Brazil: The Good, the Bad, and the Oily


The changes in the world of energy, both geographically and technologically, have been enormous during just the past decade. But almost certainly the years between now and, say, 2020 will be every bit as eventful, especially in places like the U.S., Russia, and, of course, Brazil.

South America's biggest country came on like gangbusters following the 2007 discovery in the deepwater Santos basin of the giant Tupi field by state-controlledPetrobras and its partners. Tupi resulted in a virtual stampede of companies to Brazil, all intent on dipping drill bits into the South Atlantic's Santos. Collectively, the group, which was led by Royal Dutch Shell -- the first foreign company to produce crude oil in the country -- has added enough additional finds to rank Brazil as the locus of a third of all the oil subsequently discovered worldwide.

The big one packs it in
None of this is to imply that uncovering hydrocarbons by simply wetting a bit in the Santos basin is a given, or that operations off the Brazilian coast are technically or politically simple. None other than ExxonMobil , the biggest of Big Oil, threw in the towel on its only ongoing Santos basin exploration effort last spring. Along with its partners Hess and Petrobras, the company relinquished the block in which it was drilling.

Keep in mind that South American governments are almost never pillars of predictability, and Brazil's is no exception. Chevronconfirmed such when it spent a good part of 2012 locking horns with the country's powers-that-be following a November 2011 oil spill in the company's Frade field in the Santos basin. The 3,600-barrel spill was essentially minuscule, at least compared with BP's 4.9 million-barrel 2010 Macondo gusher in the Gulf of Mexico.

That, however, didn't thwart Brazilian officials from seeking fines in the billions of dollars, charging employees of both Chevron and driller Transocean criminally, and temporarily barring both companies from operating in the country. And while it was pursuing the Frade frenzy, the government of President Dilma Rousseff was forced to deal with an emerging bribery and influence-peddling scandal at the highest levels of her governing Workers Party.

Most of those alleged transgressions had occurred under the presidency of Rousseff's predecessor, Luiz Inacia Lula da Silva, but they nevertheless continue to hinder the current regime and have done nothing to reverse the nation's economic softness. After expanding at a healthy 7.5% rate in 2010, Brazil's growth slowed to 2.7% in 2011 and tumbled to not much above 1% last year.

Challenging technology
More challenging for energy companies working in the Santos basin, however, are the extreme geologic conditions with which they're forced to contend. The biggest finds have occurred in a "pre-salt" region of the Santos. Wells there typically require drilling in more than 5,000 feet of water, penetrating thousands of feet of rock, and then continuing on through salt layers also with thicknesses in the thousands of feet. The conditions are sufficiently challenging thatSchlumberger , the industry's technology leader, has established a research facility in Brazil, with the intention of developing procedures for dealing with the pre-salt, which is thought to sit atop between 50 billion to 100 billion barrels of oil equivalent.

Among other things, the Santos requires ultra-deepwater drilling rigs that typically carry a price tag in the $600 million range and contribute mightily to the costs of exploratory wells, which frequently top $100 million per copy. For now, there's a marked shortage of rigs capable of working in pre-salt conditions, making the latter figure likely to edge higher. No wonder ExxonMobil chose to pick up its marbles and move on.

Questionable regs and a bloated budget
Perhaps the company was also less than pleased by the implementation of 2010 regulatory reforms covering the pre-salt. The most onerous of the provisions -- and likely the most detrimental to progress in the area -- is the requirement that Petrobras serve as sole operator on each pre-salt project and that the company be granted at least a 30% interest in all such programs. In part as a result, there is mounting evidence that foreign companies, the drillers in particular, are somewhat less than secure vis-a-vis their potential treatment by Brazilian authorities.

Much of Brazil's current production occurs in the country's Campos basin, which has been worked far longer than its pre-salt Santos sibling. Nevertheless, authorities in the country expect to spend more than $50 billion of a total budget north of $200 billion on pre-salt exploration and production activities by just 2015. Opinions abound, however, that the spending will come up short, because of the potential for capital insufficiency, technological roadblocks, or administrative obstreperousness.

The Foolish takeaway
The pre-salt beat goes on, however. Just last week, Petrobras announced yet another apparently meaningful discovery in more than 7,000 feet of water nearly 200 miles off Rio de Janeiro state. As such, it's difficult to conceive of any single country that will merit closer attention by energy investors than Brazil in the years ahead.

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David Lee Smith owns shares of BP and Transocean. The Motley Fool recommends Chevron and Petrobras and owns shares of ExxonMobil, General Electric, and Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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