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DE RUEHBR #0861/01 1231903
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P 031903Z MAY 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC PRIORITY 5274
INFO RUEHWH/WHADP COLLECTIVE PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC
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C O N F I D E N T I A L SECTION 01 OF 04 BRASILIA 000861 
 
SIPDIS 
 
SIPDIS 
 
STATE PASS TO USTR FOR MSULLIVAN/KLEZNY 
NSC FOR SUE CRONIN 
DEPT OF TREASURY FOR FPARODI 
AID/W FOR LAC/AA 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
USDOC FOR 3134 USFCS/OIO/SHUPKA 
USDOE FOR GWARD/SLADISLAW 
 
E.O. 12958: DECL:05/02/2016 
TAGS: EINV PREL EPET XM BR
SUBJECT:  BRAZIL - UNCERTAIN RESPONSE TO BOLIVIAN OIL AND GAS 
NATIONALIZATION 
 
REF: A) LA PAZ 1157 
      B) BRASILIA 142 
 C) BRASILIA 754 
 D) BRASILIA 799 
 E) BRASILIA 848 
 F) BRASILIA 855 
     G) BRASILIA - WHA EMAIL 2 MAY 2006 
     H) 2005 BRASILIA 3305 
 I) SAO PAULO 464 
 
¶1.  (C) Summary:  After an emergency cabinet meeting lasting 
into the evening to discuss the appropriate Brazilian response 
to Bolivia's May 1 nationalization of foreign oil and gas 
investments (ref A), the Lula Administration issued a stunningly 
bland public statement the evening of May 2 recognizing 
Bolivia's sovereignty to act as it did but reaffirming that the 
GOB would act to protect the interests of (partially-privatized 
parastatal) Petrobras. According to local media, President Lula 
will meet his counterparts from Argentina, Bolivia and Venezuela 
on May 4 in Puerto Iguazu, Argentina to discuss the situation. 
In contrast to the Lula administration's feeble public stance, 
Brazilian media commentary has been sharp, decrying Bolivia's 
use of troops to occupy oil and gas installations; some have 
called for Brazil to withdraw its Ambassador to Bolivia (ref F). 
 Although Petrobras may resort to arbitration to protect the 
approximately US$1.6 billion it has invested in Bolivia, this 
amount represents only about 2% of Petrobras' worldwide 
investments.  Given that Bolivian gas makes up only 4% of 
Brazil's overall energy consumption, most analysts foresee 
limited impacts even if the gas supply were to be interrupted. 
End Summary. 
 
Bending to Evo's Will? 
---------------------- 
 
¶2.  (SBU) The GOB's formal reaction to the nationalization 
operation finally emerged early on the evening of 2 May, after 
marathon meetings chaired by Lula that began at 11:00 am and 
extended throughout the day.  The stunningly brief and anodyne 
presidential press release -- the insipid fruit of an entire day 
of Lula-led  crisis-mode deliberations for which two cabinet 
ministers had been called back to Brasilia from abroad -- 
consisted of only five points in which the GOB recognized 
Bolivia's right to "nationalize the riches of its soil and 
control their industrialization, transport and 
commercialization," affirmed the GOB will act "with firmness and 
tranquility in all fora" to preserve Petrobras' rights and carry 
out mutually beneficial negotiations with Bolivia, and assured 
that supplies of natural gas to Brazil are guaranteed by the 
will of both countries, as reiterated in a telephone 
conversation between Morales and Lula (presumably on 2 May). 
 
¶3.  (SBU) The tepid reaction from the presidency -- despite 
expectations from senior GOB advisors that Lula would have to 
make some strong point of protest (see below) -- may well fuel 
criticisms in the opposition and media that the GOB's policy 
toward Morales has been shown to be disastrously inept.  The 
announcement that Lula will go Argentina this week to meet 
Morales and Venezuelan President Hugo Chavez -- who is now 
widely considered in Brazil to be the guarantor of Morales' bold 
action -- may further reinforce the negative impressions of a 
president caught asleep at the switch and unwilling to stand up 
forcefully for vital Brazilian interests.   Foreign policy is 
seldom a major issue in Brazilian presidential campaigns, but it 
is a certainty that this episode will feature prominently in the 
opposition's campaign. 
 
