Petrobras explores abroad: The state-run Brazilian company wants oil from foreign shores. (Investment Guide).

Petrobras is well on the road to greatly increasing its market share of the South American oil business. The state-run oil giant is investing more than US$3 billion in a strategy to spread risk, its managers say, through bold foreign exploration.

In October 2002, Petrobras paid $1 billion for 59% of Argentina's second-largest oil producer, Perez Companc (Pecom), which expects to spend another $2 billion over the next five years to beef up international production, mainly in Venezuela but also Peru, Bolivia and Ecuador. Earlier, Petrobras swapped a billion dollar's worth of assets with Spanish-Argentine energy giant Repsol-YPF for a share of Argentina's retail gasoline and refining business.

On the heels of the Pecom deal, Petrobras broke out the checkbook again, spending $88.5 million for oil and natural gas producer Petrolera Sante Fe in Argentina, with oil and natural gas output equivalent to 10,000 barrels of oil per day. It's in talks, too, to make deals in Venezuela with state-owned Petroleos de Venezuela (Pdvsa); it might bid on Uruguay's state-owned Ancap; and it expects to increase investments in the U.S. Gulf of Mexico, where it has spent $18 million to work 61 concessions since 1999.

Using its deep-water expertise to develop reserves in the Gulf of Mexico as well as offshore West Africa and its proximity to fields in South America, Petrobras is seeking to increase its international output to 300,000 barrels per day by 2005 from less than 60,000 barrels now.

"Petrobras wants to become a more international oil company because producing and exploring for oil in a variety of different places around the world diversifies risk," says Joao Figueira, executive manager of exploration and production at Petrobras Internacional. "For example, you greatly increase the likelihood of finding oil if you explore for it in a variety of places, rather than just a few places." The wider geographical spread also means lower international financing costs, says Figueira.

With the Argentine purchases, Petrobras has bumped up its international oil and natural gas output to the equivalent of 177,000 barrels of oil per day. Some observers worry that the state-run oil giant has replaced geographic risk with political uncertainty in Argentina and Venezuela.

Fast cash. Not so, says Figueira. "Our buying control of Pecom means that Pecom will generate hard currency for Petrobras," says Figueira. "For example, Pdvsa pays us in [U.S.] dollars for whatever oil Pecom produces in Venezuela. And being able to generate hard currency outside Brazil reduces Petrobras's financial risk, which makes it easier to get financing, and better payback terms."

Petrobras is also in the process of spending $7.3 billion on oil exploration abroad, roughly 23% its 2001-2005 investment budget of $31.7 billion.

Figueira added that Petrobras is trying to buy or invest in a U.S. refinery, probably in the southern United States. Petrobras CFO Joao Nogueira Batista, who announced in January plans to step down, has said that Petrobras might do so by May 2003. "We found a suitable refinery, but not at a suitable price," Nogueira Batista said. "We hope to find a suitable refinery at a suitable price in the next six months."

A U.S. refinery would be able to refine Petrobras oil that the company will, in the near future, have trouble processing in Brazil. Petrobras doesn't have much idle refining capacity left; it's now refining 1.7 million barrels of its 2 million barrels-per-day capacity. Selling the output from such a refinery would also generate additional hard currency in dollars, part of the reason, according to Figueira, Petrobras is shopping for a U.S. refinery.

"If Petrobras buys a U.S. refinery, it will have an asset that generates hard currency and lowers its financial risk," says Cleomar Parisi, an oil sector analyst with Unibanco, Brazil's third-largest private bank. "Also, generating revenues in U.S. dollars gives Petrobras the cash to pay off its debt obligations abroad and increase its credit rating."

Incoming managers may disagree. Brazilian President Luiz Inacio Lula da Silva appointed Senator Jose Eduardo Dutra to head Petrobras. Dutra, a member of Lula's left-wing Partido dos Trabalhadores, was expected to replace all of the top six Petrobras directors, including CFO Nogueira Batista.

Even as Petrobras looks abroad, there is plenty of evidence it will continue to look inward as well. Luiz Pinguelli Rosa, a drafter of Lula's energy program and a senior energy consultant for Lula's party, was named president of electricity holding company Eletrobras. He says that Brazil does need more refining capacity, especially for its abundant heavy-grade oil. New refining capacity would reduce highly discounted heavy-oil exports and reduce costly oil-product imports, thus increasing the country's trade surplus.

The former government believed investing abroad was the cheapest way to boost refining capacity and would give Petrobras greater international presence. The Lula administration, however, is not looking at the issue of boosting refining from a financial point-of-view but from the perspective that building a refinery at home would create jobs and would be custom-tailored to refining heavy oil.

"Why invest in refineries abroad which, like those now in Brazil, can't process heavy oil without having to mix it with lighter oil?" says Pinguelli Rosa. "The Lula administration will give top priority to building a refinery in Brazil that is specially designed to process heavy oil." A foreign oil company might, however, be invited to work with Petrobras, with below-market financing from Brazil's development bank, Bndes, to build in Brazil, says Pinguelli Rosa. Petrobras owns all of the country's 10 major refineries. New Petrobras President Dutra said during a press conference in early January that the company was weighing buying a refinery abroad and taking part, as a minority shareholder, in a refinery in Brazil.

Another issue is petroleum product prices, an area where the government has not been shy to exert its considerable influence over Petrobras.

The government stopped setting prices more than a year ago, allowing Petrobras to determine prices independently. Nevertheless, the government pressured Petrobras not to raise gasoline and diesel prices during most of the third quarter of 2002, apparently because doing so would boost inflation and hurt the electoral chances of presidential candidate, Jose Serra. Lula trounced Serra, getting 62% of the vote.

In control. Pinguelli Rosa says the Lula administration's oil-product price policy would work similarly to the way some countries handle monetary controls, setting floors and ceilings based on fluctuations in world oil prices and local currency prices-meaning price controls will remain a government tool. "By setting these oil-product price-fluctuation margins, government price interventions won't be unexpected but will be part of the government's price policy," says Pinguelli Rosa.

Energy and Mines Minister Dilma Rousseff adds that that pricing policy would likely link local market prices with the dollar-real exchange rate to reflect oil's dollar-based international prices. Though Brazil has liberalized its refined products market, allowing competition with Petrobras, the government still strongly influences the setting of fuel prices.

Lula's administration also would provide fiscal incentives to strengthen the competitiveness of domestic equipment manufacturing for exploration and production. Brazilian manufacturers aren't competitive now, he says, because the Cardoso government gave foreign oil platform builders and foreign equipment producers tax exemptions for temporarily importing rigs and equipment into Brazil.

Rousseff said her ministry would set industrial policy, including offering Brazilian oil equipment makers the same financing terms as foreign companies so they can compete better for Petrobras contracts, such as making offshore production platforms.

Lula himself has said that, to boost employment, Petrobras would give local companies preference over foreign bidders when awarding drilling and production rig-building contracts, assuming other criteria such as price and technology are more or less competitive. Currently, Petrobras management only uses two criteria--the lowest price and the best technology--for awarding such contracts.

Petrobras Invests Big (US$)

DEAL                TERMS                         AMOUNT

YPF-Repsol          Asset swap                    $1 billion

Pecom               Purchase 59%                  $1 billion

                    Pecom to invest (five years)  $2 billion

Petrolera Santa Fe  Purchase                      $88.5 million

U.S.Gulf of Mexico  61 concessions since 1999     $18 million

SOURCE: LATIN TRADE