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The Petrobras Exception

From the Magazine: Thursday, September 25, 2008

How a state oil company succeeds—by not acting like one.

There are many reasons oil is trading above $100 per barrel, including soaring global demand and the fading luster of the U.S. dollar. But perhaps the most important factor is the mismanagement and inefficiency of state-run oil companies. More than 90 percent of the world’s oil and gas reserves are controlled by national oil companies or by Russian energy giants caught in the Kremlin’s orbit. And as the price of oil and gas continues to rise, those outfits have less incentive to increase their production because they can collect the same amount of rent (or more) by keeping their production flat. Nor do these companies feel much pressure to operate in a transparent, efficient manner.

All of those facts make the recent successes of Petróleo Brasileiro SA, better known as Petrobras, even more notable. Indeed, at a time when most national oil companies—and most OPEC members—are seeing their output stagnate or decline, Petrobras, Brazil’s national oil company, is dramatically increasing its output.

And without that new Brazilian production, today’s oil prices would likely be higher. Between 1997 and 2007, Petrobras’s oil production doubled to about 2 million barrels per day. By 2015, the company expects its production to double again. At that level, Petrobras would be the undisputed energy superpower in the Western Hemisphere, with output almost twice that of national oil companies PDVSA of Venezuela or Mexico’s Pemex. And given its surging output, Brazil is reportedly interested in joining OPEC.

Petrobras has become an elite global energy player by doing what most other national oil companies refuse to do.

So how did Petrobras evolve into such a successful company while its fellow national oil companies have stalled? There are a number of reasons for its remarkable success, and most of them have to do with Petrobras’s embrace of capitalism and transparency. Now the world’s tenth-largest producer of liquid hydrocarbons, Petrobras has become an elite global energy player by doing what most other national oil companies refuse to do, including selling shares of the company to the public. And while many other big oil exporters, particularly within OPEC, either refuse to disclose their production data or publish fictitious numbers, Petrobras issues frequent press releases that discuss the latest developments within the company, including production trends, financial conditions, and new discoveries. And there have been plenty of new discoveries.

Last November, the company announced the discovery of the offshore Tupi field, a deposit that may hold 8 billion barrels of oil equivalent—one of the largest oil finds in decades. Since then, it has announced numerous smaller, but still significant, fields containing huge quantities of oil and gas. The Tupi discovery alone could make Brazil the 12th largest holder of oil reserves. (It currently ranks 17th.)

Those discoveries are remarkable when compared with the dismal results being reported by PDVSA and Pemex. Art Smith, a Houston-based energy investor and founder of Triple Double Advisors, an energy-focused investment fund, says that “Pemex and PDVSA don’t lack for available resources; they lack the intelligent allocation of capital and technical skill.” Unlike Petrobras, “PDVSA is doing almost everything wrong,” he says.

The numbers back up that assertion. Since Hugo Chávez was elected Venezuelan president in 1999, PDVSA’s output has fallen by about 30 percent. And with Chávez’s gross mismanagement of the company, production declines are likely to continue. While Petrobras has worked to increase the technical skills of its employees, Chávez has cleaned house, removing employees that were thought to be disloyal to his “Bolivarian revolution.” In 2002, after a period of unrest, about 20,000 PDVSA employees, including many of the company’s most technically skilled, were fired. The resulting brain drain has hampered the company’s ability to develop Venezuela’s vast resources, which include some 80 billion barrels of oil and 152 trillion cubic feet of natural gas.

In Mexico, Pemex’s oil output is falling by more than 10 percent per year, and the company is so heavily laden with debt—at $100 billion, it is approximately equal to its annual revenues—that it cannot afford to do much drilling to stem its decline. Some analysts expect that Mexico, long one of America’s main oil suppliers, may soon become a net oil importer. And it will do so even though Mexico has some 12.9 billion barrels of proved oil reserves. While Venezuela can blame the ruinous policies enacted by Chávez, Mexico can only blame decades of poor policies enacted by its Congress. Excessive nationalism and fear of foreign investors have prevented the country from developing new oil fields, either on- or offshore. The result has been near-total reliance on a handful of fields, the biggest of which is the offshore Cantarell field. But output from Cantarell, which over the past few years accounted for up to 60 percent of Mexico’s production, is declining rapidly.

