U.S. OIL EXPLORATION/PRODUCTION FIRMS FIND BRAZILIAN IVESTMENT CLIMATE WANTING

Código Fecha Clasificación Origen
06BRASILIA1178 13 June 2006 Solo uso oficial Embassy Brasilia

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ZNR UUUUU ZZH
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FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 5751
INFO RUEHRI/AMCONSUL RIO DE JANEIRO 2264
RUEHRG/AMCONSUL RECIFE 4950
RUEHSO/AMCONSUL SAO PAULO 7180
RUEHBU/AMEMBASSY BUENOS AIRES 4077
RUEHAC/AMEMBASSY ASUNCION 5488
RUEHMN/AMEMBASSY MONTEVIDEO 6306
RUEHSG/AMEMBASSY SANTIAGO 5568
RUEHPE/AMEMBASSY LIMA 3037
RUEHCV/AMMBASSY CARACAS 3294
RUEHQT/AMEMBASSY QUITO 1864
RUEHLP/AMEMBASSY LA PAZ 4643
RUEHBO/AMEMBASSY BOGOTA 3793
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDO/USDOC WASHDC

UNCLAS SECTION 01 OF 03 BRASILIA 001178

SIPDIS

SENSITIVE
SIPDIS

STATE PASS USTR
TREASURY FOR OASIA
USDOC FOR 4332/ITA/MAC/WH/OLAC
USDOC FOR 3134/ITA/USCS/OIO/WH/RD
DOE FOR SLADISLAW

E.O. 12958: N/A
TAGS: EPET, ENRG, EINV, ECON, PGOV, ASEC, BR
SUBJECT: U.S. OIL EXPLORATION/PRODUCTION FIRMS FIND BRAZILIAN
IVESTMENT CLIMATE WANTING

REF: 2005 RIO DE JANEIRO 1150

This cable contains Business-Confidential Information.

1. (SBU) Summary. During a series of June 5-6 meetings with U.S.
firms involved in upstream petroleum sector operations, our
interlocutors complained of Brazil’s inadequate climae for foreign
investment. In separate meetings,Exxon-Mobil, Chevron, and El Paso
recounted talesof Brazil’s dysfunctional regulatory regime, high
taxes, legal uncertainty, and tenuous security situation. In
addition, the difficulties of dealing with GOB agencies such as
IBAMA (responsible for environmental permits) and Receita Federal
(in charge of customs) complicated the picture. Petrobras’
dominance in all aspects of the ol sector, both upstream and
downstream, meant that independent players, even well-funded ones,
needed to tread lightly. While doing business in Brazil was
certainly easier than operating in Bolivia, we were told, in many
ways the majors found investment conditions worse than those in
Venezuela. End Summary.


ANP VS. PETROBRAS


2. (SBU) Overall, Brazil’s petroleum sector regulatory apparatus
receivd mixed reviews. El Paso’s Brazil President, Eduardo Karrer,
characterized ANP, the national petroleum regulatory agency, as
well-intentioned but often lacking the necessary authority to set
things right. When the Director of ANP is close to the President,
he said, the agency acts in a confident and decisive manner. In
contrast, when the ANP Director lacks political muscle, Petrobras,
Brazil’s oil and gas parastatal, tends to dictate the rules.
Chevron’s Tim Miller noted that even though his company often
partners with Petrobras on the E&P side, it sometimes receives the
thumb-screw treatment from the company’s gas division. Miller
stated that in one off-shore field where Chevron had found gas
reserves, Petrobras - which owned the only pipeline to the shore -
had offered the company a mere 70 cents per million BTU for the gas,
knowing full well that Chevron’s only alternative was the risky
gambit of re-injecting the gas into an underground reservoir.

3. (SBU) Exxon-Mobil’s Brazil President, John Knapp, was more
charitable toward ANP; he noted that the agency had conducted seven
transparent auctions of oil/gas blocks during the past few years and
described it as "competent and flexible." (See reftel.) The
upcoming eigth round of auctions could be the most important yet, he
declared. Knapp acknowledged that Petrobras was like an 800-pound
gorilla, but pointed out that in many ways it treated independent
players more fairly than Statoil - Norway’s respected petroleum
parastatal - which had been known to eject private sector operators
from exploration blocks. Petrobras had never gone to such lengths,
Knapp said, though its state-run status gave it access to key
information about specific blocks which ensured that it always was
able to purchase the most promising parcels.


