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 www.latinamericamonitor.com

Latin America Monitor

Brazil Vol 34 Issue 4 April 2017

BMI Research’s monthly regional report on political risk and macroeconomic prospects

BRAZIL This month’s top stories

Pension Reform Set To Rate Cuts Continue Amid Disinflation

On February 22, the Banco Central do Brasil (BCB) lowered
the benchmark Selic interest rate by 75 basis points (bps), to
Progress Through Congress 12.25%. Separately, January inflation came in at 5.4% y-o-y.
Page 3
BMI View: Brazilian President Michel Temer's reform efforts will be
supported by the selection of close administration allies to lead both Brazilian Equities Defy Underlying
houses of Congress. Pension and labour reform will likely see progress Weakness
in the coming months, though poor public approval and lingering cor- Brazilian equities have broken through strong resistance
ruption allegations will remain persistent risks. levels, suggesting that investor sentiment toward the
Brazilian President Michel Temer's country has fundamentally shifted on the expectation that
within the year. That said, growing
strong legislative majority will ensure economic activity will rebound in the coming months.
public opposition and the levelling of
page 3
that reform efforts continue to move corruption allegations against senior
through Congress over the coming administration figures will remain risks
months. After securing a major vic- to reform efforts.
Modest Growth Forecast Remains Intact
Efforts to strengthen the financial stability of Petrobras will
tory in December with the enactment Coordination between the admin-
ensure upstream improvement and encourage private sec-
of a constitutional amendment to cap istration and Congress has improved
tor participation. The Brazilian recovery will be held back by
expenditure growth, pension and la- government effectiveness over recent
less robust sector reforms and sustained oil price weakness.
bour reforms will become government months. Brazil's score on our Short-
page 4
priorities (see 'Legislative Majority Will Term Political Risk Index has risen
Support Reforms, But Risks Substantial', from 53.3 in August to 59.2 out of 100,
December 14 2016). With close admin- driven by our improving assessment of
Fuels Demand Will Stage Subtle
istration allies leading both houses of the country's 'policy-making process', Recovery
Congress, Temer will likely be able to a key component of our index. Refined fuels demand will rise in 2017 on the back of a mod-
enact key legislation address both areas ...continued on page 2 est economic recovery. However, growth will be constrained
by a large output gap and still-elevated unemployment.
page 5
RISK INDEX TABLE
Key Sector: Oil & Gas
BMI’s Country Risk Index scores countries on a 0-100 scale, evaluating short-term page 7
and long-term political stability, short-term economic outlook, long-term economic
potential and operational barriers to doing business. For a detailed methodology, visit
bmiresearch.com or contact us using the details below.
Short Term Long Term Operational Country
Regional Indicators
Political Economic Political Economic Risk Risk
2015 2016e 2017f 2018f
Chile 75.8 65.2 83.2 68.1 66.7 71.0
Latin America Indicators
Uruguay 73.1 56.0 75.3 61.2 54.6 62.5
Mexico 60.6 62.3 64.7 64.7 51.4 59.2 Nominal GDP, USDbn 5,276.7 5,369.4 6,314.5 6,789.2
Peru 64.2 68.1 62.5 66.1 50.4 60.3
Population, mn 631.5 637.9 644.2 650.4
Brazil 59.2 56.5 68.8 61.9 51.1 58.1
Colombia 66.0 61.3 64.3 63.6 49.2 59.0 GDP per capita, USD 8,356.0 8,417.3 9,802.2 10,438.8
Argentina 61.9 51.7 61.6 53.3 46.7 53.6 Real GDP growth, % 0.1 -2.1 1.0 2.0
Ecuador 51.3 56.7 51.1 57.5 47.2 51.8 Inflation, % 7.8 8.8 6.7 4.8
Venezuela 30.6 25.6 44.8 34.3 32.7 33.4
Goods Exports, USDbn 998.2 953.7 1,012.3 1,069.6
Regional Average 60.3 55.9 64.0 59.0 50.0 56.5
Global Average 63.8 51.8 62.3 52.9 49.8 55.1 Goods Imports, USDbn 1,049.1 956.6 994.3 1,047.5
Source: BMI. Notes: e/f = BMI estimate/forecast. Source: BMI.

