VZCZCXRO2459
PP RUEHRG
DE RUEHRI #0445/01 2491406
ZNR UUUUU ZZH
P 061406Z SEP 06
FM AMCONSUL RIO DE JANEIRO
TO RUEHC/SECSTATE WASHDC PRIORITY 2761
INFO RUEHBR/AMEMBASSY BRASILIA 9191
RUEHRG/AMCONSUL RECIFE 2609
RUEHSO/AMCONSUL SAO PAULO 4227
RUEHSG/AMEMBASSY SANTIAGO 0152
RUEHBU/AMEMBASSY BUENOS AIRES 0470
RUEHAC/AMEMBASSY ASUNCION 0306
RUEHMN/AMEMBASSY MONTEVIDEO 0313
RUEHQT/AMEMBASSY QUITO 0106
RUEHPE/AMEMBASSY LIMA 0106
RUEHLP/AMEMBASSY LA PAZ 0289
RUEHCV/AMEMBASSY CARACAS 0300
RUEHBO/AMEMBASSY BOGOTA 0130
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 0084
RHEHNSC/NSC WASHDC
RHEBAAA/USDOE WASHDC

UNCLAS SECTION 01 OF 05 RIO DE JANEIRO 000445 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USAID FOR LAC 
STATE PASS OPIC 
NSC FOR FEARS 
TREASURY FOR OASIA - J.HOEK 
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA 
STATE PASS USTR - CRONIN/SULLIVAN 
S/P FOR MANUEL 
DOE FOR WARD/LADISLAW 
 
E.O. 12958: N/A 
TAGS: EPET PGOV SENV PREL EINV BR
SUBJECT: AMBASSADOR'S ENERGY AND BIO-FUELS DISCUSSIONS IN RIO DE 
JANEIRO 
 
REF:  BRASILIA 1178 
 
This cable is sensitive but unclassified, please protect 
accordingly. 
 
¶1. (SBU) Summary: Some oil and gas companies in Brazil, notably 
Shell and Petrobras, are embracing bio-fuels as part of a 
diversified energy product mix, Shell Brazil CEO Diaz told the 
Ambassador in an August 21 meeting.  On August 22, Petrobras CEO 
Gabrielli said his company is expanding its ethanol distribution 
networks and hopes to increase exports of ethanol to the United 
States.  The company views bio-diesel primarily as a way to reduce 
imports of diesel to Brazil while reducing emissions to protect the 
environment and reduce the rate of climate change.  Petrobras is 
also increasing its biodiesel distribution in anticipation of the 
2008 law mandating a 2 percent mix of biodiesel with regular diesel. 
 If Petrobras can position itself accordingly, it can stimulate the 
domestic market as well as international markets.  Petrobras 
President Gabrielli told the Ambassador that, as part of its efforts 
to increase its exports and global holdings, that the company plans 
to invest heavily in the United States.  US$2.8 billion of 
Petrobras' $12.1 billion global procurements over the next five 
years will be made in the United States, Gabrielli stated.[AP1]  In 
an August 21 roundtable with the Ambassador, U.S. oil and gas 
company representatives enumerated taxes, problems with the 
environmental regulatory agency and competition from dominant 
domestic player Petrobras as the principal challenges facing them in 
Brazil.  Nevertheless, giving promising geology and a relatively 
stable regulatory regime, U.S. companies plan to be in Brazil for 
the long term.  End Summary. 
 
¶2. (U) Background: Ambassador Sobel visited Rio de Janeiro August 
21-22 where he held three separate meetings with energy companies 
headquartered there. First he met with Shell Brazil CEO Vasco Dias 
followed by a roundtable on investment issues with U.S. energy 
companies.  Finally, he met with Petrobras CEO Sergio Gabrielli. 
This cable focuses on bio-fuels, Petrobras and the investment 
climate in the oil and gas sector.  Septel addresses these 
interlocutors' comments on Bolivia and Venezuela gas issues. 
 
Bio-Fuels 
--------- 
 
¶3. (SBU) Shell Brazil CEO Vasco Dias and Vice President Paulo Lopes 
told the Ambassador that Shell has the largest global distribution 
system for bio-fuels, and sees potential for growth in exports of 
anhydrous alcohol (a type of ethanol).  According to Dias and Lopes, 
Shell began working with a wide range of fuels, i.e. gasoline, 
ethanol and natural gas, because it sees the need to become an 
energy company, not simply an oil company.  Shell has 2300 stations 
in Brazil and is the second largest energy company in Brazil after 
Petrobras.  Shell also exports ethanol, produced by Brazilian sugar 
mills, to the United States through its distributor Shell West.  The 
US$0.54/gallon duty on ethanol is not a deterrent for Shell, Dias 
said, given the current prices of oil and ethanol.  Dias noted that 
in Brazil ethanol is cheaper to produce than gasoline.  He expects 
the world market price for ethanol to settle around US $45 per 
barrel. 
 
