AMBASSADOR'S ENERGY AND BIO-FUELS DISCUSSIONS IN RIO DE

UNCLAS SECTION 01 OF 05 RIO DE JANEIRO 000445 SIPDIS SENSITIVE SIPDIS STATE PASS USAID FOR LAC STATE PASS OPIC NSC FOR FEARS TREASURY FOR OASIA - J.HOEK STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA STATE PASS USTR - CRONIN/SULLIVAN S/P FOR MANUEL DOE FOR WARD/LADISLAW E.O. 12958: N/A TAGS: EPET PGOV SENV PREL EINV BR SUBJECT: AMBASSADOR'S ENERGY AND BIO-FUELS DISCUSSIONS IN RIO DE JANEIRO REF: BRASILIA 1178 This cable is sensitive but unclassified, please protect accordingly. ¶1. (SBU) Summary: Some oil and gas companies in Brazil, notably Shell and Petrobras, are embracing bio-fuels as part of a diversified energy product mix, Shell Brazil CEO Diaz told the Ambassador in an August 21 meeting. On August 22, Petrobras CEO Gabrielli said his company is expanding its ethanol distribution networks and hopes to increase exports of ethanol to the United States. The company views bio-diesel primarily as a way to reduce imports of diesel to Brazil while reducing emissions to protect the environment and reduce the rate of climate change. Petrobras is also increasing its biodiesel distribution in anticipation of the 2008 law mandating a 2 percent mix of biodiesel with regular diesel. If Petrobras can position itself accordingly, it can stimulate the domestic market as well as international markets. Petrobras President Gabrielli told the Ambassador that, as part of its efforts to increase its exports and global holdings, that the company plans to invest heavily in the United States. US$2.8 billion of Petrobras' $12.1 billion global procurements over the next five years will be made in the United States, Gabrielli stated.[AP1] In an August 21 roundtable with the Ambassador, U.S. oil and gas company representatives enumerated taxes, problems with the environmental regulatory agency and competition from dominant domestic player Petrobras as the principal challenges facing them in Brazil. Nevertheless, giving promising geology and a relatively stable regulatory regime, U.S. companies plan to be in Brazil for the long term. End Summary. ¶2. (U) Background: Ambassador Sobel visited Rio de Janeiro August 21-22 where he held three separate meetings with energy companies headquartered there. First he met with Shell Brazil CEO Vasco Dias followed by a roundtable on investment issues with U.S. energy companies. Finally, he met with Petrobras CEO Sergio Gabrielli. This cable focuses on bio-fuels, Petrobras and the investment climate in the oil and gas sector. Septel addresses these interlocutors' comments on Bolivia and Venezuela gas issues. Bio-Fuels -------------- ¶3. (SBU) Shell Brazil CEO Vasco Dias and Vice President Paulo Lopes told the Ambassador that Shell has the largest global distribution system for bio-fuels, and sees potential for growth in exports of anhydrous alcohol (a type of ethanol). According to Dias and Lopes, Shell began working with a wide range of fuels, i.e. gasoline, ethanol and natural gas, because it sees the need to become an energy company, not simply an oil company. Shell has 2300 stations in Brazil and is the second largest energy company in Brazil after Petrobras. Shell also exports ethanol, produced by Brazilian sugar mills, to the United States through its distributor Shell West. The US$0.54/gallon duty on ethanol is not a deterrent for Shell, Dias said, given the current prices of oil and ethanol. Dias noted that in Brazil ethanol is cheaper to produce than gasoline. He expects the world market price for ethanol to settle around US $45 per barrel. ¶4. (U) Dias observed that there has been some discussion as to whether Brazil produces enough ethanol to export to third markets. Sugar and ethanol producers compete, Dias said, since ethanol in RIO DE JAN 00000445 002 OF 005 Brazil is produced from sugar cane. The expansion of ethanol production in Brazil, he stated, will depend on contracts and commitments supported by political will, i.e. a public-private partnership to support an expansion that makes economic sense. Note: Petrobras' recent acquisition of three of Shell's distribution properties underscores the company's plans to consolidate its position as a major distributor of ethanol throughout South America. However, the company still welcomes manageable competition, according to Shell CEO Dias, who noted that Petrobras has no interest in acquiring Shell's petroleum distribution facilities. ¶5. (U) On bio-diesel, Petrobras President Sergio Gabrielli highlighted two Petrobras programs, the first of which is to build three bio-diesel blending plants to begin operating at the end of ¶2007. Beginning in 2008, Brazilian fuel distributors will be required by law to sell a diesel blend that includes two percent bio-diesel, he said. In response to the Ambassador's query on export