Brazil as a new kind of oil giant

More than 180 miles off Brazil's coast, trapped under a few miles of water, rock, and salt, lie billions of barrels of light, sweet crude – the largest discovery of oil in the Western Hemisphere in a generation.

Accessing it will require some of the most advanced technology on the planet. But Brazil, once a heavy importer that celebrated its "oil independence" only two years ago, is uniquely positioned to extract reserves trapped millions of years ago when South America and Africa began to separate. The state-controlled oil company, Petroleo Brasileiro (Petrobras), says it will begin production by 2010.

The potential is enormous. Brazil's president Luiz Inácio Lula da Silva called the find "a gift from God" that would thrust Brazil to the list of top oil exporters and help end the nation's wealth disparities. It is also a significant discovery for the world: proven reserves have been declining, and drops in both Norway and Mexico last year were offset in part by Brazil.

New discoveries are creating fresh challenges as to how the oil wealth should be spent. And some of the enthusiasm has been tempered by the global market turmoil that will make financing harder to find. But the fact remains: as its peers in the region see their oil production slipping – most notably state-owned oil companies in Mexico and Venezuela – Petrobras is entering a new era as the region's silent giant. And with oil in ever-deeper waters and more inaccessible nooks, more countries are turning to Brazil for its expertise.

"Petrobras is really a standout: in finding reserves, developing reserves, and investing in technology and human capital," says Francisco Gros, former chief executive of Petrobras and vice president of the board of OGX, one of Petrobras's competitors. "It should be a model; national companies should first be treated as oil companies."

The hope Brazil has placed on oil's transformative potential is on view in the stunning bay of Angra dos Reis, where the massive P-51 oil platform juts out from the water like a giant LEGO piece. Weighing 48,986 tons – with capacity to sleep 200 and its own movie theater and soccer field – it is the first semisubmersible platform built entirely in Brazil and has created 4,000 direct jobs.

Petrobras is already the biggest company in Brazil, with a market value of more than $240 billion, and it is the government's largest single taxpayer. It employs some 52,000 workers, but the new oil find has kindled optimism that new jobs and opportunities lay ahead, especially in the shipping industry in ports along the Atlantic coast. On a recent day, the port city of Niteroi, just across the bridge from Rio de Janeiro, is humming with workers lining up to apply for jobs. Small boats were plying the waters, shuttling supplies. Down the street, students took turns practicing welding at a new trade school dedicated to building oil rigs like the P-51. "Petrobras has discovered a lot of oil, and there will be a lot of jobs in the future to build these platforms," says Pierre Robert da Silva, who just started at the school.

But hopes for the future lie in more than job generation. Last November, Petrobras announced its discovery of the Tupi field, which holds an estimated 5 to 8 billion barrels of oil. In September, the company said that the nearby Iara field holds up to 4 billion barrels. But analysts estimate that the region could contain up to 80 billion barrels, about the same as Venezuela. Brazil currently produces more than 2 million barrels a day. By 2015, that could increase to 3 million.

Lula has said the discoveries will narrow the gap between the rich and poor – and has floated the idea of a new company that has manages the "pre-salt" province. Some politicians have said the earnings should go toward education, others for the military. The company says it believes that Brazil, unlike other oil-producing nations that have squandered oil wealth or allowed it to exacerbate inequality and corruption, is a different story. "Our country has the maturity to take advantage of this oil," says Ricardo Beltrao, the general manager of production research at the research arm of Petrobras, called Cenpes. "Some other countries have a lot of resources but don't use those resources in a way that brings an increase in the standard of living of people."

Path to progress: technology

How did Brazil get here? When Petrobras began operations in 1954, it was producing just 2,700 barrels a day, less than 3 percent of the country's needs. Brazil remained a heavy crude importer over the next two decades, but the oil shock of the 1970s unfurled a technological fervor. Unlike Mexico, whose discovery of the Cantarell field in 1976 – one of the world's largest oil reserves – thrust it easily into oil exportation, most of Brazil's richest deposits were offshore.

"We learned early that to be successful we had to have technological domain," says Carlos Tadeu da Costa Fraga, the executive manager of Cenpes, which was created in 1955 and today, with 2,000 employees, is the largest research center in Latin America. "In deep waters, we have much more experience than other countries in the world."

In the 1970s, Petrobras developed equipment and techniques to pump oil that lay deeper than most other companies could reach at the time. And today a new task is at hand as Brazil gets set to tap its newest oil find, which sits at some of the deepest levels in the world – more than 7,000 meters under the ocean's surface.

But investment in technology is only part of the story. In 1997, Brazilian lawmakers created a concession model, opening up what had been a monopoly to outsiders who compete with Petrobras on bidding and developing leases. Its shares have been publicly traded on the New York Stock Exchange since 2000. The government owns the majority of voting shares, but today 70 percent of total equity is in the hands of private investors, making it much more responsive to global accounting standards and corporate governance.

