Repsol Betting on Brazilian Subsalt Finds for Growth

STENA DRILLMAX RIG, Brazil (Dow Jones), Dec. 16, 2009

The 228-meter-long platform is shaking, as the giant steel drill in the middle of the vessel slams deeper into the bed of the South Atlantic.

Depending how hard the rocks below the sea bed are, it can take up to an hour to drill a single meter, Spanish oil firm Repsol YPF SA says.

Exploring for oil under the layers of salt that lie thousands of meters below the seabed is difficult and costly, but Repsol is betting on it to pay off.

With its crew of 159 oil workers, engineers and other specialists, the Stena Drillmax floating rig, operated by the Stena Drilling unit of Swedish conglomerate Stena AB, is one of only three "sixth-generation" rigs, which can operate at water depths of 10,000 feet and drill up to a total depth of 35,000 feet. Since starting services for Repsol last year, it has already yielded four discoveries in Brazil, two of which were in the subsalt region.

At a water depth of 2,700 meters, and aiming for a further 6,550 meters below the sea bed, the rig is drilling the Seat well in Brazil's Campos Basin, 300 kilometers off the coast of Rio de Janeiro. This is where Repsol hopes to replicate the earlier spectacular oil finds that have made Brazil's subsalt one of the hottest oil regions in the world.

As oil finds in more easily accessible areas become scarce, the ultradeep Brazilian subsalt has emerged as one of the industry's few areas of growth, at a time when oil consumption in emerging markets such as China and India is expected to rise steadily.

In late 2007, Brazilian state-run oil company Petroleo Brasileiro SA, or Petrobras, sent shockwaves through the oil world when it estimated its Tupi field in the country's subsalt region to hold up to 8 billion barrels of oil equivalent in recoverable reserves. That made it the largest find since the giant, 13-billion-BOE Kashagan field was discovered in Kazakhstan in 2000. Repsol doesn't have a stake in Tupi, but it does have participations in the nearby Guara, Carioca, Iguacu and Abare West discoveries.

In total, Brazil's subsalt oil area could hold between 50 billion and 80 billion BOE, according to Brazil's National Petroleum Agency, most of it high-quality light crude. Brazil currently produces more than 2 million barrels of crude a day.

"Repsol's exposure to Brazil has been very positive, as this is the region with most exploratory success in the world recently. And Repsol is the foreign firm with the greatest acreage there," said Pablo Pena-Rich, analyst at Banco BPI.

Promising Finds So Far

Among other reservoirs, the Stena Drillmax made the giant Guara find, which Repsol and its partners say could hold up to 2 billion barrels of oil equivalent in reserves -- that represents more than three years of Spain's oil consumption.

The announcement in September of Guara's massive reserves confirms "our view that Brazil could end up being transformational for Repsol," brokerage Chevreux said in a statement, noting that the field alone could boost Repsol's reserves by 50%.

Repsol has a 25% stake in Brazil's BM-S-9 block that contains Guara and three other discoveries. Petrobras, which holds a 45% stake, is the operator, while BG Group PLC holds 30%.

The companies plan to start producing 120,000 barrels of oil a day from Guara as of 2013. This will boost Repsol's oil output from the average 893,000 BOE a day it produced during the third quarter, including its Argentine YPF unit.

Overall, ING estimates Repsol's share in Brazilian subsalt reserves at around 1.92 billion BOE, and that doesn't include possible further discoveries from wells such as Seat.

Drilling Costs High

But the greater depth and a tricky geology in the new oil region bring technological and financial challenges, during both exploration and production - not just for Repsol and Petrobras, but also for the select few companies that have ventured into the Brazilian subsalt, such as BG, Galp Energia SGPS SA and Exxon Mobil Corp.

The increased depth both in the water and below the ocean floor push up costs, Repsol exploration engineer Antonio Canal explains.

Also, he says, "the rocks below the salt layer are harder," making drilling even more challenging.

After reaching a depth of 4,500 meters, the drill has another 2,050 meters to go to reach the depth at which Repsol hopes to hit oil at the Seat well, based on its previous seismic studies. The Stena Drillmax is one of the most advanced exploration rigs in the industry, designed to operate in harsh conditions at high seas. It can withstand 100-kilometer-per-hour wind strength and 15-meter-high waves. But at $450,000 a day, operating it doesn't exactly come cheap for a medium-sized oil company such as Repsol. And though costs have already come down, drilling a well in Brazil's subsalt still costs between $100 million and $150 million, Repsol said.

When the company had to decide in 2005 whether to contract the rig to operate for it year-round for five years, everyone in Repsol's executive committee was horrified by the cost, Repsol Chairman Antonio Brufau told reporters last month.

But what was one of the most difficult decisions on his life also turned Repsol into the "company with most exploratory success at our scale," creating value for shareholders in the future, Brufau said.

Repsol's expensive bet on Brazilian subsalt is paying off, said Jose Martin-Vivas, an analyst at Madrid brokerage Ahorro Corporacion. More than half of all wells drilled in the region have found oil, he said. This compares with the industry's usual success rate of between 25% and 35%.

In the case of the Stena Drillmax's exploration for Repsol since 2008, the success rate so far is 100%, as all four wells drilled have contained crude.

The oil found in the Guara field alone will probably add between $2.5 billion and $5 billion in revenue for Repsol, easily outweighing the cost of exploration, he adds.

"Repsol's share value recently relies heavily on future discoveries in Brazil," Martin-Vivas concluded.

Production Also Costs More Than Usual

Aside from the higher costs of exploration, producing oil from the subsalt presents some costs not incurred in shallower fields. More steel and other materials are needed for the longer tubes transporting the oil and gas to the surface.

And BG has confirmed exploring companies found "a significant carbon dioxide concentration" when drilling the Abare West well in the BM-S-9 block. Other companies have also said CO2 levels are high elsewhere in the subsalt area. If the CO2 content in the oil and gas is high, it needs to be removed--a complicated and expensive process. It can be reinjected into the well, which boosts the well's recovery rate, but this is also expensive. What's more, a high CO2 content can speed the corrosion of the tubes that pump the oil to the surface.

Petrobras Chief Executive Sergio Gabrielli said last month that at an oil price of $45 a barrel, all costs, taxes and levies to pump up oil from subsalt fields would be covered. By comparison, Petrobras had a lifting cost--the cost of pumping oil from the ground--of $22.86 per barrel in the third quarter at its current Brazilian fields, the majority of which are above the salt layer. Petrobras is also Repsol's partner in most of its subsalt oil discoveries.

Repsol's Brufau said to bring its Brazilian reserves to the production stage, the company may need to invest between $10 billion and $18 billion.

Repsol May Need Partner To Help Shoulder Costs

That is a large sum for a company with a current market capitalization of EUR22.91 billion. It has neither the cash-flow of its giant partner Petrobras, nor the clearly stated financial backing for subsalt projects Brazil's government has pledged to its state-oil company.

But getting financing for the very valuable Brazilian assets shouldn't be a problem, Repsol Exploration and Production Director Nemesio Cuesta told Dow Jones Newswires.

"If you have oil, you get financing," he said, adding that banks would be prepared to provide project finance of up to 60%.

But, says Inverseguros analyst Luis Rose, if the planned sale of a further stake in its Argentine unit YPF runs into trouble, Repsol may be forced to sell some core assets, such as those in Brazil, if it doesn't want to leverage itself more than it already is.

Repsol's Brufau said the company might consider bringing in a new partner for its Brazilian developments, or carry out an initial public offering for those assets.

Copyright (c) 2009 Dow Jones & Company, Inc.

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