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.

Brazil's Bullet Train

Brazil's on-again, off-again bullet train project connecting Rio de Janeiro and Sao Paulo is back on again. A rail project you ask? Ten years into the 21st century?

Yes, it's a backwards, outdated project proposing expensive passenger rail transportation at a time when air transportation is not only faster, but cheaper and more efficient. Yes, it is more of a political move rather than an infrastructure necessity. Yes, thousands of innocent families will be booted out of their homes and paid 10 centavos on the dollar (Real) in the government's eventual appropriations. Yes, Brazilian taxpayers will be footing a large chunk of the bill with no clear benefit for them. Yes, small townships located on the proposed Rio-Sao Paulo line are already fighting to have the trains stop in their municipalities, taking the speed out of the bullet.

Here are some "bullet" points:

• Government estimated costs of US$ 18.7 billion (triple that to get true estimation)
• The company offering the lowest fare will win the bid for the 317 mile train
• The winning (wink, wink) consortium will be announced on December 16th, 2010
• President Lula expects the project to be delivered in 2016, just in time for the 2014 World Cup
• Average train speed of 177mph
• 82 miles of trajectory through tunnels
• Trains leaving every 15 minutes
• Passengers per train - 855
• Estimated time from city to city - 85 minutes
• Projected ticket price R$ 200 each way (US$ 115)

Tuesday News Briefs

Gay Pride = big market

Over 3 million people gathered in Sao Paulo on Sunday to attend the 14th annual Gay Pride Parade, making it the world's largest gay pride march, according to organizers. "Dancing to music blasting from sound trucks Sunday, they condemned homophobia and demanded equal rights for homosexuals. They also said they would push candidates in this year Brazil's presidential election to support their cause." The parade has the backing of the government - and get this - even has the state controlled oil company, Petrobras, as a main sponsor. Companies interested in tapping a big, big market might be wise to investigate how to become involved.

Brazil will meet deadlines for 2014 World Cup

That according to Brazil's Sports Minister, Orlando Silva, who guarantees that construction work will begin on stadiums in the second semester of this year. Despite currently having no stadiums in  Brazil that would be adequate to host a World Cup game under FIFA's standards, Silva appears to be "tranquilo" in relation to the schedule. On a personal note, I can't wait to see the final taxpayer bill for these projects, including the overcharges.

Visa-free in Russia

Monday was the first day that Russians and Brazilians no longer needed visas to visit each other's country. The Russia-InfoCentre states that "The Brazilian government is counting upon the increase of tourist traffic from Russia. Now the tourist flow is not very intensive." (Don't get your hopes up.)

Is privatization of Brazil's air travel industry possible?

Brazil's air travel industry has all the right elements to become a world power. The country has a young population of almost 200 million people along with a rapidly expanding economy and a growing middle class. Brazil has won the rights to host not only the 2014 World Cup, but also the 2016 Summer Olympics in Rio de Janeiro. Different from the US airlines, Brazilian carriers are actually making money. Different from Europe and Japan, the airline industry doesn't have any competition in terms of trains. The BBC recently gave a shiny report (video) on Brazil's aviation sector.

With all these positives, it's hard to imagine any obstacles, right? Wrong. This 66-page government study (Portuguese) on the "Panorama and Perspectives for Air Transport in Brazil and the World" explores all facets of Brazil's air industry and gives a particularly realistic view of its challenges. One particular impediment may be that "Brazil's airports serving World Cup 2014 venues are saturated and eight are on the brink of operational collapse", including both of Sao Paulo's airports and Rio's domestic airport.

Part of the problem lies with Infraero, the Brazilian government's corporation in charge of 67 airports, 80 air navigation support units, 32 warehouse logistic terminals, and 97% of passenger and cargo air transport. Since Infraero is not a private company, it doesn't have any incentive to perform above expectations. It does its job, some of the time, and moves on, usually losing money in operations -- very similar to the US Postal Service or Amtrak.


Interestingly enough, the government study gave five options for improving the airport situation, all of them involving some sort of privatization (see p. 50), from simply privatizing Infraero, to privatizing the airports themselves.


Another obstacle mentioned was the high corporate tax rate for airline companies, close to 39% for Brazilian companies, versus 7.5% in the US - as well as the service taxes (ICMS) that vary from state to state plus abusive storage costs from the monopolistic Infraero.


What do you think will happen? Will the air industry stay in public hands? Or will a move be made towards privatization?

