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 www.latinamericamonitor.com

Latin America Monitor

Brazil Vol 32 Issue 10 October 2015

BMI Research’s monthly regional report on political risk and macroeconomic prospects

POLITICAL OUTLOOK This month’s top stories

Rousseff Presidency Will Banking Sector: Domestic Headwinds

Will Persist
Deteriorating asset quality alongside an erosion of capital
Survive Political Turmoil buffers are increasing stress on Brazil’s banking sector.
However, we anticipate broad stability, with the loan-to-
BMI View: Brazilian President Dilma Rousseff will maintain power in deposit and leverage ratios still in line with regional peers.
the quarters ahead, despite significant political turmoil. However, with page 3
legislators and the public increasingly calling for her impeachment, we
Fuels Consumption Growth To
also explore potential scenarios for impeachment and new elections.
Remain Weak
Brazilian President Dilma Rousseff will ment proceedings. Nevertheless, given Demand for refined fuels in Brazil will increase modestly  
remain in office over the coming quarters, that Rousseff has minimal political capi- through 2024 as systemic regulatory challenges within
despite public calls for her impeachment tal – her government's approval rating is the country weigh on domestic growth. Although Brazilian
and signs that legislators from within her just 8% – and there is a growing push for policymakers are making efforts to boost economic activity,
ruling coalition are looking to oust the impeachment, we outline below our core advancement will be hindered by deep political divisions
president. Investigations into contract- view, as well as two alternative scenarios and continued fallout from the national corruption scandal.  
ing practices at state-owned oil company for political change in Brazil. page 4
Petrobras are ongoing, and the president's
close association with the company has Scenario 1: Rousseff Rides Out Conservative Outlook On Vast
eroded public trust in her. However, there Political Storm To Finish Second Term Hydropower Expansion
is currently no clear evidence that the (Core View) We maintain a positive growth outlook for the Brazilian hy-
president has committed an impeachable Likelihood: High; Impact: Low dropower sector over the next decade, but we consider the
offence. In addition, there is no strong po- With no clear evidence that President government’s official 10-year expansion plan for the industry
litical incentive for the main centre-right Rousseff has broken any laws during too ambitious. We expect hydropower capacity to grow by
opposition Partido da Social Democracia her tenure as chair of state-owned oil an annual average of 1.8% through 2024, boosted by the
Brasileira (PSDB) to support impeach- ...continued on page 2 completion of two large-scale projects in 2016.
page 5

RISK INDEX TABLE Key Sectors: Oil & Gas

Brazil’s vast pre-salt reserves suggest substantial growth
BMI’s Country Risk Index scores countries on a 0-100 scale, evaluating short-term potential, underpinning our bullish upstream view that crude
and long-term political stability, short-term economic outlook, long-term economic and natural gas output will rise.
potential and operational barriers to doing business. For a detailed methodology, visit page 6
bmiresearch.com or contact us using the details below.
Regional Indicators
Short Term Long Term Operational Country
Political Economic Political Economic Risk Risk 2013 2014e 2015f 2016f
Chile 75.8 67.7 84.2 68.2 67.6 72.0 Latin American Indicators
Uruguay 74.8 60.4 72.2 61.8 57.5 63.4
Nominal GDP, USDbn 6,227.4 6,353.8 5,315.5 5,471.8
Mexico 62.3 69.0 67.1 66.0 53.6 61.1
Peru 67.5 66.3 61.5 66.4 52.3 61.1 Population, mn 620.0 626.8 633.5 640.2
Brazil 66.9 51.9 66.5 64.7 52.6 59.5 GDP per capita, USD 10,044.8 10,136.9 8,390.2 8,547.4
Colombia 66.5 60.4 63.0 66.2 50.3 59.1
Real GDP growth, % 2.8 1.1 0.5 1.7
Argentina 51.5 42.7 63.4 56.7 48.6 52.8
Ecuador 53.3 55.4 50.2 58.1 46.2 50.5 Inflation, % 7.5 11.3 9.3 8.6
Venezuela 42.9 22.3 48.8 39.0 36.9 37.5 Goods Exports, USDbn 1,186.1 1,161.8 1,116.2 1,158.4
Regional Average 62.4 55.1 64.1 60.8 51.7 57.4
Goods Imports, USDbn 1,168.4 1,161.5 1,137.5 1,171.0
Global Average 63.9 50.3 61.3 51.0 49.9 54.4
Notes: e/f = BMI estimate/forecast. Source: BMI.
Source: BMI.

