Brazil’s Energy Conundrum

Water and oil and ethanol, oh my! Conventional wisdom has it that Brazil’s energy matrix is filled to the brim with honest to goodness hydroelectric power, green and clean sugarcane fuel for cars, and enough oil to export. But Holy Pre-Sal, Batman! All is not what it seems.

A cautiously optimistic (although secretly bearish in my view) report released by my friend Christian Gómez over at the Council of the Americas this week goes to show that the Brazilian energy miracle is hamstrung by all the same problems that keeps other Brazilian industries from joining the big leagues. Too much state and too little efficiency.

The demand problem is simple. The Brazilian middle class is growing rapidly, fueled largely by consumer spending. Demand for cars, electronics, appliances, and all those Twitter accounts is driving energy consumption like never before. At the same time, Brazil has followed in the long and storied Latin American footsteps of energy price control for consumers, all with mixed results.

Supply, however, is the devil in the details. As the report notes,

“Petrobras may be stretched too thin by having to operate that many projects across the pre-salt “polygon.” Moreover, international companies wishing to invest may be put off by stringent local content rules, which increase the costs of investment. Investor certainty remains to be fully developed.”

While investors could certainly be, well, more certain, there is no shortage of equity and bond hucksters trying to bill Brazilian energy as the opportunity of the century. And to an outside observer, or a casual investor, the outlook isn’t so bad after a disappointing year for Petrobras stock.

But there’s trouble on the horizon, and small events can show how vulnerable the country’s energy matrix really is. All it takes is one bad crop to drive ethanol prices through the roof, or protests by a small group of Amazon residents to stop Brazil’s largest infrastructure projects.

Other sources (oil in particular) critical to Brazil’s diversification are proving even tougher to crack, with the gap between the buoyant enthusiasm of new reserve finds and increasing production hitting a brick wall of underinvestment in refining capabilities and distribution infrastructure. To boot, if and when the oil does get out of the ground, political winds shifting towards redistributive policies are likely to channel revenues into social spending.

I have no interest in seeing Brazil’s great energy potential fail to materialize, but I’m wary of anyone entering Brazil’s energy sector without serious skepticism of recoverable reserve estimates (for oil and gas), a healthy dose of pessimism around supporting infrastructure (for electricity in particular), and, most crucially, a penchant for dealing with the Sisyphean task of appeasing the country’s regulators (for anything that moves).

If you don’t believe me, ask Eike Batista. 

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