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Brazil's pre-salt promise

Brazil's offshore is making big strides on costs—crucial in the post-shale landscape

It's been a rough period for Brazil's oil sector. The Lava Jato scandal, centred around a massive corruption scheme in the oil industry, has plunged the nation deep into a political crisis now more than three years old. The plunging oil price exposed state oil company Petrobras's massive debts and fragile financial foundation, forcing it to embrace deep austerity and slow its offshore developments. Hovering over these issues, however, has been another question: can Brazil's deep-water pre-salt fields still compete in an era of cheap oil supply?

The emergence of the US shale industry, and recent evidence that the major Permian and Eagle Ford plays can grow at $50 a barrel, has pushed Brazil's pre-salt up the global cost curve. Still, in terms of scale Brazil remains the world's premiere deep-water province. Productivity should lead its offshore recovery.

Petrobras, leading the development, says its pre-salt projects can break even at $40/b, and that production costs have fallen some 15% since 2014 to less than $8/b. Other estimates put the average breakeven at closer to $50/b, but that still makes it the most appealing corner of the so-called Golden Triangle—Brazil, the Gulf of Mexico (GOM) and West Africa, the world's most active deep-water plays. Most new greenfield GOM projects, those that can't be hooked into existing production infrastructure, will need $60 oil to go ahead. Major new projects in Nigeria and Angola's deep waters demand prices north of $70/b, according to Wood Mackenzie, a consultancy.

The pre-salt's productivity helps set it apart. The average Santos Basin well was producing 26,000 barrels of oil equivalent a day in June, with many producing over 30,000 boe/d. The best well, in the Sapinhoá field, was pumping nearly 39,000 boe/d, probably the most productive offshore well in the world. The best GOM deep-water wells produce 10,000-15,000 boe/d, while top West African wells can pump closer to 20,000 boe/d.

$35 - Breakeven target for the Libra pre-salt megaproject

The productivity is helping make the pre-salt's economics more appealing than first thought. Because of the remote offshore locations and extreme depths, the cost of dropping a well into the Santos Basin's pre-salt reservoirs can top $200m. Drilling and completion can make up anywhere from a third to more than half of a project's costs. More productive wells mean having to drill fewer ones overall, which has significantly improved pre-salt project economics.

Brazil's pre-salt is also benefiting from broader offshore industry cost deflation brought on by the sector's deep recession—ironically brought in large part by Petrobras's own drastically scaled back development plans. The cost of hiring rigs capable of drilling in Brazil's deep water has plunged from more than $0.5m a day a few years ago to less than $300,000/d now. There is far less work to go around, so companies are willing to bid less for everything from cementing a well to building new floating production storage and offloading (FPSO) production systems.

Brazil's onerous local content rules, which lock developers into the country's higher-cost ecosystem of suppliers, blunts some of the potential savings. But the benefits are still filtering through. Petrobras says renegotiating its contracts, squeezing costs from its drilling plans and project designs, and better-than-expected production from its latest wells allowed it to cut $2bn from its upstream capital spending plans this year, reducing it to $14bn, while maintaining its production target.

Petrobras is also showing clear signs of learning as it gathers experience. Early pre-salt wells in 2010 took more than 300 days to drill. That has been brought down more than 70% to around 90 days. The company is also rolling out new technologies and simplified well construction designs to cut drilling times and improve recovery rates. Among the most promising is a system that allows water and gas to alternately be pumped into the same injection system, allowing the company to save hundreds of millions of dollars in drilling costs while also improving recovery rates.

Petrobras hopes to bring it all together at the Libra pre-salt megaproject. The goal there, where Petrobras is working alongside industry heavyweights Shell, Total, Cnooc and PetroChina, is to bring the breakeven down to $35/b by the time full-scale development starts in 2020. The company is starting its first extending production testing from the field this year, a major milestone in the pre-salt's biggest field. Recoverable reserves are as high as 12bn barrels and the project could cost $100bn to develop.

Libra is far from the only project in the pipeline. Petrobras plans to deploy 10 new FPSOs between 2017 and 2020, all but one to pre-salt fields in the Santos Basin, adding 1.5m b/d of new deep-water production capacity.

There are good reasons to doubt Petrobras will be able to follow through on this plan given its miserly track record on meeting production targets. The plan calls for five new FPSOs to start up in 2018 alone, a big job for any company, let alone one in the grips of austerity and political turmoil. Still, Rystad, a consultancy, reckons it's doable. It puts 2020 output up around 1m b/d from today at around 3.7m boe/d, in line with Petrobras's own targets, and reckons production could reach 4.5m boe/d by 2025 as long-delayed projects finally start to bear fruit.

International cash

Petrobras and Brazil, for all their troubles over the past two years, have also received a vote of confidence from international oil majors over the past year. In a bid to cut its costs and accelerate development, the state firm has opened up its pre-salt fields to some of the world's largest offshore producers. Statoil paid $2.5bn for a 66% operating stake in Block BM-S-8, which holds the Carcará find and further exploration potential. Analysts at the investment bank Jefferies reckon Statoil paid around $3.8/boe of reserves—a relative bargain.

Total followed on with a similar deal to take a controlling stake in the Lapa pre-salt find. The French major paid around $2.8/boe of reserves, reckons Jefferies. The deal was part of a broader strategic partnership between the offshore specialists, which could lead to tie-ups elsewhere like the deep-water block Total recently won in Mexico. PetroChina has signed a similar "strategic partnership" deal and rumours have been rife around Rio of a deal with ExxonMobil.

Apart from a well-timed deal, the unparalleled scale of untapped discoveries in the pre-salt is a strong draw for international majors. Just a fraction of the pre-salt's 30bn barrels of discoveries has been produced, and it has become clear to even the most ardent Brazilian resource nationalist that Petrobras won't be able to carry the load on its own. Shell reckons there's more deep-water oil still to be produced off Brazil's coast than in the GOM and off West Africa combined. A survey carried out by Bernstein Research of the world's offshore finds under appraisal found that Brazil has 20 deep-water discoveries ready to be developed, far more than any other basin-West Africa had 13 and the GOM just nine.

Yet while scale and improved economics are a strong magnet, politics matter—and the chaos in Brasilia is a significant threat to the pre-salt's development. President Michel Temer's short tenure in office after taking over for his impeached predecessor, Dilma Rousseff, has been turbulent, but fruitful for the energy sector. A requirement that Petrobras must operate all pre-salt projects has been nixed. New areas are being opened to competitive bidding for the first time in years. Local content rules have been relaxed. But the durability of these rule changes, long lobbied for by the industry, is in doubt. Temer is deeply unpopular and won't run for office again in next year's presidential election. The contest will be wide open, and could herald a return to resource nationalism.

The pre-salt is also facing new competition. There is shale, of course. But emerging offshore plays in Mexico and off Guyana, where ExxonMobil is developing a major new find, will also draw investment away from Brazil. ExxonMobil's Liza field in Guyana will make money at less than $50 oil, while Mexico has pitched itself as an easier place to do business than Brazil.

Still, Brazil's deep waters are in a league of their own when it comes to scale and signs of falling costs will help it maintain its position as the top deep-water play in the world.

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