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  BRAZIL
...continued from front page
Administration Holds Tight Grip On
Legislative Agenda
Temer's close relationships with legislative
leaders will ensure that his reform efforts are
at the forefront of the legislature's agenda. On
February 1, Eunício Oliveira, of Temer's Par-
tido do Movimento Democrático Brasileiro
(PMDB), was handily elected President of
the Senate.
Oliveira is a party stalwart who strongly
supports Temer's agenda. On February 2,
Temer's preferred candidate – Rodrigo Maia,
of the centre-right Democratas party – was
re-elected Speaker of the Chamber of Depu-
ties, easily beating five other candidates. In
December, Temer picked Antonio Imbassahy,
of the Partido da Social Democracia Brasileira
(PSDB), to serve as the government's Con-
gressional liaison, strengthening ties with the
second-largest bloc of the PMDB's ruling
coalition.
Pension reform will be the government's
first priority, as curtailing the growth of social
security obligations is necessary to preserve
the sustainability of the spending cap amend-
ment (see 'Spending Cap Amendment Supports
ECONOMIC OUTLOOK
Quick View: Still No Signs Of A
Recovery
The Latest: Brazilian economic activity contracted 0.2% month-on-month in
December. On a year-over-year basis, activity was down 1.8%.
Implications: December's print undermines
hopes that a growth recovery has begun in
Brazil, after activity expanded 0.1% m-o-m
in November.
Bottom Passed, But Weakness Persists
Monthly Economic Activity Index
Source: IBGE
Although in y-o-y terms the contraction was
the shallowest since June 2015, monthly
activity contracted by an average of 4.4% y-
2 2 BRAZIL – APRIL 2017
Deficit Narrowing', November 18 2016). In
December, a reform bill was accepted for
debate in the lower house, clearing its first
procedural hurdle. The bill establishes a
minimum retirement age of 65, among other
changes aimed at reducing payouts. Although
a number of procedural steps remain, govern-
ment ministers are confident enough of the
needed support that they have publicly ruled
out negotiations on key areas of the reform,
including the minimum retirement age.
Labour reform will also likely progress
over the coming months, although the leg-
islation is in an earlier stage. Brazil's labour
market rigidity has long been a drag on
long-term growth potential, as it underpins
relatively expensive business costs.
In December, Temer sent bills to Congress
that would allow hourly pay and longer
workdays, and which extended temporary
work contracts and expanded outsourcing.
In a nod to the country's unions, Temer has
also proposed reforms that would give col-
lective bargaining the rule of law. Temer's
goal is to liberalise the country's relatively
rigid labour market, although his proposals
have already drawn threats of protests from
national labour unions.
o-y in 2016. This suggests that our estimate
for a real GDP contraction of 3.5% in 2016
may have been overly optimistic on growth
in Q416.
Rebound Only Tepid In 2017
Real GDP Growth, %
e/f = BMI estimate/forecast; Source: IGBE, BMI
What's Next: We expect economic activ-
ity growth to turn modestly positive over the
Risks Remain Substantial
Pension and labour reforms are likely to
draw greater public opposition than the
spending cap amendment, given the more
direct impact the reforms stand to make on
individual incomes. Approval of the govern-
ment is already low, at just 26% in December,
and likely to fall further. While Temer's stated
disinterest in running for re-election makes
him less affected by swings in popular opin-
ion, members of his legislative coalition could
waver. Major reforms like the pension bill
will require two votes, securing three-fifths
approval in both houses, which will present
a challenge to legislative leaders.
Additionally, the emergence of corrup-
tion allegations against senior administration
officials and legislators remain a risk. The
'Lava Jato' investigations are set to continue,
despite the death of Chief Justice Teori Zavas-
cki in January, and testimony collected from
Odebrecht executives as part of plea bargains
are thought to implicate numerous legisla-
tors. If senior members of the administration,
including Temer, are ruled by the court to
have received illegal funds over the years, the
ensuing resignations could jeopardise reforms
and reignite political uncertainty.
coming quarters, driven largely by investment.
Although growth remains negative, the econ-
omy has bottomed and business sentiment is
improving as inflation falls, interest rates are
slashed and the government pursues structural
reforms. That said, elevated unemployment
and fiscal consolidation efforts will weigh on
consumption, while significant underutilised
industrial capacity suggests a large output gap
to be filled before investment in new produc-
tive capacity begins to grow. We forecast real
GDP growth of just 0.8% in 2017.
Substantial Slack Will Limit Rebound
Industrial Indicators
Source: IGBE, CNI, BMI
Related Research: Improving Business Sentiment
Will Drive Modest Recovery, January 5
www.latinamericamonitor.com
ECONOMIC OUTLOOK

Quick View: Rate Cuts to bring the Selic rate to 10.75% by end-
2017. As inflation stabilises within the bank's
target range, policymakers will shift to sup-

Continue Amid Disinflation porting sluggish economic growth. Receding

domestic food price pressures, a stronger
The Latest: On February 22, the Banco Central do Brasil (BCB) lowered the exchange rate and weak demand-side price
pressures will ensure disinflation continues
benchmark Selic interest rate by 75 basis points (bps), to 12.25%. Separately,
over the coming year. We forecast inflation
January inflation came in at 5.4% y-o-y.
to average 5.24% y-o-y in 2017, down from
Implications: Both figures come in line rate cut is its fourth in as many months and 8.8% in 2016, and comfortably within the
with our view for decelerating inflation and represents an accelerating pace of cuts, follow- bank's new 3.0-6.0% target band, which it
substantial rate cuts over the coming months. ing two 25bps cuts in Q416. adopted at the start of the year.
Inflation steadily decelerated in 2016, falling What's Next: We expect BCB to con-
within the BCB's 2.5-6.5% target band for the tinue cutting interest rates over the coming Related Research: Sharper Rate Cuts As
first time since December 2014. The BCB's months, forecasting 300bps of cuts in 2017 Inflation Falls And Growth Drags, January 5

