Pre-salt: What now?
This event marked an important moment for the Brazilian oil industry, because recent discoveries in the world oil scene have been rare and also because Brazil has always carried the title of eternal latecomer in the race for oil. The Brazilian oil industry was, until then, a classic case of sudden success but with limited potential. So when their country arrived on the pre-salt scene, Brazilians began to dream of fabulous trajectories of economic development financed by the excessive reserves that surely rested under the water, just waiting to be converted to a new “oil El Dorado.” Brazil would enter the select club of oil exporting countries, and the benefits of being part of this club would be many, including the possibility of obtaining abundant oil rents and participating in OPEC.
But the entry into that club would not be without costs. First, because inevitably the process is slowed by the technological difficulties of producing oil, no matter how abundant, at a depth of several thousand meters and in some places more than 200 miles offshore. Second, because it remains unknown in which direction the world energy grid will go and so it is unclear whether Brazil could recoup the hundreds of billions of dollars spent on pre-salt exploration and production. And certainly in many countries oil hasn’t been the blessing to the economy that one would expect. Many countries that export oil or other natural resources have in the past suffered from “Dutch disease,” when the inflow of foreign currency raises the exchange rate and makes the rest of the economy less competitive. This is true in Venezuela and could easily be the case in Rio de Janeiro, which has experienced a downward economic trend since it ceased to be the nation’s capital 60 years ago. (To mitigate these risks, a series of measures such as taxes on imports or funds of oil reserves would need to be adopted.) Finally, there is the high political cost that the discussion at the federal regulatory level invariably brings to a country like Brazil, where often the direction of the economy is decided behind the scenes and does not always follow the most honest negotiation procedures.
Clearly, mere entry into the “oil club” would not magically yield economic development. On the contrary, it would be a long and arduous road. It was surely in this context of elevated costs that the prospect of pre-salt was discussed, and on Monday the 31st of August 2009, after two years of heated debate, the governor of Brazil announced his proposal to manage pre-salt oil. The proposal includes changing the regulatory framework from the current model to concessions for a shared model—one in which the state owns the reserves and the operator pays a portion for the oil produced. This would entail the creation of Petrobras—a state enterprise like the Norwegian Petoro—to manage these shared contracts and decide who would produce in partnership with the state. Additionally, a a portion of the state oil income would be reinvested into social issues, thus acting as a driving force behind the so dreamed of social economic development promised by the “oil El Dorado.” The general consensus is that the government’s proposal has some major structural defects and needs to be revisited and reworked—up until a certain point, that is, and in political terms, that clearly implies an election.
To evaluate how this proposal will impact the future of investments in the Brazilian oil chain, it is necessary to discount the ills of the political game and the hiss of the major international oil companies until the new regulatory model will in fact be the regulatory framework of the pre-salt. It is too early to say how these investments will turn out, as we are still in the second step of a long journey that must precede any true financial results.
Being that this is a long horizon, it is interesting to think in the meantime about the half-life of economic investment in post-salt oil and also about the alternative sources in Brazil—yes, Brazil possesses fantastic renewable resources—and will continue to provide good alternative investment opportunities.
