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O 022112Z DEC 09
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TO RUEHC/SECSTATE WASHDC IMMEDIATE 0037
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C O N F I D E N T I A L RIO DE JANEIRO 000369 
 
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STATE - PLEASE PASS NSC FOR RACHEL WALSH AND LUIS ROSELLO 
STATE - PLEASE PASS  DOE FOR RUSSELL ROTH 
STATE - PLEASE PASS TO DOC FOR  LORRIE FUSSELL 
STATE - PLEASE PASS TO USTR FOR KATE KALUTKIEWICZ. 
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AMEMBASSY BRASILIA PASS TO AMCONSUL RECIFE 
 
E.O. 12958: DECL: 2019/12/02 
TAGS: EPET EIND EINV PREL PGOV BR CO
SUBJECT: CAN THE OIL INDUSTRY BEAT BACK THE PRE-SALT LAW? 
 
REF: BRASILIA 1099; RIO DE JANEIRO 294; RIO DE JANEIRO 288 
 
CLASSIFIED BY: Dennis W. Hearne, Principal Officer; REASON: 1.4(B), 
(D) 
 
SUMMARY 
 
 
 
¶1.  (C) Although major international and independent oil companies 
continue to view the regulatory framework to develop Brazil's 
offshore Pre-salt oil and gas reserves as potentially debilitating 
to their future exploration and production (E&P) operations here, 
the Rio de Janeiro-based industry group that represents these 
companies has thus far been unsuccessful in efforts to enact 
changes to the law in the House of Deputies.  Industry continues to 
argue that the most detrimental aspect of the framework on the 
commercial viability of future Pre-salt operations, and even local 
manufacturing, is Petrobras' designation as chief operator, part of 
the bill addressing PSAs.  Local manufacturers and suppliers also 
will also be affected, but the largest Brazilian petroleum 
suppliers group complained the political nature of the framework 
was impeding their voice on the matter in Congress.   With industry 
resigned to the passage of the framework's four bills in the House 
of Deputies (for the most part in current forms), its strategy 
going forward is to enlist new partners to focus on the Senate, 
with the goals of winning key amendments to the bills, as well as 
pushing a vote back until after the October Presidential and 
Congressional elections.  End Summary. 
 
 
 
ELECTION YEAR MAKING FOR A "HARD BATTLE" FOR INDUSTRY 
 
 
 
¶2.  (C) Although major international and independent oil companies 
(IOCs) continue to view the regulatory framework to develop 
Brazil's offshore Pre-salt oil and gas reserves as potentially 
debilitating to their future exploration and production (E&P) 
operations here, the Rio de Janeiro-based industry group that 
represents these companies has thus far been unsuccessful in 
efforts to enact changes to the law in the House of Deputies. 
Patricia Pradal, head of government relations for Chevron told 
Econoff on November 19 that since President Lula announced the 
framework on August 31, industry had been fighting a "hard battle" 
to enact changes to the legislation, but the House of Deputies has 
not taken any industry concerns into consideration.  (Note: Pradal 
also heads the steering committee of the Brazilian Institute for 
Petroleum (IBP), the industry umbrella group that represents all 
major international and independent oil companies operating in 
Brazil, including Petrobras.  She spoke to Econoff in this 
capacity.  End Note).   Pradal lamented the lack of support from 
opposition parties in Congress, blaming Presidential and 
Congressional elections next year and explaining, "The PSDB 
[primary opposition party] simply has not shown up to this debate." 
She expressed begrudging respect to President Lula's International 
Relations Adviser Marco Aurelio Garcia and Press Secretary Franklin 
Martins as the principal orchestrators of the Government's 
strategy, stating, "They are the professionals, and we are the 
amateurs." 
 
