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Brazil and Offshore Oil Transcript

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March 2011

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Tom Heintjes: Welcome to another EconSouth Now podcast. The world's thirst for • EconSouth Now
oil is not news. What is relatively new, however, is the discovery of large oil
• Podcasts
reserves off the coast of Brazil. A world leader in the production of alternative fuels
such as ethanol, Brazil is in the early stages of preparing to extract this oil and of
preparing for the potential economic impact of newfound resource wealth.
Laurel Graefe and Steve Kay of the Atlanta Fed's research department have
written an article for EconSouth magazine about Brazil's oil resources and its
potential implications for its economy and energy markets. They are here to speak
with me about the situation and its potential impact. Steve and Laurel, thanks for
joining me today.
Laurel Graefe: Thanks for having us.
Steve Kay: Thanks, Tom.
Heintjes: Laurel, I'm going to get you to supply some
background on this discovery. The Lula oil field lies off
the coast of Brazil, four miles beneath the seabed.
What led to its discovery in the first place?

Laurel Graefe

Graefe: Well, as you pointed out, the four-mile depth
beneath the seabed is very significant in terms of oil
exploration. So, the seismic techniques that have
developed over time have an amazing capacity to see
beneath very enormous depths of ocean, and even
beneath the seabed. However, one of the main
barriers in geologists' ability to see within the layers of
the earth's surface is salt. And within the four miles
that separates the Santos Basin—the overall network
of fields that the Lula field is located in—and the bed
of the sea is an enormous amount of salt mixed with
sand and rock. And only in the middle of the past
decade were the seismic techniques developed that
enabled geologists to get a better, clearer glimpse of
what actually was lying at such depths.

So it was largely a technological find. The Lula field,
which was originally named the Tupi field, was
Stephen Kay
discovered in 2006 and only recently began
producing, although it probably won't be for several more years that it is producing
on a larger commercial scale.

Heintjes: This gets to the discussion of oil that is easy to extract versus the oil that
is harder to extract, doesn't it?
Graefe: Correct.
Heintjes: Steve, in the Gulf of Mexico, we've seen in the last year a vivid example
of the environmental risks of deep-sea oil drilling. What are the potential
environmental impacts of the extraction of oil from the Lula field?
Kay: Well, there are risks inherent in deep-water oil drilling. Other countries have
experienced disasters and near-disasters, including Brazil, where there was a fire
on an oil rig off the coast of Rio de Janeiro in 2001 that killed 11 people and spilled
10,000 barrels of fuel and crude. So officials from Petrobras, which is the Brazilian
oil company, say that they have improved safety and have emergency-response
systems that could better deal with future disasters.
Brazil's plans to develop its offshore reserves have not been affected by the Gulf oil
disaster—they are proceeding full speed ahead—and given high demand for oil,
that is to be expected. The bottom line is that globally, like we were just discussing,
large increases in international reserves are offshore. Most of the onshore and
near-shore oil has already been discovered. In fact, 70 percent of the increase in
the U.S. Geological Survey's estimate of recoverable oil in the U.S. is offshore oil,
and that is where the drilling is going to take place.
Graefe: So this falls back in line with Brazil's experience, where we see a lot of the
cheaper-to-access and easier-to-access oil, a lot of it has already been produced.
So, globally we are seeing a trend where producers are heading more toward the
more expensive, whether it's arctic oil—these more difficult to both locate and
extract—oil is starting to really come to play.
Heintjes: Laurel, we hear a lot about Canadian oil shale. Does this fall into that
category?
Graefe: Absolutely. So, as the price of oil increases, suddenly technologies that
weren't economically feasible in the past suddenly start coming into play. And that
is absolutely what we are seeing with the Canadian oil shale.
Heintjes: Laurel, one estimate indicates that the Santos Basin could hold as much
as 123 billion barrels of oil, although only a fraction of that amount is considered
proven given today's technological limitations. Still, it's a large enough find to have
an impact on world energy markets. What do you think the impact will be on the
petroleum markets?
Graefe: Well, as you pointed out, the estimates of the actual resources can vary
extremely widely just because, again, these resources are so far from land. They
are so far from anything we can actually physically assess. One hundred and
twenty-three billion barrels is one of the extremes, the very optimistic forecast.
However, regardless of what the actual amount of resources that lie underground,
you pointed out the most important measure, which is what can actually be
produced. Proven reserves are those that, given today's economic limitations,
technological, political limitations, what's actually reasonably likely to come into
production.
So, to put that into some perspective, Brazil's proven reserves are around 13 billion
barrels right now. So, despite the fact that this is an enormous resource, the

