August 30, 2007

BEYOND 'PETROSAURUS'

How a Sleepy Oil Giant Became a World Player Petrobras Taps Well Of Brazilian Talent; Inspired by Tadpoles By MATT MOFFETT August 30, 2007; Page A1

RIO DE JANEIRO -- A decade ago, state-controlled oil company Petrobras was such an industry laggard that it earned a nickname: Petrosaurus. Workers were 25% less productive than the industry average, and Brazil depended on imports for nearly half its oil. Petrobras's board consisted solely of company insiders. Today, Petrobras boasts more crude reserves than Chevron Corp., lower costs of finding oil than Exxon Mobil Corp., and a listing on the New York Stock Exchange -- with a market value of around $130 billion. It's a rare success story among state-owned oil companies as they play a growing role in an energy-hungry world. Three-quarters of the world's reserves are now in the hands of national oil companies, according to the International Energy Agency. ConocoPhillips Chairman James Mulva recently said that the top publicly owned international oil companies now have direct access to only about 5% of the world's oil reserves, with an additional 30% theoretically open through joint ventures. Most national companies are far less efficient at developing their reserves than Petrobras, whose full name is Petróleo Brasileiro SA. Production at giant Petróleos de Venezuela SA has fallen by one-quarter since President Hugo Chávez took office in 1999 and started milking the company's coffers to fund social programs. Indonesia, whose state energy company has had a history of graft and cronyism, recently turned into a net oil importer from an exporter. "If only our friends in OPEC were more like Petrobras we'd all be a lot happier because there would be a lot more oil," says Leo Drollas, chief economist of the London-based Center for Global Energy Studies.

One key to Petrobras's success is technology. Seventy miles out on the Atlantic Ocean, a 10-story-size floating production platform, P-37, is a showcase for the deep-water prowess of the company. About one in three pioneer wells Petrobras drilled in this area, known as the Campos Basin, hit pay dirt, an extraordinary percentage by industry standards. Since its founding in the 1950s, Petrobras has been a magnet for talented Brazilians, many motivated by patriotism to work for a company that symbolizes Brazilian nationalism. What has changed since the 1990s is its corporate structure. To prod Petrobras to be more open and accountable, the government set up an independent board of directors and floated shares in New York. It also abolished Petrobras's monopoly on drilling for oil in Brazilian territory. Competitive Pressure The entry of foreign companies ratcheted up competitive pressure and helped ignite a productivity revolution inside Petrobras. Over the past decade, the company has doubled oil production, boosted reserves by about 50%, and expanded internationally from Argentina to India. Petrobras's successes, plus a national project to extract ethanol from sugar cane to power vehicles, have helped Brazil achieve self-sufficiency in oil. Petrobras "learned over the last 10 years to think on its feet like an international oil company but still retained the strengths and advantages of a national company," says Richard D. Taylor, president of BP PLC's Brazilian operations. Other energy-producing countries are taking note. Delegations from a host of countries, including Mexico, Nigeria and Peru, have flown to Rio de Janeiro

to study Brazil's energy model, says Haroldo Lima, president of Brazil's National Petroleum Agency, a regulatory body. A number of oil companies are pursuing joint ventures with Petrobras, lured by access to Brazil's reserves and Petrobras's technology. One is Norway's state-controlled Statoil ASA, which is also highly regarded for its efficiency. Statoil is studying Petrobras's techniques for installing wellheads on the sea floor, while providing Petrobras with know-how on extending the life of maturing fields. Norway's King Harald V came to Rio in 2003 to formalize the deal with Brazil. Meanwhile, Petrobras has expanded abroad and now operates in 27 countries, more than double the number it did a decade ago. It recently became the first oil company to win U.S. regulatory approval to deploy a floating platform in the Gulf of Mexico. In the event of a hurricane, workers will be able to detach the connection between the platform and the well, allowing the platform to float away. For all of the company's success, some Brazilian analysts fret that politicians are meddling with Petrobras's formula. Much of the groundwork for the company's transformation was laid under the centrist government of Fernando Henrique Cardoso, who left office at the beginning of 2003. His successor and longtime rival, the leftist Luiz Inácio Lula da Silva, has faced criticism for injecting a tint of politics in the company's management. Under Mr. da Silva, Petrobras has sometimes forgone revenue by not immediately passing on to consumers international price increases of politically sensitive products like gasoline, cooking gas and diesel oil. More controversial is Mr. da Silva's move to make Petrobras buy more Brazilian-made equipment, which he says will stimulate domestic industries. After a couple of largely Brazilian-made rigs recently came in substantially over budget, some analysts questioned the policy. José Sergio Gabrielli, who has been Petrobras's president since July 2005, says criticisms are off the mark. He says the extra rig costs resulted from higher steel prices and a stronger Brazilian currency. As for the pricing policy, Petrobras says it's just trying to smooth out dramatic fluctuations. Mr. Gabrielli says critics ought to focus on the company's record profits, strong stock performance and improved environmental record. Petrobras officials argue that the company's dual identity -- part embodiment of Brazilian nationalism, part Wall Street growth play -- is an asset. "We view ourselves a having the best of both worlds," says financial director Almir Guilherme Barbassa. The company is able to draw on some of the best minds in the country, both in its sprawling in-house research laboratories and in its collaborations with Brazilian universities. Over the past several years, Petrobras has been signing new partnerships

with universities at a rate of one per business day. One cooperative venture funded by Petrobras royalties is a massive water tank at the Federal University of Rio de Janeiro. The tank, slightly bigger than a tennis court and 50 feet deep, simulates winds and waves encountered offshore, and ultimately helps design safer platforms. Ney Robinson Salvi dos Reis, an engineer at Petrobras's own lab, has a number of robotics patents to his credit. One cylindrical robot he designed cleans the gunk out of offshore pipelines. He got the inspiration for it by studying the swimming motion of tadpoles. Mr. Reis's latest invention looks like something out of Star Wars: a glass cockpit mounted on a buggy with big fiberglass wheels. This "environmental robot," with a camera mounted in the cockpit, can rumble over land and float on rivers to monitor the impact of a Petrobras gas pipeline running through the Amazon.