ECONOMIC OUTLOOK

Brazilian Equities Defy over the coming weeks, as the index faces no
significant levels of resistance. As we previously
suggested could be the case, investors appear
Underlying Weakness to be taking a bullish view on the Brazilian
economy in light of rising commodity prices,
BMI View: Brazilian equities have broken through strong resistance levels, disinflation and falling interest rates, and the
suggesting that investor sentiment toward the country has fundamentally shifted adoption of more business-friendly policies by
the administration of President Michel Temer.
on the expectation that economic activity will rebound in the coming months.
Nonetheless, we remain cautious on the
The MSCI Brazil Index appears set for ad- tum indicators. Although the real's recent extent of additional upside likely for Brazilian
ditional gains after breaking through strong gains have helped drive the market's recent equities over the coming months. Stocks have
resistance levels. The bullish move has been rise, the break higher suggests that investor already rallied substantially over 2016, and
sustained over the last week, against our more sentiment toward the country is shifting on momentum indicators still look overbought.
sceptical stance toward the market's rally, the expectation that economic activity will We expect that significant slack will remain in
which we expected would reverse in light of rebound in the coming months. The market the economy, including elevated unemploy-
technical resistance and overbought momen- is likely to remain in a higher trading range ment and idle productive capacity.

DATA & FORECASTS

2013 2014 2015e 2016e 2017f 2018f 2019f

Population, mn 204.3 206.1 207.8 209.6 211.2 212.9 214.5
Nominal GDP, USDbn 2,463.2 2,416.0 1,772.4 1,797.0 1,984.4 2,007.9 2,099.6
GDP per capita, USD 12,293 11,958 8,702 8,755 9,597 9,642 10,012
Real GDP growth, % y-o-y 3.0 0.1 -3.8 -3.5 0.8 1.8 2.0
Industrial production, % y-o-y, ave 2.1 -2.9 -8.2 -7.0 2.5 2.8 3.0
Consumer price inflation, % y-o-y, ave 6.2 6.3 9.0 8.8 5.4 5.3 5.3
Consumer price inflation, % y-o-y, eop 5.9 6.4 10.7 6.3 5.0 5.2 5.3
Central bank policy rate, % eop 10.00 11.75 14.25 13.75 10.75 9.00 8.00
Exchange rate BRL/USD, ave 2.16 2.35 3.33 3.49 3.35 3.56 3.67
Exchange rate BRL/USD, eop 2.36 2.66 3.96 3.26 3.50 3.62 3.73
Budget balance, BRLbn -157.5 -343.9 -613.0 -602.8 -595.0 -532.4 -524.8
Budget balance, % of GDP -3.0 -6.0 -10.4 -9.6 -8.9 -7.5 -6.8
Goods and services exports, USDbn 279.6 264.1 223.9 216.6 226.4 233.5 241.8
Goods and services imports, USDbn 325.6 318.8 243.1 198.3 208.4 214.9 223.1
Current account balance, USDbn -74.8 -104.2 -58.9 -17.0 -22.9 -28.8 -34.8
Current account balance, % of GDP -3.0 -4.3 -3.3 -0.9 -1.2 -1.4 -1.7
Foreign reserves ex gold, USDbn 358.8 363.6 356.5 342.2 349.0 359.5 370.3
Import cover, months 14.0 14.3 16.4 20.0 19.6 19.4 19.1
Total external debt stock, USDbn 483.8 556.9 543.4 556.3 522.8 513.2 511.3
Total external debt stock, % of GDP 19.6 23.1 30.7 31.0 26.3 25.6 24.4
Crude, NGPL & other liquids prod, 000b/d 2,114.1 2,346.3 2,527.0 2,613.9 2,544.4 2,682.3 2,833.2
Total net oil exports (crude & products), 000b/d 19.2 147.8 462.2 647.3 567.8 679.3 786.7
Dry natural gas production, bcm 21.4 22.7 23.1 23.9 24.2 25.3 26.1
Dry natural gas consumption, bcm 39.2 41.6 43.7 39.5 40.1 41.2 43.5
e/f = BMI estimate/forecast. Source: National Sources, BMI

