Exploratory drilling occurred in the Paratí prospect on bloc BM-S-10 and eventually found condensate gas in the pre-salt layer some 5,000 meters below the waterline. A second prospect was drilled in the BM-S-11 bloc where Petrobras discovered a massive reservoir of 5-8 billion barrels of oil equivalent (boe). Since then, pre-salt reservoirs have been prospected throughout the Santos and Campos basins. Today, Petrobras is working alongside Anadarko, Devon, Exxon-Mobil, BG group, Petrogal, Reposol, Shell, and UK Gas Company to prospect and produce oil and gas from these immense reserves. For example, in June of this year Petrobras, working in partnership with Reposol, discovered light crude in the pre-salt layer of the Albacora Leste field of the Campos basin some 130 kilometers offshore from Rio de Janeiro. In July, Petrobras opened up production of the Baleia Branca pre-salt field some 85 kilometers offshore from the state of Espirito Santo which could produce 20,000 barrels by the end of the year.
 
The United States Energy Information Administration (EIA) forecasts that the pre-salt reserves could add over 50 billion barrels to Brazil’s proven reserves  while others estimate much more. All agree that Brazil is sitting on a treasure of hydrocarbons that could lead the country to become one of the most important oil producers in the world during the coming decade. Already Petrobras, Exxon-Mobil, Anadarko, and Reposol are producing from the pre-salt fields to boost overall national production from 2.4 mbd in 2008 to over 2.8 mbd by the end of this year. According to Petrobras’ business plan for the period of 2010 to 2014, the firm will invest $224 billion of which 53 percent will be devoted to exploration and production, most of it in the pre-salt reservoirs. The company’s production goals include 3.9 million boe by 2014, rising to 5.4 million by 2020. Brazil will likely become one of the top five producers of hydrocarbons by the end of the decade if these goals are reached.

The drive towards transportation fuel security
Under the banner “O petroleo é nosso!”  the Brazilian government of President Getúlio Vargas created Petrobras in 1953 to undertake a drive toward oil self-sufficiency. Petrobras worked to guarantee retail supplies of transportation fuels and lubricants to all regions of Brazil during the first two decades of operations. Consequently, the company focused on building refinery capacity for oil imported from the Middle East. The oil shocks of the 1970s convinced most Brazilian policymakers that their country’s dependence on petroleum imports jeopardized national development and security. Hence, Petrobras doubled up on efforts to discover hydrocarbon reserves in Brazil while the military government established the National Alcohol Program (PROALCOOL) to subsidize and standardize national production of ethanol fuel from sugarcane to supplant production and supplies of transport fuels. Although the company began searching for offshore reserves as early as 1968 near the coast of Sergipe, it was not until 1974 that it found the Campos reserves off the coast of Rio de Janeiro, the largest discovered until the pre-salt reserves. Petrobras’ discoveries in the Campos basin allowed Brazil to implement policies and programs developed to set a solid public-private foundation for petrochemical and ethanol production to curtail the nation’s dependence on imports of petroleum and its derivatives. For example, in 1975 the federal government took advantage of declining world sugar prices to launch the PROALCOOL program to provide tax incentives, credits, and infrastructure to sugarcane and ethanol producers. Between 1975 and 1985 domestic ethanol production quadrupled. According to Sennes and Narciso, such concerted efforts to find hydrocarbons, produce ethanol, and displace imports in the 1970s were not merely the case of adjusting the national economy to the international price shock; it was also an effort to render the development and security strategy sustainable within an increasingly hostile international environment where energy was vital. So crucial was the country’s strategy of development and industrialization considered for national security that it justified a thorough political, financial, institutional, and technological mobilization (see Sennes, Ricardo Ubiraci and Thais Narciso. “Brazil as an International Energy Player,” in Brazil as an Economic Superpower? Understanding Brazil’s Changing Role in the Global Economy. Edited by Lael Brainard and Leonardo Martinez-Diaz. Brookings Institution Press. 2009:17-54).”

