Brazil and the Oil Supply Crisis

The following is a translated passage and synthesis of “A crise do petróleo e os impactos no Brasil e no mundo,” published in LinkedIn by Tabita Loureiro e Pietro Mendes on May 6, 2020 and translated by Mark S. Langevin.

I want to thank Tabita and Pietro for allowing me the honor to make elements (the Brazilian segment) of their analysis accessible to the English reading audience.

2020 began with the implementation of the new IMO 2020 standards that feature reductions in the Sulphur content of crude oil. The measure was followed by the United States attack on Qasem Soleimani, the leader of the Iranian military, at the Bagdad airport and the increasing prospects of a war between the U.S. and Iran. The subsequent rise in the Brent price led the Brazilian government to begin policy discussions over keeping fuel prices down and smoothing out periods of price volatility. Then the global oil glut emerged just as the coronavirus paralyzed national economies and sent fuel demand in a tailspin. Like other major producer nations, Brazil must adjust to the new scenario.

The impacts of the global oil oversupply crisis arrived in Brazil in mid-April when Petrobras announced the hibernation of 62 platforms. The NOC reports that it is now reconsidering its initial response of cutting production by 200,000 bpd while its crude oil exports broke records in April.[1] Brazil’s very competitive, low Sulphur sweet crude oil is still in high demand and is gaining market share under the new IMO 2020 specifications. The country is likely to see increased production driven by new pre-salt projects that serve to consolidate Brazil’s global market position behind increasing competitiveness.

Brazil set records in January with 3.17 million bpd production followed by a slight drop to 2.97 million bpd by March. The impacts of the crisis could lead to modest production declines in the coming months due to the drop in prices and production costs. Petrobras continues to dominate national production with approximately 93% of the total. As it stands, Petrobras’ lowest production costs, measured in USD/bbl., are found in the offshore Santos Basin pre-salt play ($5.60), followed by other ultra-deep water fields ($12.50), onshore ($18.90), and shallow water fields ($30.30).[2]

The world class pre-salt play will continue to be competitive in the low price scenario, especially given the high quality of its crude oil, while the company’s shallow water fields are no longer viable at $30/bbl. In March, Petrobras’ reported to the National Oil, Gas and Biofuels Agency (ANP) shallow water production of 50,000 bpd, but this level is likely to fall in April and throughout the oversupply crisis.

In the current low price scenario, the Brent benchmark may play an important factor in determining the viability of commercial production in Brazil and determining the government’s take. Employing the ANP’s reference pricing for royalties, with a 10 to 30% discount in relation to the North Sea benchmark, it becomes apparent that Brazil’s onshore and shallow water wells will lose competitiveness and may fail to achieve the break even cost, forcing operators to halt production. If the low price scenario drags on then Brazil’s onshore and shallow water production will likely recede to further reduce the government take.

The Rio de Janeiro Federation of Industry (FIRJAN) estimates that the state’s losses in daily royalty revenues could decline by $215,000 USD at $25/bbl. and a reduction of 223,000 bpd of oil and 3.7 million cubic meters (m3) of natural gas.[3]

Petroleum derivative production and consumption will also be impacted. The ANP reports that sales of gasoline in March were the lowest since 2010, a 13.34% fall in comparison to March 2019.[4] Ethanol fuel also suffered steep declines, falling 15.82% year to year. The drop in transportation fuel demand also reduce recurrent revenues at all levels of Brazilian government. FIRJAN estimates that a 50% reduction in fuel demand could reduce the state’s daily value added tax collection by nearly $1 million USD.

The crisis points to important lessons for Brazil and the rest of the world. For example, flexibility is now an essential strategy as markets become increasingly volatile. Bloomberg indicates that Brazil is in a relatively privileged position compared to other Latin American oil and gas producers because of its larger storage capacity, some 159 million bbl. and FPSO tanker capacity of two million bbl. Also, Brazil’s sustained crude oil exports to China serve to partially relieve the challenges of the storage system.[5] Most of Brazil’s natural gas production is associated and will need to be managed in order to continue oil production since the country cannot count on much pipeline system storage capacity. Downstream, Brazil has 137 million bpd capacity for fuel storage, but there are bottlenecks, including market demand for LNP that requires concurrent production of gasoline. Low demand for gasoline at the pump requires that Brazil maximize its LNP storage capacity.[6]

The crisis would have disrupted Brazil even more without recent efforts to tender the pre-salt fields. Since 2016, policymakers’ and regulators’ sense of urgency led to a number of tenders bringing in approximately $112 billion USD in government revenues (90.6% in signing bonuses), the largest upfront take in the world during the period. The current challenge is to guarantee the viability and competitiveness of E&P projects during the low price scenario, considering that each year delay for the installation of a pre-salt production platform translates into lost jobs and millions in government revenues. E&P investment is likely to contract for all but the pre-salt play while Petrobras revises its development CAPEX downwards for mature basins.

Producer-nations are struggling to cope with the global supply glut and low prices. Norway is considering tax related reforms that incentivize the continuation of E&P projects while the U.S. government makes large purchases for the strategic stockpile to secure WTI prices and relieve the storage capacity challenge. The U.S., including state governments, also consider measures to roll back production to mitigate the externalities of the supply glut.

Mark S. Langevin’s addition:

The Brazilian government is already taking measures to mitigate the damage to smaller operators, prevent the transmission of Covid-19 to upstream and midstream installations, and suspend tenders until the markets clear. These efforts may mitigate some of the damages to Brazil’s booming oil and gas industry. However, it is uncertain how well the global oil market will perform, whether demand will begin to decline after the coronavirus is defeated or whether it will mount as the global economy recovers and energy security returns as a central policy priority.

[1] Available at: https://epocanegocios.globo.com/Empresa/noticia/2020/04/epoca-negocios-petrobras-reve-corte-de-producao-de-abril-ao-ver-maior-demanda-por-seus-produtos.html.  Accessed on 4 May 2020.

[2] Available at: https://br.investing.com/analysis/petroleo-despenca-o-que-sera-das-empresas-do-setor-200434076.  Accessed on 3 May 2020.

[3] Available at: https://www.firjan.com.br/lumis/portal/file/fileDownload.jsp?fileId=2C908A8A717B32B10171C6A6710C1437. Accessed on 4 May 2020.

[4] Available at: https://www.anp.gov.br/publicacoes/sinteses/4397-sintese-de-comercializacao-de-combustiveis. Accessed on 4 May 2020.

[5] Available at: https://www.worldoil.com/news/2020/4/29/ample-storage-and-a-recovering-china-insulate-petrobras-from-the-oil-glut. Accessed on 4 May 2020.

[6] Available at: https://www1.folha.uol.com.br/mercado/2020/05/petrobras-tenta-contornar-excesso-de-combustivel-usando-tanques-de-terceiros.shtml. Accessed on 4 May 2020.