www.latinamericamonitor.com APRIL 2017 – BRAZIL 3

  BRAZIL
INDUSTRY OUTLOOK
Modest Growth Forecast
Remains Intact
BMI View: Efforts to strengthen the financial stability of Petrobras will ensure
upstream improvement and encourage private sector participation. The Brazil-
ian recovery will be held back by less robust sector reforms and sustained oil
price weakness.
The Brazilian oil sector continues on its path
toward improvement despite weakness in the
external environment. Nearly three years after
the 'Lava Jato' scandal broke open, national
oil company (NOC) Petrobras is accelerating
efforts to strengthen its financial performance
and secure long-term growth. Since taking the
helm of Petrobras in May 2016, CEO Pedro
Parente's more reformist agenda has helped
stabilise the fallout from the scandal, improv-
ing investor confidence via a more pragmatic
upstream strategy (see 'Reforms Test Upstream
Recovery', November 2 2016).
Though sustained oil price weakness and a
high debt load persist, we believe Brazil holds
considerable upside potential. This is led by a
continued focus in deepwater acreage where
both the NOC and private partners are ex-
panding exploration and development efforts
(see 'Deepwater Potential Luring In Drillers',
January 9).
Notably, an improving regulatory environ-
ment will attract international investment
suggesting a stronger showing at this year's
upstream licensing rounds. In 2017, one
round is confirmed and another is under
consideration in presalt basins, making them
the first auctions in the area since 2013.
As the overwhelming leader within the
sector, Petrobras' efforts to deleverage will
provide the most benefits over the next several
years. Operating over 80% of the Brazilian up-
stream, we believe the reduction of the NOC's
heavy debt load will free up capital for up-
BLOCKS INCLUDED IN 14TH LICENSING ROUND
Basin
Espírito Santo – Offshore
Espírito Santo – Onshore
Paraná
Parnaíba
Pelotas
Potiguar – Onshore
Recôncavo
Santos
Sergipe – Alagoas – Offshore
Sergipe – Alagoas – Onshore
Source: ANP
4 4 BRAZIL – APRIL 2017
stream investment, supporting our forecast for
3.7% y-o-y production growth through 2021.
Recent efforts include a USD5bn oil-for-loan
financing deal with the China Development
Bank which will reduce the NOC's reliance
on debt-financing and support its efforts to
expand in deepwater. In exchange, Petrobras
will supply an estimated 100,000b/d to Chi-
nese firms, solidifying China's dominance of
the Brazilian export market.
Deepwater Luring In Investors
Map Of Brazilian Offshore Basins
Note: Libra is the only existing Production Sharing Contract.
Source: Petrobras, BMI
Petrobras also issued USD4bn in 5- and
10-year notes on the international markets
to extend maturities and free up working
capital. After spiking at 8.3% in November
2016, yields on Petrobras' bonds rallied to
just over 7.0% in January, offering a window
for the NOC to issue the notes. Petrobras
will buy back up to USD2bn of existing
bonds maturing between 2019 and 2020,
lowering their short-term obligations by
just under 18%.
Upstream Challenges Remain
Though we remain optimistic with respect to
growth, our production forecast is less bullish
than that of Petrobras due to enduring above-
ground obstacles. Namely, continued declines
in economic activity have resulted in a hesitancy
towards additional reforms at the municipal
level in an effort to close large fiscal deficits,
including within key oil producing regions.
In December, the state of Rio de Janeiro
– responsible for approximately 70% of na-
tional crude production – voted to abolish a
law that reduces taxes on purchases of oil and
gas equipment, thereby raising costs while
reducing profitability. Producers in portions
of the Campos and Santos basins including
Shell, Total, Statoil and Repsol, will now pay
a combined USD1.2bn in additional taxes per
year as a result of the change.
In addition, repeated legal setbacks have un-
dermined the advancement of Petrobras' divest-
ments – a key component of their long-term
investment strategy. Most recently, on January
31, a Brazilian court order forced the NOC to
suspend the sale of its petrochemical companies
Suape and Citepe, a deal worth an estimated
USD385mn. This follows similar delays target-
ing the sale of the Tartaruga Verde and Bauna
oilfields to Karoon Gas in late 2016.
Finally, sustained oil price weakness will
limit Petrobras' ability to invest upstream.
Though prices have stabilised in the wake of
the OPEC/non-OPEC supply cut announce-
ment on November 30, we caution that in-
consistent compliance and continued output
gains from non-participants will cap upward
momentum over 2017 (see 'Fundamentals
Aligning To Support Price Growth', January
9). This will undermine efforts to increase
investments, supporting our more modest
output forecast.
Blocks
SES-AP1, SES-AP2
SES-T4, SES-T6
SPAR-CN
SPN-N, SPN-SE
SP-AP4, SP-AUP4
SPOT-T1B, SPOT-T2, SPOT-T4, SPOT-T5
SREC-T1, SREC-T2, SREC-T3, SREC-T4
SS-AR3, SS-AR4, SS-AP4
SSEAL-AP1, SSEAL-AP2, SSEAL-AUP2
SSEAL-T1, SSEAL-T2, SSEAL-T4, SSEAL-T5
www.latinamericamonitor.com
 INDUSTRY OUTLOOK

Fuels Demand Will Stage 2016, elevated unemployment will delay a

more robust economic recovery and weigh
on overall demand.

Subtle Recovery Adjustments Weigh On Consumers

Gasoline and Diesel Prices, USD/litre

BMI View: Refined fuels demand will rise in 2017 on the back of a modest
economic recovery. However, growth will be constrained by a large output gap
and still-elevated unemployment.
Brazilian consumption of refined fuels will Bolstered by decelerating inflation and
return to growth in 2017. Following a two- falling interest rates, we believe an influx
year recession, we believe improving business of investment will strengthen the industrial
sentiment will boost investment into the sector. Given its use in the industry, this
country and revive economic activity over the will revive diesel consumption which we
coming year. However, demand growth will forecast will grow by 3.2% y-o-y in 2017,
be limited by continued slack in the economy, having declined by an estimated 5.2% y- Source: Global Petrol Prices

particularly with respect to employment and o-y in 2016.

output (see 'Improving Business Sentiment
Will Drive Modest Recovery', January 5). We
therefore forecast a 0.6% y-o-y increase for the
year, compared to an estimated 4.5% y-o-y
decline in 2016.
Tepid Rebound In 2017
Real GDP and Fuels Consumption Growth, %
Substantial Headwinds Remain
However, we believe economic gains will be
offset by continued slack that has built up over
the past two years, thereby limiting overall
fuels demand. Specifically, production gains
throughout the country will be modest as a
result of under-utilised capacity and ongoing
concerns relating to project financing and
returns (see 'Improvements To New Concessions
Programme Will Not Be Enough', December
9 2016).
Moreover, a new fuel pricing strategy an-
nounced in October 2016 by state-owned
Petrobras will prove challenging for already-
constrained Brazilian consumers. Having
removed costly subsidies over the course of the
past year, the new policy seeks international
parity, with the company evaluating prices on
a monthly basis.
Refined Products Production And
Consumption Forecast
(2015-2026)

