Is the Oil Business in Brazil About to Blow Up?

Activity in offshore oil drilling has been red hot lately. The U.S. government timed its most recent Gulf of Mexico auction almost perfectly, as it came right on the heels of Anadarko Petroleum's and Chevron's (NYSE: CVX  ) announcements that the two companies had hit major paydirt at a couple of its rigs. The U.S. isn't the only country finding sucess offshore, either. This past week, Brazil completed its first oil and gas lease auction in five years, and apparently the long wait had exploration and production companies drooling. The country pulled in its largest auction revenue ever, about 2.88 billion Brazilian reais ($1.4 billion).

Let's look at who were some of the big winners in the Brazil auction and why offshore in Brazil may be the new hot commodity for oil companies. 

And the winner is ...
It all depends on your definition of "winning: to determine who came out on top of this auction. If your definition is most blocks won, then Petrobras (NYSE: PBR  )  took that prize running away. The company spent $268 million for rights on 35 blocks. The next closest in terms of bids won was OGX, which secured 13 blocks in the entire auction. It shouldn't come as a surprise to anyone that Petrobras was the most active in this auction. Not only is Petrobras Brazil's largest oil company, but it also just recently completed an $11 billion bond issuance, the largest corporate bond sale from an emerging market ever. Some of that money was probably pre-planned for both this auction and the next Brazilian auction to happen in October. This move will further secure Petrobras' position as the largest oil producer in the country. 

There is another way to measure the winner, and that is who won the bid for the most attractive asset. That prize goes to a group led by France's Total (NYSE: TOT  ) , which, with its partners BP and (surprise, surprise) Petrobras, won the bid for a 350-square-mile block at the mouth of the Amazon River. The group's winning bid for the region came in at $172 million. It was the most paid for any Brazilian block since 2006. Magda Chambriard, the head of Brazil's national petroleum agency, has gone on record saying this individual block has the potential to produce up to 150,000 barrels per day. 

Overall, though, Brazil was probably the largest winner in this auction. The country secured bids for 142 of its 289 blocks up for sale. To put that in perspective, the most recent Gulf of Mexico auction secured bids for only 400 for the 7,300 blocks up for sale. Also, according to the Financial Times, many of these blocks sold for premiums much higher than the minimum bid price from the government. This should be a promising sign for the emerging market, as it didn't put up its most lucrative asset -- the pre-salt formation -- up for auction. However, the country will auction off the pre-salt formation for the very first time in October.

Why Bet on Brazil?
Over the past couple of years, companies have been reluctant to work in Brazil, in part because the country has what is known as a local content clause, requiring that any oil and gas work being done in the country needs to contain a certain percentage of Brazilian-made equipment and personnel. That requirement is especially pertinent to oil services companies. Seadrill (NYSE: SDRL  ) has said in previous earnings statements that cost levels in Brazil are higher than most other regions in the world, and the company has been contemplating a spinoff of its Brazilian assets into its own company for well over a year.

With a massive upswing in exploration and production activity expected to happen in the next couple of months, Petrobras has requested that the government ease these regulations. The company has stated that the anticipated growth in oil production will overwhelm the country's ability to produce equipment. 

Another reason some companies have shied away from operating in Brazil was the political fervor caused by Chevron's spill back in November 2011. Estimates for the spill were about 2,600 barrels spilled, and civil lawsuits in the case were asking for as much as $20 billion between Chevron and rig operator Transocean (NYSE: RIG  ) . Just to put these numbers in perspective, the Macondo incident in 2010 spilled about 4.9 million barrels, and the maximum penalty is $17 billion. The Brazilian government also threatened to expel both Chevron and Transocean from operating in the country. Since then, the criminal charges have been dropped and Chevron has resumed drilling after paying a fine.

Despite these issues, though, it appears the juice is worth the squeeze. Brazil's pre-salt formation is estimated to contain as much as 50 billion barrels of technically recoverable oil, and the country's shale deposits represent about 6.4% of the world's shale reserves. With so much oil and gas out there for the taking in the South American giant, Petrobras has stated it wants to triple Brazil offshore production by 2017.

What a Fool believes
Brazil may be one of the hot spots for offshore exploration right now, but there are several challenges that face operating in Brazil. If local equipment production can't keep up with exploration plans, the country should seriously reconsider its local-content mandates. Brazil also needs to prove that it is more worthy of investment than some of the other lucrative offshore plays right now, such as Ghana's Jubilee field and Mozambique's gas fields.

With so many different offshore opportunities, it's definitely more lucrative for investors to pick a way to play all offshore operations rather than picking one as a winner over the other. One way to do that is investing in Seadrill. To help you size up this stock, one of The Motley Fool's top Stock Advisor analysts has written a premium research report on the company, covering everything from its strengths and weaknesses to what to expect going forward. Simply click here now to claim your copy and determine whether Seadrill deserves a place in your portfolio.


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  • Report this Comment On May 27, 2013, at 10:38 PM, DukeMontrose wrote:

    It appears, SDRL, as usual, is in the front of the pack, this time in Brazil. It has already made preparations more than a year ago to spin its Brazilian operations into a Brazilian company, per chance with listing on the local stock-exchange.

    2013 brings a better chance than before for the locals NOT to make a stupid move fueled by misguided nationalistic tendencies. I believe the Brazilian leaders realize now that keeping up friendly relationships with "foreign" partners is in the best interests of all concerned.

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