GLOBAL FINANCIAL CRISIS HITS BRAZIL'S ENERGY SECTOR

UNCLAS SECTION 01 OF 03 SAO PAULO 000590

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STATE PASS USTR FOR KDUCKWORTH
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE
DEPT OF TREASURY FOR JHOEK, BONEILL

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: GLOBAL FINANCIAL CRISIS HITS BRAZIL'S ENERGY SECTOR

REF: A. 07 SAO PAULO 0953; B. RIO DE JANEIRO 0302

SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY


1. (U) Summary: The lack of credit worldwide has hit Brazil's
energy sector. Despite the recent discoveries of billions of
barrels of oil reserves below Brazil's seafloor, Brazil faces an
increasingly uphill battle to turn the government's energy rhetoric
into reality. Estimates range that it will cost USD 300 to 600
billion to commercialize the country's offshore reserves of oil and
gas, money that Petrobras does not have. Industry analysts estimate
that Petrobras would need to tap financial markets for up to USD 30
billion over the next few years. At a minimum, delays to the
initial six year timeline are expected. In addition, the credit
crunch has hit the ethanol and sugar industry. The shortage of
short-term financing has delayed capital goods improvements and
construction of new sugar mills, causing potentially 40 to 50
million tons of sugarcane to remain unused this harvest. Finally, a
lack of infrastructure financing might delay big energy projects
down the line. Given the wealth of natural resources and diversity
of its energy supply, Brazil will probably fare better than many
emerging market peers over the medium-term. The goal of becoming
more energy self-sufficient, however, could face more delays.
Brazil may take longer to reduce its dependence on Bolivia for
natural gas. End Summary.

Pre-Salt Woes
--------------


2. (U) President Lula has touted the discovery of billions of
barrels of oil and gas reserves in the so-called pre-salt layer 185
miles off Brazil's coastline as "a gift from God" and has pledged to
use resulting revenues to end poverty and narrow the country's
income gap. But before rhetoric becomes reality, Brazil must first
get to the underwater reserves, located more than a mile below the
ocean's surface and under another 2.5 miles of earth and corrosive
salt. The cost of drilling and gathering the oil is high, largely
because salt beds can break loose and fracture pipes, making it one
of the toughest substances to drill. Similarly, the logistics of
getting the oil and gas to shore for domestic use require the
construction of an extensive network of new infrastructure projects
and massive investments.


3. (SBU) The pre-salt oil fields will be the most complicated and
costly projects that Petrobras has ever carried out. Analysts
currently estimate they will cost between USD 300 to 600 billion
over the next 30 years, and from USD 25 to 80 per barrel. Most,
however, concede that future costs cannot be defined with certainty
in the current economic environment. The more companies that drill
test wells in the pre-salt area, the less expensive the exploration
process will be as they learn more about how to drill through the
salt layer. (Note: Sao Paulo State Federation of Industries (FIESP)
energy experts told Econoff that they estimated the costs somewhere
between USD 70 to 80 per barrel. Petrobras officials told Rio
Econoff that pre-salt extraction costs are approximately USD 25 to
28 per barrel; however, none of Rio Econoff's other energy contacts
believe the Petrobras estimates. They say they are too low. End
Note.)


4. (SBU) The global financial crisis has dampened the prospects for
the potential windfall below Brazil's seafloor. The falling world
oil price and global credit crunch will likely extend the investment
horizon for many of those fields. Credit Suisse estimated that
Petrobras would have to invest USD 50 billion to exploit the
pre-salt oil fields, build new refineries, and cover additional
costs from 2008 to 2012. Even if Petrobras can sell oil at USD 80
per barrel, Credit Suisse projected that Petrobras' cash flow would
not be enough to meet the investment required and would need extra
funding of at least USD 30 billion.


5. (SBU) Former Valor Economico senior editor Carlos Eduardo Lins
da Silva told the Consul General he believed the worldwide credit
crunch probably would extend the pre-salt production timeline. He
estimated that the Tupi field, for example, would take some 20 years
to develop given financing constraints of Petrobras' suppliers and

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delays to energy infrastructure. (Note: When Petrobras first
announced Tupi in November 2007, the production timeline was closer
to five to six years. See Ref A for more on that discovery. End
Note.) Petrobras put off announcing its new investment plan to
analyze the influence of the international financial crisis and has
also signaled it could postpone the deadline for proposals for
exploration of the pre-salt oil (Ref B).

Ethanol Industry Suffering
--------------


6. (SBU) The Senior Technology and Development Vice President at
Dedini Jose Luiz Oliverio, the world leader in sugar mill equipment,
told Econoff that the sector was in a terrible crisis. He noted
that the Brazilian National Development Bank (BNDES) had been late
in delivering financing for project expansion which many customers
had planned to use to purchase Dedini products. As a result,
Oliverio said Dedini's best customers had fallen behind on payments
and many customers had already started delaying orders for new
equipment and upgrades.


7. (SBU) The Brazilian Sugarcane Industry Association (UNICA)
President Marcos Jank underscored that sugar and ethanol prices had
been low over the last few years and were now expected to climb due
to market demand in an interview with Folha de Sao Paulo. He
pointed to the credit crunch as their biggest concern because many
mills are heavily leveraged. Jank was in Brasilia October 30
lobbying the GOB for a loan package of R$14 billion to support the
industry. UNICA's Public Relations Manager Carolina Costa told
Econoff that the sector was in limbo, waiting to see how much the
crisis would affect the ethanol and sugar industries. She noted
that many members had delayed longer-term project plans due to the
lack of credit; however, short and medium term projects had for the
most part already locked-in financing and she said UNICA did not
believe they would be affected.


8. (SBU) As the Brazilian sugarcane harvest comes to a close (April
to November),post notes that some 40 to 50 million tons of
sugarcane would be left in the field if the rainy season started in
November (per normal weather patterns). Last April and May were
very wet months and many mills had delayed the planting cycle. In
addition, sugarcane farmers had anticipated that a number of new
mills would come online to crush the additional sugarcane, but many
have been delayed because of financing constraints and due to
backlogs in capital goods production. Post ATO expects the impact
from the credit crunch to filter through the sugar and ethanol
industries quicker than most because of the strong fundamentals for
the sector.

Infrastructure Delays
--------------


9. (U) According to the Brazilian Association for Infrastructure
and Structural Industries (ABDIB),Brazil has 324 large
infrastructure projects already under construction or approved that
are in serious risk of delays because of the lack of available
financing. Of the R$ 90 billion still unfinanced, R$ 82 billion
(approximately USD 39 billion) would go to infrastructure projects
in the energy sector. Electrobras, a state-run electricity
producer, in October suspended a USD 400 million international bond
emission that it needed to finance the group's investments,
including the construction of the two Rio Madeira generation
projects and the third nuclear power plant at Angra. The GOB
announced on October 21 that it was delaying the auction for
building the USD 3.5 billion Rio Madeira high-tension power line
stretching from the Amazon Basin to the outskirts of Sao Paulo.
Though not specifically citing the crisis as the reason in that
case, many economists have pointed to its potential impact on
infrastructure investments. Despite the GOB's explicit claims of
protecting the Growth Acceleration Program (PAC),Brazil has
historically cut infrastructure project financing in economic
downturns.

Comment
--------------

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10. (SBU) The short-term implications of the credit crunch for
Brazil's energy sector have already started eating into the bottom
line. Over the medium-term, however, Brazil will probably fare
better than most emerging markets. With a wealth of technology in
deep-sea drilling and the cheapest feedstock in the world for
ethanol distillation, Brazil will remain an important bioenergy
player. Delays in development of the large natural gas reserves in
the pre-salt layer, however, will leave Brazil dependent on imports
of Bolivian natural gas in the short-term. Likewise, ethanol
producers probably will delay retrofits to increase efficiency for
additional bioelectricity production, given current financing
constraints. With the promise of great oil finds off the Brazilian
coast, President Lula had begun discussing, and many Brazilians had
begun to expect, great investments in education and social equality.
These dreams may have to be put on hold given the effects of the
current global economic slowdown. End Comment.


11. (U) This cable was coordinated/cleared by Embassy Brasilia and
by the ATO in Sao Paulo.

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