Will Brazil Really Nationalize Oil?

Includes: BZF, EWZ, PBR
by: Contrarian Profits

By Irwin Greenstein

Brazilian oil workers with the FUP oil union have threatened a nationwide strike, in what seems like another step toward nationalized oil in Brazil

The saber rattling is aimed at Brazil’s biggest oil company, Petrobras (NYSE: PBR). While contentious union relations at Petrobras are part and parcel of the company’s operations, what’s different here is that the conversation focuses on the pre-salt layer off Brazil, triggered by last year’s massive Tupi find.

The newest breakthrough revealed these discoveries are likely to be contiguous, falling under a new set of guidelines that precariously lean toward nationalization of Brazilian oil. 

The Tupi field, discovered in November 2007, may be the largest pre-salt reservoir ever. Its reserves are estimated at 5-8 billon barrels of crude. It was found under an expansive layer of salt deep below the sea level) in the Santos basin, which extends from Rio de Janeiro to Santa Catarina.

To mitigate the risk and expense of this deep-water exploration, Petrobras entered into a partnership with UK’s BG Group and Portugal’s Galp Energia to develop the offshore field. Although Petrobras holds a 65% stake in the group, that apparently is not enough according to the union and other proponents of nationalized oil.

Other companies hold concessions in the region include Repsol-YPF (REP), Royal Dutch Shell (NYSE:RDS.A), ExxonMobil (NYSE:XOM), and Hess (NYSE:HES).

The latest strike threats against Petrobras take aim at the Tupi field.

“The discovery of the pre-salt puts our country’s wealth in danger. It is wrong to continue with the licensing rounds while this subject is still being discussed,” FUP spokesperson Alessandra Murteira told Business News Americas.

Ms. Murteria insists that profits from Tupi “should go to social projects” instead of Petrobras shareholders. “It’s not a strike against Petrobras. It’s a strike in favor of the people and the country’s sovereignty,” she said. “FUP hasn’t decided on the strike yet, but of course it eventually would harm Petrobras.”

Apparently Ms. Murteria either is ignorant of, or chooses to ignore, that nationalized oil companies tend to be inefficient, inept and corrupt.

For example, a report prepared in 2007 for the U.S. Congress by the Energy Economics and Policy Resources, Science, and Industry Division concluded that “Because national oil companies may be motivated by different objectives than private oil companies, their performance characteristics are also likely to be different. This might be of little consequence to consuming countries except that, in a tight oil market, the national oil companies may become an impediment to the smooth functioning of the world oil market in the future.”

The Tupi fields have become a flashpoint for nationalized oil in Brazil - not good news for Petrobras investors.

Under Brazilian law, concession areas found to be contiguous become the object of joint exploration by companies holding the various concessions to avoid drilling by one company in another’s area.

However, in July, Brazilian President Luiz Inacio Lula da Silva established a commission to study rule changes for the development of the pre-salt oil reserves. The committee was given 60 days to present proposals, but they may be delayed due to the sensitivity of the issue.

Lula’s henchman, Edison Lobao, is the country’s Mines and Energy Minister. He has proposed the formation of a separate company to oversee production in the pre-salt area. He argues that the oil is a “sovereign asset” that should be used for the benefit of the whole population and not just shareholders of companies.

Under the plan, the new state company would have full control over the oil produced in the pre-salt area. Petrobras - which is about 60% privately owned - would be a service provider, which either gains a share of production or earns a fee for services rendered.

Petrobras has already conceded to a profit-sharing plan for employees. On July 30, it raised its profit-sharing proposal to oil workers, according to the local Estado news agency, Estado.

Estado reported Petrobras has raised its offer to about 16% of the value received by Petrobras shareholders in dividends. That was up from Petrobras’ previous proposal - made July 9 - which called for oil workers to receive 12.82%.

In 2006, oil workers received 12.57% of shareholder dividends compared with 12.05% in 2005.

Under Brazilian law, workers can receive a profit-sharing payment of as much as 25% of shareholder dividends. Naturally, FUP wants Petrobras to pay the full 25% allowed by law.

The movement to nationalize Brazilian oil may be more widespread than most investors think - or would allow themselves to believe.

Columnist Ricardo C. Amaral wrote a forceful argument in favor of nationalization in the July 30th issue of Brazzil.

“It is imperative that the Brazilian government follow a major global trend and start renationalizing as soon as possible the Petróleo Brasileiro SA (Petrobras),” he wrote.

He contends that the money from Brazilian oil should be channeled into a national Sovereign Wealth Fund - the massive state-owned arms of central banks chartered to invest their reserves. In many cases, these reserves come from raw materials such as oil, natural gas and minerals.

After attending a seminar in New York on June 13, 2007, he suddenly realized that Saudi Arabia is getting its trillions from oil - and that money is being directed into the country’s Sovereign Wealth Funds. After spinning a few calculations, his comes to the conclusion that all this money is “why countries such as Russia, Venezuela, Ecuador, Bolivia and others have renationalized their oil and gas industry in the last few years.”

His conclusion: let’s renationalize Petrobras.

“It seems that if oil is so important and so rare, as they tell us, we should have a better control of our own national reserves when we take in consideration that oil is a strategic and economic asset,” he wrote.

He envisions a new Brazil with a 21st century infrastructure built on the oil profits of the nationalized Petrobras…

“It is imperative that the Brazilian government renationalize Petrobras immediately and use this amazing source of funding to fund the enclosed economic development plan to plant the seeds for Brazil to be able to develop the new economy of the future and to help it to blossom and create millions of new jobs for the Brazilian population.”

While Mr. Amaral’s utopian vision looks good on paper, most nationalized oil companies tend to recede into some form of dingy, lumbering Communist monopoly no longer stimulated by market forces. The bottom line: higher oil prices.

Disclosure: none