Brazil in flux: epic fail or opportunity boom?

May 26, 2015

If the stars align, and if foreign investors and engineers are up for the challenge, Brazil’s massive oil and gas industry could be on the brink of a massive opportunity boom for non-Brazilian oil and gas companies. Conversely, with a major corruption scandal putting Petrobras and the Brazilian government under duress, the country’s oil and gas sector could be headed for an epic fail. Can, and will, the government change energy-focused policies quickly enough to save the sector?

During a series of meetings and presentations held in Houston, Brazil’s most notable government and energy industry executives rendered speech after speech ostensibly touting the wealth of opportunities available in its offshore oil and gas sector, while subtly apologizing for the recent far-reaching corruption scandal, and politely pleading for desperately needed foreign investment and technology. Overall, the collective thinking seems to be persuasive toward new investment and technology flowing toward Brazil’s prolific offshore pre-salt plays.

During the past year, Brazil’s oil production increased from 2-2.9-billion b/d. Yet, prior to that, Brazil’s legal enforcement agencies were methodically working toward executing one of the largest corruption crackdowns in the nation’s history that centered on Brazil’s national oil company, Petróleo Brasileiro SA, commonly known as Petrobras.

Brazil corruption scandal

In 2009, a large-scale government bribery and money-laundering corruption scandal involving Petrobras was revealed via a public police operation, code-named “Car Wash,” that was undertaken by the federal police and federal judges. Enforcement agents were looking for illegal-money brokers who were laundering government-bribe money through gasoline stations and car washes. Yet, in 2010, Petrobras was able to successfully conduct one of the largest share sales in history when it raised US$70 billion in 2010.

By 2014, a number of Petrobras directors had been accused of taking bribes from construction companies and funneling funds to parties of the ruling coalition. Brazilian police have since carried out raids across six Brazilian states, arresting at least 23 people, including former Petrobras service director, Renato Duque, and 19 presidents and executives of some of the country's largest construction and engineering firms. These companies are accused of forming a cartel to drive up the prices of major Petrobras infrastructure projects.

At one point, former Petrobras director, Paulo Roberto Costa, who worked at the company from 2004 to 2012, confessed and told investigators that politicians received a 3% commission on contracts signed during this period. Black-market currency dealer Alberto Youssef also confessed to his participation. In 2014, Petrobras announced that it would have to delay the publication of its 3Q financial results due to the ongoing investigation. Furthermore, the auditing company PricewaterhouseCoopers refused to sign off on the firm's results.

In February, Petrobras CEO Maria das Gracas Foster, who had been with the company for 30 years, and five directors of the company stepped down from their posts following months of scandals. The company’s board picked Banco do Brasil CEO Aldemir Bendine to replace das Gracas Silva Foster days later.

To date, Petrobras has taken a $2.1 billion write down and a $14.8 billion impairment charge on its financial statements, according to global law firm Mayer Brown. Financial firm Morgan Stanley estimated the Petrobras financial write-down could be as much as $8.1 billion and UBS estimated the damage to be between $10-15 billion. Federal police say that at least nine of Brazil's largest construction firms are now under investigation: Camargo Correa, OAS, UTC, Odebrecht, Mendes Junior, Engevix, Queiroz Galvao, Iesa and Galvao Engenharia.

The general Brazilian population appears to be shocked and dismayed at the pervasive corruption. “On March 15, 2014, more than 2 million Brazilians demonstrated in 33 cities against corruption and the government,” explains Alex Chequer, a partner and co-leader of the global energy group at Mayer Brown. “In May 2015, Petrobras filed a $2.5 billion lawsuit against service companies involved in the corruption scheme. The government has promised to enact new legislation against corruption.”

Out of the dark

Yet, bad as it is, the scandal might be an opportunity to press the reset button on Petrobras and Brazil’s political and economic reputations. A thorough housecleaning and criminal sentences could bring Brazil out of the dark and into a new era of political and financial transparency, which would be very attractive to foreign investment.

“Because most of the biggest Petrobras suppliers of services and equipment are blacklisted now, they are not able to supply anything to Petrobras until these issues are solved,” Chequer says. “This brings a lot of opportunities for international operating partnerships and contractors to do business under the new and transparent standards. Also, for this year, Petrobras has launched a $13.7 billion divestment plan, and it is now offering, through an American investment banking firm, five very good assets, although I cannot mention the names of the assets right now.”

Petrobras also plans to sell a large part of its downstream assets, which holds a 45% marketshare in Brazil’s downstream market, which is the third or fourth largest downstream market in the world.

“As a Brazilian, I am very sad to say that we got into a very ugly situation with everything that is going on with Petrobras because, in 2007, with the pre-salt discoveries, that was the cherry on top of the cake,” says Mayer Brown’s Chequer. “They were the largest oil discoveries during the past 30 years in the world. But unfortunately, Brazil made a lot of mistakes. Now it is time to fix it. This country is the 6th largest economy in the world, and we cannot have a small group of people controlling the whole budget.”

Local content rules

In addition to improved anti-corruption and transparency legislation, the Brazilian government is looking at slightly loosening its local content rules, which currently require that a large percentage of Brazilians be employed in every venture. With a significant number of Brazilian service and supply companies banned from doing business with Petrobras, the firm is hard pressed to find adequately trained personnel.

“We would like to have local content with the same expertise as that found in the US, which has been responsible for developing technology to produce oil and gas from the shale plays,” says Jorge Camargo, president of the Brazilian Institute of Petroleum, Gas and Biofuels. “But local content is also very strategic for Brazil. Thirty years from now, we will be using the best technology to produce oil and gas efficiently and safely. But if we have not used this opportunity to build jobs and better economics, then we have failed.”

Nonetheless, Brazil intends to continue to romance US and European companies into working with Petrobras. “Now is the time for Americans to begin to seriously think about entering business in Brazil,” says Paulo Alonso, executive coordinator for PROMINP, the Brazilian government program aimed to fostering local content. He says that companies do not need to worry about local content rules becoming adversarial. “In fact, at this point, 55% to 65% of local content is really the maximum that Brazil can provide,” he says. “We are still in the process of recovering engineering skills that we lost in the 1980s and the 1990s. We need to find suppliers to help provide new technology for manifolds, flexible flow lines, Christmas trees and other subsea units because we do not have those legacy industries. Local content will be required, but there might be some regional exceptions.”

Brazilian reform

Meanwhile, Brazil and Petrobras plan to begin or continue a portfolio of reforms meant to encourage increased foreign participation and investment in its oil and gas sector. These reforms include fiscal tax adjustments, inflation-control policies, consolidated democracies, stable regulatory agencies, full transparency, contract stabilization, political stability, and a free press.

Overall, if the Brazilians’ best intentions come to fruition, foreign companies seeking to enter Brazil’s oil and gas industry should find better contract terms, reasonable local-content rules, and a Brazilian eagerness to employ non-Brazilian high-end technology and well-educated engineers — even in a time of low oil prices.  

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