Dispatch

The Twilight of the Western Oil Majors

A deal in Brazil between China and Petrobras suggests that Western Big Oil may be on its way out.

David McNew/Getty Images
David McNew/Getty Images

Brazil is home to one of the last major oil frontiers in the world — and a case study for how the balance of power in the international oil industry is shifting. In 2007, 10 years after the Brazilian government opened its oil industry to foreign investment, the state oil company Petrobras struck one of the richest oil veins in decades. Western oil companies such as Chevron, Total, and BP, thrilled by the rare prospect of a new exploration opportunity, lined up eagerly to invest.

But the outsiders have been stymied. Brazil, generally one of Latin America’s most investment-friendly countries, is now boosting the state’s role in developing its vast new oil reserves. And it’s doing so with help from China, which has recently provided Petrobas with a massive loan, making the old titans of Big Oil increasingly superfluous.

This situation is not unique to Brazil. It’s just the latest example of a new form of collaboration between China and other national governments with oil resources worldwide that is completely reshaping the industry.

Petrobras’s discovery centered on the Tupi field, part of an enormous oil-rich zone called the presalt, which lies up to 10,000 feet below the sea’s surface under a layer of salt thousands of feet deep. Petrobras refuses to put a figure on total reserves, but independent analysts estimate the presalt region holds roughly 50 billion to 70 billion barrels of reserves. The government reacted to the news by proposing major new reform legislation that won approval in the lower chamber of parliament earlier this year and is now making its way through the Senate.

The legislation would make Petrobras operator of all presalt oil fields, giving it control over day-to-day investment decisions, such as when and where to drill wells. Another measure would give veto power over investments in presalt blocks to Petrosal — a new 100 percent state-owned oil company to be created alongside Petrobras, which is publicly traded on the Sao Paulo and New York stock exchanges.

Private oil companies with interests in Brazil are now voicing concern that the new regulatory model would render them passive investors in oil projects, devoid of power to make operational decisions. The oil majors argue that excluding their expertise and technology will delay development of the complicated oil fields. French oil firm Total, for example, boasted last year that its technical expertise could "bring something new" to presalt development. One oil executive in Brazil said recently that the proposed legislation "is not in the interest of the [state] company. It’s not in the interest of the government recovering taxes or the industry as such."

This argument is based more on self-interest than fact. Petrobras, perhaps the most competent deepwater operator in the world, insists it has the technical and project management skills to develop the presalt singlehandedly. "Being operator in all presalt blocks will give Petrobras new strength," CFO Almir Barbassa recently told investors in New York.

The bigger concern, say Petrobras officials and analysts, is the company’s ability to fund the massive project. Despite Petrobras’s good credit rating and access to cheap loans through the Brazilian Development Bank, it remains unclear how the company will secure financing for such a large investment portfolio in the long term. In March, Petrobras announced a huge five-year investment plan of up to $220 billion. Petrobras is projecting 2010 capital expenditures of $47 billion — some 60 percent higher than Exxon Mobil or Royal Dutch Shell, the biggest spenders among the major private oil firms.

Senior Petrobras executives have been traveling the globe, from New York to London, as part of a campaign aimed at assuring shareholders, bondholders, and credit analysts that investing in the company is a good long-term bet. Wall Street analysts, expressing skepticism about the energy reform legislation, have been unconvinced: They fear that an excess of government intervention could ruin investment opportunities.

Meanwhile, Chinese investors seem to have no such qualms and their deep pockets have helped keep Petrobras’s spending plans on track. Last year, the state-owned China Development Bank agreed to lend Petrobras up to $10 billion — over one-third of the total debt the company raised in 2009. The initial agreement between China and Brazil was formed during Chinese Vice President Xi Jinping’s visit to South America last year and was finalized on April 15, when President Hu Jintao met with his Brazilian counterpart Luiz Inacio Lula da Silva. The loan can be repaid in cash but also included an "option to offset the debt with the export of oil … in a volume to be defined in the future."

Petrobras simultaneously pledged to increase exports to China. It agreed to start delivering 150,000 barrels per day to Chinese state company Sinopec in 2009, an amount that will rise to 200,000 barrels daily over the next nine years. Imports of Brazilian crude have risen from an average of 81,500 barrels a day last year to 187,000 barrels a day in the first two months of 2010, according to Chinese customs data. The agreement also establishes a framework for further partnerships between Petrobras and Chinese companies in the oil industry, and for Chinese firms to supply services, materials, and equipment to Petrobras. Separately, Petrobras signed a deal with China National Petroleum Corp (CNPC), increasing oil exports to 40,000 to 60,000 barrels per day.

China’s loan gives Petrobras some financial breathing room and reduces its need to seek private capital to develop Brazil’s costly oil reserves. This further sidelines the U.S. and European companies that have traditionally dominated private investment in Brazil’s oil industry. With financial support from China, Brazil has no need to hand its reserves over to international oil companies. "The government is keen to keep most of the presalt area in Petrobras’s hands," notes an industry observer.

China is using all the tools at its disposal, including abundant cash and political influence, to secure long-term oil supplies around the world. In addition to Brazil, China offered a total of $50 billion in loan-for-oil deals last year to Venezuela, Angola, Russia, and Kazakhstan. The allure for China’s partners is cash with no strings attached — in the case of Brazil, China is not requesting an equity stake in the presalt oil blocks, as Western companies nearly always do. Rather than a straightforward business deal, these agreements represent broader political alliances among developing nations pursuing policies of state-led economic growth.

As a result, national oil companies like CNPC are unseating the Exxons and BPs of the world. The Chinese, awash with cash and keen to outbid competitors, have picked up a large share of Kazakhstan’s onshore production. In Angola, loans have helped to lock in assets for its state oil companies. In 2004, for example, the Angolan government obstructed India’s state-owned Oil and Natural Gas Corp.’s efforts to buy a 50 percent stake in an oil block and later awarded it to Sinopec.

China is not along in pursuing this strategy. Russia’s government, for example, has negotiated bilateral energy deals that give its state companies access to oil reserves in politically friendly nations. As these countries spend big to drive profits, Big Oil may be forced to accept contract terms that would have once been considered unacceptable. In Iraq, another of the most important new oil frontiers in the world, majors like Exxon, Shell, and BP accepted service contracts rather than an equity stake for fees of $2 per barrel or lower — terms that are unlikely to generate big cash returns — in Iraq’s postwar bid rounds.

Once the Brazilian government starts awarding new exploration licenses, most Western oil majors will still be able to grab a stake of the presalt resources. But that prize may be a pale substitute for the returns to which they have become accustomed.

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