How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

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As Brazil becomes a global hot spot for the COVID-19 pandemic, corporations and industries struggle with the logistical choices and challenges based on the need to rapidly adapt in the COVID-19 environment and the changed world that will emerge afterward. Most are focused on mere survival, but some companies may be able leverage the situation to their advantage.

Extraordinary economic stresses such as COVID-19 and an almost unprecedented perfect storm of collapsing oil prices have wreaked havoc on the oil industry landscape. However, just as environmental stress forces ecosystems to evolve and adapt in the biological world, in the end, winners and losers will emerge in the business and geopolitical landscape and the hydrocarbon industry will emerge stronger and better able to thrive and adapt in the new environment of a post-COVID-19 world. These facts are somewhat intuitive to many, but the devil is in the details.

Who will the winners and losers be in this scenario and why? This is one of the big questions companies will seek to answer as well as what changes need to be made in their organization to help them survive—and even prosper—during the industry downturn. Within this framework, it is argued that Brazil will emerge as a winner because the country offers a diverse and unique set of investment opportunities that are unrivaled at this time anywhere else on the planet. Specific opportunities that will lead the country to success include:

  • An expanding production base of high quality, low-cost oil from the pre-salt.
  • Hundreds of re-offered exploration blocks obtainable for reasonable cost and commitments.
  • A domestic gas market poised for explosive growth in supply and demand after the ending of a de-facto monopoly.
  • Pipelines to be offered for investment, offshore fields and facilities coming online, and an accelerated pace for old platform decommissioning.

Exports to China surge amid COVID-19 oil demand drop, production sustained during supply glut

In late March, Petrobras announced plans to cut production by 200,000 bbl/d due to low oil prices and COVID-19 demand reduction. However, production in March remained flat and guidance was reissued in April, adding 200,000 bbl/d from original projections. Why? The company later said it raised production to pre-virus levels after demand was stronger than expected.

Oil exports set a record with China as the most important customer for Petrobras, as the Chinese economy reopens after recovery from the COVID-19 pandemic. This was despite domestic oil demand in Brazil dropping substantially due to a patchwork lockdown of many municipalities based on social distancing restrictions implemented in late March. Petrobras seems to have an inside track as the oil supplier of choice regarding the export market to China. The company reported May 4, 2020, the export of a record setting 30.4 MMbbl, approximately 1 MMbbl/d, in April 2020 amid growing demand from China. The previous record of 771,000 bbl/d was set in December 2019. The new record was also 145% more than exports in April 2019, with China accounting for 60% of Petrobras crude exports.

Reasons include high quality of oil and geopolitical reasons, supply stability, and continued long-term production growth expected. Pre-salt oil has high capex costs to begin production, but the lifting costs for a barrel of pre-salt oil are among the best in the world. Petrobras announced in October 2019 it had dropped to $5.03 per barrel in Q3 2019, down 20% from Q2 2019. This is primarily due to the high flow rates and dependable production of the wells as shown in the top 20 oil producers, Figures 1 and 2 below, for February 2020 (all pre-salt).

Pre-Salt Oil 20 Largest Producing Wells

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 1

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 2

In early May 2020, analyst consensus was that Petrobras was in a uniquely strong position to weather the global oil glut due to the company’s extensive storage capacity. The ANP said Brazil’s ability to store crude “remains robust,” due to storage facilities with a combined capacity of 159 million barrels, with more than half of that total located at relatively new offshore fields. Also helping is that Petrobras refineries are increasing production of in-demand marine fuels, which reduces crude inventories. China has the capacity to absorb much of Brazil’s crude exports, noted the Petrobras CEO, who also said he was more worried about selling the oil at a profit than finding markets for it.

 

Others noted that Petrobras entered the crude oil price crisis in a relatively strong position, noting that Brazil is different because the country is still in expansion mode due to pre-salt development and that puts it in a stronger position to achieve and sustain long-term gains. It was also noted that Brazil compared favorably to other Latin American exporters like Mexico, Colombia, and Ecuador that produce lower quality crudes with more limited markets compared to higher-quality crudes from the Brazilian pre-salt that can be sold to a wider market. The pre-salt Petrobras oil is low in sulfur content and good for producing marine fuels.