If the OPEC oil shocks of the 1970s reinforced Brazil’s defensive imperative to lessen energy imports, then it was the partial privatization of Petrobras in 1997 that replaced the state controlled import substitution strategy with a more balanced, entrepreneurial approach that sought greater private and foreign investment, technology transfer, and production efficiencies. The campaign to liberalize Brazilian production, through the partial privatization of Petrobras and the concurrent formation of a concessionary policy framework for hydrocarbon exploration and production, caused the favorable conditions which led to the pre-salt discoveries less than a decade later. Under the 1997 Petroleum Law, Brazil’s proven reserves of oil and gas grew by 40 percent, investment rose from $4 to $25 billion per year, production doubled in the proceeding decade, and the petroleum sector’s importance to overall Gross Domestic Product (GDP) expanded from two to ten percent. Just two decades ago Brazil purchased over 40 percent of its energy abroad. In 1999 Brazil imported 24.1 percent of its total energy consumption, including 34.5 percent of its petroleum use. By 2008 the nation had reduced its external energy dependence to 8.3 percent, achieved self-sufficiency in crude oil production, and was the world’s largest exporter of ethanol. Between 2005 and 2009, petroleum production rose from just over two million barrels per day to nearly 2.6 million, and ethanol production grew from nearly 4.2 million gallons to over 7 million gallons. With transportation fuel security at hand, the Brazilian government is tasked with developing a policy framework that doubles production of oil and gas while projecting the country’s hydrocarbon power toward the commanding heights of the global political economy.

Policy, production, and power
In August of 2009 President Lula introduced four distinct but integrated legislative initiatives to maximize state control over the pre-salt reserves. The proposed regime includes four key strategic pillars:

1) establishing a production sharing regime for the nation’s new found “strategic” oil reserves;

2) strengthening Petrobras' stake in the new hydrocarbon wealth;

3) creating a new state controlled company, Pré-Sal Petróleo, S.A  or “Petrosal”, to administer the Production Sharing Agreements (PSAs) and commercialize the state’s portion of the profit oil earned from each PSA; and

4) setting up a new Social Fund to administer the wealth generated by Petrosal’s stake in the PSAs.

This new production framework is designed to replace the concessionary model in place since 1997 for those blocs denominated “strategic” by the National Agency of Petroleum, Natural Gas, and Biofuels (known as the ANP). The proposed production sharing regime falls short of completely renationalizing oil and gas exploration and production, but the roles of both Petrobras’ and Petrosal should provide the Brazilian state with ample control over the nation’s hydrocarbon resources.
 
Petrobras serves as the corporate cornerstone of the Lula government’s strategy to leverage the pre-salt reserves into the fuel of national development and geopolitical power. Under the proposed policy framework, the National Council for Energy Policy (CNPE) would continue to formulate national energy policy, but the ANP would be authorized to identify strategic blocs from the pre-salt reservoirs and award them directly to Petrobras or to consortia with at least a thirty percent stake reserved for Petrobras. The Brazilian state, represented by Petrosal, would also participate in all strategic bloc awards without making any investment. Therefore, the government will exercise control over exploration and production of the pre-salt reserves through its majority 51 percent ownership of voting shares in Petrobras and sole ownership of Petrosal. The government’s gamble to place Petrobras at the center-stage of the national efforts to exploit the pre-salt reserves comes after the company’s widely recognized success in developing competitive advantages in deep water exploration and drilling. The company is one of the world’s most successful oil companies—among both state and privately owned companies—in terms of increases in reserves and production, technical capacity (particularly in exploration, development and production of offshore and deep offshore reserves) and development of international projects.” (Isbell, Paul."Energy and Geopolitics in Latin America," Real Instituto Elcano,  Working Paper December 2008).

