Dilma's Power Problem

Politics are hobbling Brazil's once-brilliant energy future

Brazil, the old joke goes, is the country of the future -- and always will be. Unfortunately, when it comes to fulfilling the promise of the country's rich energy resources, the joke rings only too true.

Brazil's transformation into an energy powerhouse, seemingly so close just a few years ago, has been hobbled by politics. The country's ability to take advantage of massive offshore oil resources is increasingly questioned, its once-vaunted biofuels industry is reeling, and there are even concerns this year about keeping the lights on and power companies solvent.

There are plenty of things to blame for the hiccups, starting with a severe drought that has hamstrung Brazil's ability to generate electricity from hydroelectric power, which in turn as led to a spike in fuel imports to run other power plants.

But at heart, the culprit is politics: Specifically, Brazil's tricky efforts to balance full-out energy development while keeping the state's hand firmly on the tiller. Complicating everything are government policies, championed by president Dilma Rousseff that are meant to keep prices and inflation in check, which is always important but doubly so in an election year.

"Five years ago, Brazil could get away with" a more heavy-handed approach to energy development, "but now there are political and economic constraints, and they are growing," Joao Augusto de Castro Neves, a Latin American analyst at the Eurasia Group, told Foreign Policy. "The situation is unsustainable, and the question is: How will Brazil deal with it?"

A few years ago, before the shale boom transformed the United States into an energy powerhouse, Brazil was the energy world's golden child. Sugarcane brewed into ethanol fueled a biofuel-powered fleet of cars. Abundant dams and hydroelectric power led to one of the world's cleanest electricity systems. And abundant offshore oil resources, the second largest in the region, promised a future of oil-export-driven wealth that could underwrite a new social compact with Brazil's poor.

For some, Brazil is still the country to watch. The International Energy Agency highlighted the country's promise in its latest World Energy Outlook, and still expects Brazil to account for a whopping one-third of the increase in global oil supplies over the next two decades. 

But what a difference five years make. The U.S. shale boom, which applied new technology to previously uneconomic reserves of oil and gas, has already unleashed as much new oil production in the United States as Brazil expects to see by the end of the decade. Mexico is embarking on an ambitious reform of its energy sector, with an eye toward reversing years of stagnation and decline. Even Argentina is adopting more market-friendly policies in a bid to spur the development of its own energy resources.

Meanwhile, Brazil's ability to promptly tap its offshore wealth is coming into question. The state-controlled oil firm, Petroleo Brasileiro or Petrobras, has the most ambitious investment plan in the industry, with plans to invest about $237 billion through 2017, including almost $150 billion for exploration and production in Brazil's offshore oil fields. The company's goal is to double oil production from about 2 million barrels per day to more than 4 million barrels a day by 2020.

But the firm is bleeding money in its refining arm and piling on debt, in large part because of government policies designed to keep domestic fuel prices below international prices. That's part of a broader government push to keep energy prices low in order to bolster economic competitiveness, a concern shared by policymakers from Tokyo to Berlin. But it's also having negative knock-on effects on the power sector and biofuels.

As the drought curbs Brazil's hydroelectric output, for example, the country is relying on more expensive imports of natural gas to run power plants. (California has a similar problem.) But the government doesn't want to jack up the electricity rates it prominently slashed last year. So power companies are stuck with the tab. Last year, the Brazilian government picked up the difference, and analysts assume it will do so again this year, adding as much as $6 billion to its fiscal obligations.

Those artificially low fuel prices have also squeezed homemade ethanol, one of the other pillars of Brazil's quest for energy self-sufficiency. Five years ago, the clean, domestic fuel powered four out of every five cars in Brazil; today, Bloomberg reports, it's down to one-quarter. Investment, and job creation, in the ethanol industry have followed suit.

The government's desire to keep domestic energy prices low hits Petrobras hardest. Coupled with rising demand for oil products in Brazil, and a currency that has lost value against the dollar, the oil company has to buy high on the international market and sell low at home for a loss -- domestic prices are 25 percent to 30 percent lower than overseas. A country that was meant to ride oil wealth to energy independence has instead ramped up imports of fuel, including refined products from the U.S.

The oil giant got a little relief last year on fuel prices -- a couple of small price hikes meant to bring domestic fuel prices closer to international levels -- but not the wholesale convergence between local and global prices that Petrobras executives constantly push for, and on which its investment plan and production expectations are based.

One solution would be to raise domestic fuel prices closer to international levels. But that's especially difficult during an election year, when the Brazilian government is still battling stubbornly high inflation. Keeping fuel prices artificially low is one way to avoid a repeat of last year's street demonstrations.

"When push comes to shove, what drives the government's approach (to the fuel-price question) is inflation," Castro Neves said. "The way things are set up today, oil production looks like it will increase more slowly than expected."

There are other political considerations that also stress Petrobras and raise questions about how realistic the offshore oil plans are. Under the rules of offshore development, the company has to have a 30 percent stake and be the lead operator in every project. The government also mandates that locally built gear, such as drilling platforms, make up an ever-bigger piece of the supply chain for offshore development. That is adding costs to an already expensive place to drill for oil. Ratings agencies, such as Moody's Investors Service, have put Petrobras on a negative outlook because of downstream losses, rising debt, and onerous conditions for offshore development.

"Petrobras is in danger of not meeting its investment targets," Gonzalo Escribano, an energy analyst with the Real Instituto Elcano in Spain, told FP. He said that the local-content rule could lead to a bottleneck that could crimp the pace of offshore oil development, by reducing future revenues that in turn could redouble the financial pressure on the firm.

To be sure, as much as Brazil's energy potential is limited by political considerations, the country's energy policy has been a lot more effective than many others in Latin America.