¶4.  (C) In a private meeting on 2 May (ref G), Marcel Biato, 
Lula's deputy foreign affairs advisor, provided insight on the 
thinking within Lula's inner circle on the day after Morales 
made his move.  The GOB was not surprised by the content of the 
nationalization decree -- those are the uncompromising terms 
Brazilian negotiators have been hearing for the past 7-10 days. 
Biato said that in March, Petrobras and Bolivian interlocutors 
had been engaged in what appeared to be relatively positive 
discussions.  However, Morales abruptly broke the talks off, 
insisted he would only discuss the issues with Lula directly, 
and the Bolivians only re-engaged in recent days, with the stark 
message they took public on 1 May.  In the interval between the 
March talks and the nationalization, Biato observed there was a 
 
BRASILIA 00000861  002 OF 004 
 
 
lot of Morales interaction with Chavez.  (Note: Per ref D, 
Chavez and Lula met in Brasilia on 20 April; in the meeting Lula 
was to register his concern about the nature of Venezuelan 
involvement with Morales on the hydrocarbons issues.  End note.) 
 It is clear now to the GOB that Morales was emboldened after 
hearing that Chavez would (a) provide technical help to get gas 
out of the ground if Petrobras bails (which the GOB doubts the 
Venezuelans have the know-how to do), and (b) buy the product. 
(Comment: This view has now taken hold in the Brazilian media 
and opposition as well.  End comment.) 
 
¶5.  (C) While not surprised by the terms of yesterday's decree, 
the timing, lack of diplomatic notice and use of the armed 
forces (presumably for dramatic impact in Bolivia and to show 
the military's solidarity with Morales in the action, Biato 
opined) angered the GOB, who anticipated that early Brazilian 
references to the action as "unfriendly" would be echoed by Lula 
in his statement.  Biato noted there is a domestic requirement 
that Lula "say something tough" now at a political level, though 
the GOB wants to avoid turning this into a Morales-Lula 
slugfest.  (Comment:  Biato was wrong -- the anemic presidential 
statement contains no hint of criticism or official displeasure. 
 End comment.)  As talks proceed over the next six months, Biato 
said options available to Brazil include: (1) Petrobras operates 
but prepares to break contractual obligations (e.g., non-payment 
to Bolivia, with the line that Morales can just deduct what he 
wants from Bolivia's debts to Petrobras).  GOB would prefer not 
to compromise its legal standing by breaking a contract, 
however, Biato said; (2) Petrobras prepares to pull out 
unilaterally; (3) Petrobras starts arbitration.   The latter 
course looks most likely at this point, Biato said (but see 
below). 
 
¶6.  (C) However, Petrobras will not/not accept a massive price 
increase under any circumstances, and will also not accept a 
role as just a service provider, Biato confirmed.  Those are red 
lines for both the company and the GOB, as Morales has been told 
repeatedly.  In that sense, Biato said "this is a poker game," 
where Brazil's interests are big, but Bolivia's potential for 
loss is much bigger.  But in poker, as in diplomatic 
negotiations, the players must have some sense that their 
opponents are operating from a base of logic and rationality. 
At this point, the GOB's senior level has lost confidence that 
Morales possesses those qualities, Biato said.  There is a sense 
in the GOB that Morales, "just put this out there, did what he 
wanted to for his own political reasons, and now expects all the 
rest of us to sort it out," Biato said.  Again, the influence of 
Chavez must come to mind, Biato acknowledged. 
 
Petrobras: Evo Engaging in "Scare Tactics" 
------------------------------------------ 
 
¶7.  (SBU) Despite Petrobras President Sergio Gabrielli's 
previous public statements that it would leave Bolivia rather 
than accept nationalization or become simply a service provider, 
after the occupation of its oil and gas facilities by Bolivian 
troops Petrobras has hewn to the Lula administration's bland 2 
May public response.  A Brasilia-based Petrobras contact told us 
the company's strategy after the statement is to let this issue 
remain at the government-to-government level.  Petrobras 
employees have essentially been told to stay put, shut up, keep 
their heads down, and let the Brazilian government negotiate 
with the Bolivian government.  According to our Petrobras 
contact, the company regards the timing and drama of the action 
primarily as a negotiating tactic.  The slow and contentious 
contract renegotiations, the pipeline break of last month and 
the ongoing repairs have obviously called into question 
Bolivia's position as a stable supplier for the Brazilian gas 
market.  The threat of nationalization is meant, he said, to 
scare Petrobras and others back to the negotiating table and 
make them more willing to accept Bolivian government terms. 
 
