BRAZIL - UNCERTAIN RESPONSE TO BOLIVIAN OIL AND GAS NATIONALIZATION

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06BRASILIA861 3 May 2006 Confidencial Embassy Brasilia

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E.O. 12958: DECL:05/02/2016
TAGS: EINV, PREL, EPET, XM, BR
SUBJECT: BRAZIL - UNCERTAIN RESPONSE TO BOLIVIAN OIL AND GAS
NATIONALIZATION

REF: A) LA PAZ 1157
B) BRASILIA 142
C) BRASILIA 754
D) BRASILIA 799
E) BRASILIA 848
F) BRASILIA 855
G) BRASILIA - WHA EMAIL 2 MAY 2006
H) 2005 BRASILIA 3305
I) SAO PAULO 464

1. (C) Summary: After an emergency cabinet meeting lasting
into the evening to discuss the appropriate Brazilian response
to Bolivia’s May 1 nationalization of foreign oil and gas
investments (ref A), the Lula Administration issued a stunningly
bland public statement the evening of May 2 recognizing
Bolivia’s sovereignty to act as it did but reaffirming that the
GOB would act to protect the interests of (partially-privatized
parastatal) Petrobras. According to local media, President Lula
will meet his counterparts from Argentina, Bolivia and Venezuela
on May 4 in Puerto Iguazu, Argentina to discuss the situation.
In contrast to the Lula administration’s feeble public stance,
Brazilian media commentary has been sharp, decrying Bolivia’s
use of troops to occupy oil and gas installations; some have
called for Brazil to withdraw its Ambassador to Bolivia (ref F).
Although Petrobras may resort to arbitration to protect the
approximately US$1.6 billion it has invested in Bolivia, this
amount represents only about 2% of Petrobras’ worldwide
investments. Given that Bolivian gas makes up only 4% of
Brazil’s overall energy consumption, most analysts foresee
limited impacts even if the gas supply were to be interrupted.
End Summary.

Bending to Evo’s Will?


2. (SBU) The GOB’s formal reaction to the nationalization
operation finally emerged early on the evening of 2 May, after
marathon meetings chaired by Lula that began at 11:00 am and
extended throughout the day. The stunningly brief and anodyne
presidential press release — the insipid fruit of an entire day
of Lula-led crisis-mode deliberations for which two cabinet
ministers had been called back to Brasilia from abroad —
consisted of only five points in which the GOB recognized
Bolivia’s right to "nationalize the riches of its soil and
control their industrialization, transport and
commercialization," affirmed the GOB will act "with firmness and
tranquility in all fora" to preserve Petrobras’ rights and carry
out mutually beneficial negotiations with Bolivia, and assured
that supplies of natural gas to Brazil are guaranteed by the
will of both countries, as reiterated in a telephone
conversation between Morales and Lula (presumably on 2 May).

3. (SBU) The tepid reaction from the presidency — despite
expectations from senior GOB advisors that Lula would have to
make some strong point of protest (see below) — may well fuel
criticisms in the opposition and media that the GOB’s policy
toward Morales has been shown to be disastrously inept. The
announcement that Lula will go Argentina this week to meet
Morales and Venezuelan President Hugo Chavez — who is now
widely considered in Brazil to be the guarantor of Morales’ bold
action — may further reinforce the negative impressions of a
president caught asleep at the switch and unwilling to stand up
forcefully for vital Brazilian interests. Foreign policy is
seldom a major issue in Brazilian presidential campaigns, but it
is a certainty that this episode will feature prominently in the
opposition’s campaign.

