China Inc. Battles Big Oil for Century’s Biggest Find

Cnooc Headquarters in Beijing
The headquarters of Cnooc Ltd. stand in Beijing. Cnooc said in an e-mailed response to questions on Libra that it will keep the market informed of significant developments. Photographer: Nelson Ching/Bloomberg

For Chinese oil companies, competing in Brazil’s auction today for the giant Libra field represents a change in strategy. A successful bid would be their riskiest Latin American investment.

Cnooc Ltd. and China National Petroleum Corp. are among companies registered to bid for what may become one of the world’s two largest deep-water fields, requiring an estimated $184 billion investment. Libra holds as much as 12 billion barrels, or three years of China’s consumption, Brazil’s oil regulator estimates. Other bidders include Royal Dutch Shell Plc and France’s Total SA.

“This is too big an opportunity for them to miss,” Ivan Cima, head of Latin American research at Wood Mackenzie, said in a telephone interview from Houston.

Only one successful well has been drilled at Libra, part of subsea prospects known as pre-salt that contain the biggest oil discoveries this century. Winning the license would shift strategy for Chinese state producers to one of drilling and developing new deposits, after years of buying into operating fields and more advanced exploration projects in Latin America.

China’s state-controlled companies have less experience drilling in deep waters and would work in partnership with Petroleo Brasileiro SA, the world’s biggest producer in waters deeper than 1,000 feet. Brazil requires state-run Petrobras to take at least 30 percent in concessions for the deposits that lie beneath a layer of salt below the Atlantic seabed.

New Model

“The Chinese usually prefer to pay a bit more for production” rather than exploration assets, Caio Carvalhal, an oil equity analyst at JPMorgan Chase & Co., said by phone from Sao Paulo. State-owned bidders may find it more appealing to work with Petrobras than private oil drillers, he said. No U.S. companies registered for this auction.

Other potential bidders are Ecopetrol SA of Colombia, Mitsui & Co. of Japan, India’s Oil & Natural Gas Corp., Petroliam Nasional Bhd. of Malaysia, and a partnership between Galp Energia SGPS SA and China Petroleum & Chemical Corp., or Sinopec.

Repsol SA, which had planned a separate partnership with Sinopec, has dropped out of the contest, Kristian Rix, a spokesman for the Madrid-based company, said today by phone. He declined to give further information. The government deployed army troops to protect the Rio de Janeiro hotel where the auction is being held as masked protesters threw stones and tried to set a car on fire close to the beach-side venue.

While Petrobras will automatically join the winning consortium, it also has the option to bid as part of one. The bidders haven’t disclosed which partners they plan to take.

Biggest Spenders

The first auction of pre-salt fields using a production-sharing model will require an investment of 400 billion reais ($184 billion) over the 35-year concession, which will include 12 to 15 offshore oil platforms, according to the Brazilian regulator, known as ANP. Production is forecast to exceed 1 million barrels a day when fully ramped up.

Today’s bidding round follows another held in May for onshore and offshore blocks that are not pre-salt. May’s auction, which included permits to drill in virgin waters off the northern coast, was the first in Brazil since 2008 and attracted 39 bidders including Exxon Mobil Corp. and Chevron Corp. No Chinese companies participated as standalone competitors in that round.

Since 2010, China has picked up developed assets or fields with advanced exploratory activity in Ecuador, Argentina, Venezuela, Brazil and Colombia. Sinopec is the third biggest spender in the region since 1998, according to deals data compiled by Bloomberg going back to that year.

Gaining a pre-salt foothold is enticing Chinese companies into an earlier stage project, according to Wood Mackenzie.

‘Pay More’

Located more than 50 kilometers (31 miles) from Brazil’s southeastern coast and discovered in 2007, the pre-salt gets its name from the layer of Cretaceous-era salt formed at a time when dinosaurs still lived and which traps the crude under the Atlantic seabed. Sinopec is the only Chinese company with stakes in the area, through minority partnerships in joint ventures with Repsol and Galp.

Sinopec’s venture with Repsol was formed in 2010 through the acquisition of 40 percent of the Spanish producer’s Brazilian assets in the second-biggest oil deal in the country since at least 1998, according to data compiled by Bloomberg.

Cnooc said in an e-mailed response to questions on Libra that it will keep the market informed of significant developments. Lv Dapeng, a Beijing-based spokesman for Sinopec, didn’t answer a call to his office.

‘Limited’ Data

Brazil’s regulator doubled reserve estimates at Libra to 8 billion to 12 billion barrels on May 23 after CGG Veritas, a geophysical services company, conducted a study of the first exploration well. ANP encountered a layer of oil 326 meters deep at the well and did imaging of the surrounding area. Lula, the first producing pre-salt field, has estimated reserves of about 6.5 billion barrels.

Petrobras expects pre-salt deposits to double its output by 2020. The state-run company was hired to drill two wells at Libra. The first was abandoned after problems with well construction.

The Sinopec ventures, Cnooc, CNPC and the other participants registered for Libra will face “important risks,” according to Bank of America Corp.

“The estimates are still based on relatively limited information and could be subject to important adjustments as more information becomes available,” Frank McGann and Vicente Falanga Neto wrote in a report to clients dated Oct. 14. “The information on the quality of the reservoir remains limited. This is an important variable to define flow rates, and therefore return levels, and remains a key risk.”

Disappointing Turnout

Brazil increased its control over the oil industry after it announced in 2007 the discovery of at least 50 billion barrels in the pre-salt region. Now the government is setting up a state company, Pre-Sal Petroleo SA, or PPSA, with the power to veto decisions at pre-salt projects, including Libra.

The number of participants was about a quarter of the more than 40 companies expected by Magda Chambriard, who heads the ANP, she told reporters in Rio on Sept. 19. The government responded on Oct. 11 by easing terms of the auction.

Companies probably will form two or three bidding groups, Energy and Mines Minister Edison Lobao said last month in Brasilia. He told reporters Oct. 19 that nine companies presented guarantees to participate in the auction, which will proceed even if there is a single bidder.

CNPC and Cnooc can only bid as part of the same consortium because they share the same controlling stakeholder, China, according to the ANP.

Profit Oil

JPMorgan’s Carvalhal said China’s interest makes sense because Libra isn’t as risky as it may look. While Chinese producers’ strategy has been “pay more, have less risk,” he said “this doesn’t change with Libra, because there’s high certainty that it will be developed.”

The winner will be the group offering to pay the government the highest percentage of profit oil, or the barrels remaining after all costs are covered, with a minimum of 41.65 percent. The successful bidder will pay a 15 billion-real signing fee.

Petrobras Chief Executive Officer Maria das Gracas Foster has personally sought to lure Chinese investments to Libra by traveling in August to meet with executives in the Asian country. Chambriard also visited China as part of efforts to market the auction.

“Libra is potentially one of the top two biggest deep-water fields in the world,” together with Petrobras-operated Lula, according to Wood Mackenzie’s Cima. “It’s something that hasn’t been seen before and maybe won’t be seen again.”

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