FT SPECIAL REPORT

New Trade Routes Brazil
Wednesday December 3 2014 www.ft.com/reports | @ftreports

Struggling with the transition
The end of the commodity supercycle is bringing challenges, reports Joe Leahy

Inside
Mercosur fails to open doors The country’s approach to trade policy could see it left behind
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arly in October, an event took place that showed that foreign investor interest in Brazil remains resilient, even as the economy has slowed in recent years. BMW, the German carmaker, opened its factory in the southern state of Santa Catarina to begin producing its Series 3 sedan in an investment that is projected to cost R$600m ($240m) and generate 1,300 jobs. “Whether or not to export will depend on the economy and the speed with which we manage to nationalise production of our cars,” Arturo Piñeiro, president of the carmaker in Brazil, said at the opening ceremony. BMW is not the only company investing in an economy that is undergoing a deep shift in trade flows with the end of the commodity supercycle and the slowdown in China. In the 10 months to the end of October, Brazil attracted $52bn of foreign direct investment inflows, putting it on track to reach about $60bn by the end of 2014, roughly in line with previous years. “This will be another positive year,” says Alexandre Petry, executive manager of investments at Apex-Brasil, the export promotion agency of Brazil. “The principal driver for investors is our market: 200m people with a lower middle class that is still growing.” For a Brazil that grew accustomed to almost automatic success by the end of

the first decade of the century, with the rise out of poverty of much of its population and the emergence of sectors such as agriculture and iron ore mining as national champions, the past four years have represented a transition period.

In a year in which Brazil hosted the 2014 soccer World Cup and staged a closely fought presidential election, economic growth has slowed to a crawl. It is expected to be a fraction of a percentage point this year, while inflation has

Ready for export: stacked containers at the Port of Santos — Paulo Fridman/Bloomberg

settled at the upper end of the central bank’s target range of 4.5 per cent plus or minus 2 percentage points. Lower commodity prices are taking their toll on trade. Iron ore prices have fallen 40 per cent this year to a five-year low of $70 a tonne, while soyabean and other crops are fetching lower prices. The current account deficit in October, at $8.1bn, was the widest for the month since the data series started in 1980, while over 12 months it remains at 3.7 per cent of gross domestic product. The trade balance has turned negative with $200bn of exports in the first 10 months of this year, compared with $202.3m of imports. But foreign capital market investment has taken up some of the slack, rising 6.5 per cent. “We depend a lot on foreign investors, not only for initial public offerings but directly and indirectly,” says Edemir Pinto, chief executive of the company that runs São Paulo’s stock exchange, the BM&FBovespa. He says there are about 60 equity offerings that could be launched if Brazil’s economy and currency stabilises after the elections. Much will ride on President Dilma Rousseff’s new economic team. As the FT went to press, finance minister Guido Mantega was replaced by Joaquim Levy, a capable former treasury secretary, whose main jobs are to rebuild trust with the private sector and get the country’s finances back on track. One of the problems with investor confidence has been government intervention to try to counter the effects of the transition in the global economy following financial crises abroad. Government controls on fuel and energy prices and unorthodox attempts at providing a fiscal stimulus through Continued on page 3

Mining moves A $1.4bn port terminal in Malaysia improves Vale’s export efficiency
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Finance Faced with a slowing economy at home, institutions are expanding abroad
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Comment Marcos Troyjo looks at ways to tackle the ‘Brazil cost’ of stifling bureaucracy
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An international hub for R&D Rio research and development centre attracts companies from around the globe keen to explore deeper waters
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FINANCIAL TIMES

Wednesday 3 December 2014

New Trade Routes Brazil

Mercosur fails to open doors as others seek alternatives
Trade policy Its approach puts the country at risk of being left behind, says Shawn Donnan

Mercosur Time to trade up?
Total value of goods exports by Mercosur members (2012): $340bn Brazil’s share of Mercosur goods exports to the world (2012): $243bn Value of goods exports by Mercosur members to other members (2012): $49bn Brazil’s exports to other Mercosur members (2012): $23bn Mercosur members: Argentina, Brazil, Paraguay, Uruguay and Venezuela (Source: World Trade Organisation)

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hen the European Union and Mercosur began discussing a trade deal in 1999 the logic seemed unavoidable and unassailable. Here were two great integrating regional groupings casting an opportunistic eye on the 21st century and the march of globalisation. What could possibly go wrong? Who would quibble? It says something that, 15 years on, the EU-Mercosur trade negotiations have outdone the World Trade Organisation’s long stalled Doha Round of talks in their record for stasis. And that European officials see a greater chance of success in the difficult Doha negotiations than for any Mercosur pact. Asked recently what the EU’s top trade priorities for 2015 were, a senior official in Brussels ran through a long list of negotiations with the US, Japan and even Vietnam without once mentioning Mercosur. For Brazil, that sort of response

presents a problem that it needs to address urgently, especially as it confronts slowing economic growth. Brazil’s trade policy has had Mercosur – the “Common Market of the South” or Mercosul as it is known in Brazil – at its centre ever since the bloc was formed in the 1990s. With what ought to be good reason: member countries Brazil, Argentina, Paraquay, Uruguay and Venezuela have a combined population of more than 260m and represent the world’s fourth biggest trade grouping. Brazil’s trade strategy has also long been to be an active participant in the WTO, at whose helm Roberto Azevêdo, a veteran Brazilian diplomat now sits Neither Mercosur nor the WTO has been a particularly dynamic source of trade liberalisation over the past decade and, as a result, they have increasingly become a liability for Brazil. In a July paper, Carl Meacham, the head of the Americas program at the Washington-based Center for Strategic and International Studies, cited the

