Cablegate: Ambassador's Energy and Bio-Fuels Discussions in Rio De

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UNCLAS SECTION 01 OF 05 RIO DE JANEIRO 000445

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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

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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.

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