Brazil Stumbles Through a Vital Oil Auction

Brazil’s auction on Monday of its offshore Libra oil field, a prized "pre-salt" crude reservoir -- 6,500 feet under water and trapped below a thick layer of salt -- was a predictably disappointing spectacle.

Brazil's auction on Monday of its offshore Libra oil field, a prized "pre-salt" crude reservoir -- 6,500 feet under water and trapped below a thick layer of salt -- was a predictably disappointing spectacle.

For a tender that opened the door for private companies to tap into an oil trove of at least 8.5 billion barrels of oil -- enough to cover more than a year's worth of U.S. crude oil consumption -- few seemed interested.

A consortium of five companies (Brazil's state-owned Petroleo Brasileiro SA, France's Total SA, Royal Dutch Shell Plc, China's Cnooc Ltd. and the China National Petroleum Corp.) won the license by offering the government the minimum acceptable bid of 41.65 percent of the oil left after covering the field's production expenses. No one else made an offer. Still, that didn't stop Magda Chambriard, the head of Brazil's oil regulator Agencia Nacional de Petroleo de Brasil, from telling reporters at a press briefing later that day: "It is difficult to imagine a bigger success than this."

Chambriard's imagination has been a problem. She originally expected more than 40 companies to participate. When only 11 had signed up in early October, Chambriard's ANP sweetened the terms of the tender hoping to lure more investors. In the end, less than half of those registered bothered to bid.

The 300 Brazilian protesters outside the Hotel Windsor in Rio de Janeiro, where the auction took place, showed far more passion about Libra's reserves when demanding the end of what they saw as the field's "privatization." The nearly 1,100 troops deployed to guard the event used tear gas to disperse the crowd and left six people injured.

The leftist Telesur television network took the side of protesters when its anchor reported on Monday: "Police repressed a protest that rejects the privatization of the Libra field, the country's largest oil deposit." The demonstrations crowned five days of an oil-worker strike aimed at stopping the auction that led nearly 90 percent of Petrobras workers to walk off the job.

The whole episode didn't look very good for a country that bills itself as a new oil frontier. President Dilma Rousseff tried to ease tensions with a Monday night televised speech in which she broke down the money Brazil stands to gain from Libra during the next 35 years: "First, 270 billion reais in royalties; second, 736 billion reais in excess oil; third, 15 billion reais as a sign in bonus. That amounts to a fabulous amount of more than 1 trillion reais. I repeat: more than 1 trillion reais." For those still unclear about what that means, Rousseff pointed out: "85 percent of all the rent generated by Libra will belong to the state of Brazil and to Petrobras. That is very different from a privatization."

Rousseff's attempt to sell Libra's tepid auction as a success shows just how far Brazil has fallen from its perch as a favored destination for global investment. The protests also suggest that Brazilians don't understand or have not decided how to best develop their newfound oil wealth. Jealously guarding a nation's natural resources is sensible. But Brazil's pre-salt oil wealth has not been fully tapped yet, and already many Brazilians appear to exhibit the sense of entitlement typical of those accustomed to oil riches.

O Estado de S. Paulo newspaper said it best in its Saturday editorial: The story of Libra's privatization "only rings true for those whose inclination for activism is inversely proportional to the level of information about what prompts them to hit the streets" in protest.

Opposing foreign investment in principle is not realistic. For starters, Petrobras is the world's most indebted oil company, which means it cannot develop Libra on its own. Moreover, Brazil's new production sharing contracts designed for pre-salt fields make it more enticing for the government to seek out partners. These contracts give more than 70 percent of a field's take to the government at current oil prices, according to Credit Suisse, far more than Brazil's old oil concession regime.

The good news for the winners of Libra is that the rate of return of the venture could exceed a respectable 19 percent, if the minimum estimate of 8.5 billion barrels in reserves proves accurate and if oil prices sit at $100 a barrel.

The bigger unknown for companies is how Brazil's restrictive oil rules will hurt business in the long run. For instance, Brazil's requirement that Petrobras remain the sole operator of all pre-salt fields does not sit well with a company like Exxon Mobil Corp. known for running nearly all its projects. And the "local content" rule forcing oil projects to buy goods and services locally, despite Brazil's lack of capacity to service that demand, is already a big obstacle to increasing oil output.

Add to that Brazil's legislation that gives a new state-owned company, Pre-Sal Petroleo SA, the power to veto major oil project decisions, and the absence of bidders on Monday's auction begins to make sense.

Some still support Brazil's restrictive oil policies. Giorgio R. Schutte, a professor at the Universidade Federal do ABC, made the government's case in a Valor Economico column published Monday: It would be a "grave mistake" to blame Brazil's oil output delays on local content rules, he wrote, since "it would be irresponsible not to take advantage of the long-term opportunities for local production" growth. But long-term output growth will never happen if Brazil fails to take the right steps in the short term.

Despite the problems, Rousseff did pull off a risky auction. As the daily Folha de Sao Paulo put it in its Tuesday editorial: Some credit is due to the "Rousseff administration for having faced the nationalist unions" that opposed the tender. In fairness, Libra's auction is a dress rehearsal for future pre-salt tenders. Rousseff should ponder ways to improve the process to make Brazil a desirable investment destination again, instead of a country that, as the old saw goes, once had a bright future.

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