Latin America's trump card

Friday, May 29, 2009

Latin America's oil majors have seen dramatic changes as oil prices plunged from last year's record highs. The region, though, still has some of the most attractive reserves in the world from Venezuela's Orinoco belt to Brazil's recently discovered pre-salt areas.

State companies across the region are now walking the delicate tightrope of seeking foreign investment while trying to maximize revenues that can be transferred to the state. Venezuela has taken further steps to increase its participation in the sector by nationalizing parts of its service industry last month. Some countries, such as Colombia, have seen gains from taking the opposite approach.

BNamericas spoke with Gianna Bern, president of Chicago-based energy consultancy Brookshire Advisory and Research, about the current market and how companies in the region are being impacted.

In its latest research report, Brookshire argued that the region's vast reserves may be giving state companies in Latin America a "trump card" in their negotiations with international oil companies for funding and expertise.

BNamericas: When you say in Brookshire's new report that reserves trump state regulation, how does this specifically refer to [Venezuelan state oil company] PDVSA, [Mexican counterpart] Pemex or [Brazil's federal energy company] Petrobras?

Bern: The May Brookshire Energy Series highlights PDVSA, Pemex and Petrobras. According to the latest BP Statistical Review, Venezuela, Mexico and Brazil collectively lay claim to almost 90% of Latin American reserves. While the region offers opportunities, it also presents considerable challenges for all players in the energy supply chain. When you consider global opportunities to build crude oil or natural gas reserves, all of the low hanging fruit in the industry is gone. Big oil's options include Canada, the Middle East, Libya, Nigeria, Russia, Kazakhstan, Gulf of Mexico, China, Venezuela or Brazil. There are significant issues in many of these countries. Very quickly global exploration options become limited and mired in regional geopolitics and regulation. Latin America does hold promise, in terms of hydrocarbon reserves, albeit with its own set of risks and challenges.

BNamericas: To what extent do you see Brazil's new reserves as a trump card? They're huge, sure, but incredibly expensive to develop and technologically challenging.

Bern: Yes, the pre-salt reserves are expensive and technologically challenging to develop. Brazil's [oil and gas regulator] Agência Nacional do Petróleo [ANP] has placed their reserve potential upwards of 50Bb, or more. To its credit, Petrobras has invested in technological capabilities including deepwater exploration and development. Recent initiatives to begin the pilot testing on BM-S-11 should be telling and present a map for future development initiatives in adjacent basins. This is a new frontier.

BNamericas: In a related question, now that Brazil's government is rethinking the oil and gas framework in light of the Santos discoveries, how "unattractive" can it make new terms while still attracting the foreign investment it will need? If the country creates a state company to administer Santos, would it still be able to attract the investment it needs?

Bern: A new state company would be a political response rather than a market response to an economic opportunity. A separate company is a vehicle by which local politicians might institutionalize their power and control over the market. I think two Brazilian state companies would compete for the same resources, and its efficiency could be less than optimal.

BNamericas: To what extent does your example of a "trump card" relate to Mexico, given that reserves are dwindling and that Pemex has exclusive E&P rights?

Bern: That is correct. Pemex's 1P reserves are dwindling. However, Mexico does have considerable 2P and 3P reserves totaling 43Bb. Mexico will continue to be challenging for oil producers. In Mexico, there may be better opportunities for the oil field service sector given Pemex's efforts to develop 1,000 new wells in the ATG basin in 2009.

BNamericas: Could one argue that the idea that "the era of easy oil is over" mitigates a country's trump card? For example, Mexico has huge potential reserves in the Gulf of Mexico, but if it ever opens its E&P sector to foreigners, will it be beholden to foreign operators who know how to operate it? How are the three companies attracting foreign investment? Is one strategy working better than the other?

Bern: The economic strategies that are most effective enable a foreign operator to book reserves for its account. Foreign operators bring technology, resources and capabilities that many national oil companies need. Foreign operators, smaller independents and oil juniors all add value in the supply chain. The regional model that has held the most promise is that of Brazil. Currently, according to Brazil's ANP, there are 72 concessions in the country. I would also add that for all of the geopolitical issues in Venezuela, they have had to bring in numerous partnerships and joint ventures. In Venezuela, there are approximately 18 different operators in the Orinoco Belt. Partnerships and joint ventures have become a strategic imperative given the downturn in crude prices.

