Brazil’s oil groups fail to live up to hype of five years ago when vast offshore oil discoveries promised to transform the country

November 3, 2013 5:19 pm

Brazil’s oil groups fail to live up to hype

By Samantha Pearson in São Paulo

Bewitched by the sales pitch of its charming founder, investors had high hopes for the Brazilian oil company. But several years after going public, the Rio de Janeiro-based start-up has yet to find oil at any of its wells. Its cash is dwindling and its shares have slumped about 90 per cent during the past year. The company in question, however, is not Eike Batista’s OGX, which triggered Latin America’s largest corporate default last week by filing for bankruptcy protection, but the little-known company HRT.The rapid fall from grace of Mr Batista, the world’s seventh-richest man only 18 months ago, may have been exceptional but the problems faced by his oil company are not, analysts say.

From burgeoning start-ups to Brazil’s own state-controlled behemoth Petrobras, many of the industry’s players are struggling to live up to the heady expectations of five years ago when vast offshore oil discoveries promised to transform the country.

Brazil’s 2007 pre-salt finds, estimated to contain up to 100bn barrels of oil, came as oil prices soared towards $150 a barrel and capital began to pour into emerging markets, creating a sense of euphoria in the industry that has gradually turned to disappointment.

“There was the idea that Brazil would solve all its problems with the pre-salt oil and this optimism contaminated the market, creating a large speculative bubble,” says Adriano Pires, founder of the Brazilian Centre of Infrastructure and a former member of the country’s oil regulator ANP.

Originally an oil services company, HRT remodelled itself as an exploration company in 2008 – a year afterOGX was founded. In 2010 it raised R$2.6bn ($1.2bn) in an initial public offering at the peak of the country’s IPO boom.

Just as Mr Batista won over investors by filling OGX with some of Petrobras’s best engineers, HRT’s founder, Marcio Mello, capitalised on his own experience as a geologist at Petrobras for more than two decades.

“It gave the impression they knew where to find oil,” says Felipe Miranda, an analyst at Empiricus Research. “Marcio was also a great seller – he knew how to convince people,” Mr Miranda says.

But no amount of technical expertise could help the companies when it came to the lottery of oil exploration. OGX announced in July that its only three producing oil wells at Tubarão Azul were commercially unviable.

Meanwhile, HRT has failed to produce crude from all 14 wells it has drilled so far. In May Mr Mello resigned as HRT’s chief executive, giving no explanation, but remained on the board.

What happened to OGX was partly due to bad management but with more auctions it could have bought new blocks and formed new partnerships – it would not have solved its problems, but it would certainly be a different company by now

– Adriano Pires, founder of the Brazilian Centre of Infrastructure

HRT, however, is in a much stronger financial position than OGX – although its cash dropped by more than 40 per cent to R$814m at the end of the second quarter from a year earlier, it has no debt. HRT said in a statement that it is now looking for a strategic partner to secure future growth. OGX, on the other hand, has $5.1bn in total debt.

In part, investors were guilty of ignoring the risks of these companies, letting themselves be carried away by the prospect of high yields at a time of record low interest rates globally, analysts say.

However, Brazil’s government also played a role in bursting the bubble it had itself created, suspending oil auctions between 2008 and 2013 while legislators wrangled over the division of royalties, Mr Pires says.

While this forced HRT to try its luck outside Brazil in Namibia, it prevented Mr Batista from diversifying his exploration activities across a wider selection of fields.

“What happened to OGX was partly due to bad management but with more auctions it could have bought new blocks and formed new partnerships – it would not have solved its problems, but it would certainly be a different company by now,” Mr Pires says.

One of the biggest casualties of the industry’s slowdown, though, has been the country’s state-controlled oil company itself, Petrobras. Its output has been stagnant or in decline since early 2012, straining its own finances as well as those of its suppliers.

After nearly 30 years in the market, the valve producer Lupatech adopted an aggressive acquisition strategy in the wake of the pre-salt discoveries to turn itself into a one-stop shop for Petrobras’s production needs.

But with fewer than expected orders from Petrobras, the company is now in default – it has missed three interest payments on its bonds this year. Lupatech and Petrobras declined to comment.

Unlike OGX, though, Lupatech has been able to negotiate its way out of difficulty, largely because its principle creditor and shareholder is Brazil’s national development bank BNDES. “BNDES has a vested interest in the growth of [Brazil’s oil] industry and takes a more long-term view,” says Barbara Mattos, senior analyst at Moody’s.

Although Brazil finally resumed oil auctions in May, the government must work harder to attract the investment necessary to revive the industry by adjusting its onerous production-sharing model and strict national content rules, Mr Pires says.

“This is not 2008 any more. Brazil has to compete with the US and Africa for investment from international oil companies now,” he says. “Once Mexico’s oil industry opens up it’s going to be even harder for Brazil.”