challenges that are presented—unprecedented depths and unprecedented
challenges in terms of the subsalt terrain—make this particular find very difficult to
extract, at least in current times. Although I imagine at some point in the future as
technology advances or prices change, we might actually, even without further
discoveries, these same fields could continue to add to proven reserves as
circumstances change.
However, regardless of whatever actually exists underground and how much is
proven, I guess the fields could affect world oil markets in two primary ways. One is
the traditional supply channel. So, when you see a large, unexpected increase in
supply, eventually we would expect for that to have some downward influence on
prices, whether that's actually pushing prices lower or just curtailing a rise in oil
prices. Generally—I mean, just Econ 101—that's what you would expect with an
increase. Brazil has just recently become a net exporter of oil, and so you can
imagine an increase in their overall ability to produce would also influence the
country's economic position. So, there's this one kind of general "any large oil
discovery would generally be expected to have this sort of effect" pushing down
prices, increasing global supply.
On the other hand, there's another important element to the find, which has really
come into focus in light of the recent violence in the Middle East and North Africa,
which is the world has been focusing increasingly on sources of excess production
capacity globally, and Brazil's potential ability to provide some swing production
sometime in the future as a nonâ??cartel member could really play a very valuable
geopolitical role in the coming years.
Heintjes: Steve, Brazil has been a world leader in ethanol production and
consumption. Could this new discovery make ethanol a less appealing fuel source?
Kay: Well, Brazil has been the global leader in ethanol production, and that won't
change. Of course, Brazil developed its ethanol industry as a means to reduce its
dependence on petroleum after the devastating impact of the oil shocks of the
1970s. And now that Brazil has discovered so much oil, that doesn't mean it will
turn away from ethanol, which Brazil produces from sugar cane, which it can do at
a much lower price and with less of an environmental impact than is the case with
corn.
Ethanol nearly always costs less to produce than petroleum, and Brazil's fleet of
cars are increasingly flex-fuel, which means that they can run on either gas or
ethanol, the driver can choose based on the price. So if Brazil is consuming more
of the cheaper ethanol at home, it just means that more petroleum can be
exported.
Heintjes: Among energy-industry analysts, Laurel, there's a robust debate about
how much oil remains for human consumption. Is Brazil's find likely to alter the
outlook?
Graefe: Yes and no. Brazil's find was not substantial enough to create some longterm shift in the way that industry analysts are viewing longer-term trends in oil
supplies. So, the international energy agency, the global energy watchdog, last fall
came out with a report saying that they expected that the world had already
reached peak oil production. So, that didn't necessarily mean that we were headed
for some imminent sharp decline in production, but that production was unlikely to
increase any more.

Brazil's find didn't change that assessment. However, inevitably, the potential for a
large amount of oil to come online, particularly within the next decade or so, could
play an extremely valuable and marginal supply role, especially as the global
economy continues to trend toward recovery, emerging markets have been
performing particularly strongly, and those tend to be much more energy
dependent than some of the more developed economies. And as we continue with
that trend, likely having an additional source of oil supply online could really play a
very valuable role in balancing out world oil markets.
Heintjes: Steve, my last question is for you. In your article for EconSouth, you
discuss the "resource curse." Could you delve a little bit more deeply into this
phenomenon, and how sudden resource wealth can have negative effects on a
nation's economy?
Kay: Well, it may seem strange to think of the discovery of billions of barrels of oil
as having potentially negative economic consequences. But as it turns out, there
are some risks. Economists talk about this as the "resource curse," which is based
on the fact that growth rates in countries rich in natural resources are lower than in
countries without them. Two examples are Venezuela and Ecuador, which are the
two largest oil exporters in Latin America, measured as a percentage of gross
domestic product. Both countries have averaged lower economic growth and
higher inflation than other countries in Latin America over the past few decades.Â
So The Economist magazine coined the term "Dutch disease," and that is named
after the impact of North Sea gas on the Dutch economy in the 1960s. And
essentially, the returns on investment in oil are so large—this is what took place in
the Netherlands—they were so large that they divert investment from other
economic activities. The surge in revenue from petroleum exports can lead to a
surplus in a nation's balance of payments, and that leads to a stronger domestic
currency. The overvalued exchange rate means that the country loses its
competitiveness in other sectors of the economy; its exports become too
expensive, and imports become cheaper, and that hurts domestic industry.
In fact, there has been some research in Brazil comparing growth in states that
receive oil royalties with those that don't, and it found lower growth rates in the
states that do get royalties. The CEO of Petrobras, the Brazilian oil company,
recently warned that the rapid expansion of the development of Brazil's deepwater
reserves could harm other industries in Brazil as they compete with one another for
labor, resources, and capital.
So, to deal with Dutch disease, Brazil is doing what other natural resourceâ??rich
countries like Chile have done, it has started an economic stabilization fund that
will invest in education, health, science, technology, climate change mitigation, all
of this in an effort to harness this revenue to use it for social development and to
lessen the impact on the economy of volatile oil prices.
Heintjes: Steve and Laurel, I'd like to thank you both for being with us today.
Graefe: Thanks for having us.
Kay: Thanks, Tom.
Heintjes: Again, we've been speaking today with Laurel Graefe and Steve Kay of
the Atlanta Fed's research department. This concludes our EconSouth Now

podcast on Brazil's discovery of offshore oil. For more information, please see the
first quarter 2011 edition of EconSouth magazine. On our website,
www.frbatlanta.org, you can read the full article about this topic or subscribe to
EconSouth in print.
Thanks for listening, and please return for more podcasts. If you have comments,
please e-mail us at podcast@frbatlanta.org.

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