More than 90 percent of the world’s oil and gas reserves are controlled by national oil companies or Russian energy giants heavily influenced by the Kremlin.

Pemex desperately needs to begin exploring other offshore regions to bolster its flagging production. But even if Mexico’s Congress were to ease barriers to bringing in foreign partners, it could take a decade or two for the investments to begin paying dividends. Without major political reform that could unshackle Pemex, Mexico’s oil output could fall to as little as 1.5 million barrels per day over the next decade or so. That’s a far cry from the company’s current target, which seeks to hold production steady at about 3 million barrels per day.

Meanwhile, Petrobras has been increasing its oil output by about 9 percent per year since 1980. So why has the Brazilian company been so successful? Perhaps the most important element in Petrobras’ success comes from the company management’s insulation from government interference. Unlike national oil companies that are run directly by government officials, Petrobras has a management board that is largely independent of the Brazilian government.

That independence from governmental meddling is directly related to another factor that differentiates Petrobras from its peers: The Brazilian company’s stock is publicly traded, a rarity among national oil companies. (Russia’s energy giants, Lukoil and Gazprom, are publicly traded. And while both are closely aligned with the Kremlin, they are not, strictly speaking, national oil companies.)

The Brazilian government owns the majority of the voting shares of Petrobras. But about two-thirds of the equity in the company belongs to private investors, meaning that the company has a fiduciary duty to maximize value for its shareholders. The management has done just that; Petrobras stock has been among the best-performing equities of the past few years. Since 2002, it has risen in price more than twentyfold.

The public ownership of Petrobras requires the company to adhere to generally accepted accounting principles and to operate in an open and transparent manner. That openness, which requires the company to regularly publish its financial data and production figures, is a far cry from the regime now in control of Venezuela’s PDVSA, which has not published its financial data for years. Further, PDVSA regularly claims that it is producing more than 3 million barrels of crude per day, even though the International Energy Agency, OPEC, and the U.S. Energy Information Agency all put Venezuela’s output at about 2.4 million barrels.

Of course, all of that openness wouldn’t count for much if Petrobras lacked resources. It does not. And that leads to another element of the company’s success: Brazil has an enormous resource base. In all, Brazil claims proved oil reserves of 12.6 billion barrels, and those reserves will undoubtedly grow over the coming years as some of the new offshore discoveries are delineated. Indeed, as Brazil’s offshore exploration prowess has grown, so have its reserves. Between 1998 and 2007, the country’s proved oil reserves increased by about 70 percent.

Furthermore, Petrobras has to compete against foreign companies operating in Brazil. In 1997, Brazil opened its oil sector to foreign investors. While most oil-rich countries only allow foreigners to be minority investors in oil exploration projects, Brazil decided that foreign companies can bid on—and develop—any of the territories that are auctioned. That competition has forced Petrobras to compete with some of the world’s biggest energy companies.

Brazil has not been afraid to exploit its offshore waters. That provides quite a contrast to the United States.

Another key factor: Brazil has not been afraid to exploit its offshore waters. That provides quite a contrast to the situation in the United States. At the same time that Congress and the presidential candidates are talking about the desire for “energy independence,” some 85 percent of America’s Outer Continental Shelf is off-limits to oil and gas exploration and 97 percent of the region is undeveloped. Those waters cover some 1.7 billion acres and may hold 86 billion barrels of oil and 420 trillion cubic feet of natural gas. (For comparison, the United States consumes about 7.6 billion barrels of oil and 22 trillion cubic feet of gas per year.)