LEGAL UNCERTAINTIES


4. (SBU) Knapp noted that the rules governing the auction of
oil/gas blocks were subject to endless changes. For instance, the
sixth auction round, he said, could have been even more successful
in attracting investors if ANP had not made local content such a key
component of bid evaluation. Seeking to correct this mistake, in
the seventh round ANP then changed the rules to make local content
merely a tiebreaker if there happened to be identical bids - but
then required that firms use a minimum percentage of local rigs (of
which there are virtually none) when conducting E&P operations.
Even more frustrating, Knapp continued, is the lack of clarity in
the regulation of natural gas. Currently, there are three bills in

BRASILIA 00001178 002 OF 003

Congress purporting to establish a new regulatory regime for natural
gas, but none is adequate from the company’s point of view as each
would allow Petrobras to keep its monopoly on pipeline operations
for a number of years.

5. (SBU) Chevron’s Miller complained of the ongoing legal
uncertainty raised by Rio State’s efforts to collect valued added
taxes on imported E&P rigs and well-head production. The state
statutes establishing these taxes (Lei Valentin and Lei Noel,
respectively) on their face appear to conflict with Brazilian
constitutional provisions making off-shore petroleum resources
subject to the sole jurisdiction of the federal government, he said.
However, litigation is still working its way though the Rio State
court system and the judiciary had issued conflicting decisions.
Meanwhile, Rio State government officials were trying to shore up
the legislative basis for these taxes just in case the courts ruled
against them. Payment of these taxes, Miller declared, negatively
affected the bottom line of all companies in the sector.

6. (SBU) Karrer was more upbeat, possibly because El Paso had just
settled two multi-million dollar investment disputes with joint
venture partners (one with Petrobras and the other with the State of
Parana) involving gas-fired thermoelectric plants. Having
confronted the lack of transparency on the electricity generation
side, El Paso was divesting itself of its gas-fired power plants and
planning to concentrate on relatively more "secure" E&P activities.


IBAMA NIGHTMARE


7. (SBU) IBAMA, the Brazilian agency responsible for issue
environmental permits, came in for the harshest criticism from our
interlocutors. Miller stated that a Shell-operated project (40%
Shell, 40% Petrobras, and 20% Chevron) was currently on hold
awaiting the issuance of an IBAMA permit. Shell had obtained an
injunction compelling the agency to issue the required permit, he
said, but because IBAMA workers were on strike there was no one
available upon which to serve the injunction papers. Meanwhile,
Shell was losing US$250,000 per day as its drilling rig sat idle.
In a separate field where Chevron was the operator, in partnership
with Petrobras, because of IBAMA delays Chevron just received its
permit this year - though the company had scheduled exploration
activity to begin in 2005. Although Shell/Chevron had prevailed
upon its joint venture partner Petrobras to help grease the skids
for both these projects, even the vaunted Petrobras could not get
IBAMA to move in a timely manner.

8. (SBU) The IBAMA bottleneck not only adversely affects the
majors, but smaller players as well. The U.S. firm EMGS had hoped
to bring its environmentally friendly electromagnetic survey
technology to Brazil (less ecological disruption compared to
traditional seismic surveys) but after several months of
frustrating, fruitless, and expensive waiting it left for more
profitable shores.

9. (SBU) Chevron, Exxon, and El Paso all understood the challenges
facing IBAMA, noting that inadequate staffing, low salaries, and
unclear framework statutes combined to make the agency’s job
difficult. The constant turnover in agency personnel meant that
industry had to educate staffers every three years or so regarding
their needs and concerns. Brazilian law was such that should an
IBAMA employee mistakenly issue a permit, our interlocutors
observed, that person could be held legally liable if something went
wrong. Under such circumstances, Knapp pointed out, it was natural
for staffers to push issues up to higher levels within the agency
rather than making decisions themselves.

BRASILIA 00001178 003 OF 003


CUSTOMS AND LACK OF SECURITY


10. (SBU) All three firms complained about the difficulty of
clearing key equipment - like drilling rigs - through customs.
Frequent strikes and unending paperwork made import/export
procedures a challenge. The added liability of doing business in
Rio de Janeiro, the country’s de facto petroleum capital, only
increased their headaches. The recurrent violence and constant
threat of kidnap made it hard to attract expatriates to work there.
Putting the best face he could on the situation, one company manager
pointed out that at least the situation was better than that in
Bolivia - though, despite all of President Chavez’s antics, it was
worse than that in Venezuela.

Chicola