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  BRAZIL
...continued from front page democracy is only 30 years old, several politi- does not have a unified policy agenda. Recent
cians have expressed concern that impeachment events illustrate this, with Calheiros and Temer
company Petrobras or during her presidency, proceedings could undermine democratic sta- currently trying to work with Rousseff, while
we maintain our core view that she will see out bility. As a result, we believe that policymakers Chamber of Deputies president Eduardo
her second term in spite of heightened political will move to impeach the President only if there Cunha publicly broke with the government in
pressure. The president has made it clear that is strong evidence of wrongdoing on her part. mid-July. Temer's appeals for stability in a time
she does not plan to leave office voluntarily and Even with Rousseff in power, uncertainty of political turmoil should appease investors.
will work with political leaders, particularly about the direction of economic policy will However, with coalition politics to remain key
within the most restive member of her coali- persist. The government's fiscal adjustment to Brazilian policymaking in the coming years,
tion, the Partido do Movimento Democrático programme, which aims to shore up the coun- Temer's relationship with Cunha and Calheiros
Brasileiro (PMDB), in order to maintain power. try's fiscal accounts, will remain the primary will be a major factor in his administration's
PMDB legislators have become increasingly sticking point for policymakers. The President ability to enact its legislative agenda.
vocal in their calls for Rousseff's impeachment will be forced to make concessions in the com-
Negotiations with Senate president Renan ing months in order to maintain power and Scenario 3: New Elections Upend Political
Calheiros of the PMDB are giving Rousseff a advance her fiscal austerity agenda. In addi- Landscape
lifeline in Congress. Calheiros has reportedly tion to Calheiros's proposals to reduce labour Likelihood: Very Low; Impact: High
agreed to push back against legislative proposals market rigidity and rationalise the tax code, The annulment of Rousseff's 2014 electoral vic-
that undermine the government's fiscal adjust- more substantial cabinet posts are likely to be tory and a call for new elections would prompt
ment programme in exchange for support on a bargaining chip for the president. Indeed, a a significant shift in Brazil's political landscape.
measures such as flexible labour laws, which are lack of significant cabinet appointments for the This would likely come on the back of evidence
unpopular with Rousseff's Partido dos Trabal- PMDB created a major rift with the govern- that the Rousseff-Temer presidential campaign
hadores (PT). Shoring up Calheiros' support ment following the October 2014 general elec- was partly financed by illicit campaign contri-
is also particularly important for Rousseff, as tion. Moreover, with political reform, including butions. While there is currently no evidence
the upper chamber would need to approve stricter anti-corruption measures, remaining a suggesting this, investigations into political
impeachment proceedings by a two-thirds major issue for the electorate, the topic is likely kickbacks related to the corruption scandal
majority if they are initiated by the Chamber to figure prominently on the legislative agenda at Petrobras mean that we cannot rule it out.
of Deputies. Rousseff's enduring relationship in the quarters ahead. The subsequent presidential election would
with Vice-President Michel Temer, a member likely be contested primarily by the centre-right
of the PMDB and her liaison to Congress, also Scenario 2: Rousseff Impeachment Brings PSDB and the PMDB, as officials from the lat-
indicates that she maintains some political sup- PMDB To Power ter previously suggested that they would break
port outside of her party. Likelihood: Low; Impact: Moderate with the PT and run their own presidential
In addition, we see little political incen- The impeachment of President Rousseff candidate in 2018. The ruling PT would have
tive for the centrist opposition PSDB, and would significantly increase uncertainty over little chance of winning, given a significant ero-
other centre-right parties, to move forward Brazil's policy direction in the coming years. sion of its base of support in Brazil's North and
with impeachment proceedings without strong Vice President Michel Temer would succeed Northeast regions in the year to date.
evidence of wrongdoing. The PSDB and its Rousseff, becoming the first PMDB president A victory by Aécio Neves of the PSDB,
coalition partners are not clear allies of the in 20 years. Moreover, the impeachment process the party's president and a 2014 presidential
PMDB, meaning that they would likely require itself could be politically divisive, causing fur- candidate, could shift Brazil's policy agenda
significant political concessions in order to sup- ther fragmentation in Brazil's political system. in a more investor-friendly direction. Neves
port impeachment proceedings, which would Should Rousseff be impeached following strong garnered 48.4% of the vote in the presidential
see the PMDB's Temer take power. evidence of corruption related to the ongoing run-off on October 26 2014, losing to Rouss-
Finally, uncertainty about the process by 'lava jato' scandal, we expect that the proceed- eff by a narrow margin, and the PSDB is one
which congress can remove Rousseff from ings would move swiftly and see broad support. of the only major parties that has not been sig-
power, particularly without clear evidence of However, if the President is impeached nificantly implicated in the 'lava jato' scandal.
a common criminal offense or a 'crime of re- on grounds that her government violated the In addition, Neves could benefit from some of
sponsibility', is also supportive of our view that country's fiscal responsibility law following a the politically unpopular changes that Finance
the president will remain in office. Brazil's con- claim put forward by Brazil's federal responsi- Minister Joaquim Levy has already made, such
stitution is relatively vague in what it considers bility agency, it could be a significantly more as raising taxes and cutting spending. While
'crimes of responsibility', outside of common conflict-ridden impeachment process. Indeed, Neves would likely maintain the majority of
criminal offences. As a result, should Chamber depending on the degree of discrepancy in the Levy's austerity agenda, he would avoid blame
of Deputies president Eduardo Cunha accept fiscal accounts, impeaching Rousseff on these for some of its most painful effects.
a petition for impeachment with questionable grounds could be a stretch, informing our view That said, Neves would likely encounter
evidence, there is no guarantee that the Senate that the proceedings would be unlikely to have similar congressional hurdles to Rousseff un-
will vote to impeach Rousseff. broad-based support in the legislature. less he is able to form a strong political alli-
However, we acknowledge that claims by Regardless of the process, given that the ance with the PMDB, specifically Cunha and
the country's federal auditing agency that the PMDB has not run a presidential candidate Calheiros. Neves and Calheiros would likely
government's 2014 budgetary accounts violated in over a decade, a Temer presidency would find common ground on proposals to increase
the fiscal responsibility law – an impeachable raise questions about the direction of Brazil's labour market flexibility and rationalise the tax
offence – present the greatest threat to Rouss- legislative agenda. The PMDB is more centrist code, although the extent to which they could
eff's presidency. Moreover, given that Brazil's than the PT, but is also less ideological and get Cunha on board remains an open question.