Impasse: President Dilma Rousseff at talks to resolve tensions — Georges Gobet/AFP

“constraints” presented by Brasília’s dedication to the WTO and Mercosur as one of the great limiting factors of Brazilian trade policy. The problem for Brazil is that the world has moved on. Frustrated with a lack of progress at the WTO, the US, EU and other big economies have turned to ambitious negotiations aimed at striking “21st-century” regional trade agreements that venture into cutting-edge areas such as the digital economy. Worried about being left behind, China has also been exploring new trade avenues outside the WTO, which it joined to great fanfare in 2001. Closer to home, Chile, Colombia, Mexico and Peru have in recent years solidified their economic ties and commitment to trade liberalisation via their Pacific Alliance, which has become a prime example of the potential benefits of a new “regionalism” in trade. The risk for Brazil is that it is sitting on the sidelines and that in the coming

years it will find itself increasingly left out of new trade blocs with all the economic consequences that could entail. That may be about to change. There are expectations following the October re-election of Dilma Rousseff that, with a recession hanging over it, her government may shift to more trade- and market-friendly economic policies in the hope of boosting growth. President Rousseff’s own chief of staff, Aloizio Mercadante, fuelled some of those expectations when he told a November event in Brasília that Brazil needed to pick up the pace of international trade negotiations and that Mercosur needed to “move forward” in its longstanding talks with the EU and others. But the government has played that game before and its commitment to Mercosur remains at least part of the problem. In August 2013, the then foreign minister Antonio Patriota told the Financial Times that Brazil was considering going it alone in negotiations with the EU if the talks with Mercosur did not progress, a threat that appears to have gone nowhere since. What can President Rousseff and her government do? The most obvious way forward may lie in the approach of one of her fellow left-of-centre Latin American leaders, President Michelle Bachelet of Chile. Chile has in recent months begun convening meetings of officials and ministers from both Mercosur and the Pacific Alliance to discuss how to improve ties between the two blocs. It has also been mounting a diplomatic offensive designed to play down any sense of regional rivalries. “The two blocs are neither contradictory nor competing,” Luis Felipe Cespedes, Chile’s economy minister, said in November. The discussions are clearly at an early stage. But, for Brazil, they may offer a way out of its current trade impasse while maintaining the political ties that Ms Rousseff values in Mercosur.

Dealmaker in charge at the WTO faces tough fight
Profile

Case study Melissa shoes
Some businesses have found ways to cope with the dreaded “Brazil cost” and one of the more successful is the Melissa brand of “jelly shoes”. Brazil used to be regarded as a low-cost manufacturing economy. But in the past decade, a combination of increased energy prices, high labour costs, low productivity and poor infrastructure, have made the country one of the most expensive places to produce things. According to Boston Consulting Group, average manufacturing costs in Brazil were 3 per cent lower than in the US in 2004, while this year they are estimated to be 23 per cent higher. José Augusto de Castro, president of the Brazilian Foreign Trade Association, says that 50 per cent of exported Brazilian manufactured products remain in South America. Melissa has overcome the obstacles. Its colourful plastic shoes are identifiable from afar thanks to their signature “tutti-frutti bubblegum” scent that alerts its fans a store is nearby. The innovative combination of trendy designs with the use of mono-material, which can be reused without costly separation from any other components, have contributed to Melissa’s global success. Melissa shoes began in 1979. The brand is part of Grendene, a large Brazilian footwear group set up by two brothers in the 1970s. Melissa’s success was due, in part, to its daily appearance in a popular television show in the 1980s called Dancin’ Day, where the main characters wore Melissa shoes. But when the programme ended, sales began to fall and in the 1990s Grendene executives were forced into a radical rethink. There followed collaborations with highend designers including Karl Lagerfeld and Jean Paul Gaultier. In 2004, Grendene listed on São Paulo’s stock exchange and Melissa shoes strode on to the international stage and are now available in 80 countries. Melissa does not publish figures, but Grendene’s reported profit for the third quarter of 2014 was R$126m ($50m), with 55m pairs of shoes sold, an increase of 1.4 per cent on the same period of 2013. Exports added up to 11.4m pairs, a rise of 4.3 per cent. Grendene accounted for 37.5 per cent of shoes exported from Brazil in the final quarter of last year, and continues to lead the footwear industry in exports. Thalita Carrico

