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Brazil’s Rousseff faces energy challenges after election win

Dilma Rousseff has previously retained strong government control over the energy sector, making Brazil less attractive for investors

Brazil's president Dilma Rousseff has pulled off a narrow victory over her pro-business rival Aécio Neves in the tightest election the country has seen in a generation. Entering her second term, however, Rousseff must now get the country’s energy sector and state oil company Petrobras back on track. The discovery of tens of billions of barrels of oil in pre-salt fields off Brazil’s coast has held out the promise of Brazil becoming a major global oil player, but it has also thrown up huge challenges for the government. 

Rousseff - and the Workers’ Party, which she leads – has pushed to retain strong government control over the energy sector. New laws put in place since the discoveries, for instance, require Petrobras to operate and hold a minimum 30% stake in all pre-salt projects, which has strained the company’s financial and technical capacity. It has also made the projects far less attractive to international oil companies. Critics contend that Petrobras has become a tool of the ruling Workers’ Party and its decision making overly politicised. 

Strict local content requirements, coupled with high taxes and a complex fiscal regime, meanwhile, have driven up costs. Wrangling over the new oil laws has also disrupted regular licensing rounds, frustrating many in the industry who argue the sector is adrift.  

Energy investors in Brazil and outside the country saw a lot to like in a possible Neves presidency. He had promised to roll back some of the government’s control over the sector, offering to re-visit some of the new pre-salt rules, ease local content restrictions and give Petrobras more autonomy.  

Ahead of the election, Rousseff herself appeared to acknowledge that energy policy had not been up to scratch. She promised to simplify the tax code and resume regular licensing rounds, starting with an auction scheduled for early next year. But developments in Brazil and beyond could force Rousseff to go farther than merely tinkering around the edges of energy policy. 

When the pre-salt fields were discovered in the mid-2000s, resource-rich governments clearly held the upper hand when they sat down to negotiate with foreign investors. International oil companies were being shut out of the most promising regions. High prices and the prospects of strong global demand meant they were willing to accept difficult terms for access to reserves.

That balance, however, has tipped back in the favour of the international oil companies in recent years. The emergence of unconventional resources in the US and the opening of markets such as Mexico mean that the international oil companies now have far more choice than they did just a few years ago. And although the pre-salt’s huge reserves will remain attractive to the majors, lower oil prices have put the majors into cost-cutting mode, meaning they are less likely to take on new high-cost deep-water projects for now. 

Rousseff’s most difficult task will be righting the ship at Petrobras. Just days before the run-off election, Moody’s, the credit agency, downgraded its rating on Petrobras again, arguing that lower oil prices meant the company wouldn’t be able to start reducing its debt until well after 2016. 

Petrobras, the most leveraged publically traded oil company in the world, saw its debt rise to $170 billion at the end of June, up by $25bn from the start of the year. The company owes around $74,000 per barrel of oil equivalent (boe) it produces, the highest of any oil major or national oil company, according to Moody’s. The fall in oil prices and mounting debt load is now threatening Petrobras’ expansion plans, the ratings agency warned. “We are maintaining a negative outlook on Petrobras' ratings given the probability that the company's leverage may increase further due to lower international oil prices and limited flexibility to reduce cost, with negative impact on margins. In this environment, execution on the company's capital programme and achievement of targeted production growth could be negatively impacted,” Moody’s says.

Rising debt would be expected of any company tackling the monumental task that Petrobras has in developing the pre-salt. But the problem has been compounded by government inflation-fighting policy that has prevented the company from passing the full cost of high international fuel prices on to its domestic customers. The government, especially during the extended election campaign season, has been reluctant to allow Petrobras to raise prices at the pump for Brazilian consumers. The policy has cost Petrobras around $44bn over the course of Rousseff’s term.

From this perspective, the recent oil price decline is a positive for Petrobras’ refining and marketing business. International fuel prices fell below Brazil’s domestic price for the first time in several years on 13 October, according to Credit Suisse. 

And some analysts are confident that with the election passed Rousseff will have a freer hand to raise domestic fuel prices to give Petrobras a boost. “Regardless of the outcome of the election, there is a window of 12 to 24 months after the election that the next administration could allow Petrobras to raise domestic product prices without risking too much political capital. If the incumbent remains in power, we think the first product price increase could come as early as November or December,” analysts at Barclays said in a note to clients prior to the election. 

Brazil’s finance minister Guido Mantega has said that Petrobras may be allowed to increase prices later this year even with the lower international fuel prices. Petrobras has also been stung by a corruption scandal brought to light amid the election campaign. A jailed former company executive, Paulo Roberto Costa, has said that he was part of a scheme that saw 3% of all contracts awarded to a number of major construction firms siphoned off and paid to members of the Workers’ Party. The accusations, many critics argue, have highlighted the extent to which Petrobras has been politicised under the Workers’ Party, tarnished its reputation and hit morale among the company’s rank-and-file.  

Although a dark period for Petrobras, there is reason for optimism. After years of delays, production is on the rise as the company has brought a string of important pre-salt projects on stream over the past year. Oil output had risen to 2.239m barrels a day (b/d) in September, up by 16% a year earlier. And production should continue to increase in the coming months as the new projects ramp up production. The company plans to add 1m b/d of new capacity by the end of 2018. The recent fall in oil prices, however, will blunt some of the benefits to Petrobras’ bottom line from the new production. 

Petrobras will also benefit in the months ahead from new refining capacity. The long-delayed and over-budget Abreu e Lima refinery is expected to start processing its first barrels before the end of the year. The refinery will start running at 115,000 b/d, half its full capacity, with the remaining coming on stream in mid-2015. Then the Comperj refinery is expected to come into production in 2016. 

The refinery projects have been poorly managed and have cost Petrobras far more than initially thought. Originally expected to cost around $2.5bn, Petrobras has had to spend $20bn to bring the 230,000 b/d Abreu e Lima refinery into production, or roughly $87,000 per barrel of capacity, making it one of the most expensive refineries ever built on a per-barrel basis. Abreu e Lima is perhaps only surpassed by the company’s 165,000 b/d Comperj refinery, which is expected to have a final bill of more than $21.6bn, or around $130,000 per barrel of capacity. A recent investigation into the Comperj project’s overspending called Petrobras management “reckless” and “sloppy”. 

In spite of the cost overruns, the new refining capacity will help to reduce the losses Petrobras makes on its fuel imports, giving a much needed lift to its bottom line. 

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