plans for bio-diesel, Gabrielli responded that the priority is to reduce diesel imports into Brazil, currently at 2.5 billion liters a year. ¶6. (U) Gabrielli further explained to the Ambassador that Petrobras had developed a distinct bio-diesel product, which it calls H-Bio. In contrast to existing bio-diesels, which are simply a blended mixture of normally-refined diesel fuel and oil from plant sources (particularly oil seeds),H-Bio is produced by refining an 18% vegetable-oil and crude petroleum mixture. The resulting product is a high quality diesel fuel with less sulphur content than normal diesel. Petrobras plans to begin commercial production of H-Bio in Brazil at the end of 2006, Gabrielli stated. Although he does not expect that Petrobras would export H-Bio to the United States in the near term, Gabrielli noted more than once that the company is securing a patent for the fuel in the United States and might be open to future partnerships there. The Ambassador mentioned that IPR protection was as important to us as it is to Petrobras and to Brazil and underscored its growing importance in our bilateral relationship. U.S. Investor Interests and Concerns -------------- ¶7. (U) U.S. oil and gas companies Devon Energy, ExxonMobil, ChevronTexaco, and Kerr McGee/Anadarko shared their concerns over the investment climate and oil and gas regulatory regimes with the Ambassador in an August 21 roundtable discussion. The U.S. company representatives stated that although Petrobras dominates the market in Brazil, there are still a lot of unexplored potential reserves and plenty of room to grow in the export market. They noted that, taken in a global context, Brazil has a relatively stable regulatory regime and that U.S. investors are here for the long-term. According to Kerr McGee, some of the best geology in the world, in terms of indicators of rich hydrocarbon resources, is located in Brazil. ¶8. (SBU) The U.S. company representatives highlighted two principal concerns. First, they face what they termed an "unsustainable" tax burden created by the imposition of two laws (known locally as the Lei Valentin and Lei Noel) by the State of Rio de Janeiro. They have challenged the laws in court and have been waiting 18 months for a ruling on their constitutionality. The U.S. company representatives also highlighted difficulties with the Brazilian environmental regulatory body (IBAMA). IBAMA, they said, is RIO DE JAN 00000445 003 OF 005 understaffed and under-funded. Moreover, they noted, IBAMA's personnel avoid whenever possible approving licenses for projects to avoid since Brazilian law allows that they be held personally liable should anything go wrong. The Ambassador plans to meet with IBAMA in the near future. Petrobras: Both Partner and Fierce Competitor -------------- ¶9. (SBU) Although Petrobras is an important partner for foreign investors in Brazil, the giant majority state-owned company is also an obstacle in many cases, the U.S. company representatives noted. Some groups within Petrobras (including Petrobras President Sergio Gabrielli) welcome the presence of foreign investors because they see certain advantages for Petrobras, the U.S. company representatives said. These include: 1) sharing the burden of supplying the domestic oil market; 2) while Petrobras is an innovative company in its own right, U.S. companies bring technology and know-how that Petrobras can license and adapt to meet its needs; and, 3) Petrobras is open to partnerships that make good business sense, and several foreign investors are pursuing these relationships, both in Brazil and elsewhere. ¶10. (SBU) The U.S. company representatives told the Ambassador, that while there is a good deal of competition in the downstream portion (distribution and retail) of the domestic market, Petrobras holds a virtual monopoly on the upstream portion (production and refining) of the domestic market and therefore controls the profit margins. A few foreign companies, including U.S. company Devon, have recently acquired production blocks and are close to beginning or have begun production of petroleum. Petrobras, according to Shell and several U.S. investors, in not above using its control over almost all of the pipeline infrastructure to force others to take below market rates for their oil and gas. A Chevron representative mentioned that Petrobras would only pay US$0.70 per million BTU for gas discovered in one of Chevron's blocks, knowing that Chevron's only viable alternative was the risky gambit of re-injecting the gas into an underground reservoir. ¶11. (SBU) The U.S. investors said that they nevertheless see advantages to partnering with Petrobras, and, quite frankly, they have little choice. Petrobras, they noted, has an extensive oil and gas infrastructure in Brazil and tremendous expertise in the