2 2 BRAZIL – OCTOBER 2015 www.latinamericamonitor.com

 INDUSTRY OUTLOOK

Banking Sector: Domestic growth in capital averaged just 3.4% y-o-y

during the 12 months to May 2015, well
below the monthly average asset growth of
Headwinds Will Persist 11.6% y-o-y during the same period. Never-
theless, Brazil's assets-to-capital ratio remains
BMI View: Deteriorating asset quality alongside an erosion of capital buffers largely in line with its regional peers, at 8.3.
are increasing stress on Brazil's banking sector. However, we anticipate broad We see limited risks at present, but note that
a further erosion of capital buffers could lead
stability, with the loan-to-deposit and leverage ratios still in line with regional
us to reassess this view.
peers.
Brazil's banking sector is coming under tion will challenge households to make their Sovereign Support Capacity: The Brazilian
increasing stress, as asset quality is likely to debt payments. Household debt levels have government has limited ability and willing-
continue deteriorating and capital buffers declined from their 2012 peak, but remain ness to support the country's banking sector.
have been eroded in the last several quarters. high by historical standards. Meanwhile, we A moderate total government debt load, at
We acknowledge that the next few years will also anticipate deterioration in corporate asset 41.6% of GDP as of end-2014, implies that
be difficult for the sector, but anticipate that quality. The corruption scandal at state-owned the sovereign could take on additional debt
it will remain broadly stable as most major oil company Petrobras will make it more dif- in order to bail out the banking sector if need
banks remain well capitalised. A weak domes- ficult for the oil major, as well as several con- be. However, significant fiscal deterioration
tic economic environment, including a major struction companies that have been implicated in recent years has resulted in sovereign credit
corruption scandal impacting the oil and in the scandal, to meet their obligations. The ratings downgrades, with Standard & Poor's
gas and construction sectors, will challenge extent of the deterioration has yet to be seen, rating the country BBB- (just one step above
households and businesses to make their debt and we are keeping an eye on asset quality for 'junk'). We do not expect Brazil will lose its
payments. The country's financial leverage state-owned banks in particular. investment grade status, but pressure from
(assets-to-capital) ratio remains broadly in credit ratings agencies is driving a fiscal con-
line with its regional peers, even though it has solidation programme by the government. We
On The Rebound
ticked up in the last 12 months. Continued Deposit Growth, % y-o-y 12mma
believe it would be reticent to step in to bail
retrenchment by public sector banks will see 25 out the banking sector, given the potentially
loan growth slow further in 2015, to 9.5%, 23
severe negative ramifications for the country's
21
and remain structurally lower, averaging 19
sovereign credit rating.
11.8% between 2016 and 2019, below 16.9% 17

during the previous four years. 15 Ownership Structure: Brazil's banking

A Major Burden For Households
13
sector is dominated by domestic financial
11
BCB Household Debt Servicing Ratio
9
institutions, both private and public. Foreign
23
7 financial institutions accounted for 32.2% of
outstanding credit as of May 2015, a figure
22
5
Jun-09

Jun-14
Oct-07

Oct-12
Dec-06

Mar-08
Aug-08

Feb-11
Jul-11
Dec-11

Mar-13
Aug-13
Jan-09

Apr-10

Jan-14

Apr-15
May-07

Nov-09

Sep-10

May-12

Nov-14

which has increased from approximately 22%

21

20
Source: BCB, BMI
over the last decade. The country's five largest
19
banks by assets – Banco do Brasil, Itaú, Caixa
18
Funding Structure: Brazil's loan-to-deposit Economica Federal (CEF), Bradesco and
17
ratio will remain near current levels in the BNDES – are all domestic firms, and Banco
16
coming years, hovering below the 100% do Brasil, BNDES and CEF are majority
15
threshold. Loan growth has trended lower state-owned.
Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15
Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Sep-13

Sep-14

since 2012, in line with a significant decelera-

Note: Ratio of expected household debt payments to disposable income tion in real GDP growth. With loan growth Regulatory Body Assessment: The Banco
as a quarterly moving average, seasonally adjusted. Source: BCB
set to settle at a slower pace in the next several Central do Brasil is the country's banking
Asset Quality: Non-performing loans (NPLs) years and deposit growth to remain above its sector regulator. We believe that the govern-
in Brazil are highly likely to tick up in the March 2014 trough, the loan-to-deposit ratio ment's influence over the central bank has
coming quarters. They have declined notably will hover between 88%–90% for the duration waned in recent quarters, and a new fiscal
since 2012, when an economic slowdown, of our five-year  forecast period. As a result, team focused on consolidation and regain-
following a significant run-up in household we believe the funding structure of the sector ing international investor confidence will
debt levels, saw NPLs hit 3.7% of the total remains relatively stable. see this trend persist in the coming years.
portfolio. This was largely due to an increase We do not foresee a situation as was the case
in non-performing credit from households. Capital Adequacy: Leverage in Brazil's bank- in 2012, when President Dilma Rousseff
NPLs have ticked up since H214, from 2.7% ing sector, as measured by the assets-to-capital urged public banks to bring down interest
in December 2014 to 3.0% in May 2015, and ratio, has increased considerably  in the last rates for consumers, in line with deep cuts to
we expect this trend will persist in the next 12 months. This comes as growth in capital the benchmark Selic rate, effectively forcing
several quarters. has slowed significantly since 2013, follow- private banks to follow suit or lose out to
At the household level, rising job destruc- ing years of double-digit expansion. Monthly their competition.