 
 
PSDB'S SERRA REPORTEDLY OPPOSES FRAMEWORK, BUT NO SENSE OF URGENCY 
 
 
 
¶3. (C) According to IBP's Pradal, likely PSDB 2010 Presidential 
Candidate Jose Serra opposed the framework, but seemed to lack a 
sense of urgency on the issue.  She quoted him as telling industry 
representatives, "Let those guys [Worker's Party] do what they 
want.  There will be no bid rounds, and then we will show everyone 
that the old model worked...And we will change it back."  As for 
what would happen to foreign oil companies in the meantime, Serra 
reportedly remarked, "You will come and go."   Congressional 
sources have also told Embassy officers that Serra has signaled 
PSDB and other opposition sources that they should amend - but not 
oppose the final Pre-Salt legislation, and urged opposition 
legislators to avoid vocal opposition to the law. 
 
 
CURRENT STATUS OF THE FRAMEWORK 
 
 
 
¶4.  (U) On August 31, President Lula announced the framework and 
sent it to Congress for approval.  On November 18, the House of 
Deputies (Camara) passed the first of the four bills (reftel A) 
that make up the framework, by a vote of 250 to 67, to create 
Petrosal, a new government entity that will represent the Brazilian 
government in the not-yet-approved production sharing regime. 
Further reporting will be reported septel.   (Note: The next bill 
to likely go to vote in the House of Deputies will be the creation 
of a social fund, followed by the 50 billion USD Petrobras 
capitalization bill.  We anticipate the bill instituting Production 
Sharing Agreements (PSA) - and making Petrobras the chief operator 
of all Pre-salt blocks - will be the last to go before a House of 
Deputies vote.   Once the House of Deputies passes a bill, it must 
then go before the Senate for approval.   If the Senate passes the 
bill, it is final.  If it amends the Qll, it will then go back to 
the House of Deputies for discussion and revote.  Post will report 
further on legislative developments septel.   End Note). 
 
 
 
PETROSAL: ALL THE CONTROL, NONE OF THE LIABILITY? 
 
 
 
¶5.  (C) While not opposed per se to the existence of Petrosal, 
industry is concerned this group of political appointees, who will 
administer the Pre-salt blocks on behalf of the Brazilian 
government, will also wield disproportionate power over the 
operations of any Production Sharing consortium into which an oil 
company enters.   Under the law as proposed, Petrosal controls 50 
percent of the seats - with veto power - in a PSA consortia's 
operating committee.   According to IBP's Pradal, this will 
therefore give Petrosal significant power over key E&P decisions, 
such as budget, environmental, and safety matters, in the Pre-salt 
blocks.   "They will have all the control, and none of the 
liability," she said. 
 
 
 
PETROBRAS AS CHIEF OPERATOR UNIVERSALLY CRITICIZED 
 
 
 
¶6. (C) Industry continues to argue the most detrimental aspect of 
the framework on the commercial viability of future Pre-salt 
operations is Petrobras' designation as chief operator, part of the 
bill addressing PSAs.   Emphasizing a point she made to the Charge 
d'Affaires on September 1 (reftel B), Exxon's Lacerda said having 
Petrobras run all Pre-salt blocks will effectively relegate oil 
companies to mere financing bodies.   Robert Abib of Anadarko said 
on November 19 that Petrobras' role as chief operator could shut 
out the smaller independent oil companies if the parastatal focuses 
on the Pre-salt's largest fields, rather than smaller ones where 
independents normally specialize and focus their operations. 
Exxon's Lacerda complained the PSA bill failed to sufficiently 
define the fiscal terms assigned to the contracts, and said under 
the proposed regime, such terms would only become clear immediately 
prior to a bid round, making it nearly impossible for a company to 
effectively prepare.   Both IBP's Pradal and Lacerda said ongoing 
debate on the distribution of royalties to oil producing and 
non-producing states, municipalities, and the federal government, 
which is also part of the PSA bill, was preventing any real 
discussion on the framework's transparency and ability to attract 
investment. 
 