Brazil's economy and the government's spending "cuts"

Two weeks ago, Brazil's Finance Minister promised what seemed like incredible amounts of budget cuts, totaling R$10 billion, in response to the country's "overheating" economy - without affecting social programs or infrastructure investment. The press, Brazilian and international alike, fell for it - hook, line and sinker - and thus made no investigations into its veracity.

Meanwhile, Leandro Roque had the crazy idea of actually looking up the budget figures and seeing how the government planned to cut R$10 billion in an election year. Interestingly enough, Mr. Roque discovered that the "approved" budget from 2009 to 2010 increased by R$168 billion. So the "cuts" are actually an increase of R$158 billion. Nice.

The Economist published a story last week entitled "Flying too high for safety".

NEW skyscrapers are going up along Avenida Faria Lima in the business district of São Paulo. Sales of computers and cars are booming, while a glut of passengers has clogged the main airports. Brazil created 962,000 new formal-sector jobs between January and April—the highest figure for these months since records began in 1992. Everything indicates that over the past six months the economy has grown at an annualised pace of over 10%. Even allowing for an expected slackening, many analysts forecast that growth in 2010 will be 7%—the highest rate since 1986.

The problem is that while it may be growing at Chinese speeds, Brazil is not China. Because it still saves and invests too little, most economists think it is restricted to a speed limit of 5% at the most, if it is not to crash. The growth spurt is partly the result of the stimulus measures taken by President Luiz Inácio Lula da Silva’s government when the world financial crisis briefly tipped the country into recession late in 2008. The trouble, say critics, is that much of the extra government spending is turning out to be permanent—and so the economy is starting to resemble a Toyota with the accelerator stuck to the floor.

The government is still injecting money into the economy in two controversial ways. First, the National Development Bank (BNDES), whose loans cost about half the Selic rate, has expanded its lending by almost half. It has been able to do this because the treasury granted it two long-term credits totalling 180 billion reais. Those credits, for which the BNDES has offered IOUs, have led to accusations of creative accounting. While adding to the government’s gross debt, they have not driven up the more closely watched figure for public debt, net of assets: at 42.7% of GDP, this is back to its level of mid-2008, and is much lower than the debt burdens of European countries.

Second, the government has jacked up its payroll spending. The number of federal civil servants has increased fairly modestly since 2003 (by around 10%). But they have been treated generously: the total federal wage bill more than doubled in nominal terms between 2003 and 2009, while inflation was less than 50%. Lula has pushed up the minimum wage much faster than inflation too. That has helped to make the income distribution less skewed, and boosted consumer demand. But it has a knock-on effect on pension benefits.

What's the bottom line? Well, Brazil is indeed growing quickly, no doubt about that. But it seems to be doing so without making any real structural change. There have been no reductions in the sky-high importation duties. There have been no reductions in runaway government spending. Corruption continues to haunt both companies and individuals. And it's difficult to do business in Brazil - which is ranked #129 in ease of doing business, just ahead of Lesotho and Tanzania. How long will the party last?

Thursday news

Looking to invest in an island?
According to Exame's article, there are several islands for sale off the Brazilian coast. Ilha das Couves in the state of Sao Paulo is the biggest bargain of the bunch, starting at only R$12 million (US$ 6.5 million). According to the sales literature, it's a "true paradise with no big storms, snakes or large mosquitos."  Meanwhile, the most expensive Brazilian island, located in the state of Bahia, goes for a cool R$ 41 million (US$ 22.3 million).

8.5% growth?
Businessweek is reporting that Itau Bank may raise it's growth forecast for Brazil to 8.5% this year. That's approaching Chinese levels! Economists are notoriously famous for missing the mark on economic predictions, but Brazil's economy has been on fire this year. "Citing the growth of employment, expanding retail sales and bank lending as signs that the economy may grow faster than now expected, economist Guilherme da Nobrega said that 'the theme in Brazil is really the risk of overheating.'”

Chic Shopping Mall
To take advantage of increased consumer spending, yet another high-class shopping mall should be completed by 2011 in the Vila Olimpia region of Sao Paulo. Just two years after the opening of the luxurious Shopping Cidade Jardim, located on the other side of the Pinheiros river, JK Iguatemi will try and top it. In a joint development between W Torre and Grupo Jereissati, the 4 level shopping mall plans to attract the world's best luxury brands with over 200 stores (including a 3000 sq. meter Daslu), an international top-of-the-line hotel, and 20,000 expected daily visitors. Some of the expected luxury brands include Louis Vuitton, Prada, and Bottega Veneta.