“The 21st century will be Brazil’s century. With the pre-salt, we will transform Brazil into a great global power” – Former President Lula, 2007 (Webb 2010).

A deepwater Kuwait has been found off the Brazilian coast. The pre-salt reserves are estimated between 70 and 100 billion barrels of oil and are considered the world’s largest known offshore oil deposits. An investment of one trillion dollars is expected in the industry during this decade, becoming one of the largest private sector investment programs in the history of mankind. In other words, it is “more than actually putting a man on the moon” as said by Joe Leahy in the Financial Times in March 2011.

 Figure 1. Proven Oil Reserves in the World (in billion of barrels of oil equivalent)

 It is evident that Brazil will be an increasingly important energy player in years to come. However, there is still a long way for this bonanza to be concretised as a blessing, and a number of bottlenecks could ruin this historical momentum.

After the Tupi pre-salt field discovery in 2007, the ruling PT government has been strongly committed to oil nationalism. Brazilian leaders have considered this newfound oil to be a millionaire ticket, or a passport to the First World, as was said in an article in the Economist in 2009. Thus, they have promoted a new regulatory system for the exploration of the pre-salt, with the creation of the state-owned PPSA and the increasing control of Petrobras in this sector. Also, the government has launched the local content law, which demands that the equipments and services for the pre-salt exploration must be 60-65% from local suppliers. But the truth is: these nationalistic policies pose a threat to Brazil’s swift and sustained development.

In midst of the hype, Brazilian leaders have arguably been drawn into a lyrical illusion: a euphoric optimism that the pre-salt is a gift from God and will solve all problems. This blind confidence has often led to over-optimistic expectations, increasing budgetary pressures and limiting savings in the economy, as pointed out by Alichi et al. in a working paper for the International Monetary Fund. The logic is simple: more rents means more spending, which means more costs. When the rents decrease (e.g. if the oil prices fall), the public spending doesn’t, so a deficit is likely to be accumulated.

In addition, there is a huge bottleneck in the country called the absorption problem: inefficient bureaucracies, shortage of skilled work, and inadequate infrastructure that are incapable of dealing with the massive revenue inflows and the expansionary public sector programs. In other words, it seems almost impossible for these resource rents to be appropriately absorbed in Brazil.

To make matters more complicated, a new Oil Law was promulgated in 2010 establishing the production-sharing system to the areas of the pre-salt polygon. President Lula finished his mandate in chauvinistic (or Chaveznistic) fashion by proposing this new system instead of the former regime of concessions, increasing the government’s participation in the oil sector. This new system inhibits the participation of private companies, granting Petrobras more control of the pre-salt exploration.

And what is the problem with more State control in the oil sector?

Since the end of its legal monopoly in 1997, Petrobras’ total factor productivity doubled in six years. In the post-reform period, companies would pay for the rights to explore the areas, and compete in the bidding rounds in what is called the regime of concessions. This brought a spectacular rise in productivity of Petrobras, leading to Brazil’s long-desired self-sufficiency in 2006.

Figure 2. Total Factor Productivity of Petrobras and Brazil, 1976-2001

 However, the new production-sharing system in the pre-salt area is almost like a step backwards towards the pre-reform era. It requires a minimum participation of 30% of Petrobras in the composition of the consortiums, and a massive 50% of the recently created state-owned PPSA. Petrobras already owns 92.6% of the national production of oil and gas, while big names like Shell, Statoil, Chevron, BP and OGX represent altogether only 7.1%. Why then, should the government limit even more the participation of foreign companies, since massive capital is required for the exploration of the pre-salt?

In striking optimism, the government has also adopted a policy called the local content law. It demands that 60-65% of the equipments and services for the oil industry be supplied by local industries. This may reduce the Brazilian capability of production and exploration of the pre-salt for five reasons: [1] lack of capacity, [2] higher costs, [3] weak competitiveness, [4] lack of quality and delays, and [5] lack of qualified workforce of local suppliers. For example, 76% of the local suppliers in the oil sector are small and non-exporters, highly uncompetitive and incapable of supplying for the largest expansion of the sector in Brazil’s history, according to an article published in Brazilian magazine Exame in 2012.

How then will Brazil be able to undertake such an investment by relying so much on its teenaged national industry?

The quasi monopoly by Petrobras and the local content law in the pre-salt area may actually hinder the ambitious production targets that are to be reached. A taboo, in Brazil, this post suggests that an efficient and striving oil sector does not require strong nationalistic policy-making. Yet, leaders have painted a picture of undeniable prosperity in years to come, and have found an excuse to expand the State’s dominance in the oil sector. Thus, although growth is practically a given for Brazil in future years, these challenges are formidable bottlenecks that may severely slow down the nation’s economic pace.

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 This post is a summary of the Dissertation Thesis “The Oil is Ours: The Harms of Nationalism and the Pre-Salt Discoveries in the Coast of Brazil” by the author, marked with distinction by the London School of Economics.

References

 Alichi, Ali &Arezki, Rabah, 2009. “An Alternative Explanation for the Resource Curse: The Income Effect Channel”. IMF Working Paper 09/112.

Amuzegar, Jahangir, 1982. “Oil Wealth: A Very Mixed Blessing”. Foreign Affairs 60(4): 814-835.

ANP, 2011. “O Regime Regulador Misto: Concessão e Partilha”. Agência Nacional do Petróleo.

Bridgman, Benjamin et al, 2011. “Threatening to Increase Productivity: Evidence from Brazil’s Oil Industry,” World Development 39(8): 1372–1385.

Economist, 2009. “Preparing to Spend a “millionaire ticket” from offshore”. September 3, 2009.

Economist, 2011.“The devil in the deep-sea oil”. November 5, 2011.

Exame, 2012.“Pré-Sal e a Nova Economia Brasileira”.Revista Exame. Edition 1019, June  26, 2012.

Leahy, Joe, 2011. “Brazil: Platform for Growth”. Financial Times. March 15, 2011.

O’Keefe, B., & Burke, D., 2011. “The Next Oil Colossus”.Fortune 163(4): 126-136.

Vargas, Getúlio, 1964. A Política Nacionalista do Petróleo no Brasil. Edições Tempo Brasileiro: Rio de Janeiro.

Webb, Tim, 2010. “Petrobras aspires to be world’s biggest oil producer”.Guardian. November 15, 2010.

BrazilEmerging marketsLulaNatural ResourcesOil

About the Author: Matheus Ortega

Matheus Ortega has a Master’s in International Development from the London School of Economics and graduated in International Relations from PUC-SP and PUC-Chile, Matheus has worked with post-disaster relief in Haiti and with social development in poor communities in Brazil. He was elected by Google's Zeitgeist Conference as one of 2011’s “Brightest Young Minds”, and is a Young Ambassador for the Global Changemakers program. He currently works in Government Affairs at the American Chamber of Commerce in São Paulo, Brazil. @MatOrtega