Over the past two decades, successive Brazilian governments consistently have adopted policies that support economic liberalization. In 1995, Brazil began restructuring the hydrocarbon industry, which led to the creation of the Ag?ncia Nacional do Petr?leo (ANP) and ultimately the enactment of a new petroleum law in 1997. Today, in addition to overseeing other industry activities, the ANP is responsible for granting E&P rights in Brazil to private entities, rights previously exercised solely by Petrobras – the former state energy monopoly.

The liberalization policies significantly redefined the E&P landscape in Brazil and led to increased participation in the sector by both pure-play E&Ps and integrated companies. Over time, the E&P sector in the country has become characterized by the clarity of its fiscal regime and the stability of its contract environment. However, recent legislature pertaining to future presalt developments suggests nationalism is on the rise. The new law grants Petrobras an effective monopoly over the operatorship of all future presalt projects. This leaves partner companies at the mercy of Petrobras. Notwithstanding , the country remains an attractive destination for E&P activity, and today there are 77 companies, of which 36 are foreign, involved in E&P activities in Brazil.

In 2009, Brazil had the lowest oil reserves when compared to other oil-producing countries. After adjusting for Campos Basin and presalt discoveries, Brazil’s projected reserves move to the middle of the pack. (Images courtesy of the “BP Statistical Review” and Tudor, Pickering, Holt & Co. International)

Since deregulation of the oil industry began in 1995, oil production has increased from 800,000 b/d to 2.1 MMbbl/d of oil, a compound annual growth rate of approximately 7%. This makes Brazil the 14th largest producer in the world, the third largest in Latin America, and the seventh largest producer outside of OPEC. Today, roughly 93% of the country’s production comes from offshore basins, with the Campos Basin accounting for 75% of daily production. However, the recent presalt discoveries in the Santos Basin have the potential to transform Brazil into one of world’s top oil producers. Tudor, Pickering, Holt & Co. International predicts the recent oil finds, on aggregate, could add another 50 Bbbl of oil to Brazil’s reserves, taking the country from its current proved reserve level of 12.9 Bbbl to 63 Bbbl, just behind Russia.

It is important to note that outside the Campos and Santos basins there are still vast areas of the country yet to be explored. According to the ANP, there are 29 sedimentary basins with oil and gas potential in the country, covering an area of 2.9 million sq miles (7.5 million sq km, or 10 times the area of Texas). It estimates that less than 5% of this area has been explored.

Managing growth

Tudor Pickering’s analysis of planned and ongoing development projects suggests that up to 5 MMbbl/d of oil could be produced from the Santos Basin by 2020, at a total development cost of US $250 billion. However, the increase in development activity will have unintended consequences, especially for E&P companies. Brazil already is rapidly becoming capacity-constrained in terms of production, rather than reserve-constrained, as are most non-OPEC nations. Going forward, one of the biggest issues for the country will be how it manages the growth in oil production.

The government’s desire to maximize local content in the oil services and equipment manufacturing sectors could temper production growth. Development stage local content participation has risen from less than 50% in the early licensing rounds to 84% in the 10th and most recent round. In spite of this, Tudor Pickering believes there is substantial opportunity for international oil service providers, particularly those working in deep water, to gain exposure to what is arguably the largest market for field development services over the next decade. This is because the magnitude and nature of the services required exceeds the capacity and capabilities of local service providers.

Brazil’s potential production is significantly greater than the country’s historical oil production, assuming no development constraints.

Proceed with caution

With relatively few wells drilled in the high-potential Santos Basin and largely underexplored interior and coastal areas, Brazil is set to be a focal point for E&P activity in the coming decade. Equally important, sustained global demand for hydrocarbons will continue to make deepwater, presalt, and other high-cost developments associated with the country attractive. This dynamic will continue to direct capital toward Brazil’s E&P space. Local and foreign companies with experienced management teams will take advantage of this, and they will have a high chance of achieving exploration success and consequently generating significant alpha.

In the near term, investors with exposure to such companies will benefit from Brazil’s exploration potential. However, there is an overriding risk to the monetization of discoveries in the country, particularly offshore and gas discoveries. The stringent local content requirements and the rush to develop multiple projects simultaneously will lead to delays in the development of future projects, thus eroding value. Overall, near-term opportunities in Brazil are compelling; however, investors must remain cognizant of project development and execution risks.