4. (C) In a private meeting on 2 May (ref G), Marcel Biato,
Lula’s deputy foreign affairs advisor, provided insight on the
thinking within Lula’s inner circle on the day after Morales
made his move. The GOB was not surprised by the content of the
nationalization decree — those are the uncompromising terms
Brazilian negotiators have been hearing for the past 7-10 days.
Biato said that in March, Petrobras and Bolivian interlocutors
had been engaged in what appeared to be relatively positive
discussions. However, Morales abruptly broke the talks off,
insisted he would only discuss the issues with Lula directly,
and the Bolivians only re-engaged in recent days, with the stark
message they took public on 1 May. In the interval between the
March talks and the nationalization, Biato observed there was a

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lot of Morales interaction with Chavez. (Note: Per ref D,
Chavez and Lula met in Brasilia on 20 April; in the meeting Lula
was to register his concern about the nature of Venezuelan
involvement with Morales on the hydrocarbons issues. End note.)
It is clear now to the GOB that Morales was emboldened after
hearing that Chavez would (a) provide technical help to get gas
out of the ground if Petrobras bails (which the GOB doubts the
Venezuelans have the know-how to do), and (b) buy the product.
(Comment: This view has now taken hold in the Brazilian media
and opposition as well. End comment.)

5. (C) While not surprised by the terms of yesterday’s decree,
the timing, lack of diplomatic notice and use of the armed
forces (presumably for dramatic impact in Bolivia and to show
the military’s solidarity with Morales in the action, Biato
opined) angered the GOB, who anticipated that early Brazilian
references to the action as "unfriendly" would be echoed by Lula
in his statement. Biato noted there is a domestic requirement
that Lula "say something tough" now at a political level, though
the GOB wants to avoid turning this into a Morales-Lula
slugfest. (Comment: Biato was wrong — the anemic presidential
statement contains no hint of criticism or official displeasure.
End comment.) As talks proceed over the next six months, Biato
said options available to Brazil include: (1) Petrobras operates
but prepares to break contractual obligations (e.g., non-payment
to Bolivia, with the line that Morales can just deduct what he
wants from Bolivia’s debts to Petrobras). GOB would prefer not
to compromise its legal standing by breaking a contract,
however, Biato said; (2) Petrobras prepares to pull out
unilaterally; (3) Petrobras starts arbitration. The latter
course looks most likely at this point, Biato said (but see
below).

6. (C) However, Petrobras will not/not accept a massive price
increase under any circumstances, and will also not accept a
role as just a service provider, Biato confirmed. Those are red
lines for both the company and the GOB, as Morales has been told
repeatedly. In that sense, Biato said "this is a poker game,"
where Brazil’s interests are big, but Bolivia’s potential for
loss is much bigger. But in poker, as in diplomatic
negotiations, the players must have some sense that their
opponents are operating from a base of logic and rationality.
At this point, the GOB’s senior level has lost confidence that
Morales possesses those qualities, Biato said. There is a sense
in the GOB that Morales, "just put this out there, did what he
wanted to for his own political reasons, and now expects all the
rest of us to sort it out," Biato said. Again, the influence of
Chavez must come to mind, Biato acknowledged.

Petrobras: Evo Engaging in "Scare Tactics"


7. (SBU) Despite Petrobras President Sergio Gabrielli’s
previous public statements that it would leave Bolivia rather
than accept nationalization or become simply a service provider,
after the occupation of its oil and gas facilities by Bolivian
troops Petrobras has hewn to the Lula administration’s bland 2
May public response. A Brasilia-based Petrobras contact told us
the company’s strategy after the statement is to let this issue
remain at the government-to-government level. Petrobras
employees have essentially been told to stay put, shut up, keep
their heads down, and let the Brazilian government negotiate
with the Bolivian government. According to our Petrobras
contact, the company regards the timing and drama of the action
primarily as a negotiating tactic. The slow and contentious
contract renegotiations, the pipeline break of last month and
the ongoing repairs have obviously called into question
Bolivia’s position as a stable supplier for the Brazilian gas
market. The threat of nationalization is meant, he said, to
scare Petrobras and others back to the negotiating table and
make them more willing to accept Bolivian government terms.

