Could U.S.-Brazil relations watershed survive commodity crash?

A very high percentage of "Event X was a true watershed" articles turn out to be crap, but this one on U.S.-Brazil relations (via MR) is pretty good. (Maybe because that narrative device is totally extraneous - this change has been coming for years and Obama's visit didn't actually change that much). Worth reading in full, but the punch line is:

... the major strategic interests of the US and Brazil are so closely aligned that cooperation between the two countries will be one of the building blocks of the new century... [Brazil’s] its instinct for “order and progress” (the slogan appears on its flag) dovetails very closely with what the United States wants to see in the world.

I agree except for a nagging doubt - with Brazil's economic ascendancy so dependent on commodities, how much of this unravels if resource scarcity isn't all it's cracked up to be and prices crash? After all, we've heard the same arguments before (ahem Paul Ehrlich).

Let me back up a bit to build up the logic. Brazil has historically been commodity-dependent...

In the 19th century Brazil was part of Britain’s ‘informal empire’; Britain was the dominant foreign investor in the country and Britain controlled the markets for the primary commodities (sugar, rubber, cotton, coffee) whose falling and rising prices set the tempo for Brazil’s growth. But the system seemed rigged in Britain’s favor; Brazil could never escape its role as a commodity producer — a hewer of wood and a drawer of water in the international community. Brazil did the backbreaking labor; Britain grew rich.

... but isn't it still? I don't have the stats on hand about how much soy, iron ore, etc. etc. Brazil exports, but it's a lot; it's not clear to me that the economy has fundamentally transformed, rather than simply ridden the latest commodity wave on the way up.

The premise continues that Brazil has demonstrated a successful new model...

Lula’s Brazil stuck up for Venezuela at international gatherings and danced with it at parties. But all the while, Lula’s Brazil was destroying the political logic of the Bolivareans by demonstrating that a pluralistic democracy integrated into the global market can do more for the poor than incompetent populist blowhards. Chavez talked; Lula delivered

(again, on the back of a commodity boom...)

What that means is that Brazilians, even those on the left like former president Lula, are now less inclined to think that Brazil needs to overturn the global economic system.

I have lived in Brazil and I agree with this sentiment, and that "Brazilians have an immense capacity for hard and focused work." But in a world with lower commodity prices (and, again, I don't think this is the most likely scenario, but remember it's been less than 30 months since crude oil was in the low $30s), how will the Brazilian economy hold up, and if it falters, won't that popular support as well?

This is very much a preliminary perspective and I would welcome debate and pushback on it.

Quote of the day: Easy problems to solve

Lula no doubt came to this conclusion on his visits to the United States, where racism has been eliminated since the election of Barack Obama.

That's FP Passport on Lula's choice of successor and the supposed death of macho.

Brazil's oil policy: cost vs. jobs

Brazil has prioritized local job creation over speed and lowest cost to develop its considerable pre-salt oil reserves.

Brazil has instated heavy local content rules for production of equipment such as oil platforms to ensure the development of the deep-sea reserves provides jobs and economic growth while fortifying domestic industry.

Note the euphemistic use of the word "rhythm" by Petrobras CEO Jose Sergio Gabrielli:

"The rhythm (of bidding) for those new areas will be heavily determined by the capacity of domestic industry to provide goods and services for the gigantic investment program," Petrobras Chief Executive Jose Sergio Gabrielli said in a conference call. "That is for me the driving force for the rhythm of bids in those areas."

This may seem like a poor decision from the traditional Western capitalist mindset - it will both delay the onset of production and result in higher costs than internationally open bidding would. But the Brazilian government - particularly Lula's, which has deep left-leaning roots despite its generally careful and centrist stewardship of Brazil's economy - is trying to optimize a different objective function. Local oilfield equipment manufacturing will need to spring up to supply the demand, creating jobs and potentially companies that can then compete internationally as other countries make ultra-deepwater discoveries. Viewed through that lens, the local content rules make more sense.

And while Petrobras would object if they were an independent private company, I suspect they are actually largely aligned with the government. After all, the chairwoman of their board, Dilma Rousseff, is Lula's heir apparent. And more broadly speaking, the culture of Petrobras is of a proud organ of the state. A friend who works there once described it to me as a bizarre combination of world-class technical expertise and massively inefficient and overstaffed management bureaucracy.

PetroSal's raison d'être

The concept has been much-discussed, but it looks like now the government of Brazil is moving forward with plans to create a separate state oil company called Petrosal to control its heralded potential oil reserves in the pre-salt geological layer of the ocean off the Brazilian coast.

I haven't seen much understanding in the English-speaking media of the purpose of PetroSal. It will not be an operating company (Petrobras is already among the best in the world at deepwater exploration and production, private oil majors included). Rather, it will be a separate legal and financial entity that will "own" the reserves and interface - legally speaking - with foreign oil majors interested in the pre-salt area.

Why is this necessary? For one, Petrobras is publically traded, and while the government controls voting through golden shares, any profits to Petrobras would be distributed widely to international investors, rather than kept entirely within Brazil.

Second, there are little-understood tax implications. Under existing contracts, royalties for offshore accrue mainly to the states of São Paulo and Rio de Janeiro - two of the richest states in Brazil. President Lula's goal is to use the proceeds to fund massive social spending to rise the standard of living in the poorest parts of Brazil, and a new legal structure for oil royalties would channel more of the proceeds to the federal government.

This points to a third reason for Petrosal, which in my mind is a good one - separating social goals from business ones. We've seen in Venezuela how Chavez has used PdVSA as his private piggy bank for social programs, and its oil-related investments suffer as a result. This has hit Venezuela's overall oil production; Petrosal could be a step in the right direction to avoid that fate.

The creation of Petrosal and other new rules alone will not be enough to avoid the resource curse, which as Moises Naim points out in the FT can result from both macroeconomic factors (Dutch disease) and political ones (corruption and lack of government accountability). But I remain optimistic that Brazil will be able to walk the delicate line between attracting enough foreign investment in exploration and giving away too many of the proceeds. As for the efficacy of the resulting social spending, on that only time will tell.

P.S. For anyone interested in the many manifestations and implications of "the resource curse", I highly recommend Escaping the Resource Curse, a collection of essays from diverse points of view (academic, government, legal, business) on the resource curse. Oh, and both Joe Stiglitz and Jeff Sachs are editors.

P.P.S. Apparently the markets didn't like the announcement too much, shaving $7bn off of Petrobras' ~$180bn market cap. I'm not convinced the market really understands what's going on here, though. Bloomberg certainly doesn't.