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The problem is that while Brazil’s offshore resources may be vast, to actually extract them at scale will require a much higher oil price environment. I have no doubt that Petrobras and the government would like to convince others–and themselves–that this is not the case. But that’s just not true. The original test drilling in 2007-2008 produced a bill to Petrobras in the billions, and in the lower price environment since oil was trading above 100 has clearly slowed down Brazil’s development of these fields. Finally, the very significant boost to overall production in Brazil, that most anticipated in the 2005-2008 period, has not exactly taken place. Yes, Brazil has increased production.  By about 200 kbpd from the tail end of 2006 to the present. That’s not exactly a huge leap forward for what had been a 1.8 mbpd producer. Moreover, with the country’s significant economic growth and other extractive and manufacturing industries, Brazil actually needs alot of this oil.

What I anticipate happening for Brazil and Petrobras is that in a very high-cost and thus low margin price environment, Brazil’s offshore oil will indeed be extracted but not at high rates. Accordingly, that oil will be used to fund the growth of Brazil’s economy more than it will pay rewards to investors in Petrobras. Whether you agree or not with my analysis, one has to at least respect that Brazil has already told us this would be the case. For, last year, the government indicated that it would no longer be the goal of the country to extract oil as quickly as possible, but rather to measure out the resource more slowly over time. Thus, we can get to the same result either through a political, or a geological explanation. My perspective is that these explanations tend to track each other.

From an investment standpoint, therefore, I would favor investing in the Canadian Oil and Gas sector to gain exposure to “oil” and then insofar as Brazil is concerned, investing in the primary receiver of Brazil’s quasi-subsidized oil supply: the Brazil economy itself. That may sound surprising to prefer oil sands equities over a company like Petrobras, but we have to consider that much of the infrastructure in Alberta is already in place. For Brazil offshore oil, the super-high cost and investment cycle still lays ahead, and is already deemed to run into the hundreds of billions of dollars out to 2020. If the world can somehow sustain oil prices in the 150-200 dollar range, I will have to revisit this analysis. But while spikes to 150-200 are always possible in the near term, a new price band at those levels will be very, very tough to sustain anytime in the next few years.

(Today’s post is a free post for subscribers and newcomers alike.)

-Gregor

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Photo: Church Gate Station, by Sebastiaio Salgado

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Photo: Church Gate Station, by Sebastiaio Salgado

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Predictably, the offshore drilling news was met with the usual outdated reactions that have defined the US energy debate for 30 years. Environmentalists were against it–a group that has said little to nothing about the Obama Administration’s promotion of highways and automobiles. The right was all for it–a group that incorrectly believes we can become energy independent…(this article continues for subscribers through the membership gateway, on the right side of this page)