Short Term Bolivia Risk Already Figures In 
------------------------------------------ 
 
¶8.  (SBU) A number of contacts have told Econoffs that financial 
markets already had factored in substantial Bolivia risk into 
Petrobras' share price and expect little disruption in the short 
term.  Roberto Troster, the Chief Economist at FEBRABAN (the 
Brazilian banking industry association) said that financial 
 
BRASILIA 00000861  003 OF 004 
 
 
circles are in a "wait and see" mode, since there does not 
appear to be a threat that gas supplies will be cut in the near 
term and because Bolivia is such a small percentage of Petrobras 
assets.  Likewise, a Banco Pactual analyst saw limited effects 
on Petrobras in the short term as Bolivia accounts for less than 
3 percent of the company's oil and gas production and about 2 
percent of Petrobras' US$66 billion assets.  Petrobras shares, 
which opened on the NYSE May 2 with a small drop, made up the 
lost ground and closed up overall. 
 
Limited Economic Impact foreseen 
-------------------------------- 
 
¶9.  (SBU) While gas from Bolivia is 43-44 percent of the natural 
gas consumed in Brazil, it makes up only about four percent of 
Brazil's total energy consumption.  Gas is used principally for 
cooking, gas-fueled cars and buses, industry (iron and steel, 
chemical, ceramics, glass) and power generation.  A Petrobras 
contact told post that the company's contingency plan in the 
event of a gas shortfall is to cutback on gas-fired electricity 
generation plants to preserve supply for other uses.  Brazil is 
in a good position to do so as currently the reservoirs at 
Brazil's hydroelectric power plants, which make up well over 80% 
of Brazil's power generation capacity, are at high levels.  This 
will preserve scarcer gas supplies for industrial uses (which 
generate employment), as well as domestic and transportation 
uses.  A May 2 Credit Suisse First Boston report estimated that 
the inflationary and growth impact of the nationalization (or 
any reduction in supplies from Bolivia) will be low based on the 
availability of hydroelectric power to supply energy demands. 
 
Medium to Long Term Alternatives 
-------------------------------- 
 
¶10.  (SBU) Brazil recently had dusted off its contingency plans 
to deal with gas supply shortfalls after the Bolivia pipeline 
was damaged by recent rains (ref C).  Local analysts also have 
pointed out that Brazil has alternatives in the longer term, as 
development of the offshore Campos basin will provide a new 
domestic gas source to rival the size of current Bolivian supply 
in the 2010 to 2012 time frame (ref I).  In the medium term, 
however, Brazil could face a crunch, as expected power demand is 
projected to exceed projected capacity in the 2009 time-frame. 
Removing the gas-fired thermal generation plants from the power 
mix likely would bring forward the moment when Brazil faces 
power generation shortfalls.  Industry contacts have told us 
that the gas-fired electricity generation plants (many of which 
are presently idle as hydro power is cheaper) could be converted 
to diesel or oil to help deal with the situation.  The process, 
however, would take some time and would be expensive (ref H). 
Separately, Petrobras is examining the feasibility of building 
two Liquid Natural Gas (LNG) re-gasification plants, reportedly 
at a cost of about US$400 million each, to allow gas imports 
from countries such as Nigeria and Algeria. 
 
Comment 
------- 
 
¶11.  (C) On the political level, Lula and his foreign policy 
team could not look worse at this moment.  The image of Bolivian 
soldiers moving into Petrobras installations is vivid and 
offensive for Brazilians of all classes, and will appear to many 
as a massive rebuke to the Lula administration's theology of a 
Brazilian-led new era of "regional integration."  Indeed, in the 
Brazilian press and popular imagination, Lula is increasingly 
seen as outmaneuvered, manipulated and flim-flammed by his 
"hermanos," Chavez and Morales.  The PSDB opposition and much of 
the media can be counted on to keep this episode alive, pointing 
it out as another defeat for Lula's foreign policy, and 
blistering evidence that the ideological bias and operational 
incompetence of Lula' government can place key Brazilian 
national interests in peril. 
 
¶12.  (C) On the economic front, Brazil is likely far less 
vulnerable to serious immediate damage from Morales' May 1 
nationalization decree than the headlines suggest.   Although 
there is clear potential for a medium term energy crunch and 
certain gas-consuming Brazilian industry may be hurt, the GOB 
has the luxury of time and resources to work on alternatives. 
This makes Lula's weak-kneed response to the spectacle of 
 
BRASILIA 00000861  004 OF 004 
 
 
Bolivian troops occupying Petrobras' facilities -- which itself 
followed on the heels of Morales' expulsion last week of 
Brazilian steel company EBX -- all the more puzzling.  Although 
Petrobras may nevertheless ultimately seek arbitration, 
depending on the evolution of events, it will be much harder for 
it do so without more energetic GOB backing. 
 
CHICOLA