PETROBRAS WILL PLAY BALL WITH BOLIVIA OR ELSE

UNCLAS SECTION 01 OF 03 BRASILIA 000142

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: ENRG EINV ECON PGOV BR
SUBJECT: PETROBRAS WILL PLAY BALL WITH BOLIVIA OR ELSE

REF: A) Brasilia 24, B) 05 Brasilia 1503, C) 05 Brasilia 943, D) 05
Sao Paulo 721


1. (U) The information provided is industry sensitive. Please
protect accordingly.


2. (SBU) Summary. Banco Pactual energy analyst Pedro Batista,
commenting on the recent visit of Evo Morales to Brazil and what it
means for Petrobras, told us that the partially privatized
Brazilian petroleum parastatal Petrobras has no choice. It must play
ball with Morales, even if that means taking a less than optimal
offer in the newly proposed partnership with the soon-to-be
reconstituted YPFB, the defunct Bolivian petroleum parastatal.
According to Batista, accommodation of Bolivia in the near-term will
help Brazil maintain a leadership role in the region and guarantee
much needed gas supply in the long-term. He foresees a possible
reduction of output from the Bolivia-Brazil gas pipeline from the
current 24 million cubic meters to 19 million because, for now, even
investment on maintenance of production wells has been frozen.
While Petrobras has announced positive initial results from the
Mexilhao and BS-500 fields in the Santos basin, Batista believed the
projections of an extra 12 million cubic meters per day by 2008 from
these fields (and 30 million cubic meters by 2010) are ambitious at
best. If rain shortfalls were to occur, gas-powered thermoelectric
production would stress gas supply even more, causing a 40 percent
shortfall in gas supply for uses other than power generation.
Batista also predicted that increased demand for gas will
necessitate spin off of Petrobras gas production into a separate
entity by 2015. End Summary.

NOT PLAYING WOULD BE TOO HIGH A PRICE
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3. (SBU) During a January 18 conversation with Econoff, Banco
Pactual energy analyst Pedro Batista said that the long term needs
of Brazil are better served by Petrobras' short term concessions to
Bolivian President Pedro Morales. The costs of a combative Petrobras
stance, both to Brazil and to the region, would be too high. Simply
stated, if gas supply from Bolivia completely stopped flowing to
Brazil, Bolivia would lose its best paying customer, 10-15 percent
of its GDP and would be forced to seek other means to raise cash.
The resulting deep energy crisis in Brazil would cause GDP to shrink
significantly, dampen foreign direct investment in Brazil and more
than likely cause capital flight. The region would lose its economic
leader -- Brazil -- and sink into an economic hole that would risk
political instability.


4. (SBU) While Batista did not speculate what form an accord with
the Morales government would take, the bottom line would be
Petrobras acceptance of a smaller profit margin in Bolivia. This
would not be especially harmful to Petrobras since its assets in
Bolivia represent only about 2 percent of the company's total
assets. Moreover, accepting such a deal would not be the first time
Petrobras has acted more like a government entity than a profit
seeking independent company, Batista pointed out. Recent domestic
price increases notwithstanding, since 2003 Petrobras has kept
domestic gas prices below international market prices, foregoing
about 5 billion Reals (about US$2.1 billion) in potential income.
This would be a problem if Petrobras could not afford such a
haircut, but according to Batista, it can. He speculated that
Petrobras would be willing to accept an overall loss of 200 million
Reals (US$86 million) per month on its gas operations (an extra 62
million Reals, or US$26 million, more than its current, monthly
losses). Batista stated he has discussed this scenario with
Brazilian government officials and they have confirmed his
conclusion, i.e. that Petrobras' good relations with Morales means a
lot more than profit margins to Brazil.

A LOOK AT FUTURE AMBITIONS

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5. (SBU) Pactual is expecting a potential fall in supply from
Bolivia from its actual 24 million cubic meters/day to 19 million
cubic meters/day over the next 12 months, even though Petrobras
would like to expand its production capacity in Bolivia from 30 MCM
a day to 34 MCM. Batista was sure Petrobras would not attempt
further capacity expansion above 34 MCM since that would require
more than tripling its current 1.5 billion dollar investment in
Bolivia -- something Petrobras is not willing to do. To further
shore up its supply of gas, Brazil would have to rely on imports
from Argentina. However, Argentina's own energy supply
difficulties, which Batista expected would worsen, and its contracts
with other countries, complicate the Argentine picture.


6. (SBU) Brazil's most viable option is looking inward, with some
caution. First, it could convert its gas-field power plants to
diesel - a step which is already in train - though this could be a
costly process. Second, Batista said, the country could rely upon
increased domestic production. Petrobras, Batista said, had
recently forecast increased production from two gas fields in the
offshore Santos basin, Mexilhao and BS-500. Batista qualified the
forecast of 12 million cubic meters per day by 2008 and 30 million
by 2010 as "ambitious at best." Petrobras' engineering partners and
other analysts agree with Batista's assessment that significant
technical difficulties would have to be overcome to reach those
production levels.

HARD TO PREDICT THE FUTURE
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7. (SBU) If any drop in rainfall over the next few years resulted in
electricity generation shortfalls (over 70% of Brazil's current
power is generated by hydroelectric power plants),Brazil would
increasingly need to rely on thermoelectric power, with a projected
11 percent of the thermoelectric supply coming from gas-fired
plants. Combined with a projected 11 percent per year increase in
gas consumption for non-power generation uses (due to its effective
encouragement of gas consumption, including as a fuel for vehicles),
Petrobras finds itself facing a difficult choice. If it continues
to promote reliance on natural gas, at some point it will severely
cut into its own core petroleum business.


8. (SBU) Batista speculated that by 2015, the growth in gas
consumption would require that Petrobras spin off gas production
into an entirely separate entity. Otherwise, Petrobras will
increasingly rob Peter to pay Paul, limiting the growth of its core
petroleum business. More importantly, current and projected
national production and imports will not be sufficient to supply
demand. Batista's worst case scenario: if Brazil were forced to
rely on all of its installed capacity of gas-fired thermoelectric
power generation, then natural gas supply (imports and national
production) would only meet 60 percent of non-power-generation
demand by the end of 2007.


9. (SBU) Comment: It is clear that Petrobras' approach to Bolivia
is more that of an arm of Brazilian foreign policy than that of a
profit-seeking company. Moreover, high oil prices have earned
Petrobras record profits over the last two years, giving it some
significant ability to take losses on its Bolivian operations.
Should oil prices fall, however, expect some tension as the
partially privatized company (Petrobras shares trade on the BOVESPA
and NYSE) attempts to balance shareholders' insistence on profit
margins with the demands of its regional stabilization role. End
Comment.


10. (U) This cable was coordinated with AmConsulate Rio de
Janeiro.


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