Nearing A Comeback
Diesel Consumption and Industrial Production
Growth, %

e/f = BMI estimate/forecast. Source: IGBE, ANP, BMI

Comprising upwards of 46.0% of total

fuels demand, diesel fuel will drive the
recovery in 2017. Over the next several
quarters, an increase in fixed investment e/f = BMI estimate/forecast; Source: ANP, BMI

will increase output y-o-y, with much of the

funds directed toward the upstream sector.
A series of business-friendly reforms enacted
over the past six months have targeted the
oil and gas sector, encouraging private sec-
tor partners to expand their foothold in the
market (see 'Deepwater Potential Luring In
Drillers', January 9).
Source: IBGE, JODI
This will prolong high levels of unem-
ployment with debts dragging on household
spending. At nearly 12.0% as of November
Nonetheless, we maintain that 2017 will
witness a moderate uptrend in demand, as
citizens adjust to modest economic gains,
while contending with continued headwinds.
Beyond this year, we believe fuels consump-
tion will rise alongside economic activity,
averaging 1.7% y-o-y through 2021.

DATA & FORECASTS

2015 2016e 2017f 2018f 2019f 2020f 2021f 2022f 2023f 2024f 2025f 2026f
Refined products consumption, 000b/d 2,136.10 2,040.00 2,052.20 2,080.90 2,126.70 2,162.90 2,197.50 2,241.40 2,284.00 2,322.80 2,360.00 2,395.40
Refined products consumption, % y-o-y -5.8 -4.5 0.6 1.4 2.2 1.7 1.6 2 1.9 1.7 1.6 1.5
Dry natural gas consumption, bcm 43.7 39.5 40.1 41.2 43.5 45.1 46.4 47.6 48.6 49.6 50.5 51.3
Dry natural gas consumption, % y-o-y 5.1 -9.7 1.5 2.8 5.5 3.7 3 2.5 2.2 2 1.8 1.6
Crude & other liquids net export, 000b/d 422.5 703.5 595.8 667.5 737.8 833.1 953 988.1 1,015.70 1,088.10 1,181.80 1,297.90
Crude & other liquids net export, % y-o-y 308.4 66.5 -15.3 12 10.5 12.9 14.4 3.7 2.8 7.1 8.6 9.8
Crude & other liquids net export, USDbn 7.7 10.5 11.7 13.9 16.4 19.5 23.3 24.9 26.3 28.6 31.1 34.1
e/f = BMI estimate/forecast. Source: BMI

