Navigating Risk in Brazil's Energy Sector

CONTENTS Foreword ................................................................................................ii Introduction ...........................................................................................1 Margaret Myers and Lisa Viscidi Political Risk and Resource Nationalism: Why the Chinese are Moving Cautiously into Brazil’s Oil Sector ......4 Naki Mendoza Weighing Local Risks and Opportunities: Sino-Brazilian Cooperation in Renewable Energy ...........................13 Ilan Engellaum Cuperstein State Grid’s Bold Leap: Chinese Investment in Brazil’s Transmission Sector ........................18 Chris Cote OCTOBER 2014 i FOREWORD am pleased to present “Navigating Risk in Brazil’s Energy Sector: The Chinese Approach,” a new report edited by Margaret Myers, director of the China and I Latin America Program, and Lisa Viscidi, director of the Energy, Climate Change and Extractive Industries Program, at the Inter-American Dialogue. The report analyzes critical challenges to investing in Brazil’s oil and gas, electricity generation and transmission sectors from the perspective of Chinese companies and identifies opportunities for cooperation and policy improvement. This Dialogue report was made possible through the generous support of the Alcoa Foundation. It highlights findings from a public meeting on Chinese investment in Brazil’s energy sector, organized in collaboration with the China- Brazil Business Council (CBBC) and the Industrial Federation of the State of Sao Paulo (FIESP) during FIESP’s 2014 Infrastructure Week conference in Sao Paulo. Our report features the work of three distinguished analysts of Latin America’s energy sector. Naki Mendoza, a reporter at Energy Intelligence Group, analyzes Chinese investment in Brazil’s oil and gas sector. Ilan Cuperstein, the Federal University of Rio de Janeiro representative to the China Brazil Center for Climate Change and Energy Technology Innovation, outlines China’s role in renewable energy generation in Brazil. And Chris Cote, MPP candidate at the Harvard Kennedy School of Government and former research associate at BrazilWorks, examines investment by China’s State Grid Corporation in Brazil’s transmission sector. The Dialogue’s China and Latin America program engages and informs aca- demics, policy-makers and private sector leaders in China, Latin America and the United States on evolving themes in China-Latin America relations. The Energy, Climate Change and Extractive Industries program informs and shapes policies that promote investment while encouraging economically, socially and environmentally responsible development of natural resources. The Inter-American Dialogue is the leading US center for policy analysis, exchange and communication on issues in Western Hemisphere affairs. The views expressed in this report are those of the authors, and do not necessar- ily reflect the perspectives of the Inter-American Dialogue, the China-Brazil Business Council (CBBC) or its sponsors. ii Michael Shifter President INTRODUCTION Margaret Myers and Lisa Viscidi hinese investment in Brazil has in Brazil, and to readily exchange their Cexpanded over the past decade, abundant capital for opportunities to albeit more slowly than bilateral trade, enhance competitiveness in emerg- and the oil and gas and electricity sec- ing service sectors. Through mergers tors are an important destination for and acquisitions, NOCs are gradually Chinese direct investment. But despite expanding their portfolios to include demonstrated interest on the part upstream oil and gas holdings. Chinese of China’s government and firms in firms of all sorts are also bidding across Brazil’s energy sector, Chinese inves- value chains, including in infrastruc- tors have been slow to engage in many ture, services, and equipment exports. cases. The authors of this report indi- Chinese electricity giant State Grid, for cate several barriers to investment that example, expects large returns from its have obstructed Chinese involvement electricity infrastructure projects in in recent years—the same barriers fac- Brazil and is now interested in expanding other international investors in ing into Brazil’s generation and distribu- Brazil. They range from price controls tion markets. and stringent local content stipulations The Chinese and Brazilian gov- to a lack of familiarity with local mar- ernments still have a hand in large- ket dynamics. Chinese firms are also scale deals, however, especially with increasingly weighing the costs and respect to energy projects. As indi- risks of investing in Brazil with invest- cated in the first section of this report, ment options elsewhere in the world. Presidents Dilma Rousseff and Xi As elsewhere in Latin America, Jinping are thought to have arranged