www.latinamericamonitor.com OCTOBER 2015 – BRAZIL 3

  BRAZIL

INDUSTRY OUTLOOK

Fuels Consumption Growth Continued Structural Weakness Will Limit

Domestic Demand
Although Brazilian lawmakers will turn
To Remain Weak increasingly towards more business-friendly
economic policies, we caution that posi-
BMI View: Demand for refined fuels in Brazil will increase modestly through tive change will be slow to translate into
2024 as systemic regulatory challenges within the country weigh on domestic a significant uptick in growth. We believe
growth. Though Brazilian policymakers are making efforts to boost economic Brazil's poor business environment, weak
consumer confidence and a lacklustre exter-
activity, advancement will be hindered by deep political divisions and continued
nal environment will provide little upside for
fallout from the national corruption scandal.   
real GDP growth over the next several years,
Refined fuels demand in Brazil will experi- of higher commodity prices and increased resulting in weak consumption growth for
ence limited upside over the next decade as private investment, the subsequent fall in oil refined fuels.
economic deterioration continues to weigh benchmark prices will usher in a period of While fuel demand will be limited to only
on overall consumption growth. The country more modest economic gains in Brazil. In a 1.2% y-o-y increase over the next decade,
entered a recession on the back of weak com- 2015, declining economic growth is primar- Brazil will maintain a supply deficit as down-
modity prices due to softer demand for pri- ily attributed to a substantial deterioration in stream capacity growth remains insufficient.
mary product exports. With prices unlikely to Brazil's labour market, which will drive real The effects of the 'Lava Jato' corruption
recover and global demand to remain weak, we private consumption growth to the lowest scandal continue to take shape as the NOC
believe the Brazilian economy will be unable level in over a decade. Less robust demand reduces spending into the downstream sec-
to regain its previous growth rates over course will reduce domestic consumption of refined tor amid allegations of inflated contracts for
of our 10-year forecast period. fuels by 1.0% in 2015, as Brazilian real GDP these projects.
In addition, higher fuel prices will weigh contracts by 1.7%. This resulted in the abandonment of
on Brazilian demand for refined products as Demand in 2015 will be further weak- the Premium I and II refinery projects in
national oil company (NOC) Petrobras main- ened by a rise in gasoline and diesel prices February 2015, followed by the indefinite
tains higher prices to protect its downstream which were increased by 3% and 5%, re- postponement of phase II of the  Abreu e
profits. This strategy has become increasingly spectively, in November 2014. This was Lima   facility and  the entire Comperj   re-
valuable as lower crude prices and the 'Lava followed by the introduction of a higher finery which were expected to come online
Jato' corruption scandal have threatened the fuels tax which raised the price of fuels by in H115 and H116, respectively. While the
company's other sources of income. between BRL0.15-0.22/litre (USD.0.04- state of these projects remains unclear, their
0.06/litre). This policy, although beneficial suspension eliminated over 880,000b/d in
Price Volatility Weighs On Short-Term for Petrobras' heavily-leveraged balance refining capacity gains, supporting continued
Demand sheet, will weigh on consumer demand over demand for refined fuels imports over the
After a decade of strong growth on the back the remainder of the year. course of our 10-year forecast period.

DATA & FORECASTS

2011 2012 2013 2014e 2015f 2016f 2017f

Nominal GDP, USDbn 2,611.5 2,411.0 2,389.6 2,345.5 1,889.5 1,879.6 1,991.8
Real GDP growth, % y-o-y 3.9 1.8 2.7 0.1 -1.7 0.9 1.7
GDP per capita, USD 13,260 12,136 11,926 11,609 9,277 9,158 9,633
Industrial production, % y-o-y, ave 0.4 -2.7 -0.2 -0.3 -1.0 1.5 2.5
Population, mn 200.5 202.4 204.3 206.1 207.8 209.6 211.2
Consumer price inflation, % y-o-y, eop 6.5 5.8 5.9 6.4 9.1 5.5 5.2
Consumer price inflation, % y-o-y, ave 6.6 5.4 6.2 6.3 8.8 6.0 5.5
Central bank policy rate, % eop 11.00 7.25 10.00 11.75 14.25 13.50 11.75
Exchange rate BRL/USD, ave 1.68 1.95 2.16 2.35 3.11 3.35 3.40
Exchange rate BRL/USD, eop 1.87 2.05 2.36 2.66 3.45 3.55 3.45
Budget balance, BRLbn -108.0 -108.9 -157.5 -343.9 -293.8 -251.9 -230.2
Budget balance, % of GDP -2.5 -2.3 -3.1 -6.2 -5.0 -4.0 -3.4
Goods and services exports, USDbn 294.2 282.4 281.3 265.4 253.0 261.0 277.0
Goods and services imports, USDbn 302.4 304.1 326.3 320.6 308.0 317.0 333.0
Current account balance, USDbn -52.5 -54.2 -81.4 -93.6 -88.3 -88.2 -87.8
Current account balance, % of GDP -2.0 -2.2 -3.4 -4.0 -4.7 -4.7 -4.4
Foreign reserves ex gold, USDbn 352.0 373.1 358.8 363.6 340.0 350.0 375.0
Import cover, months 18.7 20.1 18.0 18.9 19.0 18.8 18.9
Total external debt stock, USDbn 404.0 440.5 482.5 533.5 582.4 636.3 695.0
Total external debt stock, % of GDP 15.5 18.3 20.2 22.7 30.8 33.9 34.9
Crude, NGPL & other liquids prod, 000b/d 2,192.9 2,149.0 2,114.1 2,346.3 2,437.4 2,508.7 2,570.0
Total net oil exports (crude & products), 000b/d -531.2 -721.5 -836.4 -649.3 -526.1 -483.4 -458.5
Dry natural gas production, bcm 14.6 16.9 21.3 23.4 25.1 26.3 27.4
Dry natural gas consumption, bcm 25.1 30.3 37.6 41.4 43.6 46.3 48.1
e/f=BMI estimate/forecast. Source: National Sources, BMI

