Can a Desperate Brazil Finally Tap Its Oil Wealth?

Brazil is wracked by the Zika virus, rising inflation, a deep recession, massive political and corporate scandals, and worries that athletes at the 2016 Summer Olympics will have to compete in dangerously polluted waters. Yet, despite it all, Brazil might have cause for celebration — if politics don’t get in the way.

That’s because Brasília is finally taking steps to open up its oil and gas sector and make it more attractive to foreign investors, reforms that are as controversial as they are necessary to help the country tap the energy resources it has long eyed but only partially developed.

Earlier this week, Brazil unveiled new rules meant to kick-start investment in oil and gas production, part of a suite of measures that Energy Minister Eduardo Braga thinks can lure billions of dollars of new investment from foreign firms, including some in the United States and Europe. Even bigger changes are afoot: Brazil’s lower house of congress is wrestling with legislation that, if passed, would throw open the door for foreign oil and gas firms to develop the country’s massive offshore oil deposits without needing to go hand in hand with the debt-ridden and scandal-plagued Brazilian national oil company.

That could finally make it possible for Brazil to realize the promises of its potential offshore oil wealth, first discovered almost a decade ago. Those offshore deposits, estimated to hold more than 60 billion barrels of oil — as much as the North Sea fields that fueled decades of British and Norwegian oil exploration — were expected to turn Brazil into one of the world’s big oil producers. As recently as 2013, the International Energy Agency said that Brazil, next to Iraq, would be the world’s biggest source of new oil production for the next two decades.

The initial promise floundered. Brazil, expecting oil companies to beat a path to its door to tap what could be world-class oil resources, failed to offer enticing terms for investors. Restrictive laws, like strict rules about using locally made oil-field equipment, made it hard for international oil companies to develop the fields. And state-owned Petróleo Brasileiro, known as Petrobras, was forced by law to take the lead in developing all of the offshore fields.

But Petrobras today is staggered by a massive corruption scandal and a mountain of debt; it simply doesn’t have the financial or technical muscle to turn the offshore promise into reality. Petrobras has slashed its own investment budget four times just since last summer, and it has repeatedly cut its estimates of future oil production.

For a country facing back-to-back years of economic contraction, getting the energy industry back on track is crucial.

“Opening up certain sectors of the economy is key to attracting the investments that Brazil needs to find the path back to economic growth,” said Paulo Sotero, director of the Brazil Institute at the Wilson Center in Washington, D.C. “Either that, or we will continue to be in this morass.”

The measures are part and parcel of a wholesale reassessment of “resource nationalism” taking place across Latin America, from Mexico to Argentina. For decades, governments in the region have sought to control mineral wealth like huge offshore oil fields and ensure that most of the benefits from those resources go to their people, rather than foreign companies. That formula can work when oil prices are high, and companies are desperate to get their hands on any promising resources, whatever the terms. But when oil prices are low, and there is fierce competition for an ever-shrinking pool of energy investment, those nationalist policies can backfire.

“Brazil’s legal and fiscal regime is atrocious,” said Scott Schwind, an energy lawyer with Jones Day in Houston. “In my view, Brazil is out of the running for some of the private investment dollars that people are going to be spending in the next few years.”

In response, countries like Mexico, Argentina, and, now, Brazil are tearing up their nationalist playbook to avoid losing out to neighbors who are friendlier to foreign companies. Mexico in late 2013 took aim at the ghosts of its own revolution and launched a radical energy reform meant to throw open the country’s oil sector to foreign investors. Later this year, it will auction off lucrative tracts in the Gulf of Mexico in sales that could bring in billions in planned investments. Argentina, under new President Mauricio Macri, is moving quickly to regain the trust of international investors, reaching a deal with creditors and courting foreign players for the country’s potentially vast reserves of shale oil and gas.

Now Brazil, prodded by opposition politicians and business groups increasingly frustrated with 14 years of rule by the same party, is on the verge of rewriting its own restrictive laws. That could move the country one step closer to fulfilling its promise as one of the biggest sources of new oil production in the world.

“All the pressures are in the direction of liberalization,” said Sotero.

On Wednesday, the Energy Ministry announced a series of changes to the oil and gas investment framework meant to entice the kind of international capital that could turn things around. That includes steps like extending concessions given to foreign firms years ago, giving companies the option to expand their holdings if they see promising potential nearby, and compelling companies sitting on nonproductive leases to drill or get off the pot.

At a time when low oil prices make investment decisions tougher for everyone, the ministry said that “new investments in the oil industry require stable and effective rules” that will offer long-term certainty for oil companies struggling with the worst capital-investment climate in decades.

But much bigger changes are potentially on the way. Last month, the Brazilian senate passed legislation that would essentially dismantle the administration’s signature approach to resource development, which was to give Petrobras a leading stake in every oil field project. Given Petrobras’s woes — a battered balance sheet and a far-reaching corruption investigation — that has proved a recipe for stagnation, not for quick development of those fields. With Petrobras unable to take on big, challenging new projects, Brazil under the current law can’t auction off any offshore blocks for development.

Taken together, the energy minister said, the changes could attract as much as $120 billion in new investment.

The reforms are “a positive step and a necessary first step,” said Schwind. They are a sign that policymakers realize they need to make changes in order to attract investors, he said. “But what’s really going to matter is what happens from here on — is the government going to continue making the changes it needs to make in order to make Brazil an attractive destination for international capital?”

International oil companies, logically enough, welcome the proposed changes. Royal Dutch Shell, which just snapped up BG Group, is now the largest foreign player in Brazil and is looking to massively expand its oil production there. But the current stalemate, especially the Petrobras monopoly, makes it hard.

“Brazil might benefit from being a bit more flexible on this,” Shell chief executive Ben van Beurden told reporters last month.

Now, the bill faces a contentious fight in the lower house of Congress, where the ruling Workers’ Party of embattled President Dilma Rousseff and former President Luiz Inácio Lula da Silva is fighting tooth and nail against reform.

Complicating matters further are the corruption scandals that have plagued Petrobras and stained Rousseff and Lula; the former president was detained and questioned late last week by Brazilian prosecutors for allegedly taking millions of dollars in kickbacks while president. Prosecutors are also seeking Lula’s arrest in an unrelated money-laundering case.

The political scandals, and public dismay at the state of the economy, have reached such a level that even much-needed reforms like the oil-sector changes could take a back seat to a settling of political accounts: Opposition politicians are increasingly calling for Rousseff’s impeachment. Until Brazil sorts out its political mess, it will be hard to make progress on the energy-sector overhaul.

“Once the political situation is resolved, then they’ll go back to the drawing board and see what to do about the oil,” said Sotero. “Obviously, we’ll need more foreign investors.”

Photo credit: VANDERLEI ALMEIDA/AFP/Getty