Chinese investment is driven by a com- China National Petroleum Corporation plex mix of government planning and (CNPC) and China National Offshore profit-based motivations. While occa- Oil Corporation (CNOOC) partici- sionally supporting China’s energy pation in the exploitation of Brazil’s security objectives, Chinese national oil Libra oil fields. Bilateral cooperation in companies (NOCs) are known to oper- renewables is also largely government- 1 ate according to profit-based incentives driven. As noted in the second section, China’s private sector deals in Brazil’s 2) Liberalize prices for renewables are fairly insignificant, transportation fuels and although there is potential for growth electricity tariffs given increasing power demand and the Government-imposed price caps on capabilities of Chinese suppliers. transportation fuels and electricity The following suggestions for tariffs deter investment from Chinese Brazilian policymakers and Chinese companies and inhibit private sector firms —based on analysis from the investment in refining and electricity authors of this report—could reduce generation more broadly. perceived risk and provide additional A government policy capping the opportunity for growth-promoting retail price of diesel and gasoline below investment in Brazil’s energy sector. international prices led Petrobras to incur downstream losses of more than 1) Revise local content supply $40 billion since 2011, forcing it to take regulations on more debt in order to deliver on the Easing of local content restrictions cash-generating upstream projects that would benefit Chinese oil firms look- it operates on behalf of partner compa- ing to expand their involvement in nies. Fuel price caps have also dissuaded Brazilian exploration and production. Chinese companies from investing in It would afford them opportunities to Brazil’s refining sector. A government procure a familiar base of suppliers policy to align fuel prices and alleviate and top notch equipment from abroad, Petrobras’ financial pressures would aid lessen their dependence on domestic in removing risk and uncertainty among human resources, and reduce the time potential consortium partners and required to understand local market could encourage companies from China compliance regulations. and elsewhere to invest in Brazil’s down- Local content regulations also pose stream sector. challenges for Brazilian firms. In Brazil’s Likewise, in the power sector, price oil industry, the percentage of products controls have deterred investment from and supplies used in upstream projects Chinese firms in renewable energy gen- that must be manufactured in Brazil eration, particularly wind and solar, has historically ranged from 37–65 per- where production costs are higher cent, depending on the project’s phase than traditional hydropower projects. of development. But given the enor- Liberalizing electricity tariffs would mity of the resource base and the recent help attract investment in power genera- expansion of domestic upstream proj- tion from renewable energy sources as ects, Brazil’s industrial shipyards have well as natural gas. become increasingly overstretched. As the dominant operator in the country, 3) Improve community Petrobras is struggling with infrastruc- engagement ture bottlenecks, domestic service sec- Chinese firm State Grid has imple- tor capacity constraints and inadequate mented a highly successful approach human resources, which have led to to community engagement and public project delays and cost over-runs. relations over the past few years, which Local content regulations set by the could be easily replicated by Chinese Brazilian Development Bank (BNDES) firms that are struggling to build a posi- have also limited Chinese participation tive image in the region. in Brazil’s growing wind market. Efforts to revise wind industry local content 2 regulation have been blocked by Brazil’s steel industry, however. In order to cultivate a positive image 4) Promote dialogue among in Brazil, State Grid hires local manag- the private and public ers, invests in local communities, and sectors and with non- sponsors local cultural events. The pres- governmental organizations ident of State Grid, Cai Hongxian, also As several Chinese scholars and energy participated in several interviews with industry experts have indicated, China’s Brazilian business magazines, noting NOCs should engage with a broad range the importance of his Brazilian manag- of stakeholders, including civil soci- ers and the fact that many of his Chinese ety, unions, and political parties not in employees have learned Portuguese. Cai power, in order to avoid political con- attributes much of his company’s suc- tingencies and build deeper ties with cess in Brazil

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