¶4. (U) Dias observed that there has been some discussion as to 
whether Brazil produces enough ethanol to export to third markets. 
Sugar and ethanol producers compete, Dias said, since ethanol in 
 
RIO DE JAN 00000445  002 OF 005 
 
 
Brazil is produced from sugar cane.  The expansion of ethanol 
production in Brazil, he stated, will depend on contracts and 
commitments supported by political will, i.e. a public-private 
partnership to support an expansion that makes economic sense. 
Note: Petrobras' recent acquisition of three of Shell's distribution 
properties underscores the company's plans to consolidate its 
position as a major distributor of ethanol throughout South America. 
 However, the company still welcomes manageable competition, 
according to Shell CEO Dias, who noted that Petrobras has no 
interest in acquiring Shell's petroleum distribution facilities. 
 
¶5. (U) On bio-diesel, Petrobras President Sergio Gabrielli 
highlighted two Petrobras programs, the first of which is to build 
three bio-diesel blending plants to begin operating at the end of 
¶2007.  Beginning in 2008, Brazilian fuel distributors will be 
required by law to sell a diesel blend that includes two percent 
bio-diesel, he said.  In response to the Ambassador's query on 
export plans for bio-diesel, Gabrielli responded that the priority 
is to reduce diesel imports into Brazil, currently at 2.5 billion 
liters a year. 
 
¶6. (U) Gabrielli further explained to the Ambassador that Petrobras 
had developed a distinct bio-diesel product, which it calls H-Bio. 
In contrast to existing bio-diesels, which are simply a blended 
mixture of normally-refined diesel fuel and oil from plant sources 
(particularly oil seeds), H-Bio is produced by refining an 18% 
vegetable-oil and crude petroleum mixture.  The resulting product is 
a high quality diesel fuel with less sulphur content than normal 
diesel.  Petrobras plans to begin commercial production of H-Bio in 
Brazil at the end of 2006, Gabrielli stated.  Although he does not 
expect that Petrobras would export H-Bio to the United States in the 
near term, Gabrielli noted more than once that the company is 
securing a patent for the fuel in the United States and might be 
open to future partnerships there.  The Ambassador mentioned that 
IPR protection was as important to us as it is to Petrobras and to 
Brazil and underscored its growing importance in our bilateral 
relationship. 
 
U.S. Investor Interests and Concerns 
------------------------------------ 
 
¶7. (U) U.S. oil and gas companies Devon Energy, ExxonMobil, 
ChevronTexaco, and Kerr McGee/Anadarko shared their concerns over 
the investment climate and oil and gas regulatory regimes with the 
Ambassador in an August 21 roundtable discussion.  The U.S. company 
representatives stated that although Petrobras dominates the market 
in Brazil, there are still a lot of unexplored potential reserves 
and plenty of room to grow in the export market.   They noted that, 
taken in a global context, Brazil has a relatively stable regulatory 
regime and that U.S. investors are here for the long-term. 
According to Kerr McGee, some of the best geology in the world, in 
terms of indicators of rich hydrocarbon resources, is located in 
Brazil. 
 
¶8. (SBU) The U.S. company representatives highlighted two principal 
concerns.  First, they face what they termed an "unsustainable" tax 
burden created by the imposition of two laws (known locally as the 
Lei Valentin and Lei Noel) by the State of Rio de Janeiro.  They 
have challenged the laws in court and have been waiting 18 months 
for a ruling on their constitutionality.  The U.S. company 
representatives also highlighted difficulties with the Brazilian 
environmental regulatory body (IBAMA).  IBAMA, they said, is 
 
RIO DE JAN 00000445  003 OF 005 
 
 
understaffed and under-funded.  Moreover, they noted, IBAMA's 
personnel avoid whenever possible approving licenses for projects to 
avoid since Brazilian law allows that they be held personally liable 
should anything go wrong.  The Ambassador plans to meet with IBAMA 
in the near future. 
 
Petrobras: Both Partner and Fierce Competitor 
--------------------------------------------- 
 
¶9. (SBU) Although Petrobras is an important partner for foreign 
investors in Brazil, the giant majority state-owned company is also 
an obstacle in many cases, the U.S. company representatives noted. 
Some groups within Petrobras (including Petrobras President Sergio 
Gabrielli) welcome the presence of foreign investors because they 
see certain advantages for Petrobras, the U.S. company 
representatives said.  These include: 1) sharing the burden of 
supplying the domestic oil market; 2) while Petrobras is an 
innovative company in its own right, U.S. companies bring technology 
and know-how that Petrobras can license and adapt to meet its needs; 
and, 3) Petrobras is open to partnerships that make good business 
sense, and several foreign investors are pursuing these 
relationships, both in Brazil and elsewhere. 
 
¶10. (SBU) The U.S. company representatives told the Ambassador, that 
while there is a good deal of  competition in the downstream portion 
(distribution and retail) of the domestic market, Petrobras holds a 
virtual monopoly on the upstream portion (production and refining) 
of the domestic market and therefore controls the profit margins.  A 
few foreign companies, including U.S. company Devon, have recently 
acquired production blocks and are close to beginning or have begun 
production of petroleum.  Petrobras, according to Shell and several 
U.S. investors, in not above using its control over almost all of 
the pipeline infrastructure to force others to take below market 
rates for their oil and gas.  A Chevron representative mentioned 
that Petrobras would only pay US$0.70 per million BTU for gas 
discovered in one of Chevron's blocks, knowing that Chevron's only 
viable alternative was the risky gambit of re-injecting the gas into 
an underground reservoir. 
 
