Pre-salt reserves make Brazil ripe for investment, but risk remains

Pre-salt reserves make Brazil ripe for investment, but risk remains

On October 27, 2017, new auction rounds for the eight pre-salt blocks in Brazil were launched. As the Brazilian government approved a new regulatory framework for the bidding process to allow more investors, 14 foreign companies and two Brazilian entities were qualified to participate in the auction.

As a result of the auction, The National Agency for Petroleum, Biofuels and Natural Gas (ANP) awarded six offshore blocks to Shell, Brazilian state-run Petroleo Brasileiro (Petrobras), and Statoil. This generated BRL 6.15 billion (about USD 1.9 billion) in signature bonus and BRL 760 million (about USD 234.8 million) in investments. The ANP also announced that two more auction rounds for pre-salt layer fields are planned in 2018 and in 2019. ExxonMobil (USA) took eight blocks of pre-salt reserves in the recent auction in April 2018, whereas Petrobras took six blocks.

Moreover, the new regulatory and economic changes in the Brazilian oil and gas sector have brought more transparency on future investments in the pre-salt reserves, incentivizing foreign investors such as ExxonMobil (USA) and Statoil (Norway) to invest again in Brazilian energy projects. The improved regulatory framework ended the mandatory participation of Petrobras as “the sole operator in pre-salt”, creating new opportunities for other investors.

A bright future, but risks abound

The future of the Brazilian oil and gas sector, and subsequently the Brazilian economy, is positive. In 2017, the oil and natural gas sector accounted for 11 percent of Brazil’s GDP, and keeps on growing. With a recovered economy, the Brazilian government claimed that Brazil has become the largest oil producer in Latin America, and that the pre-salt reserves has been regarded as “one of the most promising oil reserves in the world.” The Brazilian government thus expects the auction to yield investments of about USD 36 billion for the next 10 years, and would create about 500,000 direct and indirect jobs. This development in the oil and gas sector provides an optimistic outlook for many Brazilian states’ economy that depend on oil production, as “the exploration of [the pre-salt] areas should generate BRL 400 billion in royalties and taxes over the next 30 years.” This development could invite more economic and social development in Brazilian states that have suffered from the recent dire economy.

As corruption, fraud, and bribing remain pervasive and ongoing problems in Brazil, the investors will look to Brazilian President Michel Temer’s administration to reinforce new regulatory and economic laws to mitigate these risks in the oil and gas industry and in Brazil as a whole. Indeed, Reuters indicated on April 17, 2018 that President Temer launched a series of policy changes to “tempt investors to return to Latin America’s No.1 economy.” The President aimed to cut restrictions on oil and gas production by eliminating the exclusive rights of Petrobras in operating pre-salt oil fields.

However, despite the positive developments in the oil and gas sector, there are persistent political risks that investors must be wary about. These risks include judicial insecurity, high-level corruption, reputational damage, expropriation and nationalization with the involvement of Petrobras, and contract uncertainty. For instance, an October 27, 2017 Financial Times article reported that a federal judge issued an injunction to block the October 2017 auction, a political move sought by the leftist Workers’ Party. While the auction was briefly suspended, the injunction was overturned. However, this recent play provides a cautionary tale for investors, as judicial and political insecurity can undermine the progress of the auctions and pre-salt reserves investments. Along with these issues, the upcoming presidential elections could reverse Temer’s policies and new regulatory framework.

Petrobras and ongoing security crises in Brazil

In addition, according to the Brazilian government, Petrobras “now has the freedom to choose which [pre-salt auction] blocks it will participate in.” The new regulatory framework of the pre-salt reserves has thus allowed Petrobras to gain more autonomy for its strategic management and investment in the oil and gas industry. Increasing the state-owned oil and gas company’s influence and power over one of Brazil’s essential sectors for economic growth may be too early for Petrobras. As the company remains entangled in the biggest corruption probe in Brazil’s history, investors remain cautious of political and judicial development around the company.

This scandal has had a disastrous impact on Brazil’s economy, as investors strayed away from the country for a few months and stock prices dipped quickly in 2014. Overall, this issue was a staggering setback for Brazil’s political, social, and economic growth and worsened the already-existing grievances in country. It took several years for Petrobras to recover from the scandal, as it became the world’s most indebted oil company and reported revenue growth only by 2017. The ongoing investigation and its impact on the public and private sector in Brazil remain a rampant issue that investors, policy makers, and international organizations should continue to monitor.

In addition to the aforementioned political and operational risks, investors must also take into account worsening security risks. In the past five years, Brazil’s security status quo has deteriorated, as over 55,000 people were killed in 2015 due to a surge in police strikes, street crime, violent protests, and armed conflicts between the Brazilian security forces and organized criminal organizations. A vacuum of instability and violence in various cities across the country has persisted since 2015, and along with civilian unrest and excessive responses from Brazilian security forces, drug trade, arms trafficking, robbery, extortion, and kidnapping activities have soared. The rampant corruptions in the government and security forces, and endemic economic and social instability have undermined the Brazilian government’s ability to effectively tackle security crises.

About Author

Alicia Chavy

Alicia Chavy is currently pursuing a Master's in Security Studies at Georgetown University. Previously, Alicia worked at Kroll where she conducted due diligence and compliance research for Fortune 500 companies. There, she analyzed open sources intelligence on corruption, fraud, money laundering, and organized crimes perpetuated by companies and senior executives in Spanish, Portuguese, French, and English-language speaking jurisdiction. Alicia also worked at The Asia Group, where she provided political and business risk analysis, and strategic support for Fortune 500 companies working to expand their business presence in the Asia-Pacific region. Prior to her consulting experience, Alicia worked at non-profit organizations where she conducted detailed assessments on foreign policy, security and economic issues in Latin America, Europe, and the Middle East. Alicia Chavy graduated from Georgetown University's School of Foreign Service, earning a Bachelor of Science in International Politics.