4 4 BRAZIL – OCTOBER 2015 www.latinamericamonitor.com

INDUSTRY OUTLOOK

Conservative Outlook On Vast technology in the country over our forecast

period – accounting for 60.1% of the capac-
ity mix in 2024. This represents a reduction
Hydropower Expansion compared to the current share, which we
expect to stand at 66.5% by end-2015, and is
BMI View: We maintain a positive growth outlook for the Brazilian hydropower a result of significant additions of renewables
sector over the next decade, but we consider the government's official 10-year (mostly wind) and thermal power capacity
throughout the coming decade.
expansion plan for the industry too ambitious. We expect hydropower capacity
to grow by an annual average of 1.8% up to 2024, boosted by the completion Hydro To Dominate Power Generation Mix
Brazil - Generation, % Of Total Generation, 2014-2023
of two large-scale projects in 2016.
Within the Brazilian power sector, we expect is based on two factors:
hydropower to register the biggest expansion in
terms of new capacity installed over our 10-year • We have chosen to leave out of our
forecast period, with total hydropower capacity forecast two controversial hydropower
growing from 91.70 gigawatts (GW) in 2015 mega-projects that are included by EPE,
to 106.76GW in 2024. This growth will be the the 11,000MW Belo Monte plant and
result of significant capacity additions over the the 8,040MW Tapajós plant – due to
next few years, as several large-scale projects that their prohibitive costs, previous delays
are currently under construction are brought to  development and the high level of
online. We expect the 3,150MW Santo Anto- public opposition to their implementation e/f = BMI estimate/forecast. Source: EIA, BMI

nio and 3,750MW Jirau hydropower plants on a social and environmental basis. Belo
to enter commercial operations by the end of Monte is currently under construction and Corruption Investigations Pose Downside
2016, supporting our forecast for hydropower is scheduled to be completed in 2019; Ta- Risk To Outlook
capacity to grow by 7.5% y-o-y in 2016 and pajós is still undergoing feasibility studies We highlight that we see both upside and
by an annual average of 2.5% between 2015 but is expected to come online in 2020. downside risks to our 10-year forecast for
and 2019. hydropower capacity in Brazil:
Vast Hydro Capacity Additions Ahead
Slower Economic Growth To Weigh On Hydropower Installed Capacity And Growth Rate
Power Consumption • The negative impact of an investigation
Real GDP Growth And Total Power Consumption into allegations of corrupt contracting
practices at Petrobras – coupled with the
recent extension of the probe to state-
owned utility Eletrobras – could threaten
our growth forecast for the hydropower
sector. Eletrobras and local engineering,
procurement and construction companies
have a dominant role in the development
of Brazil's hydropower project pipeline;
e/f = BMI estimate/forecast. Source: EIA, BMI
as such, higher financing costs, contracts
investigations and operational challenges
e/f = BMI estimate/forecast. Source: EIA, BMI • We believe the PDE 2023 overestimates resulting from the probe could mean
the amount of power Brazil will consume that projects that are planned or under
Looking further ahead, our outlook for over the next decade. The agency forecasts construction are delayed or halted over
the hydropower sector is still positive but less that between 2013 and 2023 Brazil's GDP the coming quarters.
upbeat, as we expect capacity to grow at an and power consumption will both grow • Conversely, the main upside potential to
average annual rate of 1.2% between 2020 and by an annual average of 4.3% – well above our forecast stems from the commitment
2024. Our forecast takes into account Brazil's BMI's expectations. Our Country Risk of the Brazilian government to bringing
10-year Energy Expansion Plan to 2023 (PDE team expects Brazil's real GDP growth online the Belo Monte plant according to
2023) – the latest such document published by to average 2% between 2015 and 2024, the planned schedule. As a case in point,
the government agency Empresa de Pesquisa informing our forecast for power con- in July 2015 Eletro Norte (a subsidiary
Energética (EPE) – which states that Brazil sumption to grow at an average annual of  Eletrobras) awarded several contracts
will bring online 14,679MW of hydro capacity rate of 2.1% over the same period. to EPC companies for the development of
between 2019 and 2024. However, we consider the project. In particular, the State Grid
the government's forecast too ambitious and we Despite our conservative approach to the Corporation of China was awarded a
have only included around 6,180MW of new implementation timeline  for  Brazil's hydro- USD2.2bn contract to build and operate
capacity in our forecast for 2020-2024. power projects, both planned and under an 800kV, 2,550km-long transmission
Our more cautious stance on hydropower construction, we maintain that hydropower line that will connect the plant in north
capacity expansion relative to official estimates will remain the dominant power generating Brazil to Rio de Janeiro in the south-east.

