Green shoots of Brazil’s recovery

Changes falling into place after a catastrophic period of scandal, corruption and collapse

Brazil’s oil sector is undergoing a transformation that is starting to generate new interest among investors and offer hope to domestic industry after a ruinous two years.

The first changes are gradually falling into place, with the passage of a bill that ends the rule that made Petrobras operate all pre-salt contracts, plus imminent changes in the regulatory frameworks for unitisation, local content policies and the gas sector.

The improved mood is evident at Petrobras, where market value has nearly doubled since chief executive Pedro Parente took the helm five months ago.

Factors include the speeding up of Petrobras divestments, a business plan with debt de-leveraging at its core, and a new market-driven fuel pricing policy that reduces the threat of government interference.

Petrobras will now focus its efforts on lower-risk projects with the fastest returns, seeking additional leveraging and technological gains through peer partnerships.

The company aims to be in a position to begin investing in higher-risk and higher-return projects again within five years.

There are risks for Brazil, however. The calamitous state of regional finances makes it harder to convince cash-strapped state governments to back off from threatened tax grabs, even though some of the proposals, especially in Rio de Janeiro, undermine Brazilian competitiveness.

Industry insiders hope that federal government help in restructuring states’ debt could offer some leverage for securing reforms in regional fiscal systems.

With the clock already ticking on promised licensing rounds, it is time for Brazil’s new administration to deliver on all these pledges.

The promised 14th licensing round offers a wide selection of plays, ranging from the northern and southern fringes of the pre-salt polygon to relative-frontier plays in the Pelotas and Parana basins, but the authorities should not be overconfident about the level of interest that this will drum up.

On the other hand, with the promised regulatory framework in place, the offering of pre-salt areas is poised to attract highly competitive bidding.

For Petrobras, there are tough challenges ahead. Parente has brought forward the de-leveraging target to 2018, demanding that net debt retreat to 2.5% of the company’s EBITDA rate, from 4.5% at present.

The company may be hard pressed to achieve a promised modest rise in production during this period. Improved oil recovery in Campos basin reservoirs may hold the key.

One immediate test is the success or failure of the ongoing sale of onshore and shallow-water assets, amid signs that the procedure has not been going as planned. This in turn will affect the attractivness of the onshore acreage on offer in the 14th round.

Perhaps the biggest challenge of all lies with Brazil’s domestic supply chain companies, asked to transform themselves into globally-competitive enterprises even as they emerge from the Car Wash corruption scandal and the collapse of Petrobras investments.

Local content will be removed as a bidding criterion in the licensing rounds, but minimum percentages are likely to be retained in some categories.

There is also scope for offering incentives for domestic industry as part of the renewal of Repetro, a special tax regime for imported oil sector equipment.

The trick for the Brazilian government is to come up with a rational policy that fosters the development of a competitive and innovative industry without succumbing either to protectionism or laissez-faire wrecking.

In the long run, the Brazilian supply chain has a chance to escape from dependence on a neo-monopolistic customer and, by focusing on areas of excellence, break into overseas markets.

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