VZCZCXRO8904
PP RUEHRG
DE RUEHSO #0031/01 0231139
ZNY CCCCC ZZH
P 231139Z JAN 08 ZFF6
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 7836
INFO RUEHAC/AMEMBASSY ASUNCION PRIORITY 3279
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RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY
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C O N F I D E N T I A L SECTION 01 OF 07 SAO PAULO 000031
SIPDIS
SIPDIS
STATE FOR WHA/BSC, WHA/AND,WHA/EPSC, EEB/ESC/ENR,
EEB/ESC/EPC
STATE ALSO FOR E - GREG MANUEL
STATE PASS USTR FOR KATE DUCKWORTH
STATE PASS FED BOARD OF GOVERNORS FOR ROBITAILLE
STATE PASS EXIMBANK
STATE PASS OPIC FOR DEMROSE, NRIVERA, CMERVENNE
NSC FOR TOMASULO
DOE FOR GARY WARD
TREASURY FOR JHOEK
USDOC FOR 4332/ITA/MAC/WH/OLAC
UDSOC ALSO FOR 3134/USFCS
E.O. 12958: DECL: 01/22/2018
TAGS: EPET ENRD EINV ECON PREL BR
SUBJECT: BRAZIL FACING DIFFICULT YEAR FOR NATURAL GAS SUPPLY
REF: A. LA PAZ 3898
B. SAO PAULO 0639
C. SAO PAULO 0953
Classified By: Econ-Pol Chief James B. Story for reasons 1.4 (b) and (d
).
1. (C) SUMMARY: The Brazilian government began 2008 amid
concerns of a possible electricity crisis due to a shortage
of natural gas and lack of rain to fill hydropower
reservoirs. Energy sector experts have been pointing to a
possible shortage of natural gas since 2006 when Bolivia
nationalized its energy sector. Nearly half of Brazil's
natural gas supply comes from Bolivia and a large number of
Brazilian industries run on natural gas. In October, Sao
Paulo and Rio de Janeiro states experienced first-hand the
effects when Brazilian parastatal Petrobras was unable to
fulfill its contract obligations to natural gas distributors.
Infrastructure bottlenecks limit additional production in
both Bolivia and Brazil over the near-term. Brazil is
unlikely to increase domestic natural gas supply before 2009
when several new natural gas fields become productive. In
addition, foreign investors in Bolivia have largely halted
investments in that country. In the interim, the private
sector in Sao Paulo worked with its largest natural gas
distributor Comgas to develop flexible contracts that allow
Comgas to better calibrate the available supply of natural
gas. Brazil needs to develop legislation and a stronger
regulatory framework as well as improve energy infrastructure
to realistically improve the market for natural gas. As a
result, energy prices, especially prices of natural gas and
electricity, are expected to increase by 10 to 25 percent
this year. END SUMMARY.
Not a New Problem, No Big Surprise
----------------------------------
2. (U) The natural gas shortages are no surprise to those
following the sector closely. Brazil's parastatal energy
company Petrobras had been warning the GOB of an impending
natural gas crisis for some time. Since the last major
energy crisis in 2001, the GOB instituted several system
checks and added new bureaucratic layers and organizations,
but did little to improve the infrastructure required to
increase the supply of natural gas. At the same time, the
GOB had introduced an incentive program in 1999 when it
signed a natural gas contract with Bolivia; Petrobras was
only using about 25 million cubic meters per day (MMm3/d) of
the contract supply, and the GOB had encouraged wider use of
natural gas to develop a market for Bolivian natural gas that
Petrobras had committed to purchasing. The GOB encouraged
vehicular natural gas use, promoted thermal-electricity
generation, and provided industry incentives for industrial
plants to use natural gas. As a result, demand for natural
gas in Brazil has nearly quadrupled since 1998. Brazil more
than doubled its supply of natural gas via Bolivian imports
and increased domestic production; however, the additional
supply of natural gas has been insufficient to keep up with
rising demand. (Note: According to the National Energy
Balance for 2007 prepared by the Ministry of Mines and
Energy, total consumption in 1998 was 18.4MMm3/d and in 2006
was 61.2MMm3/d. In 1998, before Brazil began importing
natural gas from Bolivia, natural gas production totaled
29.6MMm3/d; in 2006 production including all domestic
production and Bolivian imports totaled 75.3MMm3/d. The
domestic production in 2006 is exaggerated by approximately
10MMm3/d that Petrobras uses for internal consumption for its
SAO PAULO 00000031 002 OF 007
refineries and re-injection into its oil wells to increase
production. As a result, the surplus of natural gas in 2006
was closer to 4MMm3/d. End Note.)