www.latinamericamonitor.com OCTOBER 2015 – BRAZIL 5

  BRAZIL

KEY SECTORS

OIL & GAS

This report is from our latest Brazil Oil & Gas pressed share price despite nearly a year tory challenges within the country weigh on
report, which includes in-depth research on the of consecutive output growth. domestic growth. Though Brazilian policy
sector, full five-year forecasts and a thorough • We maintain our bullish long-term out- makers are making efforts to boost economic
analysis of the competitive landscape. BMI look for Brazil’s crude production. While activity, advancement will be hindered by deep
currently covers 24 industries across over 180 pre-salt fields will boost production in the political divisions and continued fallout from
countries. For further information, or to order short term, we believe forthcoming up- the national corruption scandal.
a report, please contact subs@bmiresearch.com. stream developments will support liquids After a decade of strong growth on the
output growth at an average rate of 2.3% back of higher commodity prices and increased
y-o-y over the next 10 years. private investment, the subsequent fall in oil
BMI Industry View • Demand for refined fuels will continue benchmark prices will usher in a period of more
Brazil’s vast pre-salt reserves suggest substantial to outpace production for the duration modest economic gains in Brazil. Under the
growth potential over the long term, underpin- of our forecast period. This dynamic will current fuel price subsidy regime, which has
ning our bullish upstream view that crude, be exacerbated by the continued delay been in place to varying degrees since 1980,
natural gas, and other liquids output will rise and recent cancellations of planned down- Brazilians not only demanded greater quantities
throughout our forecast period. However, stream projects. of gasoline, but were also able to fill their tanks
production growth will be limited by lower oil • Brazil’s sizeable natural gas resources pre- at artificially low rates, encouraging greater con-
prices and decreased capex funds. As such, we sent a tremendous growth opportunity sumption. This trend, coupled with Petrobras’
maintain a relatively modest outlook, reflecting for the country. While we foresee a rise production deficit, resulted in a steady increase
our view that the above-ground environment in production at 4.4% y-o-y from 2015 in fuel imports to feed rising domestic demand.
remains a considerable obstacle to the upstream to 2024, significant financial pressures This dynamic created a sustained trade deficit
and downstream segments due to weakening on state-run Petrobras and less robust and a tremendous financial burden on the in-
project economics, waning investor confidence, growth of associated presalt gas projects debted NOC, amounting to nearly USD40bn
and a burdensome regulatory environment. will expand the trade deficit throughout from 2011 to 2014.
The key trends and developments in the our ten-year forecast period to 2024. However, changing market dynamics will
Brazilian oil and gas sector are: • With y-o-y consumption of natural gas weigh on domestic fuel demand, alleviating a
• Significant financial burdens faced by projected to rise over the next decade, source of financial strain on the NOC. In 2015,
state-owned Petrobras, the dominant combined with less upstream develop- declining economic growth will be primarily at-
player in the sector, will keep the country ment, we believe Brazil will remain highly tributed to a substantial deterioration in Brazil’s
from achieving its full production poten- dependent on imported gas supplies. labour market, which will drive real private
tial as the company struggles to finance the Given Brazil’s plans to expand natural consumption growth to the lowest level in
development of pre-salt resources amid a gas-fired power generation by 2019 to over a decade. Less robust demand will reduce
weakening real, a rising ‘Custo Brazil’, and reduce its dependence on less reliable domestic consumption of refined fuels by 1.0%
lower oil prices. hydropower, we believe net exports of gas in 2015, with Brazilian real GDP expected to
• The ‘Lava Jato’ corruption scandal will will steadily decline through 2024, par- contract by 1.7%.
place additional pressure on the na- ticularly in the form of liquefied natural Demand in 2015 will be further weakened
tional oil company NOC to shore up its gas (LNG). by a rise in gasoline and diesel prices which
finances and outperform. Given the size were increased by 3% and 5%, respectively,
and scope of this scandal, the company Industry Forecast in November 2014. This was followed by the
could find itself the victim of prolonged Demand for refined fuels in Brazil will increase introduction of a higher fuels tax which raised
investor uncertainty, as seen by its de- modestly through 2024 as systemic regula- the price of fuels by between BRL0.15-0.22/

REFINED PRODUCTS CONSUMPTION*

2013 2014e 2015f 2016f 2017f 2018f

Refined products consumption, 000b/d 3,003.0 3,048.0 3,017.6 3,047.7 3,085.8 3,132.1
Refined products consumption, % y-o-y 2.7 1.5 -1.0 1.0 1.3 1.5
e/f = BMI estimate/forecast. Source: EIA, BMI

REFINED PRODUCTS CONSUMPTION*

2019f 2020f 2021f 2022f 2023f 2024f

Refined products consumption, 000b/d 3,182.2 3,233.2 3,280.0 3,329.2 3,382.5 3,436.6
Refined products consumption, % y-o-y 1.6 1.6 1.5 1.5 1.6 1.6
f = BMI forecast. Source: EIA, BMI