www.latinamericamonitor.com APRIL 2017 – BRAZIL 5

  BRAZIL
This report is from our latest Brazil Oil & Gas
report, which includes in-depth research on the
sector, full five-year forecasts and a thorough
analysis of the competitive landscape. BMI
currently covers 24 industries across over 180
countries. For further information, or to order
a report, please contact subs@bmiresearch.com.
BMI Industry View
BMI View: Brazil’s vast presalt reserves suggest
substantial growth potential over the long term,
underpinning our view that crude, natural gas,
and other liquids output will rise over the next
decade. However, production growth will be
tempered by declining investment funds from
Petrobras, continued headwinds from the cor-
ruption scandal and a still challenging policy-
making environment.
Latest Updates and Key Forecasts
• Petrobras posted a BRL16.5bn
(USD4.9bn) third quarter loss on No-
vember 10. The loss was driven by a
BRL15.3bn impairment on its assets and
a BRL417.0mn write down of its invest-
ments. The results disappointed analyst
expectations of a BRL1.5bn profit and
threaten downside pressure on the share
price. However, we believe the outlook
on Petrobras remains broadly positive
from a multi-year perspective though
significant risks remain.
• In December, Petrobras announced the
start-up of upstream operations from
Lapa presalt field in the Santos basin. The
FPSO Caraguatatuba has the capacity
to process 100,000 b/d and is operated
in partnership with BG and Repsol
Sinopec Brasil.
• Brazil’s economy will stage a modest
recovery in 2017, emerging from a re-
cession that began in Q214. Investment
will drive the recovery, as business senti-
ment improves in light of decelerating
inflation and more business-friendly
policies. However, the recovery will be
constrained by substantial slack in the
economy, including a large output gap
and still-elevated unemployment. We
have downgraded our forecast for growth
in 2017 to 0.8%, from 1.0%.
• We believe Brazil’s ultra-deepwater acre-
age will be a hotspot for global oil and gas
6 6 BRAZIL – APRIL 2017
KEY SECTORS
Oil & Gas
exploration this year. After a prolonged
oil price downturn, developers have en-
gineered increasingly efficient methods to
tap resources, supporting greater activity
as prices stabilise and rise. National oil
company (NOC) Petrobras has improved
well productivity in the presalt by 30%
since 2010, lowering breakevens in the
play to below USD45/bbl and incentivis-
ing greater private sector participation.
• The Brazilian oil sector continues on its
path toward improvement despite weak-
ness in the external environment. Nearly
three years after the Lava Jato scandal
broke open, Petrobras is accelerating
efforts to strengthen its financial per-
formance and secure long-term growth.
Since taking the helm of the company in
May 2016, CEO Pedro Parente’s more
reformist agenda has helped stabilise
the fallout from the scandal, improving
investor confidence via a more pragmatic
upstream strategy.
• Brazilian consumption of refined fuels
will return to growth in 2017. Follow-
ing a two-year recession, we believe
improving business sentiment will boost
investment into the country and revive
economic activity over the coming year.
However, demand growth will be lim-
ited by continued slack in the economy,
particularly with respect to employment
and output. We therefore forecast a 0.6%
y-o-y increase for the year, compared to
an estimated 4.5% y-o-y decline in 2016.
Industry Forecast
Gas
Rising natural gas-fired electricity consump-
tion combined with rising domestic power
demand will result in a negative natural gas
trade balance throughout our forecast period.
Brazil’s efforts to increase gas production will
not be sufficient to meet more robust domestic
demand, resulting in a deterioration of the net
trade balance through 2025.
Latest Updates
• Between January and September 2016,
LNG imports into Brazil fell by 63%
y-o-y according to a Petrobras announce-
ment. Imports reached 42,000b/d
compared to 112,000b/d in 2015. The
decline was attributed to a reduction in
thermoelectric demand in the country as
macroeconomic activity slowed.
• Petrobras’ proposed sale of two LNG
import terminals remains under threat
as an associated legal case regarding the
Pecem port advances. The lawsuit hopes
to remove all fuel storage and distribution
operations from a portion of the port
which includes the Pecem floating LNG
terminal due to the hazardous nature of
the infrastructure.
Structural Trends
An increase in natural gas-fired electricity gen-
eration coupled with an overreliance on less
reliable hydropower generation will support
demand for natural gas as a source of power
feedstock. With domestic gas output already
below consumption levels, this increase will
require greater amounts of imports, increasing
the trade deficit over the course of our forecast
period. As such, we forecast the balance will
decline from a net deficit of 15.6bcm in 2016
to a deficit of 19.8bcm by 2026.
With the majority of the country’s natural
gas imports having traditionally come from
Bolivia by pipeline, Brazil has increased its
supply of natural gas via LNG to confront
both rising consumption levels and concerns
over adverse weather conditions. However,
with the GASBOL pipeline nearing max
import capacity, persistent droughts and a
planned increase in natural gas-fired power
capacity will require consistent amounts of
LNG imports over the next decade.
Brazil’s three LNG import terminals allow
the country to hedge against a shortage of gas
supply from insufficient domestic production.
However, spot-market purchases have taken a
financial toll on the NOC, straining the coun-
try’s power grid and raising electricity prices.
Such activity will be supported by the
development of additional LNG terminals,
namely by Grupo Bolognesi (GB) following its
awarding of a new natural gas-fired power plant
at the A-5 power auction in November 2015.
The company will invest nearly USD2.3bn in
the construction of two new LNG regasification
facilities to supply the two 1,238MW gas-fired
power plants it will build in Pernambuco and
Rio Grande do Sul. In February 2017, the
government set a deadline for August to prove
the viability of the plants. The facilities were
expected to begin operating in 2019 while the
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two LNG terminals targeted a H117 start-up.
This long-term LNG agreement would
be the first in Brazil’s history as Petrobras has
historically purchased LNG exclusively through
the spot market. The 25-year commitment of
the PPA encouraged GB to opt for this method
due to the more costly nature of spot market
purchases. As such, GB’s long-term purchasing
agreement, combined with Petrobras’ contin-