3. (U) Nearly half of Brazil's current 63.7MMm3/d natural
gas supply comes from its neighbor Bolivia. An abrupt change
in Bolivia's energy policy in May 2006 has discouraged
international investors from renewing investments in Bolivia.
As a result, natural gas production and supply in Bolivia
are declining. Furthermore, in December Bolivia publicly
admitted it could not meet contractual obligations due to
supply shortages after having contractually overextended
itself over the last year. In the Bolivia-Brazil gas
pipeline (Gasbol) contract between the Bolivian State Oil
Company (YPFB) and Petrobras, which expires in 2019, Brazil
would buy 30MMm3/d in a take or pay contract whereby
Petrobras pays for the total contract supply even if it
doesn't have the adequate market demand.
4. (C) Comgas Manager for Natural Gas Supply and Thermal
Generation Carlos Montagna told Econoff that since 2002,
Comgas had been expecting a natural gas shortage sometime
after 2006, depending on economic growth. (Note: Comgas is
Brazil's largest natural gas distributor and the largest of
three distributors for the state of Sao Paulo. End Note.)
In 2004, Comgas submitted requests for proposals to increase
its supply of natural gas. Montagna said the expansion of
the Gasbol pipeline was one in a series of options that
included adding new potential suppliers; however, Bolivia's
nationalization in May 2006 halted further discussions.
Comgas resumed discussions with Petrobras in October 2006 to
fill the supply gap and has been building contingency plans
since that time without success.
Supply Crunch Hits Sao Paulo and Rio Distributors
--------------------------------------------- ----
5. (U) The most recent example of the impending shortage
occurred last October 31 when Petrobras did not have enough
gas to supply its distributors and feed thermal power
generators. The company reduced the supply of natural gas to
Rio de Janeiro state gas distributors by 17 percent and to
Sao Paulo distributors by five percent. Low rainfall in
October prompted the Brazilian Electricity System Operator
(ONS) to fire up several thermal power generators to conserve
water reservoirs. (Note: Approximately 70 percent of
Brazil's electricity comes from hydroelectric generators,
followed by natural gas (10 percent), imported electricity (7
percent), petroleum (4 percent), biomass (4 percent), and
nuclear (2 percent). End Note.) ONS told Petrobras to send
more natural gas to the thermal generators at the same time
that Petrobras took one of its big platforms in Espirito
Santo offline for maintenance that supplies natural gas to
Rio. Petrobras didn't have enough supply to meet its other
contract demands with Rio and Sao Paulo distributors, and the
order of priority goes first to thermal generators, followed
by consumers, and last to industry.
Sources of Natural Gas in Brazil
--------------------------------
6. (C) The Brazilian consulting firm PSR Consultoria
estimated that Brazil had on the order of 63.7MMm3/d of
natural gas in 2007 from domestic sources and from Bolivia.
The Gasbol pipeline from Bolivia supplied approximately
28MMm3/d to Brazil and the remainder came principally from
the two production areas in Brazil's southeast (current
SAO PAULO 00000031 003 OF 007
production from Campos and Espirito Santo basins). Comgas
supplies approximately 14MMm3/d of natural gas for Sao Paulo,
the state with the highest natural gas consumption. Montagna
told Econoff that Comgas currently has only 12.9MMm3/d of
natural gas contracted--Petrobras supplies 3.5MMm3/d from
domestic production and 8.75MMm3/d from Bolivia, and British
Gas (BG) supplies 650 thousand cubic meters per day also from
Bolivia. Comgas said that Petrobras has previously provided
an emergency supply when BG was unable to meet its contract
with Comgas due to unrest in Bolivia (see ref A for more on
natural gas and Bolivia). As a result of the Bolivian
government's announcement that it would be unable to fulfill
its contract obligations with BG, Montagna told Econoff that
Comgas' contract with BG is now a flexible contract that
allows BG to supply natural gas when Bolivian gas is
available. Comgas recently signed a new agreement with
Petrobras for 14.75MMm3/d beginning in 2009; however, Comgas'
Vice-President and Director of the Large Consumers Market,
Vehicular Natural Gas, and Gas Supply Sergio Luiz da Silva
said that the natural gas market would be tight over the next
two years because of the projected four to five percent
increase in demand needed to sustain anticipated GDP growth.
