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Brazil's buyers beware

The country has taken steps in the right direction. But the risks are too great to ignore

Last year total foreign direct investment in Brazil reached a six-year high of $15.4bn. It was one of the strongest signals yet that measures taken by the government could soon pull Latin America's largest economy out of its worst recession in a century.

The speedy recovery of Brazil's battered oil and gas industry, though, is less evident, despite important efforts to revive confidence in an industry responsible for more than 10% of gross domestic product.

Efforts taken over the past year are significant. State-led Petrobras is no longer the only legal operator of production-sharing concessions in the promising deep water pre-salt area. National content rules for concession-holders are being eased. New exploration areas are being readied for auction.

Under chief executive Pedro Parente, the state-owned firm has shored-up catastrophic, and largely self-inflicted financial damage caused by a corrupt government and its hand-picked accomplices in key executive positions. Its debt has fallen. Major assets have been put up for sale, and fuel pricing has been put on a market footing.

Meanwhile, prosecutors and judges have made great strides against the politicians, executives and contractors who looted Petrobras. Stolen cash is being returned to Petrobras from offshore hiding places. Financial settlements are being made with some aggrieved bondholders.

But there are signs these developments don't yet go far enough to justify spending billions or even tens of millions of investors' dollars on Brazilian oil and gas projects.

"The government and Petrobras have done some things right, but there are still far too many problems for real enthusiasm," said John Forman, a Rio de Janeiro oil consultant and former board member of Brazil's oil industry regulator, the ANP. "Those excited about improvements seriously risk missing a forest of problems for the sake of a few small but handsome trees."

First, there is no guarantee that recent reforms will last. Brazil faces elections for president and Congress in 2018. The man ahead in early polls is Luiz Inácio Lula da Silva. President from 2003-2010, Lula built, led and benefited from the corrupt cabal that looted Petrobras. His hand-picked successor, Dilma Rousseff, as his Energy Minister and chairwoman of Petrobras for seven years, wrote the nationalist oil policies that are only now being tweaked under Michel Temer. Lula, his Workers' Party and much of Congress oppose even Temer's limited reforms.

Temer, Rousseff's vice president, assumed office last year after she was impeached, but may not even finish his mandate. The country's electoral authority may annul their election within weeks on the grounds it was financed by Petrobras graft. This would force the Congress to elect an interim head of state within
30 days of the ruling. With many of its members and leading parties implicated in the Petrobras scandal and bitterly divided over broader economic reforms, interest, time and support for further oil-industry change is weak.

Crushing debt

Nor have Petrobras' improvements been deep. The company ended 2016 with $118bn of debt. That's smaller than the $126bn at end-2015 but still crushing and larger than any other oil company in the world. Its asset-sale program missed its 2016 target of $15.1bn.

Last month, national auditors ordered it to re-draft all future asset-sale plans, questioning sales at below book value, and claiming it failed to sell at least one asset to the highest bidder. It also ordered new transparency rules on the asset sale process, which will force Petrobras to list companies interested in bidding for them. Unions have tied up all sales in legal and political knots and promise to keep doing so.

As for promised oil-rights auctions, bidders beware. Since 2013, when Brazil sold its first concessions in five years, not a single winner has been issued an environmental license to explore their leases. Companies making the biggest recent investments such as Shell and Statoil, have bought existing projects well into development or into ones that Petrobras is too broke to exploit. Total's plans to buy Petrobras assets will free up cash for its partner to pay its share of their giant Libra subsalt joint venture.

"We're in the market, but not for anything new, only existing projects where investors want out and are selling cheap," the Brazil chief of a second-tier Western oil company told Petroleum Economist. "We're not excited about doing business with Petrobras."

Then there's the new world oil-price dynamic. If US shale's ramp up continues to undercut prices, Brazil's higher cost deep waters will suffer, especially with countries such as Mexico easing investor rules faster. Brazil's oil business could be treading water for a long time.

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