Energy Anxiety in Brazil? / by Mark Langevin

Reuters’ Jeb Blount recently published a critical article of Brazil’s energy policies,

“Brazil's once-envied energy matrix a victim of "hubris."  Blount asks,

“Today, the outlook is much darker. Oil output is falling, ethanol production has plunged, and fears have recently returned of electricity rationing that could further depress a stagnant economy and embarrass President Dilma Rousseff.

What went wrong?”

Blount blames government policy during the past decade, arguing that the government’s efforts to take more control over energy production, both power and transportation fuels, led to greater inefficiencies and scared off investors.  Blount calls on Christopher Garman of the Eurasia Group to sustain his assertion that government hubris has led the country into a dark energy nightmare.  His story quotes Garman,

"When things were going so well for Brazil, and after they discovered oil, the administration was infused with a sense of hubris," he said. "They thought they had more room to conduct an active industrial policy and change the regulatory landscape."

Separating out Eurasia’s own interests in serving private sector clients interested in taking advantage of Brazil’s remarkable energy resources, the negative scenario painted by Blount and Garman is not as clear cut as they suggest.

As Blount includes in the story, Brazil’s drought is real, probably a consequence of global warming and climate change, and a threat over time to hydro-electrical power generation.  The drought explains the current, and probably sustained challenges inherent in an overdependence upon hydroelectricity, but it doesn’t explain why commentators, many representing private sector clients, claim that the country is on the highway to rationing.  Blount argues that

“the troubles go much deeper than just a few impaired dams. Brazil's whole energy sector is riddled with inefficiencies and investor anxiety.”

Certainly private sector investors are more than anxious about the government’s measures to lower electricity costs for consumers and industrial customers by lowering prices and forcing the renegotiations of concessions.  The government move to shake up the power market does have consequences, including investor anxiety and the possibility of losing some private sector investments in the short term.  Yet, anxiety and loss of future investment does not explain the current challenge, low water levels that lessen hydroelectric generation and compel the generation system to switch over to natural gas fueled thermoelectric plants.  Yes, the government has taken calculated the lower power prices will prove to offer greater benefits in the future than the evident costs, and certainly energy intensive industries, including the aluminum and steel among others, approve of government efforts to reduce electricity costs.

What Blount, Garman and the others quoted in the story failed to mention is that natural gas production is booming in Brazil. Blount calls on Adriano Pires, Executive Director of the Brazilian Infrastructure Institute, and Luiz Pinquelli Rosa of the Federal University of Rio de Janeiro to sustain his arguments.  Pires, a respected expert on Brazilian infrastructure, argued much earlier than 2012 that Petrobras’ stock was underperforming; and his remarks were registered before the current flattening of petroleum production.  However, Blount does not report on natural gas production in Brazil or even mention recent production levels. As recently as October the Wall Street Journal reported that the Director of Brazil’s oil, gas, and biofuels regulatory agency, called ANP, Magda Chambriard, claims that gas production could “double by 2020, reaching up to 120 million cubic-meters a day.” In 2011 Brazil’s natural gas production grew by 2.5 percent. In November of 2012 production surged to 8 percent over the same month in 2011; and natural gas production in Brazil could certainly show another incremental gain in 2012 over 2011.

What is perplexing from a neutral viewpoint is that Blount and Garman suggest that the prior concessionary regime would have produced better aggregate national results, but the current production levels (whether one considers them disappointing or not) are directly related to the prior concessionary regime of 1997; so the argument on oil and gas seems chronologically misplaced.  To this date Brazil has not operationalized its new production sharing agreement regime through block auctions.  The investments, both private and by Petrobras, that are now producing oil and gas were planned well before the PSA regime was formulated and instituted. So the question for Mount and Garman is whether the passage of the PSA regime in the Brazilian congress was sufficient to discourage private sector producers from making additional investments in their concessions; and even if the PSA did have this effect, would it show up already in production numbers, especially given Petrobras’ increasing investments?

Of course, the real challenge is meeting Brazil’s mounting demand for power and fuel.  Let’s face it, Brazil is developing quickly and needs more energy to move forward.  The GTD system needs more investment, but even under prior cost/price conditions the private sector was not exuberant over the Brazilian market, leaving most of the heaving lifting to the government. Now with the low water levels, the demand for natural gas as fuel for power plants, industrial energy, transportation fuel, and for the growing number of homes now constructed throughout Brazil is likely to spike upwards in the next several years. Slow growth in 2012 probably served to buy time for Brazil’s current investments in power generation and oil and gas production to become operational; and certainly Petrobras and government policymakers are counting on a more productive 2013 as investments made in recent years begin to show commercial production.  These current investments, largely made by Petrobras and the government, although with measurable contributions by private sector firms, led the Business Monitor International to a bullish forecast as recently as November of 2012,

“The long-term outlook for the Brazilian energy sector is decidedly bullish, with an average oil and gas production growth rate of 7.7% and 11.4%, respectively, over our forecast period. Included in our forecast is a total oil production increase from 2.87mn barrels of oil per day (b/d)in 2011 to 3.91mn b/d in 2016, largely driven by increased volumes coming from the country's vast pre-salt oil reserves. This is particularly true as state-owned Petrobras is placing increasing emphasis on increasing pre-salt production over the next few years.

Our short-term view is more cautious as Petrobras, the dominant player in the sector, seeks to implement an extensive reform agenda as a part of their US$236.5bn strategic plan for 2012-2016. The extent to which the company maintains a credible commitment to reform, however, will be an important bellwether for the next several quarters.”

Blount, Garman, Pires, and even Pinguelli Rosa do not mention the increasing commercialization of the pre-salt offshore oil and gas fields in Brazil; which in some ways detracts from their arguments since these are the fields where Petrobras has large stakes and is concentrating investments.  Yes, there are opportunity costs, but production increases in these fields bode well for future aggregate national increases in production as well as a return for private investors, but not soon enough for Reuters and Blount.  There are other bright spots as well, including the rapid increases in biodiesel as well as other alternative renewables.

Certainly Brazil needs to make difficult choices about pricing energy, managing the anxiety of private investors and producing firms, and financing the productive investments of Petrobras and other publically controlled energy enterprises.  2013 will not be easy, given the drought, the lag on productive investments, and the growing demand for energy in Brazil. Yet, it does seem early to forecast disaster as Blount, Garman and others are inclined to do since Brazilian policymakers chose to bet on government intervention rather than depend on private sector firms during President Lula’s administration.  One does not have to be a cheerleader for President Dilma and Petrobras as well. Rather, it is critical that commentators assess the overall energy balance, supply and demand, and factor in the scale of investments that are now just beginning to produce for commercial consumption.

We should all be cautious about the prospects for leaps in oil, gas, ethanol, and electricity production; but we should not be sounding the alarm bells just yet.