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UNCLAS SECTION 01 OF 03 BRASILIA 000142 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR 
TREASURY FOR OASIA 
USDOC FOR 4332/ITA/MAC/WH/OLAC 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD 
DOE FOR SLADISLAW 
 
E.O. 12958: N/A 
TAGS: ENRG EINV ECON PGOV BR
SUBJECT: PETROBRAS WILL PLAY BALL WITH BOLIVIA OR ELSE 
 
REF:  A) Brasilia 24, B) 05 Brasilia 1503, C) 05 Brasilia 943, D) 05 
Sao Paulo 721 
 
¶1.  (U) The information provided is industry sensitive. Please 
protect accordingly. 
 
¶2. (SBU) Summary. Banco Pactual energy analyst Pedro Batista, 
commenting on the recent visit of Evo Morales to Brazil and what it 
means for Petrobras, told us that the  partially privatized 
Brazilian petroleum parastatal Petrobras has no choice. It must play 
ball with Morales, even if that means taking a less than optimal 
offer in the newly proposed partnership with the soon-to-be 
reconstituted YPFB, the defunct Bolivian petroleum parastatal. 
According to Batista, accommodation of Bolivia in the near-term will 
help Brazil maintain a leadership role in the region and guarantee 
much needed gas supply in the long-term.  He foresees a possible 
reduction of output from the Bolivia-Brazil gas pipeline from the 
current 24 million cubic meters to 19 million because, for now, even 
investment on maintenance of production wells has been frozen. 
While Petrobras has announced positive initial results from the 
Mexilhao and BS-500 fields in the Santos basin, Batista believed the 
projections of an extra 12 million cubic meters per day by 2008 from 
these fields (and 30 million cubic meters by 2010) are ambitious at 
best.  If rain shortfalls were to occur, gas-powered thermoelectric 
production would stress gas supply even more, causing a 40 percent 
shortfall in gas supply for uses other than power generation. 
Batista also predicted that increased demand for gas will 
necessitate spin off of Petrobras gas production into a separate 
entity by 2015. End Summary. 
 
NOT PLAYING WOULD BE TOO HIGH A PRICE 
------------------------------------- 
 
¶3. (SBU) During a January 18 conversation with Econoff, Banco 
Pactual energy analyst Pedro Batista said that the long term needs 
of Brazil are better served by Petrobras' short term concessions to 
Bolivian President Pedro Morales. The costs of a combative Petrobras 
stance, both to Brazil and to the region, would be too high. Simply 
stated, if gas supply from Bolivia completely stopped flowing to 
Brazil, Bolivia would lose its best paying customer, 10-15 percent 
of its GDP and would be forced to seek other means to raise cash. 
The resulting deep energy crisis in Brazil would cause GDP to shrink 
significantly, dampen foreign direct investment in Brazil and more 
than likely cause capital flight. The region would lose its economic 
leader -- Brazil -- and sink into an economic hole that would risk 
political instability. 
 
¶4. (SBU) While Batista did not speculate what form an accord with 
the Morales government would take, the bottom line would be 
Petrobras acceptance of a smaller profit margin in Bolivia.  This 
would not be especially harmful to Petrobras since its assets in 
Bolivia represent only about 2 percent of the company's total 
assets.  Moreover, accepting such a deal would not be the first time 
Petrobras has acted more like a government entity than a profit 
seeking independent company, Batista pointed out.  Recent domestic 
price increases notwithstanding, since 2003 Petrobras has kept 
domestic gas prices below international market prices, foregoing 
about 5 billion Reals (about US$2.1 billion) in potential income. 
This would be a problem if Petrobras could not afford such a 
haircut, but according to Batista, it can. He speculated that 
Petrobras would be willing to accept an overall loss of 200 million 
Reals (US$86 million) per month on its gas operations (an extra 62 
million Reals, or US$26 million, more than its current, monthly 
losses).  Batista stated he has discussed this scenario with 
Brazilian government officials and they have confirmed his 
conclusion, i.e. that Petrobras' good relations with Morales means a 
lot more than profit margins to Brazil. 
 
A LOOK AT FUTURE AMBITIONS 
 
BRASILIA 00000142  002 OF 003 
 
 
-------------------------- 
 
¶5. (SBU) Pactual is expecting a potential fall in supply from 
Bolivia from its actual 24 million cubic meters/day to 19 million 
cubic meters/day over the next 12 months, even though Petrobras 
would like to expand its production capacity in Bolivia from 30 MCM 
a day to 34 MCM. Batista was sure Petrobras would not attempt 
further capacity expansion above 34 MCM since that would require 
more than tripling its current 1.5 billion dollar investment in 
Bolivia -- something Petrobras is not willing to do.  To further 
shore up its supply of gas, Brazil would have to rely on imports 
from Argentina.  However, Argentina's own energy supply 
difficulties, which Batista expected would worsen, and its contracts 
with other countries, complicate the Argentine picture. 
 
¶6.  (SBU) Brazil's most viable option is looking inward, with some 
caution.  First, it could convert its gas-field power plants to 
diesel - a step which is already in train - though this could be a 
costly process.  Second, Batista said, the country could rely upon 
increased domestic production.  Petrobras, Batista said, had 
recently forecast increased production from two gas fields in the 
offshore Santos basin, Mexilhao and BS-500.  Batista qualified the 
forecast of 12 million cubic meters per day by 2008 and 30 million 
by 2010 as "ambitious at best."  Petrobras' engineering partners and 
other analysts agree with Batista's assessment that significant 
technical difficulties would have to be overcome to reach those 
production levels. 
 
HARD TO PREDICT THE FUTURE 
-------------------------- 
 
¶7. (SBU) If any drop in rainfall over the next few years resulted in 
electricity generation shortfalls  (over 70% of Brazil's current 
power is generated by hydroelectric power plants), Brazil would 
increasingly need to rely on thermoelectric power, with a projected 
11 percent of the thermoelectric supply coming from gas-fired 
plants.  Combined with a projected 11 percent per year increase in 
gas consumption for non-power generation uses (due to its effective 
encouragement of gas consumption, including as a fuel for vehicles), 
Petrobras finds itself facing a difficult choice.  If it continues 
to promote reliance on natural gas, at some point it will severely 
cut into its own core petroleum business. 
 
¶8.  (SBU) Batista speculated that by 2015, the growth in gas 
consumption would require that Petrobras spin off gas production 
into an entirely separate entity. Otherwise, Petrobras will 
increasingly rob Peter to pay Paul, limiting the growth of its core 
petroleum business.  More importantly, current and projected 
national production and imports will not be sufficient to supply 
demand. Batista's worst case scenario:  if Brazil were forced to 
rely on all of its installed capacity of gas-fired thermoelectric 
power generation, then natural gas supply (imports and national 
production) would only meet 60 percent of non-power-generation 
demand by the end of 2007. 
 
¶9. (SBU) Comment:  It is clear that Petrobras' approach to Bolivia 
is more that of an arm of Brazilian foreign policy than that of a 
profit-seeking company.  Moreover, high oil prices have earned 
Petrobras record profits over the last two years, giving it some 
significant ability to take losses on its Bolivian operations. 
Should oil prices fall, however, expect some tension as the 
partially privatized company (Petrobras shares trade on the BOVESPA 
and NYSE) attempts to balance shareholders' insistence on profit 
margins with the demands of its regional stabilization role.  End 
Comment. 
 
¶10.  (U)  This cable was coordinated with AmConsulate Rio de 
Janeiro. 
 
 
BRASILIA 00000142  003 OF 003 
 
 
CHICOLA