ued demand for LNG supplies amid less robust
production growth, supports our view that
Brazil’s LNG market will remain viable through
2026. Additional supplies from deepwater plays
serviced through the Route 2 pipeline inaugu-
rated in February 2016 will not be enough to
service domestic demands. Namely, we expect
that production growth will be outpaced by
consumption as additional gas-fired power
capacity is brought online through 2020. This
will maintain Brazil’s trade deficit through the
end of the decade as new generation facilities
demand increasing amounts of feedstock.
Moreover, we caution that the Route 3
pipeline is likely to experience delays own-
ing to its planned point of delivery, the
Comperj refinery. The 165,000 b/d facility
is one of several downstream facilities being
re-evaluated in the wake of the Petrobras
scandal due to its inflated project costs and
alleged involvement in the scandal. Given the
refinery’s continued suspension we have yet to
include either project in our current forecast
for downstream capacity growth. Such delays
will undermine the development of the third
deepwater natural gas pipeline and supports
our view for higher import demand through
the remainder of the decade.
Oil
Rising oil production will improve Brazil’s
overall crude and liquid trade balance over
our 10-year forecast period. Although below-
ground rewards will provide considerable gains
for the upstream sector, looming debt and
strong operational headwinds will weigh on
downstream capacity expansion, maintaining
the country’s status as a net importer of fuels.
Crude Oil Trade Forecast
Latest Updates
• Our forecast for crude exports remains
constant this quarter. Rising domestic
demand will reduce Brazil’s trade sur-
plus over the next two years. The lack of
downstream capacity expansion will free
up more crude for exports, raising total
shipments through 2026.
• In Q316, Petrobras announced a 14.8%
y-o-y increase of crude exports to an aver-
age of 419,000b/d while corresponding
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imports fell by more than 50.0% y-o-y
to 154,000b/d.
Structural Trends
With Brazilian crude production expected
to rise over the next decade, we expect the
country’s net deficit of oil to decline over the
course of our 10-year forecast period. Specifi-
cally, we expect crude output to increase by
3.5% y-o-y through 2026 driven by rising
output in deepwater pre-salt acreage. Stalling
downstream capacity growth will free up more
of this crude for export, increasing net exports
from an estimated 700,000 b/d in 2016 to a
surplus of over 1.2mnb/d by 2026. However,
a potential restart of refining projects poses
downside risk to this forecast as more output
would be utilised as domestic feedstock. We
do not foresee a rise in downstream capacity
happening over the next year given Petrobras’
increased focus on upstream operations and
continued financial constraints.
Reduced US consumption of Brazilian im-
ports will encourage producers to tap alternate
sources of demand. We believe Asian countries
will make up a greater share of Latin American
export volumes due to their relative market
size and existing commercial ties between the
two regions. Specifically, we believe China and
India will lead this charge given a broad strat-
egy to increase refining capacity and diversify
exports away from Middle Eastern grades.
Since Petrobras’ signing of a USD7.0bn loan
with the Chinese Development Bank in
May 2015, exports to China have increased
markedly. In 2015, the country’s share of the
Brazilian market went from 20.6% in 2014 to
nearly 40.0%. This trend accelerated in 2016
and is expected to remain intact in 2017.
Refined Fuels Trade Forecast
Latest Updates
• We maintain our forecast for refined fuels
trade this quarter following the delay of
RNEST train 2. As refineries continue to
be delayed, import demand will rise de-
spite weaker consumption growth amid
a low-growth macroeconomy.
• We believe Brazil will remain a net import-
er for the majority of our forecast period as
stagnating downstream capacity is unable
to catch up with rising domestic demand.
Structural Trends
In the absence of downstream capacity growth,
Brazil will be unable to meet rising domestic
demands through 2020. This is attributed to a
lack of growth within the refining sector which
will require increasing amounts of imported
volumes as the Brazilian economy recovers.
The primary source for refined fuels will
continue to be the US as rising crude produc-
tion has permitted a substantial increase in its
refined products exports. Specifically, imports
from the US have risen from an average of
55,000b/d in 2009 to 180,000b/d by 2015,
comprising over 25% of total imported fuels.
Though import demand likely fell in 2016
on the back of lower demand, we expect this
trend will remain largely intact over the long
term as consumption trends recover.
Although there are vast below-ground
rewards in Brazil, we note our forecasts are
still somewhat conservative as a result of
mounting above-ground obstacles. This stance
is underpinned by Brazil’s still challenging
investment environment and Petrobras’ sig-
nificant financial burden, amounting to over
USD120bn in total debt through Q316.
However, we recognize a degree of upside po-
tential to our production and trade forecasts,
dependent upon the country’s ability to revive
its downstream expansion plans, particularly
beyond 2017.
Refining
Petrobras’ near monopoly over Brazil’s refining
sector will perpetuate an imbalance between
production and consumption. We believe the
country’s overall capacity will be stymied by con-
tinued infrastructure delays, weighing on Brazil’s
fuels trade balance for the foreseeable future.
Latest Updates
• We maintain our forecast for refining
capacity growth this quarter having ac-
counted for Petrobras’ delay of the Abreu
e Lima (RNEST) train 2 in Q117. During
its Q316 results announcement in Novem-
ber, the company announced it had taken
a BRL2.5bn impairment on the RNEST
facility, resulting in the repeated delay.
• In Q316, Petrobras’ share of domestic oil
used as processed feedstock increased to
93% from a rate of 84% the year prior.
This represented the 11th consecutive
quarter of increase. Over the first 9M16,
the average share of domestic oil was 91%
vs. 86% in 9M15.
Structural Trends
Petrobras operates nearly all of Brazil’s current
refining capacity, comprising 12 refineries
which are largely in the south-eastern indus-
trial heartland of the country. The most recent
start-up was phase I of the Abreu e Lima
project in November 2014 which raised the
country’s capacity to approximately 2.4mn
barrels per day (b/d).
Petrobras had plans to expand the country’s
APRIL 2017 – BRAZIL 7
  BRAZIL