¶11. (SBU) The U.S. investors said that they nevertheless see 
advantages to partnering with Petrobras, and, quite frankly, they 
have little choice.  Petrobras, they noted, has an extensive oil and 
gas infrastructure in Brazil and tremendous expertise in the field. 
These partnerships in Brazil can pay off elsewhere as Petrobras is 
known to be seeking partnerships with foreign companies as a 
strategy to grow internationally, reduce risks, and take advantage 
of technological synergies.  U.S. investors stated that they do not 
perceive any ideological motive behind Petrobras' decisions on 
partnerships, which are purely good business opportunities.  Most of 
the 44 foreign energy companies operating in Brazil, they stated, 
have adopted a "if you can't beat them, join them" strategy.  For 
example, Chevron upstream President Timothy Miller said that 
Petrobras holds a tremendous influence over national petroleum 
regulator ANP and knows everyone at environmental regulator IBAMA, 
hence any effort by the industry to deal with regulatory issues can 
work better if channeled through "powerful Petrobras." 
 
¶12. (SBU) According to the U.S. company representatives, there is 
also a perception that Petrobras enjoys an unfair advantage in 
obtaining the best explorations blocks.  Shell CEO Dias said that 
the bidding process for oil exploration blocks that ANP conducts is 
transparent.  Petrobras, nevertheless, appears to have an 
 
RIO DE JAN 00000445  004 OF 005 
 
 
information advantage, he said, as it generally gets the best 
blocks.  Chevron's Miller said he suspects Petrobras of having 
influenced ANP to change the oil block portfolio to be auctioned off 
at the upcoming 8th oil licensing round.  (Note: The 8th round is 
scheduled for November 28, 2006; however, it looks like it is going 
to be less attractive to interested U.S. companies than originally 
expected due to the reduced number and the profile of oil blocks to 
be auctioned off.  Specifically, several blocks are in new frontier 
areas that require added geological studies and thus more 
investment.  The GoB has stated that the change was necessary given 
its desire to prioritize development of blocks more likely to 
contain natural gas than oil.) 
 
Petrobras' Investments in the United States 
------------------------------------------- 
 
¶13. (SBU) Petrobras President Gabrielli told the Ambassador that, as 
part of its efforts to increase its exports and global holdings, the 
company plans to invest heavily in the United States.  US$2.8 
billion of Petrobras' US$12.1 billion global procurements over the 
next five years will be made in the United States, Gabrielli stated. 
 The company currently holds interests in over 200 oil blocks in the 
Gulf of Mexico (GOM), and recently acquired 34 new ones.  Most of 
these blocks will require deep water drilling, a specialty in which 
Petrobras prides itself on its expertise.  Moreover, Petrobras 
recently acquired 50 percent of the Pasadena refinery in Houston in 
an operation Gabrielli expected would be concluded in October.  A 
refinery in California may be Petrobras' next acquisition target. 
These acquisitions, Gabrielli said, are part of the company's plans 
to increase oil production (worldwide) from 2.4 million barrels of 
oil per day (bpd) today to 4.5 million bpd by 2011.  To reach this 
goal, Petrobras has recently increased its planned investments from 
US$56 billion to US$87 billion, virtually 100 percent will be funded 
out of cash flow.  The Ambassador noted, and Petrobras agreed, that 
a tax treaty between Brazil and the United States would greatly 
benefit Petrobras.  The Ambassador encouraged Petrobras to use its 
considerable connections with the GoB to promote discussion about a 
bilateral tax treaty. 
 
¶14. (SBU) Petrobras has its own concerns about the investment 
climate in the U.S.  Gabrielli noted recent legislation passed in 
Alaska to increase royalty payments.  While Petrobras does not have 
operations there, Gabrielli said it is concerned that other states 
may follow suit, which could negatively impact its expansion plans. 
The company, according to Gabrielli, also is concerned that the 
House of Represntatives is discussing changes to incentives to 
deep-water exploration in the Gulf of Mexico.  Petrobras  is eager 
to increase its Exploration and Production (E and P) in the Gulf of 
Mexico, where it is implementing new hurricane adaptive technology 
to mitigate the impact on production of future storms. 
 
¶15. (SBU) Comment:  Despite no longer having a legal monopoly, 
Petrobras truly dominates the Brazilian oil and gas industry, from 
bio-fuels to fossil fuels.  GoB majority ownership of Petrobras 
complicates the issue, and Chief of Staff Rousseff's position as 
Chair of Petrobras' board underscores this as GoB public policy 
goals at times receive greater consideration than the interests of 
Petrobras minority shareholders.  Many foreign energy companies, 
nevertheless, have found niches and partnerships where they can 
prosper, and their competition has benefited the market as whole. 
 
MARTINEZ 
 
RIO DE JAN 00000445  005 OF 005 
 
 
[AP1]I think these were the numbers the Ambassador questioned, best 
to delete this part.