salt earlier this fall. Previously it retained a mandatory 30 per cent holding in all pre-salt fields.

The move is expected to attract interest from major global players with the deep pockets required to develop the resource.

There is other work afoot designed to make Brazil an attractive place in which to do business for midsize Canadian producers, as well as for the service sector, says Nadine Lopes, trade commissioner of ocean technologies and oil and gas with the Canadian Trade Commissioner Service in Rio de Janeiro.

Rebuilding trust

Lopes says the country’s tortured history, as well as the soiled reputation of Petrobras, will mean Canadian exploration and production and service companies will be very cautious about entering—or in some cases, re-entering—the market.

“It will take awhile for them to recover trust in Petrobras and in the Brazilian environment,” she says. “The last 10 or 11 years have been difficult for foreign companies to operate in this market.”

Strict local content requirements made it virtually impossible for Canadian and other foreign companies to operate in the country, she says. Those are now to be gradually eliminated.

“There was a minimum requirement that 70 per cent to 80 per cent of all goods and services had to be Brazilian, even though Brazilian companies couldn’t supply those goods and services,” she says.

The Brazilian oilfield service sector isn’t developed enough to provide most of the services required, either onshore or onshore.

With Petrobras focused on the pre-salt, conventional offshore and land-based assets, which it’s divesting, are theoretically open to the private sector. “But there were no annual bidding rounds for five years, so there were no projects,” Lopes says.

However, now the government agency responsible for overseeing the sale of blocks to private operators has scheduled two rounds for next year, with the expectation there will be a third involving both pre-salt and other offshore assets. The March bidding round should be of interest to Canadian juniors and intermediates, she says, since it will involve mostly land-based blocks with proven reserves.

There are about 104 fields that could eventually be auctioned.

Lopes says Brazilian government officials have largely ignored Canada in the past. They held bidding rounds for 10 years before they were suspended five years ago. “They went to London, New York and Singapore,” she says.

With the suspension of local service requirements, there will be opportunities for Canadian oilfield service companies as well, she says.

After too many years of a closed market, Lopes is optimistic about the future opportunities for outside investors in the country’s oil and gas space. “Things are changing,” she says. “I believe the new government is bringing a more market-oriented vision, and Petrobras is committed to transparency and compliance.”

Mara Roberts, a New York City–based senior analyst of oil and gas at BMI Research, a Fitch Group Company, says that, despite the problems of Petrobras, “it is very good at finding oil.” In particular, it has been one of the best deep offshore explorers in the world.

“You need a lot of expertise at 7,000 metres offshore, and there aren’t many players who can do that,” she says.

Statoil and Royal Dutch Shell certainly have the required expertise, which is why they’re so active in the country. Roberts agrees with Lopes about most of the opportunities for Canadian juniors and intermediates, as well as for oilfield service players, being in the mature land-based blocks and some shallow offshore areas as well.

The country held a bidding round a year ago for some mature fields, and it did terribly with essentially no bids, she says. But she is convinced the upcoming rounds will be more successful. “The success of those rounds will be a litmus test for the future of energy reform,” Roberts says.

The mature onshore and shallow offshore blocks are not insignificant producers, she says. In total, according to a recent report from Petrobras, they are responsible for about 500,000 bbls/d.

Similarities to Mexico reforms

Roberts says one interesting aspect of the reform process in Brazil is that, to some extent, it echoes what is occurring in Mexico, where a similar process is seeing the monopoly of Petróleos Mexicanos (Pemex) come to an end, with the entrance of several private sector players into the country’s upstream, midstream and downstream sectors.

And, as with Mexico where Chinese player CNOOC recently won the bidding for two deep offshore blocks, the Chinese are very much in evidence in Brazil. Chinese companies have won the bidding for midstream assets, and both CNOOC and China National Petroleum are investors in Libra, the largest pre-salt field found to date, with reserves of eight billion barrels. The Chinese companies each hold 10 per cent stakes, along with partners Petrobras with a 40 per cent share, Total with 20 per cent and Shell with 20 per cent.

Roberts says the huge deep offshore opportunities in Mexico’s Gulf of Mexico, where reserves are in the billions, and in Brazil’s pre-salt are “crowding out” other oil and gas regimes in South America where prospects aren’t as significant, such as Colombia and Argentina.

However, given Brazil’s past failures at bringing about a reformation of its economy, interest in non-pre-salt assets will be tepid. “Brazil has burned the investor community,” and it will take time for confidence to be restored, she says.

As for unconventional oil and gas development prospects, Roberts says they are likely to remain largely untapped in the country given the environmental sensitivity of their location in the Amazon and the fact that the oilfield service sector in the country lacks the technology to develop the resources.

Junior Canadian producers

There are already a few Canadian juniors operating in the country.

Calgary junior Alvopetro Energy is high on its prospects in Brazil, almost exclusively focused on natural gas, which the country now imports from Bolivia as LNG. The country, which is about 70 per cent reliant on hydro for its electricity, is focused on diversifying its power mix by using more wind, solar and natural gas. It imports about half of its current requirements.

Corey Ruttan, president and chief executive officer of Alvopetro, says the Brazilian gas assets were spun off from the former Petrominerales when it was sold to Pacific Rubiales Energy in 2013 for $935 million. Pacific Rubiales has since changed its name to Pacific Exploration & Production, and Ruttan formerly led Petrominerales.

He says his current company’s holdings of 120,000 acres in the Reconcavo Basin, where it is focused on its Gomo tight gas play, give it the opportunity to steadily increase its gas production, close to the industrial city of Salvador, a heavy gas user.

“We had a large discovery there, with a certified resource of 40 bcf,” Ruttan says. There is 100 mmcf/d of gas being produced in the area, he says.

Alvopetrol is negotiating with the government and adjacent landowners on a “unitization” that should be resolved in the next 12–18 months. It would then have a 50 per cent share of production in the area, which should reach 23–24 mmcf/d.

Since that gas fetches around $6/mcf in the local market, it could generate annual revenue of $33 million and up (minus an 11 per cent royalty and operating costs).

“And once we show we can monetize our blocks, we think we can do that over and over again,” he says.

Maha Energy is another Calgary-based company active in Brazil. It’s listed on the Swedish stock market and has a large group of investors from that country as its chief executive officer, Jonas Lindvall, is a Swede who moved to Alberta several years ago after having a successful business career in his home country.

The company also owns a 100 per cent share of a heavy oil asset in Wyoming called the LAK Ranch and some assets in Manitoba.

Ron Panchuk, the company’s chief corporate officer, says Maha is concentrating on its 8,000-acre Wyoming property, which is in the Powder River Basin and has 100 million barrels in place. It is testing a hot water flood there in the hopes of increasing production from about 50 bbls/d.

But its biggest hope lies in its newly acquired Brazilian property, Tartaruga (Portuguese for turtle). It bought its initial 37 per cent stake in the property from Vancouver-based Petro Vista Energy and is in the process of acquiring other stakes from private Brazilian companies. If successful, it would then have a 75 per cent stake, with Petrobras holding a 25 per cent interest. In the past, production there has reached 800 bbls/d of light oil.

Although production is from shallow offshore pools, it is produced from shore, which makes it a good asset for a junior, Panchuk says.

Maha recently raised $12.8 million, and Panchuk says it has big plans for Brazil and hopes to participate in upcoming auctions.

“We think the dynamics of Brazil are excellent,” Panchuk says. “It’s like Colombia 25 years ago. We think there will be a strong oil and gas industry there.”

Panchuk, who spent all of November 2016 in Brazil, says his personal experience in the country convinced him that corruption is not as widespread as it might seem, and it will be a good place to do business.

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