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Saturday, May 17, 2008

Brazil, Petrobas, Investment Grade, Soya Exports, Shipbuilding and Consumer Demand - We Have Take-Off!

Petroleo Brasileiro SA, Brazil's state-controlled oil company, continues to drill away and is now about halfway through its offshore Carioca deposit according to Mines and Energy Minister Edison Lobao said. Carioca forms part of Brazil's new pre-salt region, which lies beneath 2,000 meters of water and as much as 4,000 meters of seabed. The pre-salt region is also home to the Tupi field, which holds an estimated 8 billion barrels of oil and is the largest Western Hemisphere oil discovery in three decades. Lobao is also quoted as saying that Betrobras will need more time to determine the size of the Carioca field, so I suppose for the time being it's just a question of "on we go with the drilling".

Following up on my post about oil rigs earlier in the week, Petrobras have also announced plans to lease 146 Brazilian-built ships over 6 years to support offshore oil exploration and production. The purchases will be paid for in part with some of the $50 billion Petrobras has earmarked for investment on Brazilian oil equipment over the next four years. It is Petrobras' intention to offer long-term leases to companies that agree to build the ships in Brazil with 70 percent to 80 percent local material.

Petrobras expects to spend $112 billion on expansion in the 2008-2012 period, helping support efforts by the government, its controlling shareholder, to maintain GDP growth rates of 5 percent or more a year. The ship-building plan is part of an industrial policy program which was announced by Brazilian President Luiz Inacio Lula da Silva earlier last week.

To boost shipbuilding in Brazil, Petrobras is helping finance the construction of new shipyards and the renovation of old facilities, including yards in Rio Grande in Brazil's south and in Suape, near the northeastern port city of Recife.

In the 1970s, Brazil was the world's second-largest shipbuilder. Its industry was almost wiped out by the oil shocks of the 1980s, debt defaults and inflation. A key plank in Lula's first-term victory in 2002 was revitalization of the shipbuilding industry. A $3 billion plan for tankers is already under way.

Clearly this rapid expansion is being financed by the ongoing commodities boom, and sustainability will depend with some high degree of sensitivity on the evolution of that boom. Brazilian exports have tripled since President Luiz Inacio Lula da Silva took office in January 2003 on rising world demand for soybeans, iron-ore, beef and cars. The economy expanded 5.4 percent in 2007, the fastest rate in three years, buoyed by rising exports and falling interest rates.

Obviously were there to be a negative commodities shock caused by a rapid slowdown in global growth and large scale capacity overhangs then all of this could go the same way as the 1908s boom, but there are reasons for thinking that this time round - and despite a possible short term slowdown in global growth in 2009 and a temporary downward adjustment in commodity prices - that the mid- to longer-term outlook (5 to 10 year horizon) is pretty bullish. I have elaborated on some of the relevant points in this article/post.

Also Bloomberg today have a very interesting interview with Roberto Egydio Setubal, head of Brazil's second-biggest non-government bank (Banco Itau Holding Financeira). Setubal said his nation is in a "transformation" that's creating the best conditions for business he's ever seen.

Brazil, Latin America's largest economy, has broken a cycle of boom and bust because of rising commodity exports and will enjoy sustainable annual growth of 4 percent to 5 percent, Setubal said in an interview this week in Sao Paulo. An investment-grade rating granted by Standard & Poor's last month will make Brazil a magnet for foreign investors.

Setubal is expanding abroad and at home, capitalizing on the 31 percent rise in Brazil's real against the dollar since May 2006, the collapse of inflation from almost 5,000 percent in 1994 to 5 percent now, and losses at global competitors. He's opening offices in the Middle East and Asia, hiring bankers from Deutsche Bank AG and Merrill Lynch & Co. and looking to buy Brazilian assets that may get dumped by foreign firms at discount prices.

``I don't see Brazil going back,'' the 53-year-old chief executive officer said at his office in Sao Paulo. ``The strong currency and investment grade are here to stay.''

Brazil's $1.07 trillion economy grew 5.4 percent in 2007, the fastest in three years. Controlled inflation led the central bank to cut the benchmark interest rate to as low as 11.25 percent in September, encouraging people and companies to borrow record amounts and boosting profit at Brazilian banks. Lending has increased every month since February 2004 to 992.7 billion reais ($600.8 billion) in March.

Brazil, the biggest debtor among emerging markets for decades, became a net foreign creditor in January after international reserves surged to a record $195.8 billion.

Brazil was the third-biggest market for initial public offerings globally in 2007, according to Bloomberg data. This year, only three companies went public, reflecting the reduced appetite for risk by international investors. Foreign investors bought 75 percent of the shares sold in public offerings in Brazil last year and 49 percent of the ones sold this year, according to the local stock exchange, Bovespa.