6 6 BRAZIL – OCTOBER 2015 www.latinamericamonitor.com

litre (USD.0.04-0.06/litre). trend will continue as more expensive gasoline tant to enact proposed changes to the licensing
This policy, though beneficial for Petrobras’ is less able to compete with the more affordable terms for the country’s pre-salt resources due
heavily-leveraged balance sheet, will weigh on renewable alternative. to the more nationalist nature of upstream
consumer demand over the remainder of the development in Brazil.
year, informing out more modest outlook. Market Overview Under the 1997 Law Regulating the Pe-
Given our forecast for Brent crude to average Our estimates suggest that in 2014, Brazil troleum Industry, companies bought rights to
USD57 per barrel (bbl) in 2015 and to average was the 10th largest hydrocarbons consumer explore defined blocks, onshore and offshore.
below USD60/bbl through 2017, we believe in the world, the third largest in the western Concession holders accepted the full risk and
Petrobras will maintain higher domestic fuel hemisphere and the largest in Latin America. cost of exploration and were rewarded with
prices over the coming decade to maintain its According to the Energy Information Admin- rights over whatever was discovered, paying roy-
downstream profits. istration (EIA), its 2015 proven oil reserves alties to the government on what was produced.
Though Brazilian lawmakers will turn totalled 15.31bn barrels (bbl), ranking it second The prolific resources found in the pre-salt
increasingly towards more business-friendly in Latin America behind Venezuela, and ahead area offshore Rio de Janeiro state, however,
economic policies, we caution that positive of Mexico. The majority of the country’s proven convinced the Brazilian lawmakers to change
change will be slow to translate into a significant reserves are located off the country’s south-east the terms to prepare the country for oil-exporter
uptick in growth. We believe Brazil’s poor busi- coast, particularly in the offshore Campos and status and to capture more oil revenue for the
ness environment, weak consumer confidence Santos basins. There are also upside risks to the state. Following the pre-salt discoveries, the
and a lacklustre external environment will country’s oil reserves base, as this estimate does government withdrew several blocks from its
provide little upside for real GDP growth over not fully account for the additional resource 2007 annual auction, possibly in a move to
the next several years, resulting in long-term potential in the country’s vast pre-salt reservoirs. prevent potentially prolific fields from falling
weak consumption growth for refined fuels. into foreign hands. A shift towards a production
With efforts to increase refining capacity Overview/State Role sharing agreement model in pre-salt areas – with
progressing at a much slower than anticipated Until 1998, state-controlled Petrobras had a the majority state ownership of every project
rate, the financial burden created by Brazil’s monopoly on exploring, producing, refining – represents a compromise of sorts, allowing
artificially cheap fuel prices is unlikely to be and distributing oil in Brazil. International oil foreign firms to participate in Brazil’s new oil
alleviated in the near future. This was witnessed companies (IOCs) have since been allowed wealth but on restricted terms.
by the November 2014 start up of the highly to enter the upstream and downstream oil One of the changes deemed necessary be-
anticipated Abreu e Lima refinery’s phase I sector. Many leading IOCs are now active in cause of deepwater discoveries was the reorgani-
after repeated delays, followed by the indefinite exploration, with a number of big discoveries sation of the boundaries of the pre-salt fields
suspension of its second phase. The 165,000b/d recorded. There is competition in domestic that extend beyond their original exploration
Comperj refinery was also suspended in H115. fuel retailing, although refining remains largely blocks, or unitisation. The need for unitisation
The sharp fall in global oil prices has brought Petrobras’ domain. was prompted by Petrobras’ August 2008 an-
Brazilian fuel prices closer to average global In 2010, President Rousseff signed a decree nouncement that oil discoveries in the pre-salt
rates, shifting from a 19.1% discount in early launching a new state-owned company in layer of the Santos Basin could be contiguous,
October 2014, to a 1.0% discount from as of Brazil, Pre-Sal Petroleo (PPSA). The company forming one giant oil seam.
May 11. This is following a peak of 19.7% administers all production-sharing and sales Moreover, the government put state-owned
premium to international prices in February contracts governing oil and natural gas fields Petrobras front-and-centre in terms of develop-
2015 when Brent benchmark prices were at in the pre-salt areas offshore Brazil, on behalf ing the country’s pre-salt resources, cementing
their lowest. of the Brazilian government. The company will Petrobras’ involvement in the development of
Given the extensive debt of the NOC, also be responsible for the technical and finan- the country’s pre-salt potential with the passage
which now stands at USD133bn, there are clear cial assessment of any hydrocarbon project in of a package of laws in December 2010. The
advantages to maintain or even increase prices the area. PPSA is supervised by the Mines and laws replaced the existing concession-based
further. The primary risk to a fuel price decline Energy Ministry and was created with an initial system for oil fields with a production-sharing
rests with Petrobras’ balance sheet. Given the capital investment of BRL50mn. model for future pre-salt development project.
ongoing accounting scandal and its USD17bn Within the next five years, there are sev- It also gives Petrobras a minimum 30% operat-
impact on the NOC’s financial performance, eral planned IOC-operated projects, although ing stake in all future pre-salt projects.
the company will be unable to cut fuel prices development of Brazil’s pre-salt reserves will A separate law to even out the distribution
this year in favour of greater cash-flow to sup- fall firmly on the shoulders of Petrobras. The of oil royalties between Brazil’s provinces – an
port its ambitious five-year spending plan. state-owned company launched a USD220.6bn unpopular move with those oil-producing
With respect to renewable fuels consump- five year investment in 2014 which was later re- regions that receive the lion’s share – remains
tion, we believe more supportive regulations duced to USD130.3bn for 2015-2019. Though controversial. It has been a significant issue
and a weaker real will increase demand for the overall investment plan was significantly since December 2010, when outgoing President
domestic supplies over the next several quar- reduced, the NOC will now allocate a greater Lula da Silva vetoed a congressional proposal to
ters. In Q115, the government increase in the share of funds the upstream sector, from 70% distribute oil royalties beyond the three main
mandated national blending ratio from 25.0% in the previous plan to approximately 83% in oil-producing states, while putting forward
to 27.0%, raising demand for the good over the revised version. a similar plan with a less redistributive slant.
the past several months. In July 2015, Brazil’s Brazil’s exploration framework had been Brazilian President Dilma Rousseff’s ad-
monthly consumption of ethanol hit an all-time widely criticised, particularly in the wake of ministration proposed a new oil royalties plan
high at 1.55bn litres, outpacing the previous lower oil prices and the ‘Lava Jato’ corruption in a bid to ease tensions over distribution of
record set in December 2009. We expect this scandal. However, lawmakers have been hesi- oil revenues between states. The bill sees a