Brazil’s sizable offshore reserves are being tapped because the company has carefully cultivated in-house technical expertise that has made it one of the world’s elite players in the high-stakes casino of deepwater and ultra-deepwater oil exploration. Petrobras provides much of its own personnel when working on complex projects, while other national oil companies often rely on outside service providers.

“The seeds for the success of Petrobras were planted some 20 to 30 years ago, when the company decided to invest massively in research and in training of its personnel,” says Renato Bertani, the former president of Petrobras Americas. Now the CEO of Houston-based Thompson & Knight Global Energy Services, Bertani says that Petrobras created its own research center and has been actively cooperating with universities, research institutes, and other companies around the world to improve its technical skill base. “The key to Petrobras’ success was to invest continuously in research and in building a strong technical team,” he says.

That technical skill is readily apparent. The Tupi discovery was made in 7,000 feet of water. The well was drilled to a total depth of 16,000 feet below the ocean floor. The drill bit had to punch through a 1.2-mile-thick layer of salt, a substance that is extraordinarily tricky to manage because it tends to be unstable. The first well drilled at Tupi cost about $240 million, and developing the prospect will likely require an investment of more than $5 billion.

A final factor that cannot be overlooked is Petrobras’s relative youth. Petrobras was created in 1953, long after other leading countries began producing oil. Venezuela’s big oil find occurred in 1922. Iran’s oil-producing history began in 1908. In nearby Saudi Arabia, the first big oil find occurred in 1938.

While most of the older national oil companies are under-investing in new oil exploration and production, Petrobras is spending heavily to increase its output—and its financial return to shareholders. Between now and 2012, it will spend about $40 billion on new exploration and production activities.

In short, Petrobras operates more like an international oil company than a national oil company. And that’s the essential point. Last year, Nadejda Makarova Victor of Stanford University’s Program on Energy and Sustainable Development estimated that if the national oil companies were operated as efficiently as the international oil companies, global oil output could be more than double its current levels. Victor claimed that if all of the oil reserves now controlled by the national oil companies were instead under the control of the international oil companies, “world oil production would be about 140 million barrels per day higher.”

That claim is impossible to prove. Further, if there were a glut of oil, the major producers would almost certainly agree to limit production in order to keep prices at reasonable levels. That said, it’s abundantly clear that if the national oil companies were run more efficiently, global oil production would be dramatically higher and prices would likely be far lower than they are today.

The obvious need is for more capitalism—and less socialism—in the oil sector. With the national oil companies controlling so much of the world’s hydrocarbons, the main impediment to increased supplies is not the amount of available resources. Rather, it is an overall lack of capital discipline, technical skill, and aggressive exploitation of the resources.

Of course, there are risks that Petrobras could revert to the behaviors that are common in petro-states like Russia and Venezuela. In recent years, Russia, under Vladimir Putin, and Venezuela, under Chávez, have ousted foreign investors and placed the central government in charge of all major energy assets. As Petrobras gets “larger and richer, they will be a target for the government and the legislature” in Brazil, says A. F. Alhajji, chief economist at NGP Energy Capital Management in Dallas. “And we could see something like what we are now seeing in Russia, where the government reasserts control over the company.”

That certainly is an ongoing risk. And only time will tell whether that actually happens. Furthermore, Brazil may join OPEC and by doing so could agree to reduce its production in order to comply with the organization’s objectives. But in the meantime, consumers—and savvy energy investors—should be pleased that Petrobras is marching to the beat of a different drummer. The company’s CEO, José Sergio Gabrielli, doesn’t expect that to change. He insists that Brazil’s energy sector will remain open to foreign investors and competition, which should result in increased production for the foreseeable future.

Robert Bryce is the managing editor of Energy Tribune magazine. His latest book is “Gusher of Lies: The Dangerous Delusions of ‘Energy Independence.’” He last wrote for THE AMERICAN about the process of decarbonization

Image by Luis Veiga/Getty.

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