According to Brazil Focus, by 2012 production in Brazil will
total 72MMm3/d, plus 30MMm3/d from Bolivia and 31MMm3/d from
liquefied natural gas (LNG), totaling some 134MMm3/d, of
which 46MMm3/d is earmarked for thermal-electric generation.
Who are the Consumers?
----------------------
7. (U) Brazil's two top consumers, excluding Petrobras
itself, are industrial producers and the thermal electricity
generators. The industrial producers alone account for 38
percent of national daily natural gas consumption, almost
exclusively by Sao Paulo industry. Brazilian industries used
natural gas for 10 percent of their energy needs on average
in 2006; however, several industries including chemicals (30
percent), textiles (28 percent), and ceramics (26 percent)
rely heavily on natural gas as their primary energy source.
Thermal generators consumed 16 percent of Brazil's natural
gas supply, and 10 percent of Brazil's electricity supply is
from natural gas thermal generators. Vehicular natural gas
makes up about 10 percent of the market and residential
consumers less than one percent of the market.
8. (U) The distribution of natural gas by Sao Paulo's three
distributors reflects the state's role as the country's major
industrial pole. Statistics from "Brasil Energy" through
November 2007 show that approximately 82 percent of natural
gas distributed supplied the industrial sector and 11 percent
for vehicular natural gas. The state of Sao Paulo has only
two thermal power generators, the largest with a capacity of
2.76MMm3/d, which Petrobras supplies directly. Therefore,
the primary threat of natural gas shortages is that Petrobras
would divert its contracted supply to other thermal
generators outside of Sao Paulo state when the GOB mandates
supplemental thermal power generation. (Note: The average
daily distribution through November 2007 in Sao Paulo was
15.65MMm3/d, of which: industrial 12.9MMm3/d, transportation
1.8MMm3/d, residential 0.4MMm3/d, commercial 0.3MMm3/d,
co-generation 0.6MMm3/d, and thermal generation 0.01MMm3/d.
End Note.)
9. (U) As expected, the shortages in October hit Sao Paulo
industries particularly hard given their relative dependence
on natural gas. The 2007 annual survey by the Sao Paulo
State Industry Center (CIESP - see ref B) of its 551 company
SAO PAULO 00000031 004 OF 007
members conducted in November 2007 showed that 12 percent of
the respondents use natural gas to operate. The study showed
that the lack of natural gas would boost production costs by
about 10 percent on average. Furthermore, the Federation of
Industries of Sao Paulo (FIESP) reported that an eventual
natural gas shortage would totally interrupt 19 percent of
Sao Paulo industries, 20 percent of industries would be
partially affected with the absence of natural gas, and 61
percent could substitute another fuel for natural gas if
there was a shortage.
Domestic Supply Uncertain and Infrastructure Limitations
--------------------------------------------- -----------
10. (C) Infrastructure is the biggest constraint to
expanding the natural gas supply to distributors in the short
and medium term. Petrobras hopes to inaugurate the first LNG
terminal in Pecem, in northeastern Brazil, with a capacity of
7MMm3/d within the first half of 2008 and a second terminal
in Rio's Guanabara Bay for 14MMm3/d in 2009. Montagna told
Econoff that he expects the Pecem terminal to succeed;
however, he is less optimistic about the second LNG terminal
in Rio due to environmental and regulatory obstacles. FIESP
Vice-President for Infrastructure Development Saturnino
Sergio da Silva told Econoffs that although the LNG terminals
will allow Brazil more market flexibility, Brazil would need
to enhance existing infrastructure to transport the gas.