 
 
¶7.  (C) Should Petrobras' chief operator designation remain, IBP's 
Pradal said it would be impossible to compete in bid rounds against 
National Oil Companies (NOC), such as China's Sinopec and Russia's 
Gazprom.   According to Pradal, it will come down to who gives the 
government the most profit.  "The Chinese can outbid everybody," 
 
she explained. "They can break-even and it will still be attractive 
to them.  They just want the oil."  Pradal said Chevron would not 
even bid under such circumstances.   (Note: Foreshadowing greater 
NOC involvement in Brazil, Colombia's 90 percent state-owned oil 
company Ecopetrol opened an office in Rio de Janeiro on November 
¶18.  Furthermore, Petrobras CFO Barbassa said on November 23 that 
the parastatal would be sending top executives to China in early 
2010, in an effort to attract Chinese petroleum equipment suppliers 
to Brazil.  Post will report on both issues septel.  End Note). 
 
 
 
WHAT ABOUT THE LOCAL MANUFACTURERS? 
 
 
 
¶8.  (C) Brazilian manufacturers and suppliers also stand to lose 
from Petrobras' role as chief operator, but Brazil's largest 
petroleum suppliers group complained the political nature of the 
framework was impeding their voice on the matter in Congress. 
Exxon's Lacerda said local manufacturers and suppliers would stand 
to lose by having only one principal client, suggesting the 
National Organization for the Petroleum Industry (ONIP), a 
nonprofit forum that brings together Brazil's largest petroleum 
service providers and suppliers, could be a powerful ally in this 
fight.  She complained, however, that ONIP had thus far been 
"quiet" on the issue.  ONIP Director Alfredo Renault told Econoff 
on November 23 that while ONIP does not engage on public policy or 
lobbying, it was concerned about Petrobras' designation of chief 
operator in the framework, and expressed these worries to Congress. 
Unfortunately, he explained, the Special Committee in the House of 
Deputies where Renault made his presentation was driven by 
"politics rather than logic," and appeared indifferent to his 
concerns.  According to Renault, having only one client would not 
benefit Brazilian manufacturers' competitiveness nor provide them 
with the opportunity to establish the buyer-supplier relationships 
with major international and independent oil companies, crucial to 
doing business overseas.  Renault stated some industry associations 
within ONIP favored the framework, but said these groups tended to 
include companies that already have extensive commercial 
relationships with Petrobras. 
 
 
 
RISKY PETROBRAS CAPITALIZATION 
 
 
 
¶9. (C) Oil company representatives see legal problems with the bill 
concerning the capitalization of Petrobras through a guarantee of 5 
billion barrels of Pre-salt oil, and question the constitutionality 
of the transaction.  IBP's Pradal explained the proposed 
capitalization, which will infuse Petrobras with promised reserves 
in exchange for increased government shares in the company, has 
precedent in other countries; she said, however, such precedent 
involved proven reserves, rather than unproven ones, as they are in 
this case (Note: Pradal was unable to name the country where this 
occurred, but stated Chevron's legal team was researching the 
precedent.  End Note).  Anadarko's Abib emphasized the risk of 
diluting Petrobras' shareholder value, and said the company was 
risking a breach of its fiduciary responsibilities.   Claiming it 
was impossible to accurately value the Pre-Salt oil, he claimed 
Petrobras shareholders could sue the company, if it turns out the 
reserves were over-valued.   According to Pradal, accounting firms 
and investment banks held serious concerns over the transaction, 
but only one group of minority shareholders was vocally expressing 
these worries.  She expressed consternation that the CVM had not 
even opened an investigation into the transaction.  (Note: CVM is 
the Brazilian equivalent of the SEC.  End Note).   Pradal added, 
"As a matter of fact, we do not believe Petrobras is doing things 
by the books," claiming Petrobras willfully overestimated the 5-8 
billion barrels of oil deposits in the Tupi offshore area.  (Note: 
Petrobras is currently under Congressional investigation for 
fraudulent practices - tax evasion, overpaying for goods, and 
favorable donations to Lula supporters - but is widely expected to 
be cleared of charges by a Senate committee controlled by the 
governing coalition.  End Note). 
 