Gas, refining, and distribution markets wide open as Petrobras forced from monopoly

In June 2019, Brazil’s National Council for Energy Policy (CNPE) presented 24 guidelines for opening the natural gas market and new annual targets for greenhouse gas emission reductions for fuels. The CNPE proposals aimed to increase unbundling throughout the natural gas value chain and, most of all, create conditions for access not just to gas pipelines, but to all the essential infrastructures of the sector, such as outlets, processing units, and LNG terminals. In short, the proposals were designed to open the market and promote competition. The CNPE also recommends that the federal government encourage the states—through its programs of resource transfers and fiscal adjustment—to voluntarily modernize the regulation of piped gas services. The resolution was approved by the CNPE establishing the formal beginning of the new gas market agenda and a great opportunity for companies that could also serve to boost Brazil as the country’s natural gas market opens.

Petrobras, by law, is losing its de-facto monopoly in the natural gas sector and in refining and distribution, so a large comparatively virgin market is now opening to the outside world for the first time, despite the opening of the upstream sector in 1999. The current Bolsonaro government is supportive of free-market economics and wants to encourage competition in the sector with an objective to lower the price of natural gas and expand its currently modest position in the energy matrix. Also, an expanded market is urgently needed for the large quantities of pre-salt associated gas that will need to be handled as production comes online.

Analysts see Brazil as an underdeveloped gas market in comparison to other countries nearby, especially when compared to those with as much gas resource as Brazil, which had more than 10 Tcf of proven gas reserves at the end of 2018, but far more gas resources. This does not consider any areas without commerciality declarations or areas where the gas is being reinjected. As of March 2020, Brazil produces about 1.69 Bcf/d for the energy market while total production is 4.307 Bcf/d, so only about 39% of produced gas is used, with the rest reinjected. It’s projected that 5.189 Bcf/d will be in the energy market by 2030. The expansion should come mainly from increased pre-salt production in the Campos and Santos basins and new production from post-salt fields in the Espírito Santo and Sergipe-Alagoas basins. These two basins currently lack gas pipelines and processing infrastructure.

Smaller companies, such as Eneva in the Parnaiba Basin, have adopted business models utilizing the gas to wire power strategy with much success. Canada’s Alvopetro has also recently adopted this model. Brazil, at the country level, realized it would need to reduce imports of Bolivian gas to make way for the pre-salt gas resource coming online. The 20-year contract was renegotiated for 2020 to a six-year contract with roughly two-thirds of the previous volumes, even though Petrobras has a significant slice of the pipeline consortium and the fields used for export from Bolivia.

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 3

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 4

Offshore gas pipelines

Meanwhile, Petrobras has moved ahead with three major offshore gas pipelines and is planning three more after those.

Petrobras announced March 6, 2020, it will centralize its stakes in three offshore natural gas pipelines into one company and might list those company shares in an initial public offering (IPO) on the Brazilian stock exchange in 2021. The new division could be spun off in an IPO, like Petrobras did in 2019 with BR Distribuidora. Petrobras sold a stake in the company with an IPO, then added a follow-up share offer later that allowed Petrobras to cede control of the unit, marking the first time a public company was privatized through a share offer in Brazil. The spinoff would continue the Petrobras effort to vacate Brazil’s domestic natural gas industry per an antitrust agreement signed in 2019 with CADE, ending the natural Petrobras monopoly and opening the door to more private-sector participation.

Brazil currently has two major operating offshore gas pipelines—Rota 1 and Rota 2. The Rota 3 pipeline will be finished in 2020 but is not expected to start operating until 2021, after the gas-processing plant is completed later in 2020.

The three pipelines represent 1.694 Bcf/d capacity and connect the Santos basin pre-salt fields to gas markets in Rio de Janeiro and São Paulo. Petrobras currently has a 100% stake in the first part of Rota 1, linking the Mexilhão Field to the coast. The second stage of Rota 1 connects Mexilhão to Lula Field. Petrobras has 65%, with Shell at 25% and Galp at 10%. For Rota 2, Petrobras has 55%, Shell 25%, Repsol 10%, and Galp 10%. For Rota 3, Petrobras has 100%.