Short Term Bolivia Risk Already Figures In


8. (SBU) A number of contacts have told Econoffs that financial
markets already had factored in substantial Bolivia risk into
Petrobras’ share price and expect little disruption in the short
term. Roberto Troster, the Chief Economist at FEBRABAN (the
Brazilian banking industry association) said that financial

BRASILIA 00000861 003 OF 004

circles are in a "wait and see" mode, since there does not
appear to be a threat that gas supplies will be cut in the near
term and because Bolivia is such a small percentage of Petrobras
assets. Likewise, a Banco Pactual analyst saw limited effects
on Petrobras in the short term as Bolivia accounts for less than
3 percent of the company’s oil and gas production and about 2
percent of Petrobras’ US$66 billion assets. Petrobras shares,
which opened on the NYSE May 2 with a small drop, made up the
lost ground and closed up overall.

Limited Economic Impact foreseen


9. (SBU) While gas from Bolivia is 43-44 percent of the natural
gas consumed in Brazil, it makes up only about four percent of
Brazil’s total energy consumption. Gas is used principally for
cooking, gas-fueled cars and buses, industry (iron and steel,
chemical, ceramics, glass) and power generation. A Petrobras
contact told post that the company’s contingency plan in the
event of a gas shortfall is to cutback on gas-fired electricity
generation plants to preserve supply for other uses. Brazil is
in a good position to do so as currently the reservoirs at
Brazil’s hydroelectric power plants, which make up well over 80%
of Brazil’s power generation capacity, are at high levels. This
will preserve scarcer gas supplies for industrial uses (which
generate employment), as well as domestic and transportation
uses. A May 2 Credit Suisse First Boston report estimated that
the inflationary and growth impact of the nationalization (or
any reduction in supplies from Bolivia) will be low based on the
availability of hydroelectric power to supply energy demands.

Medium to Long Term Alternatives


10. (SBU) Brazil recently had dusted off its contingency plans
to deal with gas supply shortfalls after the Bolivia pipeline
was damaged by recent rains (ref C). Local analysts also have
pointed out that Brazil has alternatives in the longer term, as
development of the offshore Campos basin will provide a new
domestic gas source to rival the size of current Bolivian supply
in the 2010 to 2012 time frame (ref I). In the medium term,
however, Brazil could face a crunch, as expected power demand is
projected to exceed projected capacity in the 2009 time-frame.
Removing the gas-fired thermal generation plants from the power
mix likely would bring forward the moment when Brazil faces
power generation shortfalls. Industry contacts have told us
that the gas-fired electricity generation plants (many of which
are presently idle as hydro power is cheaper) could be converted
to diesel or oil to help deal with the situation. The process,
however, would take some time and would be expensive (ref H).
Separately, Petrobras is examining the feasibility of building
two Liquid Natural Gas (LNG) re-gasification plants, reportedly
at a cost of about US$400 million each, to allow gas imports
from countries such as Nigeria and Algeria.

Comment


11. (C) On the political level, Lula and his foreign policy
team could not look worse at this moment. The image of Bolivian
soldiers moving into Petrobras installations is vivid and
offensive for Brazilians of all classes, and will appear to many
as a massive rebuke to the Lula administration’s theology of a
Brazilian-led new era of "regional integration." Indeed, in the
Brazilian press and popular imagination, Lula is increasingly
seen as outmaneuvered, manipulated and flim-flammed by his
"hermanos," Chavez and Morales. The PSDB opposition and much of
the media can be counted on to keep this episode alive, pointing
it out as another defeat for Lula’s foreign policy, and
blistering evidence that the ideological bias and operational
incompetence of Lula’ government can place key Brazilian
national interests in peril.

12. (C) On the economic front, Brazil is likely far less
vulnerable to serious immediate damage from Morales’ May 1
nationalization decree than the headlines suggest. Although
there is clear potential for a medium term energy crunch and
certain gas-consuming Brazilian industry may be hurt, the GOB
has the luxury of time and resources to work on alternatives.
This makes Lula’s weak-kneed response to the spectacle of

BRASILIA 00000861 004 OF 004

Bolivian troops occupying Petrobras’ facilities — which itself
followed on the heels of Morales’ expulsion last week of
Brazilian steel company EBX — all the more puzzling. Although
Petrobras may nevertheless ultimately seek arbitration,
depending on the evolution of events, it will be much harder for
it do so without more energetic GOB backing.

CHICOLA