 
INTERNAL CONFLICT IN PETROBRAS? 
 
¶10. (C) Petroleum industry players in Rio claim there is a division 
of opinion within Petrobras over the framework, and how it will end 
up affecting both Petrobras and the Pre-salt's overall development. 
Industry insiders claim some key Petrobras personnel oppose the 
shift to PSAs and the chief operator role, Qile Petrobras' upper 
management mostly favor the framework, viewing the Pre-salt 
reserves in zero-sum, nationalistic terms.  For example, at a 
November 23 conference in Rio de Janeiro, Petrobras CFO Almir 
Barbassa expressed concern over whether Petrobras had the capacity 
to meet even its current commitments.   "The pace of growth of new 
projects continues to increase, and I always wonder how much longer 
we will be able to grow at this pace," he said. "Projects abound, 
but we are constrained by a lack of available personnel, material, 
and equipment."   Fernando Jose Cunha, General Director for 
Petrobras for Africa, Asia, and Euroasia told Econoff in August 
that the chief operator provision, along with the 30 percent 
mandatory share in every block, would "chase investors away" 
(reftel C).  On the other hand, Exxon's Lacerda said Petrobras E&P 
Director Guilherme Estrella was largely responsible for the PSA 
bill's terms that prejudice international oil companies.  (Note: 
Estrella has publicly compared Petrobras to a national space 
program, in terms of nationalist ambition, and is considered close 
to President Lula.  End Note). 
 
 
 
INDUSTRY STRATEGY: WHAT NOW? 
 
 
 
¶11. (C) With industry resigned to the passage of the framework's 
four bills in the House of Deputies (for the most part in current 
forms), its strategy going forward is to focus on the Senate, which 
has a greater number of opposition legislators than the House of 
Deputies.  Pradal said IBP would seek to enlist new partners to 
focus efforts, such as Brazilian independent E&P company OGX, the 
Federation of Industries of Sao Paulo State (FIESP), the 
Confederation of National Industries (CNI), and various Chambers of 
Commerce, in order to win Senate amendments concerning the 
Petrobras chief operator role and Petrosal terms.   She also said 
it would be ideal to prevent a Senate vote before May, which could 
then push a vote back until after the October Presidential and 
Congressional elections.  According to Pradal, the "real fight" 
would take place in February, after Congress returns from Recess. 
Exxon's Lacerda also stated industry planned to make a "full court 
press" in the Senate, but, not leaving anything to chance, Exxon 
would now also branch out on its own to conduct lobbying efforts. 
Pradal emphasized both IBP and Chevron's hopes that 
Ambassador-designate Shannon could make a significant impact in 
this debate, and asked Econoff on multiple occasions when 
Congressional confirmation was expected. 
 
 
 
COMMENT 
 
 
 
¶12. (C) As they increase their efforts within this highly 
nationalistic debate, the IOCs will have to tread cautiously. 
Numerous Congressional contacts have shared their assessments with 
Post that, by becoming more vocal on the subject, the IOCs risk 
galvanizing nationalistic sentiment around the issue and damaging, 
rather than helping, their cause.   At the same time, the IOCs are 
not optimistic over their ability to force key amendments to the 
current framework.   Furthermore, even if the IOCs succeed in at 
least forcing a delay of a Senate vote until after a possible - but 
uncertain - victory of an opposition President, there is a sense 
that the wait to bid on commercially attractive opportunities in 
the Pre-salt will be long.   Such outlooks, as well as the limited 
attractiveness of onshore blocks and the uncertainty of 
non-Pre-salt offshore frontier acreage, impede the IOCs' ability to 
effectively map out their local operations, and threaten their 
overall interest in Brazil.  End Comment. 
 
¶13. (U) This cable has been coordinated with Embassy Brasilia. 
HEARNE