``This is a big change in Brazil,''Setubal said. ``Politicians used to believe spending was very popular and nowadays they learned that stable prices is much more popular.''

Update Tuesday 20 May 2008

I another "sign of the times" piece of news Petroleo have today passed both Microsoft and Industrial & Commercial Bank of China to become the world's sixth-largest company by market value.

Petrobras, as Brazil's state-controlled oil producer is known, climbed 3.8 percent to 50 reais, pushing its capitalization to 487.9 billion reais ($295.6 billion), according to data compiled by Bloomberg. Microsoft, which yesterday revived the possibility of purchasing Yahoo! Inc., fell 1.8 percent to $29.46, lowering its overall value to $274 billion. ICBC's A shares listed in Shanghai rose 0.2 percent to 6.22 yuan. The market value of the world's largest bank is 2.02 trillion yuan ($289.3 billion).

Six of the top 10 companies by market value are energy or mining companies, while three are from China.

Petrobras, which has seen its market value quadruple since 2004, is worth 41 percent less than Exxon Mobil, the world's largest company at $498.6 billion. By overtaking Microsoft, Petrobras also becomes the third-largest company in the hemisphere after Exxon and General Electric.


Anonymous said...

It's an exciting time for Brazil -- less so for someone who once thought of retiring there.

5 years ago I saw Brazil as an almost 1st-world country but with 3rd-world prices (3-1 exchange rate). Relatively stable, great beaches, and good infrastructure.

Now, of course, Brazil is twice as expensive, plus inflation, and the real-estate boom (bubble?) is in full force (at least in the south).

Ultimately, as mentioned in your post, I see Brazil as a commodity play, the sustainability of which depends on whether or not we are actually in the midst of a commodities bubble.

Edward Hugh said...


"It's an exciting time for Brazil -- less so for someone who once thought of retiring there."

Interesting thought. I hadn't considered it this way.

"5 years ago I saw Brazil as an almost 1st-world country but with 3rd-world prices (3-1 exchange rate)."

Well exactly, and in 20 years Brazil may well be a 1st-world country but with 1st-world prices. Not so good for anyone wanting to retire there, but basically very good for most Brazilians.

"and the real-estate boom (bubble?) is in full force (at least in the south)."

And this is only just beginning. Whether it is a bubble or not depends, as you indicate, on what happens next to commodity prices.

Of course we are going to see volatility here - oil was around $80 last September, now is around $125, but could just as easily be back around $80 next September, depending. (This is not a forecast, I have no idea, simply an illustration of what volatility might mean).

But basically I don't think the commodities surge is simply a bubble. I think there are structural reasons connected with the rate of global economic growth (and in particular economic development in the emerging economies) which mean that this may well become a trend which lasts a couple of decades (with volatility - ie ups and downs), since the rate of population increase PLUS economic growth in the emerging economies is likely to outstrip productivity increases plus capacity increases over this sort of horizon. Eventualy of course things will settle down, but in the longer term, and about the longer term from where we are now it is very hard to say anything useful.

I tried to have a go at outlining all this in this post on the Demography Matters blog.

"Ultimately, as mentioned in your post, I see Brazil as a commodity play"

Oh, I think it goes a lot deeper than that. I think in particular the demography is now very very favourable. They are about to get the demographic dividend - which basically means that the proportion of the population which is of working age is set to grow steadily over the coming years, before succumbing to population ageing and rising elderly dependency ratios of the kind Western Europe is experiencing now. So during this very favourable demographic period it is very important that Brazil gets the economic growth which will enable it to handle the ageing as and when it comes. It is also important to get the whole pensions situation sorted out now, and learn from the mistakes of the already developed economies - ie no PAYGO.

As well as favourable demography, Brazil also has HUGE human capital potential among the current middle classes. This is what gives Brazil that first world "feel" that you are talking about. Brazil has long produced a large quantity of excellent PhDs. The problem was that it was impossible to put them all to good use inside Brazil itself. Hence several decades of diaspora and critical social movements inside Brazil (India is a quite similar case here).

Now there is the possibility of employing many of these people productively inside Brazil itself, and what Petrobras is up to is just one example of this. So there is a commodities boom, I doubt it is a bubble, and what we should see is the impact of this surge in revenue and confidence spreading across the whole economy.

Evidently letting the real rise too fast is a danger to be avoided, since it can skew the development process away from industry and into an excess of services and construction, and as we have just seen in the case of the US (or Spain where I live) that is not necessarily a good way to go. You need a balanced platform for economic success. So I am certainly not saying everything is just plain sailing, but there is a very favourable tail wind here.