BNamericas: Is any one of the three companies better prepared to face lower oil prices?

Bern: Petrobras is the most prepared to adapt to the current low crude oil price environment. Over the last several years of the crude oil bull market, Petrobras stockpiled cash and used it for deepwater investment. The company's leverage is still very low and, while it has used some of its cash, Petrobras is now in an enviable position of having a fairly strong balance sheet and sitting on extraordinary geology in the south Atlantic. Few countries can lay claim to the reserve potential off the Brazilian coastline.

BNamericas: Should we believe the reserve figures we see from Venezuela? Authorities typically use the term POES (original oil on site) to certify reserves? Is this standard?

Bern: The terminology is different than what we are more accustomed to seeing in terms of [US securities regulator] SEC or [global society of petroleum engineers] SPE reserves certification. However, Venezuela has publicly acknowledged using Ryder Scott to certify its reserves. There are very few companies that do this kind of work and Ryder Scott is very reputable.

BNamericas: Why would anyone want to participate in the Carabobo tender when the country doesn't seem to respect contracts? There were the famous nationalizations in 2007 and now the government has just taken over the oil field service sector. What's in it for the majors? Why not just look somewhere else?

Bern: There's no question that current nationalization efforts will cause new investors to rethink investing in Venezuela. Ironically, since the 2007 nationalizations, very few companies have actually left Venezuela. There are primarily two reasons. The financial investment is considerable and many companies are just not willing to walk away from their significant operations in Venezuela. Writing off that considerable financial investment is a tough pill to swallow. Having said that, many of the companies that stayed in Venezuela are complying with the JV policies of the Venezuelan government. The other reason for staying is the 200Bb of reserves that are present in the Orinoco belt. Quite simply, there aren't too many places on the globe today that offer that kind of reserve opportunity. Yes, Venezuela poses considerable geopolitical and regulatory risk, but so do many other geographies. Big oil has fewer options today than it did 20 years ago.

BNamericas: There are some new reports that say Venezuela could actually be producing close to 2.6Mb/d. Who should we believe? Does it even matter? Why is it so hard to get actual numbers?

Bern: Venezuelan production numbers are elusive. There are varying layers of other liquid hydrocarbons and the production associated with the Orinoco belt that have to be stripped away [from public filings] to get to actual PDVSA production numbers. The 2.6Mb/d figure sounds high.

BNamericas: What about [Colombian state oil company] Ecopetrol? They seem to be going strong despite the downturn. Could Latin America's other majors learn anything from its experience?

Bern: Yes, Ecopetrol is an example of what can be accomplished with a more free market economic model. In my opinion, credit can be given to a more favorable regulatory environment and a level of transparency that enabled so many independent oil companies to go to Colombia and participate. Certainly, Ecopetrol has benefitted from the regulatory structure. The fact that there are now outside investors will guide Ecopetrol towards corporate governance practices that will provide investors with greater transparency. Overall, Ecopetrol has turned out to be a very positive story for the region. While Ecopetrol is smaller in scale than Petrobras, it is indeed a gem in the region.

About Gianna Bern

Gianna Bern is an energy analyst and president of Brookshire Advisory and Research, an independent consulting firm focused on corporate management consulting and energy economics research. Bern has 20 years experience in corporate finance and treasury, portfolio management and energy analysis.

Prior to Brookshire, Bern was a senior director at Fitch's Latin America corporate finance group, where she was responsible for rating both oil and gas, and utility companies in Latin America. Prior to that, she was a credit portfolio manager, handling US$2.5bn in funds.

Bern has also held managerial positions in energy risk management at both British Petroleum and Amoco Oil Company, prior to their merger. She has also been an energy analyst at both major oil companies.

Bern has a BBA in finance and accounting from Illinois Institute of Technology and an MBA from The University of Chicago Graduate School of Business in International Business and Finance.