www.latinamericamonitor.com OCTOBER 2015 – BRAZIL 7

  BRAZIL

15% royalty rate for new PSCs applied to the regulations will likely temper overall enthusiasm remaining 40%. However, while the country’s
coveted sub-salt regions, which could contain for these offerings. High local content require- petroleum regulator touted the country’s first
up to 100bn bbl of recoverable oil. Outside ments of 63% in the exploration phase and pre-salt auction as ‘an absolute success’ we have
of these regions, a concession system would 75% in the production phase, the required a more mixed view.
remain, along with a 10% royalty rate. A participation of national oil company Petrobras With only a quarter of the expected bidders
windfall profits tax would also be introduced for and the lack of an explicit stabilization clause taking part in the auction in the first place, and
existing contracts as revenues are redistributed all pose a significant deterrent to doing busi- only one consortium having bid, the lack of
to non-producing regions. This Royalty Law ness in Brazil. competition for such a highly prospective field
was passed in November 2012, and signed by Furthermore, investors are likely to be in- is telling. While the field is highly prospective,
President Rousseff in May 2013. However, creasingly hesitant towards investing in Brazil in potentially holding between 8bn and 12bn bbl
Rio de Janeiro, Espirito Santo and Sao Paulo the wake of the ‘Lava Jato’ corruption scandal. of recoverable oil, the head of Brazil’s oil regula-
– all south-eastern states where the majority of Specifically, we believe the potential negative tor has stated that between a substantial sign-
Brazil’s offshore oil is produced – have vowed impacts of the wider investigation against the ing fee, as well as high royalties and taxes, the
to challenge the law in court. NOC and its OFS partners, coupled with lower government could take away more than 75%
After some delays, Brazil has published a oil prices and a challenging investment environ- of total profits. The situation is exacerbated by a
new regulatory framework governing frack- ment, will deter international investment into relatively unfavourable regulatory environment,
ing as of April 2014. The National Petroleum the sector for the foreseeable future. burdensome local content requirements and
Agency (ANP) has stated that these are not potential for significant delays to production,
intended to act as a roadblock to the develop- 12th Licensing Round (November 2013): which could add to the cost of exploiting the
ment of the country’s unconventional resources, Focused on conventional and shale gas - this Libra field. As such, while ultimately field was
and will target effective waste management round can be classed as somewhat low impact. successfully auctioned, and the willingness by
during the exploration phase. The new rules The ANP put up 240 exploration blocks in Total and supermajor Shell to take stakes is a
require developers properly to cement wells, seven inland basins, including concessions positive sign, we believe the round represented
map out aquifers within 1km and prohibit in the states of Amazonas, Acre, Tocantins, a mixed success, at best.
fracking within 200m of wells used for irriga- Alagoas, Sergipe, Piauí, Mato Grosso, Goiás
tion or drinking water. We note that Brazil has and Bahia. Importantly, a large number of the 11th Licensing Round (May 2013): The 11th
only recently begun to auction of blocks with blocks were offered in frontier areas, such as the licensing round had been delayed repeatedly,
unconventional potential and the fact they have basins of Acre, Parecis, São Francisco, Paraná but finally moved forward in 2013. 172 blocks
not seen significant take-up speaks of the delay and Parnaíba in the hope of attracting invest- were put up on offer, covering onshore, shal-
in bringing online new regulations. ment into the country’s little-explored regions. low- and deep-water acreage lying above the
However, Brazil awarded only 72 explora- already explored Sergipe-Alagoas, Recôncavo,
Licensing Rounds tion blocks, with 12 companies winning blocks Potiguar and Espírito Santo basins and the
While the early 2013 11th licensing round was (eight Brazilian and four foreign) including: underexplored Foz do Amazonas, Ceará, Pará-
record-breaking in terms of investment, more Alvopetro, Bayar, Companhia Paranaensae Maranhão, Barreirinhas, Potigua and Parnaíba
recent rounds, including the country’s first pre- de Energia, Cowan, GDF Suez, Geopark, basins. The round saw a minimum level of
salt and 12th licensing round (focused on gas) Nova Petróleo, Ouro Preto, Petra Energia, around BRL6.9bn (USD3.2bn) in investment
have seen less take-up. We believe this reveals Trayectoria e Tucumann and Petrobras itself. committed to exploration activities – more than
how the country’s, a poor regulatory environ- Indeed, the state-owned company was by far three times the amount pledged during any of
ment has acted as a significant deterrent in spite the biggest winner, snapping up 49 of the 72 the previous rounds. Some 142 of the blocks
of its significant resource potential. blocks, either alone or as part of a consortium. were purchased, with signing bonuses totalling
Moreover, while Chambriard noted that a BRL2.8bn (USD1.3bn). These were allocated
13th Licensing Round (October 2015): After number of the blocks taken were in the Parnaiba among 30 different companies: 12 local and
several delays, Brazil’s ANP has confirmed the block -strengthening exploration in the highly 18 foreign. Winners include IOCs such as BP,
start of the highly-anticipated 13th hydrocar- prospective acreage, we note that the majority of BG Group, Chevron, ExxonMobil, Total
bon licensing round in October 2015, opening blocks taken were still from the mature basins of and Statoil.
the door to additional international investment Reconcavo and Sergipe-Alagoas (54 out of 72).
in the country’s Eastern Margin blocks. 10th Licensing Round (December 2008):
The 13th hydrocarbon licensing round will 1st Pre-salt Round (October 2013): In the ANP concluded the 10th licensing round
comprise onshore and offshore blocks from first pre-salt round, a consortium consisting of in December 2008, awarding 54 of the 130
the state of Rio Grande do Sul in the south to Shell, Total, PetroChina and China National tendered concessions to 17 companies. As
Rio Grande do Norte in the northeast. Both Offshore Oil Corporation won a 35-year usual, Petrobras was the biggest winner. The
Petrobras and Integral Petróleo e Gás have production sharing contract to develop Brazil’s company spent BRL39.9mn (USD17mn) ac-
made multiple discoveries in the north-eastern giant Libra field under a production-sharing quiring the rights to 27 blocks, of which it won
Sergipe-Alagoas Basin in recent months, which contract, in concert with state-owned energy 17 as sole owner and 10 as part of consortia.
we expect will boost interest in these assets. firm Petrobras. Shell and Total will each take a Although the ANP said the round was a suc-
Although the upcoming round offers prom- 20% stake, while the two Chinese companies cess, 76 blocks did not receive any bids, and
ising prospects for investors, several existing will each take a 10% stake and Petrobras the the only major participating IOC was Shell.

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