downstream capacity over the past two years,
including the start-up of the 115,000b/d phase
II of the Abreu e Lima facility in H215. Fur-
thermore, the 165,000b/d Comperj refinery
was expected to start up in 2016 but has yet
to be re-tendered following its suspension
amid allegations that its builders Iesa and
Queiroz Galvão were involved in the cor-
ruption scandal.
In January 2016, Petrobras announced it
would resume construction work on Abreu e
Lima Phase II later in the year, with plans to
bring the project online by year-end 2017.
On July 22, the company’s board of directors
approved plans to resume construction at
both RNEST and Comperj. This will allow
continuation of procurement activities to
complete the sulphur emissions reductions
unit and other construction work for phase
II. This will allow the facility to treat up to
650,000cm of gas and to produce 750,000
tonnes per day of sulfuric acid. Our view for
continued delays to the project played out in
November 2016 when the company delayed
RNEST train 2 to 2023.
With respect to Comperj, the board ap-
proved work to resume for the implementation
of the natural gas processing unit. This is facil-
ity is part of the company’s Route 3 integrated
project which will eventually connect to the
third offshore pipeline planned in deepwater
acreage. This is a crucial element of the project
given the deficit of domestic supplies for use in
the power sector. The remaining units of phase
I, however, remain suspended until December
2020 while phase II was cancelled, supporting
our log-held downstream forecast.
Continued delays are largely due to the fact
that downstream facilities have cost significant-
ly more than originally estimated. For exam-
ple, the Comperj refinery’s total cost increased
from an initial USD8.5bn to USD13.5bn,
after which it rose to USD21.6bn after a
four year construction delay before being
suspended altogether. Moreover, the account-
ing scandal forced Petrobras to repeatedly cut
downstream capex given their reduced ability
to access international capital markets. The
NOC’s continued prioritisation of upstream
development will hinder downstream devel-
opment, as evidenced by the abandonment
of the Premium I and Premium II refineries
in January 2015, accounting for a combined
600,000b/d in lost capacity.
Depending on the rate at which Petrobras
is able to recover from the Lava Jato scandal,
we acknowledge potential upside risk to our
more bearish forecast. However, given the
NOC’s challenging financial position, we
believe advancement of cancelled projects is
highly unlikely. We do see scope for the com-
pletion of projects under construction, but
not until the NOC can shore up its finances
in a meaningful way. This is further supported
by reductions to the company’s BMP which
suggest downstream projects have been de-
prioritised.
Biofuels Production
Ethanol and other biofuels output is estimated
to have reached to 560,000b/d in 2016 as a
result of stronger government-led support. The
Brazilian authorities indicated a commitment
to bolstering biofuels production, putting in
place a number of policies, including:
• An increase of mandatory ethanol content
in gasoline from 20% to 25% in May 2013,
and from 25% to 27% in March 2015
• Access to cheap credit through the
prorenova programme which provides a
credit line (BRL4bn in 2013) to finance
and/or expand sugarcane fields. Payment
is due within 72 months, and in the past
year, interest rates have dropped
• A sales tax break of BRL0.12/litre
(USD0.06/litre) on ethanol exports
We forecast the Brazilian real will aver-
age BRL3.35/USD in 2017 rising from
BRL3.48/USD in 2016 amid rising com-
modity prices and improving investor
sentiment. This will have a notable impact
on the biofuels sector with respect to ex-
port demand as Brazilian supplies become
increasingly competitive.
However, we see rising downside risk to
our forecast as a result of weaker government
support under the Temer administration. In
addition, though we expect US demand will
rise, a potential policy reversal could weaken
our forecast. In October 2016, the Environ-
mental Protection Agency (EPA) finalised
the volume requirements of biofuels in the
US gasoline supply in the Renewable Fuel
Standard (RFS) for 2014 through 2016. The
mandated blending volumes for all types of
renewable fuels increased markedly over the
three year period, providing support for more
competitively priced Brazilian exports.
Gas Consumption
Growing dependence on natural gas-fired elec-
tricity in Brazil will raise consumption levels
over the next decade. A deficit of domestic
feedstock will maintain Brazil’s reliance on
pipeline imports and require continued pur-
chases of LNG, weighing on the financially
overstretched Petrobras.
Latest Updates
• We maintain our outlook for Brazilian
natural gas consumption this quarter as
hydropower capacity continues to grow.
The country will continue to diversify its
power mix, but at a less robust rate than
previously anticipated.
• Improved status of the country’s hydro-
power reservoirs following the comple-
tion of the El Niño phenomenon in
Q216 reduced thermoelectric power
demand in Brazil, thereby reducing de-
mand for natural gas.
Structural Trends
Given our Power team’s stronger growth
forecast for hydropower capacity, we maintain
our more modest gas consumption growth
forecast which expects demand to rise by an
average rate of 2.7% y-o-y through 2026. This
reflects recent advances in the implementa-
tion of Brazil’s massive hydropower project
pipeline, cementing our view that this source
will dominate the country’s energy mix over
the next decade.
However, natural gas will remain a crucial
part of Brazil’s power matrix given the inherent
challenges associated with hydropower. Our
Power team has highlighted the risks associated
with Latin American countries’ heavy reliance
on hydropower, often resulting in severe en-
ergy shortages when confronted with adverse
climate conditions. Brazil’s dependence on this
type of power for nearly 70% of its generation
capacity revealed a fatal flaw in the country’s
electricity matrix. Severe droughts in 2012,
and again in 2014/2015, reduced reservoir
levels to below 30%, with some regions falling
below 20%.
Natural gas is the dominant source of
thermal power generation in Brazil and we
expect it will account for just under 12.0%
of the country’s power mix in 2017. As a
result of thermal power plants being idled as
hydropower generation recuperates after the
2015 drought, we expect total gas-fired power
generation to have contracted by 6% in 2016.
Moreover, the long-term outlook for gas has
deteriorated; we now expect gas-fired power
generation to total 87.0TWh in 2025, down
from a previous estimate of 90.6WTh.

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