Roberto Azevêdo is a Brazilian who plays a global role in trade negotiations, writes Shawn Donnan
Will Roberto Azevêdo be able to rescue the World Trade Organisation again? After the Brazilian head of the WTO led its 159 trade ministers to the first tangible deal in its history in Bali in December 2013, many, including the FT, saw the victory as his. At the very least, the arrival of Mr Azevêdo, a career diplomat and dealmaker, seemed to offer a distinct change in tone for the WTO, which for 13 years now has languished under the dark shadow of the long-stalled Doha Round of trade negotiations. “The WTO is back!” an exhausted Mr Azevêdo proclaimed to hugs, cheers and tears in Bali after ministers approved a deal to streamline procedures at borders around the world that was the result of three months of round-the-clock negotiations

that the Brazilian shepherded tirelessly. But a year on, prospects for the WTO look a lot less hopeful than they did then. And the challenge facing Mr Azevêdo is arguably twice as daunting as it was when he took over in September 2013 from the erudite Frenchman Pascal Lamy. The problem confronting Mr Azevêdo is that, what initially appeared to have been a successfully delivered confidence-building episode in Bali, descended into acrimony within months. A push in July by the new government in India to renegotiate part of the agreement led the US and others to cry foul. The result was that, once again, for months paralysis descended on the WTO, just as Mr Azevêdo was beginning work on the more complicated task of delivering something that might be called the Doha Round. That stand-off was finally resolved in November, when India and the US negotiated a solution that hinged on the rewriting of a single sentence and the placing of a comma. But that was not until the dispute had led to what Mr Azevêdo called the “most

serious crisis” in the WTO’s 20-year history. Mr Azevêdo now faces the task of turning that bitter episode into something constructive in a hurry. That is because the Bali deal was always about something bigger. Besides passing the “Trade Facilitation Agreement” to reduce red tape at borders, ministers also agreed the WTO should come up with a plan by the end of this year to rescue the Doha Round,
‘I want to put the human dimension at the heart of our work’ Roberto Azevêdo

which collapsed in 2008 and has only shown faint signs of life since. Until the new government in India derailed his plans, Mr Azevêdo and his key advisers had been working assiduously at sounding out key members on their opening positions and whether a deal might be possible. Their plan was to cobble something together that might pass muster when ministers gather at the end of next year.

Then the world and the WTO could move on. “You can’t kill [the Doha Round] unless you deliver it,” is how one senior trade official in Geneva described the strategy. The uncomfortable news is that the debate in Geneva over where to go next remains stuck on some basic issues, starting with what the ground rules should be. Some developing countries want to resume negotiations on the basis of the text that was produced in 2008, a suggestion that neither the EU nor the US is keen to accept. The US has also made clear that it no longer views China, now the world’s largest trading nation, as a developing economy or as eligible for the special WTO treatment that entails. China, meanwhile, has indicated it will not give up that status without a fight. The best bit of news may be that Mr Azevêdo is in charge. His stock remains high within the WTO and he has worked hard to make his leadership inclusive. In the lead-up to Bali, he made sure that even the smallest members could have a role in

negotiations if they wanted one and that approach has endured. It helps too that he is still seen as the candidate of the developing world and that his ascension to the head of the WTO has forced Brazil to become a more constructive player in negotiations. But the task of reviving and delivering something resembling the Doha Round is still a mammoth one and may be beyond whatever charm or negotiating skills Mr Azevêdo can deploy. It also remains the surest way the WTO has to assert its role in the global economy, even as important members such as the US and EU turn to new regional and sectoral agreements out of frustration with the stasis in multilateral trade negotiations. “I want to put the human dimension at the heart of our work and change the terms of the debate to change this organisation,” Mr Azevêdo told the opening session of the WTO’s public forum this year. He may still be the best candidate to keep that promise. But whether Roberto Azevêdo – and the WTO’s members – can deliver that change is still a frustratingly open one.

‘Plan B’ puts Vale back in the driving seat – at a cost
Mining

The new $1.4bn Teluk Rubiah port terminal allows speedier transportation, reports Samantha Pearson
For Vale, the world’s largest producer of iron ore, its location in Brazil has always been both its greatest strength and its biggest challenge. On the one hand, its proximity to high-grade iron ore mines such as Carajás in the north of the country has turned it into a world leader in the industry and Brazil’s most international company. Between January and October this year, iron ore ranked as Brazil’s secondbiggest export just behind soyabeans, accounting for about 12 per cent of total shipments in value terms. However, on the other hand, with its biggest mines more than 10,000 miles away from the key Chinese market, its geographical position has been its Achilles heel in its battle with rivals BHP Billiton and the Rio Tinto Group, located in Australia, much closer to Asia. While demand from China is slowing, the country still accounts for 49.6 per cent of Vale’s total iron ore sales and

Asia as a whole represents 65.4 per cent, according to the company’s thirdquarter results. As such, finding ways to reduce the logistics costs of these vast delivery routes has always been one of Vale’s top priorities. As the global commodity supercycle ends, pushing down iron ore prices worldwide, these cuts have become even more important. So far this year, iron ore prices have fallen by more than 40 per cent to a fiveyear low as new supply from Australia and Brazil has hit the market just as demand from Chinese steelmakers has slowed. Pedro Galdi, an analyst at SLW Corretora in São Paulo, says: “The three large miners – