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Brazil’s onshore oil renaissance
DEEP-DIVE: The energy transition is roiling oil prices, favouring short-cycle investments
The oil market is entering a period of structural volatility amid upstream underinvestment and extreme uncertainty over long-term demand. Against this backdrop, short turnaround investments that can get barrels to market quickly are highly sought-after. The chastised US shale space is sitting on its hands, opening a small-scale but high-margin investment opportunity in the Brazilian onshore space as national oil company Petrobras retreats from the sector.
Is the oil price going to $50 per barrel, or $100? Probably both, but nobody knows in which order. The latest wobble caused some to question whether Brent could hit triple digits in this cycle, although underinvestment in the upstream means this could yet come to pass in the coming few years.
Brent is yo-yoing on every OPEC+ contortion and Covid-19 dataset. Strong post-pandemic demand is set against the unknowable longer-term caveat of decarbonisation. Market opportunities could be fleeting.
The structural volatility of the energy transition is giving short-cycle oil investments primacy over longer-lead plays. Few upstream opportunities in today’s market fit that bill.
US shale used to play the role of global swing producer, with the rig count responding to macro price signals. But that role is now openly questioned by seasoned market observers.
After burning many fingers on Wall Street, the debt-laden shale sector is struggling to lure in fresh capital to fund more drilling, leaving it unable to fully capitalise on the current oil price recovery.
This is renewing investor interest in alternative oil provinces such as the Brazilian onshore, where national oil company Petrobras is actively relinquishing its monopoly.
In 2010, the NOC’s onshore portfolio produced 187,000 barrels of oil per day, equating to 83% of the Brazilian onshore market at the time, according to market data. Fast-forward ten years and Petrobras’ onshore portfolio has dwindled to 96,000 barrels/d and falling.
Onshore today accounts for just 3% of Petrobras’ overall production portfolio, which is dominated by offshore pre-salt (71%) and post-salt projects (26%). Large scale opportunities abound in the Brazilian offshore, and they dwarf the atomised onshore segment.
For Petrobras, “there is no comparison” between the two and the decision was made several years ago to focus offshore, a local market expert told Energy Flux.
New blood
Petrobras’s strategic retreat from the onshore is giving rise to a new wave of independent players dedicated to acquiring and revitalising mature assets with productive life left in them. These include PetroReconcavo, 3R Petroleum, Petro Rio and Petro-Victory Energy, among others.
“Brazil’s onshore oil production has been in decline due to a lack of investment,” says Ben Leith, director at Gneiss Energy, which was recently appointed as exclusive financial advisor to Petro-Victory.
A focus on mega fields offshore has left the onshore neglected, Leith told Energy Flux. Brazil is dotted with ageing wells drilled 30 or 40 years ago using unsophisticated 2D seismic data that are producing only tens or hundreds of barrels per day.
“You don’t need scale. Small scale is enough for great returns,” Leith said. “Operating costs are low, there is no big government take through PSC (production sharing contracts), just a flat royalty in the range of 5-10% plus Brazilian corporate income taxes of 25%.”
These small wells can be “massively ramped up” through “simple workovers” that can deliver positive free cashflow and a return on investment in a matter of weeks or months, rather than the several years typical of larger upstream plays.
Also, a large amount of promising underexplored acreage is located in areas adjacent to legacy wells, offering the possibility of “easy, short term, low risk, low capital development opportunities,” Leith added.
Barriers to entry in Brazil are high: securing permits and acreage can be an onerous and time-consuming exercise in Brazilian bureaucracy. And since this opportunity has been on the horizon for some time, competition for assets is already high.
“But once you’re in, conditions are extremely favourable,” the Gneiss director said. In addition to the low government take, Brazilian oil is by convention priced at a small discount to Brent, even when sold into the domestic market:
“Oil is generally light (Petro-Victory’s is 35° API) and therefore comparable to Brent. Many of Petrobras’s divestments came with offtake agreements to Petrobras which were based on Brent with a fixed discount. If you look at 3R’s assets, for example, they have offtakes in place that range from Brent-$0.6/bbl to Brent-$6.5/bbl. Petro-Victory doesn’t have any long-term offtakes but is still able to sell locally at Brent linked prices.”
The small scale of the opportunity means big players in the Brazilian upstream such as Shell, BP or Equinor aren’t competing for acreage. And the fact that wells are vertically drilled into conventional resources, re-development is less capital-intensive than shale oil, which must be hydraulically fractured.
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The gas play
The retreat of Petrobras, accompanied by a deregulation push, is creating opportunities in the natural gas space too.