It is also not known yet whether the Petrobras divestment will involve only new companies or if the current partners can exercise rights of first refusal to increase shares in the pipeline company. On the partner side, there is apparently interest in expanding their shares in the pipelines. Rota 1 has been operating since 2011 and Rota 2 since 2016. Rota 1 is 359 kilometers and ends at the Monteiro Lobato Gas Treatment Unit in Caraguatatuba. Rota 2 is 382 kilometers and transports gas to the Cabiúnas Gas Treatment Unit in Macaé. Rota 3 has a total length of 355 kilometers and transports gas to Comperj in Itaboraí. Three new pre-salt natural gas pipelines are also planned called Rota 4, 5, and 6 that will pipe gas to the coast from the Santos and Campos basins. Definitive plans for these pipelines are still under discussion, along with other innovative ways to utilize the pre-salt gas. IBP Natural Gas Secretary Luiz Costamilan noted that the currently installed capacity in Brazil should be sufficient to absorb increased gas production until 2024 when anticipated gas production growth is expected to require new infrastructure investments.

Opportunity knocks natural gas and midstream

A wide variety of other opportunities in the natural gas/ and midstream sector are already active and mainly centered on Petrobras divestment. Some of these include:

  • Selling shares of petrochemical giant Braskem on the stock market.
  • Further share divestment of BR Distribuidora.
  • Closing the sale of eight refineries with over 1 MMbbl/d combined capacity.
  • Divesting the remaining 10% in gas pipeline subsidiary Nova Transportadora do Sudeste (NTS).
  • Divesting 51% controlling share in holding company Gaspetro with more than 10,000 kilometers of gas pipelines and stakes in 19 regional natural gas distribution companies.
  • Divesting remaining 10% in natural gas pipeline distribution subsidiary Transportadora Associada de Gas (TAG); French company Engie holds a 90% stake purchased from Petrobras in June 2019 for $8.6 billion.
  • Petrobras has until September 2020 to begin the bid process to lease the Bahia LNG Regasification Terminal (capacity 706 MMcf/d) in Salvador to interested companies.
  • Brazil could receive 32.2 billion reais ($7.8 billion) in investment to build 11 new gas processing plants (total capacity 2.47 Bcf/d).

Offshore platforms coming online and going offline

Another way to consider the offshore sector in Brazil is to look at all the FPSOs scheduled to come online over the next four to five years. Although some delays in their schedule may be incurred by the COVID-19 pandemic and historically low oil prices, these mostly pre-salt projects are generally resilient due to low per barrel lifting costs. Delays may happen based on company cash flow issues, oil supply gluts, and lower demand from the pandemic and beyond, but these are more likely to affect the pace of implementation for the projects, rather than whether or not they will ultimately proceed.

Petrobras also said it is now prepared to operate in a scenario of $15-per-barrel prices. The company has $15.5 billion in cash available, which is three times the minimum forecasted amount, “because preserving liquidity is crucial now,” the CEO explained. A total of 13 Petrobras FPSO units are due to start operations in 2020-24, but that schedule is now under revision. Three of these are due to come online in 2020-2021. Petrobras has already anchored the P-70 platform in the pre-salt Atapu Field of the Santos Basin and it should begin producing in June 2020. The Sepia and Mero FPSO units are due to come online in 2021.

FPSOs Planned to Start Production Next Five Years

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 5

The ANP approved 16 plans for decommissioning of offshore oil & gas fields May 8, 2020. The fields involved are Bauna Sul, Cacao, Camarao Norte, Carapia, Espadarte, Guaiuba, Guaja, Linguado, Marlim Sul, Mexilao, Piranema, Pirapitanga, Roncador, Salema Branca, Tambuata, and Tartaruga Verde. Of the approved plans, 10 involve deactivation of the entire field, while the other six involve a partial replacement of assets. The decommission involves a permanent plug and abandoning of the wells and at least 10 platforms will also be decommissioned in the Cacao, Piranema, Marlim Sul, Espadarte, Tartaruga Verde, and Roncador fields. Five of the fields involved are in the Campos and Santos basins while three are in the Potiguar and the Camamu, Espirito Santo, and Sergipe-Alagoas basins, with each having one field.