Similarly, the expansion of the Cabiunas-Vitoria gas pipeline
from Espirito Santo to Rio de Janeiro (24MMm3/d to 30MMm3/d)
is scheduled to be finished in February. Critics, however,
are skeptical because the project has already been delayed
several times. Da Silva told Econoffs he didn't expect the
pipeline expansion could be completed by 2008 and said that
Brazil would need some sort of short-term solution for
potential gas shortages until the infrastructure bottlenecks
could be addressed. Da Silva said that Petrobras expects to
begin production at the natural gas fields in the Santos
basin (Mexilhao, expected production of 9MMm3/d in 2009) and
Espirito Santo basin (Paroa-Cangoa) to begin supplying the
domestic market in 2009 after extensive delays acquiring
infrastructure and services to set up drilling platforms.
Natural gas reserves are unknown and unproven at the recently
announced oil and gas find at Tupi (ref C) and would be
available in the best-case scenario in 2014. Similarly,
Executive Vice-President for Latin America for BG Group Rick
Waddell told Econoffs that a worldwide shortage of drilling
rigs means that it would e years before BG could determine
the market suiability of the natural gas reserves at Tupi,
and several other industry specialists speculate it primarily
would be used to supply oil platforms and maintain reservoir
pressure.
Bolivian Supply Prospects Limited
---------------------------------
11. (C) Brazil is unlikely to increase its natural gas
supply from Bolivia until at least 2011 even if Petrobras and
other investors ramp up investment in Bolivia because of
infrastructure constraints. Waddell told Econoff that
although BG is fed up with the Bolivian government, the
company plans to stay in Bolivia because BG would prefer to
have the Bolivian government confiscate its investments than
to abandon them. Waddell opined that the Bolivian government
didn't understand the investment process and how to build an
appropriate investment climate. He noted that BG cannot
prepare an investment plan or field development plan without
a sales contract with a creditworthy buyer--an industry
SAO PAULO 00000031 005 OF 007
standard. Furthermore, he said that inadequate
infrastructure is also a dire concern for expanding
production in Bolivia. According to Waddell, BG and others
aren't going to invest in Bolivia until they know they can
transport gas and generate revenue there, which he said means
no additional supply for Brazil in the near-term.
12. (C) Brazil's contract with Bolivia does levy hefty
penalties; however, Petrobras would have to pursue
arbitration in New York to recover them, and Waddell told
Econoff that he doubted Petrobras would go to such lengths.
He said he was not surprised when Bolivia declared that it
would not meet its 2008 contractual obligations with BG and
the Cuiaba power plant in western Brazil. He told Econoff
that BG's investment in Bolivia is relatively small and
pursuing international arbitration under the UK Bilateral
Investment Treaty for the violation of its contract would not
be worth the effort. He opined that the contract with the
Cuiaba power plant involves a much larger investment, but
that the plant's stakeholders to date (Ashmore Energy) have
avoided challenging the Bolivian government.
Industry Perspective for Investment Promises in Bolivia
--------------------------------------------- ----------
13. (C) Petrobras in December announced an investment of USD
one billion in Bolivia's natural gas sector. (Comment: Most
interlocutors have opined that this investment was done for
geopolitical reasons and was not a decision based on business
considerations. End Comment.) Da Silva of FIESP told
Econoffs he believes Petrobras' decision to renew investments
in Bolivia was a strategic decision to counterbalance
Venezuela's role in the region and especially in Bolivia. Da
Silva applauded the decision, saying Brazil had an obligation
to help countries like Bolivia and Paraguay. In his view,
Bolivian gas is important for FIESP and is cheaper than
domestically produced gas. Da Silva calculated that Bolivian
natural gas costs about the equivalent of USD 35 per barrel.
For his part, Waddell told Econoff that Petrobras officials
told him just before Christmas that their recent commitments
in Bolivia were previously planned investments needed to
maintain the flow of 30MMm3/d of gas to Brazil out of the San
Alberto/San Antonio fields in Bolivia. He said Petrobras had
also agreed on conditions to begin discussing future
exploration investments in Bolivia.
Government Response Limited
---------------------------
14. (C) The GOB's response to potential natural gas
shortages for the most part has been insufficient and
sluggish. Since winning his second term, President Lula has
left several key energy positions unfilled (including leaving
his Minister of Mines and Energy vacant from May 2007 until
January 16, only to then be filled by a self-admitted
novitiate in the energy sector). Waddell's view is that
Brazil is mostly operating out of the fear that Brazil could
be in for severe electricity shortages similar to those in
2001. (Note: In 2001, the demand for electricity, following
strong economic growth the year before, could not keep up
with supply and the GOB had to implement an electricity
rationing program. Brazilian businesses spent millions on
additional electricity costs and had to cut back production.