The government is legislating to break up the NOC’s monopoly on gas distribution, which rendered it virtually impossible to get wellhead gas to market in the absence of pipeline infrastructure.
“You can’t have a simple gas-to-wire arrangement like you have in other countries, because Petrobras owns the monopoly,” Leith said. “It’s been extremely difficult to get Petrobras involved in putting in gas infrastructure. That’s completely opening up with the new gas law.”
Stranded gas will be much easier to monetise under the new rules, for example by piping it to a nearby industrial user or using it to generate power that is injected into the local distribution network.
Onshore sites with significant volumes of gas at the wellhead will soon be able to plot a route to market, flipping the calculus on these molecules from costly ESG liability to additional source of revenue.

Brazil’s febrile politics
Environmental, social and governance risks abound in president Jair Bolsonaro’s Brazil. The hawkish populist has come under sustained attack for turning a blind eye to destruction of the Amazon rainforest, which is now emitting more CO2 than it absorbs.
Onshore oil sites are predominantly located across Brazil’s vast savannah rather than in rainforest locations, so ESG concerns are limited in this regard. But the same domestic factors that helped create the Brazilian onshore opportunity could threaten its longevity.
Petrobras’ relinquishment of its monopolies was propelled in part by the fallout from the Lava Jato (Car Wash) corruption mega-scandal, in which it played a lynchpin role. The sprawling federal corruption investigation that followed embroiled many of Latin America’s ruling elites and plunged Brazil’s NOC into prolonged political crisis.
Federal prosecutions and a concerted political operation saw leftist president Dilma Rousseff impeached and her predecessor Luiz Inácio ‘Lula’ da Silva imprisoned, prompting sporadic civil unrest over the latter half of the last decade. Rousseff’s replacement, Michel Temer, ended his term in disgrace after being convicted of breaking campaign finance laws.
Discontent with Brazil’s corrupt ruling elite propelled Bolsonaro into power in late 2018. Simmering public anger came roaring back to life this month as tens of thousands of protestors took to the streets over his administration’s abysmal handling of the coronavirus pandemic.
Brazil remains prone to bouts of political instability, which can result in policy direction whipsawing as power passes hands. The deregulation agenda, and particularly the generous royalty regime that is spurring onshore investment, could come under review if Bolsonaro were to leave office.
In some instances, onshore operators are counting on further royalty reductions on licence renewal but this is out of their hands and potentially subject to political influence, a market source told Energy Flux.
“So there is always the chance that these more favourable rates don’t come through, or that royalties go the other way, or even that renewals aren’t authorised. Similar risks apply to every jurisdiction but given the big recent shift, there is potential for a backlash,” the source added.

Asset inflation
Awareness of the Brazilian onshore opportunity has been growing for some time and there are already signs that asset prices are inflating, leading to speculation of a bubble. Shares in 3R Petroleum have more than doubled since the company debuted on the Brazilian stock exchange in November.
The company has a $1.06 billion market capitalisation and production rate of 5,458 barrels of oil-equivalent per day (boe/d). This equates to a production equity valuation of almost $200,000 per boe/d — well above national and regional averages.
3R’s production equity valuation is the highest among the six main listed Brazilian onshore operators, which average ~$84,000 per boe/d. The Latin American average is much lower, at $45,600/boe.
Brazil is one of the few remaining investor-friendly countries in Latin America, alongside Chile and Colombia. And since Chile has no notable hydrocarbons resources, oil investors are not spoiled for choice in the region – which is supporting Brazilian asset valuations.
The Brazilian onshore market “hasn’t peaked yet”, a regional market expert source told Energy Flux. “But anyone not already established in-country on the ground could be getting in towards the top of the market. Retail investors are particularly at risk.”
Still, many investors see “tremendous upside” and are gobbling up assets from Brazil’s national petroleum agency ANP. Returns could be spectacular if market tightness persists into the late 2020s, experts say.
The overall size of the opportunity is barely a drop in the global oil market. Even if Brazil were to recoup its 2010 onshore production rate of ~225,000 barrels/d, it would still account for less than 0.3% of worldwide oil production – which is expected to hit a new record of 101.81 million barrels/d in 2022.
Since oil demand shows no signs of abating this side of mid-decade, investment will keep flowing into supply-side opportunities that can pay off before then. For those able to secure suitable assets under the right regulatory terms, the payoff could be handsome regardless of how quickly the world transitions away from oil.
Seb Kennedy | 2nd August 2021 | Energy Flux
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