field. These partnerships in Brazil can pay off elsewhere as Petrobras is known to be seeking partnerships with foreign companies as a strategy to grow internationally, reduce risks, and take advantage of technological synergies. U.S. investors stated that they do not perceive any ideological motive behind Petrobras' decisions on partnerships, which are purely good business opportunities. Most of the 44 foreign energy companies operating in Brazil, they stated, have adopted a "if you can't beat them, join them" strategy. For example, Chevron upstream President Timothy Miller said that Petrobras holds a tremendous influence over national petroleum regulator ANP and knows everyone at environmental regulator IBAMA, hence any effort by the industry to deal with regulatory issues can work better if channeled through "powerful Petrobras." ¶12. (SBU) According to the U.S. company representatives, there is also a perception that Petrobras enjoys an unfair advantage in obtaining the best explorations blocks. Shell CEO Dias said that the bidding process for oil exploration blocks that ANP conducts is transparent. Petrobras, nevertheless, appears to have an RIO DE JAN 00000445 004 OF 005 information advantage, he said, as it generally gets the best blocks. Chevron's Miller said he suspects Petrobras of having influenced ANP to change the oil block portfolio to be auctioned off at the upcoming 8th oil licensing round. (Note: The 8th round is scheduled for November 28, 2006; however, it looks like it is going to be less attractive to interested U.S. companies than originally expected due to the reduced number and the profile of oil blocks to be auctioned off. Specifically, several blocks are in new frontier areas that require added geological studies and thus more investment. The GoB has stated that the change was necessary given its desire to prioritize development of blocks more likely to contain natural gas than oil.) Petrobras' Investments in the United States -------------- ¶13. (SBU) Petrobras President Gabrielli told the Ambassador that, as part of its efforts to increase its exports and global holdings, the company plans to invest heavily in the United States. US$2.8 billion of Petrobras' US$12.1 billion global procurements over the next five years will be made in the United States, Gabrielli stated. The company currently holds interests in over 200 oil blocks in the Gulf of Mexico (GOM),and recently acquired 34 new ones. Most of these blocks will require deep water drilling, a specialty in which Petrobras prides itself on its expertise. Moreover, Petrobras recently acquired 50 percent of the Pasadena refinery in Houston in an operation Gabrielli expected would be concluded in October. A refinery in California may be Petrobras' next acquisition target. These acquisitions, Gabrielli said, are part of the company's plans to increase oil production (worldwide) from 2.4 million barrels of oil per day (bpd) today to 4.5 million bpd by 2011. To reach this goal, Petrobras has recently increased its planned investments from US$56 billion to US$87 billion, virtually 100 percent will be funded out of cash flow. The Ambassador noted, and Petrobras agreed, that a tax treaty between Brazil and the United States would greatly benefit Petrobras. The Ambassador encouraged Petrobras to use its considerable connections with the GoB to promote discussion about a bilateral tax treaty. ¶14. (SBU) Petrobras has its own concerns about the investment climate in the U.S. Gabrielli noted recent legislation passed in Alaska to increase royalty payments. While Petrobras does not have operations there, Gabrielli said it is concerned that other states may follow suit, which could negatively impact its expansion plans. The company, according to Gabrielli, also is concerned that the House of Represntatives is discussing changes to incentives to deep-water exploration in the Gulf of Mexico. Petrobras is eager to increase its Exploration and Production (E and P) in the Gulf of Mexico, where it is implementing new hurricane adaptive technology to mitigate the impact on production of future storms. ¶15. (SBU) Comment: Despite no longer having a legal monopoly, Petrobras truly dominates the Brazilian oil and gas industry, from bio-fuels to fossil fuels. GoB majority ownership of Petrobras complicates the issue, and Chief of Staff Rousseff's position as Chair of Petrobras' board underscores this as GoB public policy goals at times receive greater consideration than the interests of Petrobras minority shareholders. Many foreign energy companies, nevertheless, have found niches and partnerships where they can prosper, and their competition has benefited the market as whole. MARTINEZ RIO DE JAN 00000445 005 OF 005 [AP1]I think these were the numbers the Ambassador questioned, best to delete this part.