It has all gone a bit wrong for Brazil, once touted as the next frontier for non-OPEC supply growth. Back in 2006, the IEA predicted Brazil's output to surpass 3 mb/d by 2009 - that expectation now extends to 2018. Petrobras, meanwhile, has lowered its production targets consistently over the past few years as Brazilian growth continues to disappoint.
Brazil's pre-salt production has not disappointed. Quite the contrary, it has reached record highs of more than 0.4 mb/d as of February 2014, and the discovery to production period of seven years surpasses previous large discoveries in other parts of the world. But scaling up production remains a substantial challenge due to project delays, cost inflation and steep decline rates from legacy assets. On a 10-year CAGR basis, Petrobras' costs have risen by 22%, but over the past three years costs have risen by more than 30% each year from 2010 levels.
Our detailed analysis of existing well production indicates that rampant double digit declines in existing fields are offsetting the efforts being made in upstream. More than one large FPSO is needed each year to offset declines and that number rises with the ageing of the fields. On an annual basis, average declines in deepwater production are between 17% and 20% - this compares with 14% in 2005. With liquids output at around 2 mb/d, around 0.3 mb/d needs to be installed just to stand still. Thus, any equipment and project delays quickly exacerbate the declining production trend.
The declines in the Campos basin have been compounded by a robust demand backdrop which has reduced the amount of crude available for export. Since 2006, Brazilian oil demand has grown by almost 1 mb/d or at a compound annual growth rate of 6%, with the last three years adding 0.3 mb/d. On the other hand, production has grown at a compound annual growth rate of 2.2% over the same period, with the last two years seeing negative growth rates. As a result, crude exports have dwindled from 0.63 mb/d in 2010 to 0.38 mb/d in 2013, with Brazil even becoming a net importer of crude at certain points of last year.
Making matters worse was the 2011 decision by the government to subsidise fuel prices through an unofficial mechanism, spurring domestic demand growth further and resulting in Petrobras having to import products such as gasoline and diesel at international prices. As a result, the downstream segment has made an accumulated loss of $26 billion over the last three years, which has strained the much required investments in upstream.
The move from the initial concession approach to production sharing contracts has also resulted in a significant deterioration in the attractiveness of Brazil's upstream sector for IOCs. With Petrobras now the mandatory operator of the fields, capital participation from foreign companies has dropped and working capital overruns are becoming more frequent.
Since January 2013, six major projects have come on stream with a production capacity of 0.82 mb/d, yet in 2013, Brazilian production registered declining output for the second consecutive year. Between Q2 14 and Q4 16 another 13 projects are expected to come online, with a capacity of 1.6 mb/d, but over the same time period we foresee production growth of only 0.5 mb/d. Indeed, we see Brazil surpassing 3 mb/d only by late 2018.