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Low oil prices and a massive scandal in Brazil threaten the country's ability to fulfill its expected role as a source of future oil growth.
Brazil produced an estimated 2.9 million barrels of oil per day in 2014. The 2007 discoveries of vast reserves of oil located beneath a thick layer of salt prompted optimism that the country could lift its oil output significantly. Just two years ago, Brazil confidently predicted that it would be able to double its oil production on the back of its pre-salt fields, allowing the country to produce 5 million barrels per day (mb/d) by 2020. Expectations and excitement soared.
Since then, Brazil and its partially state-owned oil company Petrobras (NYSE:PBR) have had to ratchet down projections in dramatic fashion.
The collapse in oil prices is sapping the company's revenues. High costs and the complexity of tapping presalt oil prompted a more modest assessment last year. In September 2014, Brazil lowered its forecast to 4 mb/d in oil production by the end of the decade. But even that now looks unrealistic. The bribery scandal that emerged in late 2014 and embroiled top officials at Petrobras and the ruling Workers' Party began to hollow out the company's balance sheet.
Petrobras is the most indebted oil company in the world, with total debt reaching $124 billion as of the first quarter of 2015. The mounting toll of low oil prices coupled with the epic scandal plaguing the company -- causing a broader malaise across Brazil's entire economy -- has dimmed the prospects of Brazil's most important company. Earlier this year, Moody's downgraded Petrobras' credit into junk territory after the oil company struggled to even get a handle on the final financial bill resulting from the scandal.
Petrobras has since tried to put its troubles behind it, but the damage has been done. On June 29, Petrobras announced a 37 percent cut in capital spending, with a plan to spend $130 billion over the next five years instead of the initially proposed $206 billion. It will also increase its level of planned asset sales in order to raise cash. Lower spending will result in a rather deep reduction in what Petrobras thinks it will be able to produce -- 2.8 mb/d by 2020. That will result in scaled-down expectations for both Petrobras and Brazil as a world oil producer.
The more pessimistic assessment of Petrobras' future is not confined to just the company's shareholders or Brazil as a whole. The implications are more far-reaching than that. Although the world is experiencing a short-term glut in oil supplies, it is still becoming harder and harder to find new sources of oil. The shale revolution in the United States could be short-lived according to the IEA, and by the 2020s the world will need new oil supplies to come from more traditional sources, i.e., mainly the Middle East.
In fact, for several years the IEA has predicted that oil prices would rise in the future, but not excessively so. That is because the agency was assuming large sources of oil would come from two countries: Iraq, which faces its own set of obstacles, and Brazil.
Only in the IEA's most recent report did it start to question whether global producers are up to the task.
"The complexity and capital-intensity of developing Brazilian deepwater fields, the difficulty of replicating the US tight oil experience at scale outside North America, unresolved questions over the outlook for growth in Canadian oil sands output, the sanctions that restrict Russian access to technologies and capital markets and – above all -- the political and security challenges in Iraq could all contribute to a shortfall in investment below the levels required," the IEA wrote in its 2014 World Energy Outlook.
If one or a few of these sources of new supply do not pan out, that could contribute to a price spike in the years ahead. It probably won't happen this year or next, but over the long-term the supply picture looks pretty tight.
Petrobras' June 29 announcement is an admission that it will likely fail to live up to the hype surrounding its presalt fields.