Petrobras was created in 1953 amid the nationalist rallying cry "O petróleo é nosso!" -- "The oil is ours." The rhetoric was somewhat theoretical, since at the time Brazil was producing only 2,700 barrels a day. Unlike most state companies, which were either born with reserves or nationalized them, "our objective was to find reserves," says Mr. Gabrielli, the Petrobras president. With more than 80% of Brazil's oil lying offshore, Petrobras began adapting land rigs for offshore conditions and deploying diving teams to do the perilous work of maintaining them. As it moved into depths beyond 1,000 feet, Petrobras built robots to do the underwater upkeep. Despite the company's technical competence, its management was parochial and sometimes undermined by politicians. The board consisted of Petrobras's top executives, and the company's monopoly on Brazilian territory relieved it of the need to raise efficiency. The company's

international trading arm busied itself marketing shoes and lobsters. Sky-High Inflation In the 1980s and part of the 1990s, the government set artificially low prices for Petrobras's gasoline and other products to try to arrest the sky-high inflation that then ravaged Brazil. The policy starved Petrobras of investment capital. While other oil companies racked up windfalls during the price runup amid the 1991 Gulf War, Petrobras bled red ink because it was selling highpriced imported oil at a loss. When he became Brazil's president in 1995, Mr. Cardoso says, Petrobras was in a state of "total confusion." Knowing that Mr. Cardoso wanted to shake the company up, the powerful oil-workers union challenged him with a national strike in 1995. But the walkout backfired. With kitchens running short of gas and long lines at service stations, public opinion swung against the status quo at Petrobras. Mr. Cardoso termed his policy for Petrobras "flexibilization." He wasn't willing to privatize it fully, but he used market forces, like a stock flotation and foreign competition, to make Petrobras behave more like a private company. In 1999, the government started allowing foreign operators to bid against Petrobras for offshore blocs. To prepare the company for competition, Mr. Cardoso named an investment banker as its president. The new chief cracked down on dicey deals with suppliers, started an incentive-based bonus system for managers and cleaned up the books by acknowledging billions of dollars in pension and health liabilities. The next year, the government sold a 16% stake in Petrobras for $4 billion on stock markets in New York and São Paulo. While Petrobras shares already traded locally, the Big Board listing "had a big impact on governance," says Mr. Gabrielli. "It forces transparency. It forces disclosure." U.S. Standards Petrobras has adopted U.S. accounting standards and faces scrutiny from some 50 Wall Street analysts who follow the company's shares, among the most widely traded overseas issues on the New York Stock Exchange. Under the company's two-tier stock structure, the federal government maintains a slight majority of voting shares, but about 60% of overall equity is now in the hands of outside shareholders. The government of Mr. Cardoso also created Petrobras's first independent board of directors. Even critics of Mr. da Silva, Brazil's president, praise him for beefing up the nine-member board with four heavyweight Brazilian corporate executives. They include Roger Agnelli, chief executive of Companhia Vale do Rio Doce SA, a giant mining company, and Jorge Gerdau, head of Grupo Gerdau SA, a multinational steelmaker.

The arrival of foreign competitors has had a huge psychological impact on Petrobras. But the international operators have encountered a steep learning curve made tougher by Brazil's legislation covering environmental and labor matters. In a number of exploration and production projects, international companies such as Royal Dutch Shell PLC and Spain's Repsol YPF have formed joint ventures with Petrobras rather than competing with it. Oklahoma City-based Devon Energy Corp. recently became the first international firm to produce oil in Brazil without Petrobras's help. International oil companies are projected to invest about $25 billion in Brazil through 2011, about one-quarter of total oil-industry investments in that period, according to the Brazilian Petroleum Institute, a trade group. For its part, Petrobras has tripled spending on research and development over the past five years to $700 million in 2006. The company's sprawling research center develops technologies that are being adopted throughout the offshore industry. Rather than using a conventional steel anchor to moor its platforms, Petrobras found a more efficient way: dropping a 55-foot-long, 100-ton torpedo that embedded in the ocean floor and was tethered to the rig by a high-strength polyester cord. Platform 37 in the Atlantic, a floating production unit made from a converted tanker, is staffed with a personal trainer and outfitted with a gym and a small swimming pool for workers. Fresh fruit and produce are shipped aboard regularly. "If you're Brazilian, you dream of working at Petrobras," says Fernando de Souza Mello, 23 years old, who recently arrived to work in the control room. The captain is Rogerio Proner, a Petrobras veteran. He says P-37 is hitting new milestones in recovering oil and preventing worker accidents. Also on the upswing is Mr. Proner's Petrobras stock, which has risen in value eightfold to $200,000 over the past eight years. At the time of the opening to foreign investment, he says, "there was some fear about what would happen. But the threat of competition turned out to be a healthy thing."

1

Write to Matt Moffett at [email protected]