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Brazil banks on pre-salt bonanza to increase production

Petrobras plans to double its oil production by 2020. Can it do it?

AMBITIOUS plans to almost double Petrobras's domestic production to 4m barrels a day (b/d) by 2020 could see Brazil rocket from 14th in the oil producers' league to fourth, behind the US, Russia and Saudi Arabia.

A bold target needs bold spending. Under Petrobras's five-year plan, announced last year, the state-controlled firm planned capital expenditure (capex) of $224bn. The pre-salt fields, the most significant discoveries in the world in the past decade, take centre stage. As oil output rises from today's level of 2.2m b/d to 3m b/d by 2014, the pre-salt is expected to supply just 241,000 b/d of the total – but this should rise to 1.08m b/d by 2020, the company claims. Petrobras also wants to increase its refining capacity by 50% over the next decade, too.

Brazil is placing a big bet on its pre-salt. So potentially great are the reserves in the deep and ultra-deep play that former president Luiz Inácio Lula da Silva joked in 2007 that God must be Brazilian. Resource estimates vary, but some analysts say total recoverable oil and natural gas reserves could be more than 50bn barrels of oil equivalent (boe).

The Tupí field alone, discovered in 2007 by a joint venture consisting of Petrobras, BG Group and Petrogas, could hold 6.5bn recoverable boe, the US Energy Information Administration (EIA) says. Meanwhile, the Tupí and Iracema fields, which have been renamed Lula and Cernambi, respectively, contain a combined 8.3bn boe, according to Petrobras.

Plenty of promise

But while these reserves give Petrobras plenty of reasons to think it can double production, technical and financial challenges remain.

The reserves, named pre-salt because they lie 18,000 feet below the ocean's surface under a thick layer of salt, are in the Santos, Campos and Espirito Santos basins off Brazil's southeast coast. The technical difficulty of accessing the pre-salt reserves, because of the substantial depths and high pressures involved with pre-salt oil production, will require a specialised workforce and investment in new technologies.

Marc Howson, an analyst from Wood Mackenzie says the 2020 target is "realistic" and the Santos pre-salt basin is "the most attractive area globally right now" – but an inadequate oilfield services sector and a lack of skilled labour in Brazil will provide obstacles for Petrobras. The low number of qualified engineers in the country is a "fairly onerous" problem, he says.

The scale of expansion Petrobras is aiming for will stretch the company's exploration and production (E&P) resources, as well as Brazil's infrastructure. Chief executive Jose Sergio Gabrielli says Petrobras has the "financial and technological conditions" to push the firm to its targets. But some analysts are sceptical, saying that while Petrobras has the technological know-how to pull it off, finances are another matter.

Of the $224bn expenditure plan – up from the $174bn specified in its previous plan – Petrobras plans to spend around $118bn, a little over half its budget, on E&P. To account for this hefty outlay, Petrobras will need to issue a further $30bn-40bn in debt during the next three to four years. And capex is likely to rise again later, too.

Petrobras is "pushing the boundaries" of its financial resources, says one analyst – meaning it will probably need to share the risk with joint-venture partners in the coming years.

And much will hinge on global oil prices, says Howson. If Brent prices remain at present levels above $100 a barrel, Petrobras will have ample cash for its expansion plans. But at $60/b, "cash flow could turn negative".

There are also concerns over the role of the state in Brazil's energy sector and the effect this could have on investors. Congress voted on a bill in 2009 to create a new parallel licensing regime for pre-salt blocks not previously under concession, as well as on a controversial proposal to alter the way royalties are distributed between states. In contrast to the earlier concession-based framework, the new one renders Petrobras the sole operator of each pre-salt production-sharing contract and guarantees the company a minimum 30% stake in all projects.

Investors are wary. Uncertainty last year about the timing and scale of flotation of some of Petrobras's shares riled some investors. The government's decision to increase its stake in the firm was also a blow. Over the course of 2010, Petrobras's market valuation slumped by almost a quarter. President Dilma Rousseff, who was inaugurated in January, has vowed to "strengthen" the oil company by placing it under tighter state control. But that move may not hearten investors.

Over the course of 2010, Petrobras's market valuation slumped by almost a quarter

Indeed, some analysts fear that an increased level of state involvement could drain Petrobras's resources and slow its growth plans. Howson says Petrobras may be forced to "reprioritise" its portfolio to re-route cash to its pre-salt assets, resulting in weaker growth in the company's other upstream areas.

But Petrobras thinks the pre-salt push will drag the rest of the sector forward. Investments in pre-salt assets will drive the development of a "high-tech production chain", the company says, because of the advanced technology needed to access the resources. Petrobras will also offer financial and technological "co-operation opportunities" with domestic and international operators.

The sheer volume of oil in the pre-salt should also compel more companies to take a slice of the action. Energy-hungry China has been quick to spot the potential. Sinopec, one of its state-owned firms, took a 40% stake in Repsol's Santos basin pre-salt assets for $7.1bn in October. Repsol is planning capex of $4bn-5bn for its Brazilian operations in 2010-14 and a further $6bn-9bn in 2015-19, but needed outside cash to develop its Santos basin assets, which could hold 50bn boe, according to the EIA.

Sinopec's move followed one from fellow Chinese company Sinochem, which spent $3.07bn in May 2010 to buy a 40% stake in Statoil's offshore Peregrino field, where first oil is due to flow this year. And in March, BG Group said it would invest up to $30bn in Brazil over the next decade, including a technology centre to help bridge the gap in finances and services needed to develop pre-salt reserves.

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