Brazil's Oil Euphoria

Petrobras’s offshore bonanza may transform the country -- if oil prices hold and the company can extract the crude from beneath kilometers of salt and rock.

By Jeb Blount and Adriana Brasileiro
Bloomberg Markets, May 2009

It was a Sunday morning in August 2006 when Gilberto Lima broke the bad news to Mario Carminatti, executive manager for exploration at Petroleo Brasileiro SA, Brazil’s state-controlled oil company. The company’s quarter-billion-dollar bet on a new offshore oil field was a bust.

Years earlier, Petrobras’s study of the geological formations beneath Brazilian territorial waters had indicated there was oil -- lots of it. So the company spent $240 million drilling a test hole in the seabed more than 300 kilometers off the coast of Rio de Janeiro state.

All the drillers found, said Lima, Petrobras’s general manager for exploration, was water, salt and rock.

“I told Gilberto, ‘That’s impossible,’” Carminatti recalls. “‘Tell them to look again.’ It was one of the worst days of my life.”

It turned out that the drilling crew had sunk the wrong probe through the test hole. When they took a new sounding, they changed their minds about the presence of oil.

They also changed Brazil.

What the Petrobras geologists discovered was a pool of petroleum, now called the Tupi field, that the company says may hold 5-8 billion barrels of oil and gas. That would make it the largest strike in the Americas since Petroleos Mexicanos, Mexico’s state oil monopoly, found its Cantarell Field in 1976.

Tupi is just one of several “elephant” finds of more than a billion barrels each. If they pan out, they may make Brazil the world’s fourth-largest oil producer after Saudi Arabia, Russia and the U.S. It’s now 13th, according to London- based BP Plc, which ranks countries by production.

Oil Euphoria

In the wake of the discovery, there was euphoria in Brazil. Citizens literally danced in the streets of Rio de Janeiro at 2008’s Carnival parades to celebrate the find, with one float named “The Black Gold That Comes From the Sea.” President Luiz Inacio Lula da Silva said the flood of oil money would allow the government to attack poverty among Brazil’s 191 million people, 24 percent of whom live on less than $3 a day.

Then the world economy hit a wall, and the price of oil sank to $32 on Dec. 12 from a peak of $147 on July 11. Even though prices have recovered somewhat -- they stood at $48.4 on March 30 --investors are now wondering whether Tupi will be a bonanza or a case of misguided national celebration.

Petrobras shares fell 45.2 percent to 28.78 reais on March 30 from their peak in May 2008.

Deep-Water Leader

Rio-based Petrobras leads the world in deep-water oil drilling; it operates dozens of fields in Brazil, Africa and the Gulf of Mexico. “At $140 a barrel, or even $70, you could make lots of money,” says John Ditierri, who manages $7 billion of developing nation stocks for Emerging Markets Management LLC in Arlington, Virginia. “At $20 or $30, it’s not worth anything.”

Ditierri won’t say whether his firm owns Petrobras shares.

Analysts say Brazilian officials shouldn’t underestimate the technical challenges of extracting oil from Tupi, no matter what happens to the price of crude. The field, in Block BM-S-11, lies 340 kilometers (210 miles) from the Brazilian coast beneath 2 kilometers of water and 5 kilometers of sand, rock and salt.

“Much of their planning is based on the assumption that they can use the same technology they are using to produce oil offshore today and that they will only need to make minor adjustments,” says Rio-based Sylvie D’Apote, a director at Cambridge Energy Research Associates Inc., or CERA, in Cambridge, Massachusetts. “If that turns out not to be true, costs are likely to rise a lot.”

Brazil could also be hampered by a surge of economic nationalism, says Adriano Pires, a former member of the national petroleum agency board and head of Centro Brasileiro de Infra Estrutura, a Rio-based energy and infrastructure research group.

Government-Controlled

Though the government owns 40 percent of the total stock and 58 percent of the voting shares of Petrobras, Energy Minister Edison Lobao wants to form a new state-owned corporation to take control of the offshore oil reserves.

Creating a new state company would let the government keep out foreign oil companies, which now have a big stake in some of Brazil’s offshore oil fields, usually through partnerships with Petrobras. In 2007, Lula’s National Energy Policy Council temporarily blocked the sale of new licenses for the exploration blocks around the Tupi site.

Petrobras’s government-controlled board has approved an ambitious agenda for exploiting Tupi and other new offshore fields. In January, the company announced a five-year, $174.4 billion capital spending plan, which represents a 55 percent increase over the 2008-12 budget it supplants. The company says the new spending will let it increase production 52 percent, to 3.66 million barrels a day, which would make Brazil the second- largest producer in the hemisphere, after the U.S.

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