"When it opened up, Petrobras could begin to act as an oil company. The lesson from Brazil is opening up the system," says John Forman, the former director of Brazil's oil and gas regulator and today an independent consultant at J. Forman Consultoria.

The discoveries, of course, come with financial, logistical, and technical challenges. It is unclear whether the production will be economically viable, especially as the price of oil has fallen about 60 percent since mid-July to less than $60 a barrel today. The first "presalt" well cost $240 million to drill. Although newer ones cost a quarter of that, the demands on financing and infrastructure are high. The most common estimate cited, by the bank UBS, puts the cost of development at $600 billion. And some of the most promising reserves are the farthest away.

Still, all the wells sunk so far – eight in total – have struck oil, and confidence runs high. "We have reason to be optimistic. There are not barriers, but challenges we will be able to overcome," says Jose Formigli, executive manger of Petrobras's subsalt exploration and production.

Mexico looks to Brazil

The euphoria here stands in contrast to the outlook at other state-oil companies in the region. Mexico's production is in trouble since output at Cantarell has been declining at a rapid clip. At its peak four years ago, Mexico, the third-largest supplier to the US, was producing 3.8 million barrels a day; today production has slipped to 2.8 million barrels.

In order to maintain its position as a major oil exporter, the company says it will have to start aggressively exploring deepwater reserves – where they estimate 30 billion barrels lie. But they have not had the technology or money to undergo such exploration. Carlos Morales Gil, exploration chief for Mexico's state-owned oil firm, says that Petroleos Mexicanos (Pemex) wasn't forced to put resources in deepwater research because its oil was in shallow waters. Now that is starting to change, but catch-up alone will not suffice. "We are entering an era of big challenges for the oil industry in Mexico," says Mr. Morales Gil. "We have to put all capacities into deepwater [drilling] as fast and as strong as we can."

Mexico has been caught in a political storm over ways to revamp Pemex. Its Constitution mandates that the industry remain under state control – the country celebrates the 1938 nationalization of the industry as one of the defining moments in its history. A heavy tax burden has also hindered its technological development for years. Last month, Mexico's Congress passed a reform, enabling limited foreign participation in Pemex, but it was a watered-down version that Mexican President Felipe Calderón originally floated to attract investment in the Gulf of Mexico and help revive the stagnating company.

Today, Petrobras is gaining momentum while Pemex is slipping – a scenario that was unlikely 10 years ago. "The gap is narrowing considerably," says David Shields, a Mexico-based oil expert who has written extensively on Pemex. "Pemex is a giant bureaucracy and national symbol, and in that context has become very inefficient," he says. "Brazil hasn't had that problem. Petrobras is still a national company in a way but it doesn't have any hang-ups."

The region's other oil giant, Petroleos de Venezuela (PDVSA), is also starting to stagnate. Production in Venezuela has slipped from 3.1 million barrels a day in 1999 to 2.6 million barrels daily last year, according to the Energy Information Administration. Jorge Piñón, an energy researcher at the University of Miami and a former executive for Amoco in Latin America, says the drop is due partly to the fact that Venezuela's leftist President Hugo Chávez has used the proceeds to fund his social programs instead of investing it back into the company. In 2006, its earnings before spending on social development and income tax were $22,931 billion and the company contributed $13 billion of that to his social missions, including literacy and health programs in the most marginalized neighborhoods, according to the company website.

"PDVSA was not created as a social entity, but it's performing as one," Mr. Piñón says. "That's where your performance fails; this goes back to stewardship. You shouldn't take away money from the company that is supposed to be creating the future of the country."

But political challenges are on the horizon in Brazil. Just as Mexico debates the merits of private enterprise, Brazil's politicians are discussing whether it should move in the opposite direction. An interministerial commission has been debating how to govern future oil proceeds, including the prospect of a creating an entirely new state-run company.

Will Brazil suffer the "oil curse" that has afflicted so many other nations? The slogan under which Petrobras was born – "the oil is ours" – has been dusted off and unfurled across the country. But for many, the debate is premature. "Brazil has found a new oil province with a large potential. It is no sea of oil without risks of production," says Mr. Forman.

Or, as Mr. Gros puts it, "The chickens haven't hatched yet."

And if it gets bogged down in a political morass, Petrobras could lose its competitive advantage. "If they follow the right policies, this could bring the country very fast to being one of the most developed countries in the world," says Marcio Rocha Mello, a petroleum geologist who worked for Petrobras for 26 years and was one of the first pushing for ultradeep exploration, earning him the nickname "Mr. Go Deep." "And if they try to hold down production, we'll become importers of oil."