Deepwater Risk.

Texaco is making a billion-dollar bet on Brazil to boost its maturing reserves--and keep its shareholders happy.

FROM HIS PERCH INSIDE A GLASS SKYSCRAPER, ANTONIO PINHO, vice president of exploration and production for Texaco's Brazilian subsidiary, Texaco do Brasil, has a panoramic view of the cube-shaped monolith that houses state-owned oil company Petrobras.

But Pinho, a slight and bespectacled former geologist who's been with Texaco for 25 years, no longer has to peer out his window at his neighboring competitor, wondering what its next move will be. Texaco and Petrobras recently became partners in their search for new oil deposits, and Pinho is confident that the partnership will greatly boost the U.S. firm's own maturing reserves. "The name of the game is building potential reserves to provide the revenues your shareholders want," he says.

His self-assurance is reflected by Texaco's investing more capital to enter Brazil's exploration and production sector than any other company since the government ended the half-century-long Petrobras monopoly two years ago.

Texaco was the leader of a consortium--also involving Petrobras--that will spend an initial US$1.2 billion to develop the deepwater Frade field where Petrobras has already discovered oil. The Frade field is located in the Campos Basin, Brazil's largest oil-producing region, which accounts for 75% of the country's output and boasts some of the world's highest offshore production rates. Frade, to be Texaco-operated, is expected to produce 100,000 barrels of oil per day by 2003, nearly 10% of Brazil's current oil output and just over 10% of Texaco's current worldwide output.

The Frade field is in the yet-undrilled offshore area closest to Petrobras's most recent major discovery--the Roncador "giant" field in the Campos Basin with an estimated 2.7 billion barrels of reserves. And Roncador isn't far from the Campos Basin's other two biggest-producing fields, Marlim and Barracuda, both of which were discovered in 1985.

Pinho says that oil companies constantly weigh risk versus investment. But he adds that Texaco has committed a sizable amount of capital in Brazil because discoveries of giant fields like Roncador greatly decrease risk. "There aren't many Roncador, Marlims and Barracudas discovered within such a relatively short time period in any world [geological] basin," he says.

Texaco's faith in the Campos Basin also led the U.S. major to join an Exxon-led consortium--also involving Petrobras--that will invest an initial $1.5 billion to develop the basin's East Albacore deepwater field, where Petrobras has also found oil. East Albacore is expected to produce 13% of Brazil's current output by 2003.

Another Texaco-led consortium has also formed a partnership with Petrobras that will invest an initial $50 million to explore for oil--as opposed to developing already-discovered finds--in another Campos Basin deepwater area near Roncador. And in mid-June, Texaco won the right to explore for oil independently in two areas, and as a member of a consortium in one other area, as part of the government's first-ever exploration-and-production licensing round of 12 other deepwater areas not belonging to Petrobras.

Texaco is not alone in committing large sums to Brazil. Aside from leading the consortium that will spend $1.5 billion to develop the East Albacore field, Exxon formed a partnership with Petrobras to explore for oil in two other offshore basins and won first licensing-round bids to independently--or as part of a consortium--explore for oil in two other offshore areas.

None of the world's other major oil companies have decided to invest anywhere near the amounts that Texaco and Exxon have committed. Mobil has made only modest exploration investments via partnerships with Petrobras. Shell, a minority partner in the Exxon-led consortium that will work the East Albacore field, was also a minority member in one consortium that placed a winning $7 million bid for a first licensing off the coast of northern Brazil. "We looked at the areas in terms of risk versus investment and, as such, most of the areas being auctioned off weren't that attractive," explains David Pirret, president of Shell Brasil.

Oil-sector analysts believe that Texaco has found Brazil's deepwater acreage far more attractive because of the company's pressing need to build reserves. While Texaco has invested heavily in exploration and production in the Gulf of Mexico, West Africa and the United Kingdom, many of its Gulf of Mexico fields are reaching maturity.

"Texaco's oil production has grown at a rate of 2% per year over the last five years, which has been in line with other major oil companies," says Douglas Terreson, Houston-based international oil analyst for Morgan Stanley Dean Witter. "However, an important focus for Texaco has been in North America, where the maturing nature of the region has forced Texaco to look elsewhere--to Brazil, in particular."

Terreson adds that Brazil is particularly attractive to Texaco because both it and partner Petrobras have developed deepwater technological expertise. So far, Texaco is investing only in deepwater Brazilian fields. Texaco coordinates the Gulf of Mexico "Deepstar" project that has pioneered technologies that can be applied to deepwater exploration and production in Brazil, Nigeria and the UK. Petrobras itself holds two deepwater world records--for the deepest producing well at 1,855 meters and the deepest exploratory well at over 2,300 meters. Exxon also touted Petrobras' being a "leader in deepwater [exploration and production] activity" as one reason for its partnerships with the Brazilian oil company.

James Clark, a New York-based oil analyst with investment firm Credit Suisse First Boston, says another reason for Texaco's interest in Brazil was its "huge market" and "huge growth opportunities downstream." Indeed, Texaco's Pinho agrees that Brazil's considerable rate of oil consumption--at 1.8 million barrels of oil per day--made it the best local market to sell oil from Texaco's activities here.

But Nelson Ribas, Texaco do Brasil's vice president in charge of marketing combustion fuels, says that Texaco's major stake in the oil product distribution market was another reason for the firm's substantial investments. Texaco gas stations account for 13.8% of the Brazilian market, with Petrobras, Exxon, Shell and Ipiranga, a local distributor, accounting for the remainder.

"Texaco's having administrative infrastructure already in place for its oil product distribution activities means that we can and will use that existing back office," Ribas says. "This synergy reduces our overall upstream/downstream costs and makes undertaking E&P activities here more attractive."

Texaco also plans to use the natural gas it finds in offshore Brazilian areas to supply a $160 million thermoelectric plant it plans to build in partnership with Petrobras and steelmaker Companhia Siderurgica Nacional (CSN) in northern Ceara state by 2001. Texaco's stake in the plant further verticalizes its participation in the Brazilian energy matrix.