Venezuela, for example, has driven down oil production through mismanagement of its own state-owned oil company, and has been plagued by several major blackouts in its power sector. Argentina is blessed with some of the biggest shale reserves in the world, but has struggled to entice foreign investment. Even Mexico, for all its grand plans to reverse more than seventy years of oil nationalism, has yet to work out the details of just how it will open its energy sector and reverse years of production declines.

"Even if it's not as attractive as it was four or so years ago, Brazil is still in better shape than plenty of other countries," Escribano said.

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Hey Ukraine, That Crackdown Is Gonna Cost You

With Kiev in flames, the West hopes sanctions will force the Ukrainian government to put down its guns.

After weeks of disagreement between American and European leaders over how to respond to escalating violence in Ukraine, the mounting bloodshed and chaos in the streets of Kiev seems to have finally brought about a hard-won consensus.

United States and European Union officials made clear that they would be prepared to move ahead with targeted sanctions against the government of embattled Ukrainian President Viktor Yanukovych if his security forces continued using live ammunition against the protesters clogging the streets of most of the country's major cities.

The situation continued to spiral out of control Thursday, after a truce announced by the government Wednesday quickly fell apart. Government snipers shot into crowds of protesters who also took up arms and lobbed firebombs back at police. The new bout of violence left 70 people dead and brought the weekly death toll to at least 99, according to the Associated Press.

With events on the ground in Ukraine changing almost by the hour, the Obama administration and its allies began imposing a limited set of punitive measures and laying the groundwork for a more extensive campaign. On Wednesday, the State Department barred 20 Ukrainians from getting American visas. A senior State Department official wouldn't name the people, but said it included "the full chain of command" of Ukrainian government and security personnel involved in the crackdown that left 26 people dead and hundreds injured earlier this week. The official stressed that the United States and the EU were prepared to take further measures if the situation in Ukraine doesn't improve.

That discussion has sparked a harsh response from Russia. A top Russian official condemned threats of sanctions Thursday and criticized EU diplomats' overtures to the Ukrainian government.

"How can you expect that your services will be in demand when the parallel threat of sanctions makes everything very similar to blackmail?" Russia's foreign minister, Sergey V. Lavrov, said during a visit to Iraq.

Sanctions are emerging as the latest flashpoint between Moscow and the West. Both sides have issued competing offers of financial aid to help the struggling Ukrainian economy. The current crisis began late last year when Ukrainians took to the streets after Yanukovych rejected an EU trade deal in favor of a bailout from Russia.

German Chancellor Angela Merkel, who dismissed the idea of sanctions just weeks ago, reversed course Wednesday and said that EU foreign ministers would discuss imposing sanctions at a meeting Thursday. At a joint press conference with French President Francois Hollande, Merkel said sanctions would show that the EU was serious about pressing for a political solution in Ukraine.

The cooperation on sanctions marks a sharp change for U.S. and EU leaders, who have been bitterly divided about how to respond to the Ukrainian political crisis. U.S. leaders have been preparing sanctions for weeks, but EU officials opposed sanctioning Kiev and had instead preferred to provide Ukraine with financial assistance designed to boost its moribund economy. European leaders, in an about face from their earlier opposition, have now joined the U.S. chorus calling for sanctions against Ukrainian officials.

The acrimony of the U.S.-European divide was revealed in discussions among senior diplomats about the two sides, which leaked two weeks ago. In a now infamous conversation posted to YouTube, Assistant Secretary of State Victoria Nuland told the American ambassador to Ukraine that Europe was taking too soft a line with Yanukovych. "Fuck the EU," she said.

In a separate conversation, which was also leaked, Helga Schmid, a senior German diplomat, told the EU ambassador to Ukraine that it was "very annoying that the Americans are going around criticizing the EU and saying we are too soft."

The violence in Kiev seems to have papered over those rifts, but it's not yet clear what shape a sanctions regime would take or whether the measures would be effective. Some U.S. policymakers have been pushing for targeted financial sanctions against government officials and wealthy businessmen close to the regime since violence first broke out. Those kinds of measures are widely believed to have brought Iran to the negotiating table to discuss rolling back the country's nuclear program.

Future sanctions against Ukraine would almost certainly be far more limited than what has been in place against Iran because of concerns that they would hurt ordinary Ukrainians and push public opinion toward embracing an alliance with Russia.  Sanctions would likely focus solely on Ukrainian officials and their supporters. They would also be less effective without the participation of Russia, which could become a safe haven for assets that Ukrainian officials fear could be frozen.

Sam Cutler, a policy advisor for sanctions law firm Ferrari & Associates, says sanctions alone are unlikely to force the government to ease its crackdown or negotiate with protesters. "It's a way for politicians in the EU and the U.S. to say, ‘Look how much we're doing,' and to take a moral stand, but it has to be a complement to a broader policy," Cutler said.

What that policy would be remains to be seen. In a briefing aboard Air Force One on Wednesday, Deputy National Security Advisor Ben Rhodes said the United States was consulting with the EU on which individuals should be targeted by sanctions, but made clear that the Western response could change if Ukrainian leaders relented.

"If the government takes the appropriate steps of pulling back riot police, of respecting the right of peaceful protest, releasing prisoners and pursuing serious dialogue with the opposition about how to pursue a more unified government and way forward, that would obviously factor into our calculus as well," said Rhodes.

Secretary of State John Kerry, speaking to reporters in Paris, said the growing sanctions push meant that Yanukovych now had to choose between talking to protesters and using violence against them. If he didn't, Kerry said, there would be clear repercussions.

"We are talking about the possibility of sanctions or other steps with our friends in Europe and elsewhere in order to try to create the environment for compromise," Kerry said.

This story was updated at 2:00pm.

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