In April 2009, China became Brazil’s largest trading partner. While the new title was mostly due to an increase in soybean and iron ore trade and the decline in the US economy, new ties between the two emerging giants’ energy industries helped.
According to Petrobras (PBR.NYSE, PETR3.SAO), Brazil’s state-owned oil firm and the largest company in the southern hemisphere by market capitalization, the US remained the biggest buyer of Brazilian oil this March, accounting for 32% of exports. China now ranks third, with a 20% share, yet as recently as 2005, this share was near zero.
The growth has been so extraordinary that Petrobras CEO Sergio Gabrielli hinted in a press conference that China might eventually displace the US as its top oil partner. "There isn’t someone in the US government that we can sit down with and have the kinds of discussions we’re having with the Chinese," he said.
Deep sea oil
Those discussions have already proved fruitful for both sides. In 2007 and 2008, Brazil found several enormous oil fields off of its southeastern coast in what was the largest oil discovery in the Americas in 30 years. However, the cost of exploration and extraction of the oil, which is thousands of feet below the sea floor in the subsalt region of the ocean, is projected to approach US$300 billion. Unable to fully finance the project on its own, Brazil turned to China.
In the first set of negotiations, China Development Bank (CDB) agreed to lend Petrobras US$10 billion for exploration. The Brazilian firm also made a deal with Chinese oil giant Sinopec (SNP.NYSE, 600028.SH, 0368.HK) to guarantee export of between 150,000 to 200,000 barrels of oil per day to China. PetroChina (PTR.NYSE, 601857.SH, 0857.HK) then signed a memorandum of understanding with Petrobras to import 40,000 to 60,000 barrels per day.
That commits Petrobras to selling a large amount of its total production, estimated at two million barrels a day, to China. Beyond securing a stable supply, Chinese oil firms also hope that these financing deals might lead to their own extraction projects in the lucrative subsalt region. But that seems unlikely for now.
"Foreign oil companies are free to develop oilfields throughout Brazil, but the subsalt region is an exception. The [Brazilian] government wants Petrobras to be the sole operator of the area," said Adriana Perez, an oil expert at the International Commerce Center at Brazil-based higher education institution Funda??o Getulio Vargas (FGV).
"So if China wants to be part of the subsalt’s development, it can only take a financing role."
Additional benefits
Sinopec’s closer ties to Petrobras are, however, opening other doors in Brazil’s energy industry. For example, in April the Chinese company completed a US$1.3 billion natural gas pipeline in Brazil, its largest overseas project to date.
Another area in which Chinese energy giants stand to benefit is technological expertise. Petrobras is arguably the world’s leader in deep-water oil extraction and in past partnerships with foreign oil companies it has offered technology and geological portfolios in return for support in upgrading its capabilities. As China moves from importing oil to setting up extraction operations around the world, such knowledge would be invaluable.
In addition to petroleum products, Petrobras, through its subsidiary Petrobras Biocombustível, is the world’s leader in ethanol production. While Chinese firms have so far been more interested in oil than sugarcane ethanol, this could be starting to change, albeit gradually.
"Ethanol imports from Brazil are almost at zero. The reason is, before January of this year, the import tariffs on ethanol were 30%. It wasn’t economical to buy ethanol from outside of China. Furthermore, there wasn’t an incentive to do so," said Rob Earley, an expert on China’s biofuels industry at the Innovation Center for Energy and Transportation (ICET), a think tank that promotes low-carbon policies. "The import tariff has now been reduced to 5%, but it’s not clear that the motivation behind that move was to import more ethanol from Brazil."
Imports to increase
Whatever the motive, there is reason to believe that China might begin importing some ethanol from Brazil. Beijing wants to blend 10 million metric tons of ethanol into gasoline by 2020. With China’s current domestic capacity only about 1.35 million metric tons, imports are necessary to make up the balance.
To that end, Petrochina recently agreed to work with Petrobras Biocombustível. According to Paula Almada, a press officer at the Petrobras, the two firms will assess the technical and economic feasibility of developing ethanol production projects in Brazil over a six-month period, and also work on projects aimed at exporting ethanol to China.
The partnership is likely to be long-term because Chinese production capacity will remain low for the foreseeable future.
First, the country needs to conserve arable land for food production and has banned the use of feedstock, like corn and wheat, to produce ethanol. Even non-grain crops, like cassava and tapioca, are required to be grown in lower quality soil, and thus produce marginal outputs.
Second, the current process used in China to produce ethanol is not environmentally friendly. Brazilian ethanol producers, who have created some of the world’s leading low-carbon liquid fuels, should be able to help out in this area.
"The good thing about Brazilian sugarcane ethanol is that once they get the sugar out of the sugarcane, they burn the waste material, which powers the ethanol plant and produces bio-mass electricity," said ICET’s Earley. "Most of the ethanol plants in China are fueled by coal and they are not environmentally sustainable."
China’s ethanol industry is unlikely to change soon. Although the government and some domestic companies are working on more sustainable ethanol production, including the use of breakthrough cellulosic technology to produce ethanol, widespread funding for research is being withheld. Biofuels are taking a backseat to other technologies that are seen as better bets for keeping carbon emissions low.
"China’s push into electric vehicles right now is distracting from the need for more sustainable liquid fuels [and] so there is not a lot of policy development with liquid fuels," said Earley.
The problem this presents to ethanol imports is that China is not yet building many ethanol-friendly cars. Most gas stations have the technology to mix ethanol into gasoline, but most vehicles are not designed to handle high-percentage ethanol fuel. In Brazil, 100% of gas stations have ethanol and 15.6% of cars are equipped with flex-fuel engines.
Chinese auto companies are only just beginning to produce flex-fuel cars and are focusing on those that can run inefficient methanol fuel, not ethanol.
One-track demand
While China is unlikely to follow Brazil’s path to energy independence, it will continue to strengthen ties with the South American nation’s energy industry. A closer relationship between the two vocal BRIC members is economically and politically desirable, but it is not expected to detract from Brazil’s long-standing links with the US and Europe. This is mainly because, at present, China is only really interested in natural resources.
"During the recent crisis in the West, China was able to increase its position as Brazil’s trading partner," said FGV’s Perez. "However, the US and Europe are partners with Brazil in a wide variety of industries, not just commodities. So, we see a bigger role for China, but not a central one."