Brazil has many platforms on the shelf that are approaching the end of their useful life after installation in the 1980s and 1990s in fields with marginal output. Thus far, all the decommissioning plans approved are the responsibility of Petrobras, which had a monopoly in exploration and production in Brazil until 2000. The Petrobras business plan released in late 2019 includes investments of $6 billion to decommission 18 production platforms, as well as subsea pipelines and offshore wells from 2020-2024. However, some of those projects have not yet been submitted for ANP approval.

Permanent offer blocks

Another important opportunity in Brazil not to be overlooked for both the majors and the overwhelming majority of companies that will never have the capex billions to invest in the pre-salt, is the Permanent Offer of Areas for Exploration and Production established for open acreage. The Second Cycle of this program is slated to be held in the second half of 2020 while both the other rounds slated for this year have been canceled due to COVID-19, with 57 companies currently registered.

The Permanent Offer Round provides for the continuous offer of fields and blocks relinquished or in the relinquishment process and exploratory blocks unbid in previous rounds. This round allows registered bidders to submit a declaration of interest, accompanied by an offer guarantee payment for blocks or areas on offer. After one or more declarations of interest have been submitted and all documentation has been approved, the bidding committee publishes a schedule to begin a cycle to present offers. If only one qualified bid is received for an area, the bidder automatically gets it at the minimum established price and work commitment established by the ANP. The First Cycle for the Permanent Offer was held Oct. 9, 2019, resulting in 33 blocks and 12 marginal areas won by operators.

The ANP approved the new version of the bidding notice and drafts of the concession contracts for the round in mid-April, which now includes 567 blocks with exploratory risk and two marginal accumulation areas. The Second Cycle blocks now include 519 blocks from the First Cycle of the Permanent Offer conducted in 2019 and 24 blocks that were unbid from Round 16. In addition, at least 149 more blocks have obtained environmental clearance for the round and could be added at any time.

On Feb. 14, 2020, Minister of Mines and Energy Bento Albuquerque presided over contract signings and final awards for the First Cycle of the Permanent Offer of Areas for Exploration and Production established for open acreage that took place Sept. 10, 2019, under the concession model. The 45 contracts involved 18 winning bidders and raised 22.3 million reals in signature bonuses, with minimum exploratory investments totaling 320 million reals. Exploration blocks were claimed in the offer in the Sergipe-Alagoas, Parnaiba, Potiguar, and Reconcavo basins and 12 areas with marginal previous accumulations were claimed in the Potiguar, Sergipe-Alagoas, Reconcavo, and Espirito Santo basins.

For exploratory blocks, the total bonus collected was 15.32 million reals ($3.77 million) with an average goodwill of 61.48% above minimum and a forecast of 309.8 million reals ($75.6 million) in investments.

For the marginal areas, the total bonus was 6.98 million reals ($1.72 million) with a very high goodwill of 2,222% above the minimum and a forecast of 10.5 million reals ($2.6 million) in investments. The bottom line for this round is the low cost and commitments to obtain a block.

Campos Santos Basin Blocks Available in Permanent Offer Second Cycle 2020

How Will COVID-19 and Low Oil Prices Impact Oil & Gas in Brazil?

Figure 6

Lots of acreage is available at low cost, based on the first cycle. The onshore sector in Brazil has been declining, under-invested, and completely dominated by Petrobras historically. That is changing and the government has and may introduce more measures to boost the sector of the industry and get it to live up to its potential. Also, as some of the comparatively better blocks get relinquished there will be a rush by the government to get them back in the program for reoffering, meaning better opportunities for contractor work such as permanent abandonment, decommissioning, remediation, removal, and disposal of equipment.

Outside of the pre-salt, this Permanent Offer program is the future for Brazil and could be a good fit for anyone from the supermajors on down.

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Scott Stewart

Scott Stewart

Scott Stewart has more than 27 years of experience in the oil & gas industry. He has been directing intelligence efforts in the Latin American region for the last 11 years. Scott has a Bachelor of Science in Geology from the University of Tennessee.