According to Petrobras’ Director of Exploration and Production, Guilherme Estrella, the company’s success and discovery of the pre-salt reservoirs, "is the result of five decades of exploration investments of Petrobrás, which resulted in a growing knowledge of Brazilian sedimentary basins. It reflects, too, the focus on the development of technologies, analytical procedures and innovative solutions in exploratory processes, particularly seismic and drilling of wells and the increased willingness of Petrobras for exploration risks.” (ibid)

These competitive advantages in deep water drilling were confirmed by the results of the 2007 ANP auction of the eleven blocs associated with the pre-salt reserves located in the Cluster region of the Santos basin. Petrobras participated in every winning consortium, leading with over a 60 percent stake in nine of these blocs and holding 40 and 45 percent stakes in the remaining two. Therefore, it is not surprising that the Lula administration’s proposals would mandate Petrobras as the sole operator with a minimum 30 percent stake in all strategic blocs. Under the new regime, ANP will administer public auctions of the strategic reserves to consortia with at least 30 percent Petrobras participation or opt to directly award an exclusive PSA to the state controlled firm. Thus, the ANP determines under which conditions participating private sector or foreign state owned enterprises (SOEs) will be allowed to invest and apply their technological and managerial capacities in partnership with Petrobras.
 
Petrobras does face significant hurdles to successfully exercise its operational control under the proposed PSA regime, including the need for a constant flow of capital to fully exploit the ultra-deepwater pre-salt reserves. On June 30, 2010 President Lula signed one of the key pre-salt proposals into law which allows for the transfer of rights to five billion boe from the pre-salt fields to Petrobras in return for the recently negotiated $42.5 billion worth of company shares. This completed deal now sets up Petrobras’ impending public stock issue which could raise some $75 billion depending on how investors gauge the company’s falling stock price and the politics surrounding the pre-salt production. Although bullish on Petrobras, it reminds investors of the increasing risks associated with the government’s control of the company and the 25-30 percent stock price dive in the past year. Politics have certainly challenged Petrobras and slowed complete passage of the new regulatory framework as the producing states of Espirito Santo, Rio de Janeiro, and São Paulo duel with the non-producing states over the distribution of rents and royalties. However, the probable victory of President Lula’s hand picked successor, Dilma Rousseff of the Workers Party, in October’s presidential election should encourage full congressional passage of the PSA regime and a rebound of Petrobras’ share price in early 2011. These probable outcomes will provide Brazil with state control over the nation’s hydrocarbon resources and one of the largest oil and gas companies of the world, providing future governments the revenues and tools for accelerating national development and projecting geopolitical power for decades to come.
 
The country’s hydrocarbon inheritance permits Brazil to make a critical contribution to regional energy security in South America and to become a stable supplier of crude oil and transportation fuels around the world, including the United States. Currently, Brazil is the second largest oil producer in South America, but it is expected to surpass Venezuela in the coming years as increasing numbers of pre-salt blocs come onto production.

The United States imports approximately 60 percent of Brazil’s current oil exports, with volumes expected to rise in the next decade. Indeed, if bilateral biofuel cooperation expands in the coming years it is possible that Brazil would play a growing role in meeting the rising demand for ethanol in the US. Brazil’s capacity to increase production and exports of oil, gas, petrochemicals, and ethanol in the coming decades will likely lead to greater economic interdependence with its neighbors in South America, providing a stronger political stage for projecting national power through multilateral forums and international governmental organizations, including the Organization of Petroleum Exporting States (OPEC), the Organization of American States (OAS), and the United Nations Security Council. The Brazilian state’s control over hydrocarbons is likely to place the nation in an “advantageous position as an energy player to gain preferential standing in other areas” and to “gain a more assertive political and economic presence in the world."  The pre-salt reserves all but guarantee Brazil’s energy security and geopolitical importance. Now, the question is whether the Brazilian state can effectively manage the nation’s hydrocarbon wealth to take a giant leap in economic and social development.

Mark S. Langevin, Ph.D. is Director of BrazilWorks (www.BrazilWorks.org), Associate Researcher at the Centro Universitário de Brasília (UniCEUB), adjunct Associate Professor of Government and Politics at the University of Maryland-University College, and regular contributor to the Inter-American Dialogue’s Latin American Advisor