What does Monday's oil auction mean?

Monday's biggest news came from Rio de Janeiro, where the Brazilian government held an auction for oil rights. Of course, these were not just any oil rights. They were the rights to the entire "Libra" oil field, the world's potentially largest discovery of oil since 2008, located deep in the ocean's floor 140 miles off the coast of Rio.

So perhaps it comes as no surprise that there was controversy. The left attacked the government for "privatizing" Brazil's natural resource. Businesses criticized the opaque auction process and the myriad conditions required in order to do business. There was some violence between protesters and police.

A couple of security agents on guard outside the Hotel Windsor in Barra da Tijuca

However, these were predictable events. The surprises happened in the weeks and months leading up to the auction, as the rules of the game were defined. The government envisioned 40 companies vying for the rights, and paying almost $1 million each, to bid for the 35 year concessions. Only 11 showed up. Missing were giants Exxon, Chevron, BP, and BG. Industry experts theorize that the requirements to use Petrobras as a minimum 30% partner and operator, along with sharing a minimum of 41.5% of profits with the state, may be just two of the obstacles that most likely account for the low participation. Another is that some companies may just not believe in the official estimates of 8-12 billion barrels of recoverable oil.

Even with only 11 participants, the government awaited several bids. However, the auction was over after five minutes. Only one bid was received - thus, the consortium of Petrobras (40%), two Chinese government controlled companies, along with Shell and Total, won the auction.

So, you ask, what does this all mean? What is the big picture?

First, it means that Petrobras, the money-losing, monopoly-holding energy giant - recently ranked the world's most indebted company by Merrill Lynch - will need to get its act together quickly. In order for Brazil to play among the world's leaders in oil production, Petrobras will need to be very efficient.

Second, it means potential opportunities for energy related companies in Brazil - especially in the upstream sector. This auction was just the first of many. There are potentially even more lucrative oilfields off the coast of Sergipe, located in the northeast of Brazil, to be explored in the future.

Third, companies can use this auction as example of doing business in Brazil. It represents a microcosm of the rewards and pitfalls of tapping into the country's large market. More on that in a future blog entry.

Fourth, Brazilian motorists will be paying more at the pump. In order for Petrobras to reach profitability, the government will need to raise gas prices, currently hovering around $5 per gallon, once again.

The Weakening Brazil Real

The Brazilian Real settled at 2.27 to the US dollar today, its weakest closing since 2009. The WSJ says that the currency has lost 11% this year and the country is in a "sticky situation" due to several factors, including a recent decline in industrial production, high inflation, and political uncertainty due to protests. "The once dynamic Brazil has not only lost its luster as a fast-growing economy but is also becoming a risky place to seek returns."

Increasingly similar to Monopoly money

Not all of this is Brazil's fault. The US dollar has gained against most currencies, especially after a Ben Bernanke speech where he mentioned the possibility of scaling back the Federal Reserve's infamous quantitative easing program if the economy picks up. Many observers, such as Peter Schiff, think the tapering "is about as likely as an NSA-sponsored ticker tape parade for whistleblower Edward Snowden".

So what are the immediate effects of the weakening of the Real? First of all, Brazilian residents face higher foreign tourism prices. Of the thousands of Brazilian families going to Florida during the July winter break to visit Mickey Mouse and the outlet malls, all will feel the impact on their wallet. However, prices at Sawgrass Mills will continue to be significantly lower than in Brazil.

Another effect of the weakening currency is the cost increase for imported goods in Brazil. This could worsen the already stretched official inflation number, which is already running above the government's ceiling of 6.5%, but its main impact is simply to decrease the purchasing power of the average Brazilian.

Is there a bright side? Maybe. Foreign tourists in places like Rio de Janeiro will pay less to visit Sugarloaf. And the weakened Real is spurring coffee sales from the world's largest producer and, as a result, lowering your future Starbucks bill world coffee prices.

One year graph showing USD to BRZ exchange rate.
Not a pretty roller coaster if you earn Reais.