As a result, the Brazilian economy suffered a serious
setback. End Note.) The GOB's response to the limited
prospects for natural gas, apart from ignoring the problem,
has been to prioritize consumers. Lula clarified in November
SAO PAULO 00000031 006 OF 007
and again in January that thermal power plants continue to be
the top priority consumer for the country's supply of natural
gas. In contrast to 2003 when the GOB was encouraging the
use of natural gas, Petrobras and the GOB have started
encouraging alternatives to natural gas. Petrobras president
Sergio Jose Gabrielli and then interim Energy and Mines
Minister Nelson Hubner in November publicly discouraged the
use of vehicular natural gas. Due to insufficient supply,
Brazil's National Agency for Electricity (Aneel) withdrew
from its projected energy matrix some 3,600 megawatts of
electricity that it had estimated that natural gas generators
would supply.
Private Sector Contingency Planning
-----------------------------------
15. (C) In the absence of a government-led solution for
natural gas supply and infrastructure development, Brazil's
private sector had been working to find an alternative. In
the face of possible natural gas shortages since Bolivia
nationalized its energy sector in 2006, FIESP has been
working with Comgas to develop a contingency plan, together
with Petrobras, to avoid short-term hiccups in the supply of
natural gas, da Silva said. He told Econoffs that FIESP had
formed a working group two years ago to identify industries
that could use different fuels for power and had developed a
contract with Petrobras that would allow Petrobras to supply
other fuels besides natural gas in the case of emergency
without penalties.
16. (C) The natural gas shortages in October pushed their
contingency planning into practice. On December 18 Gabrielli
and Comgas President Luis Domenech signed contracts that
create new modalities for Sao Paulo industrial consumers
which took effect this month. In addition to the existing
inflexible contracts, they created flexible and interruptible
contracts between Comgas and industrial consumers that
compensate for intermittent natural gas shortages in the
domestic market due to technical problems or lower volume
from Bolivia. According to Montagna, the flexible contract
allows Petrobras to substitute natural gas for oil at its own
expense and is designed for industrial consumers that can
alter energy supply without interrupting their operations.
Comgas expects that approximately nine percent, or one
MMm3/d, of its industrial customer base would opt for the
flexible contracts, and told Econoff that Comgas had already
secured nearly that amount in new contracts in 2007.
Interruptible contracts, on the other hand, allow Comgas to
interrupt distribution to industrial consumers with these
contracts if the GOB mandates additional thermal electricity
generation. Montagna said Comgas expected to sign
interruptible contracts totaling 1.5MMm3/d with industrial
customers. In total these two contracts would provide Comgas
with a cushion of 2.5MMm3/d of natural gas in the event of a
supply shortage. He said Comgas believes these contracts
will prevent legal challenges and offer Petrobras and Comgas
a coordinated solution to intermittent supply shortages for
Sao Paulo industrial consumers.
Comment
-------
17. (C) Brazil is entering what many believe will be the
most difficult year for guaranteeing enough natural gas to
supply thermal power generators if a possible electricity
crisis were to occur due to insufficient rain for hydropower
or larger than anticipated increases in demand for
SAO PAULO 00000031 007 OF 007
electricity. (Note: Septels will further address the current
energy situation in Brazil. End Note.) Despite some efforts
to avoid a crisis similar to 2001, the GOB failed to plan and
develop a natural gas supply to feed its growing thermal
generation capacity. The private sector has stepped in where
the GOB could not; however, distributors such as Comgas are
limited by national infrastructure bottlenecks and incomplete
regulation in the sector. Clearly Brazil needs a new and
specific natural gas regulatory framework, but the bill is
languishing in Congress and the Lula Administration has not
used its considerable strength to get it moving.
Furthermore, the impending gas crisis will require
fundamental changes to Brazil's model for electricity
generation. As a result, Brazil will expect higher energy
prices, on the order of 10 to 25 percent, in the interim
because of tightening supply and additional domestic demand,
coupled with a worldwide shortage of natural gas and higher
exploration costs for the potential fields discovered in Tupi
and elsewhere. Higher energy prices could drive up inflation
as well as constrain growth in Brazil over the next several
years until new supplies of gas come on line. END COMMENT.
WHITE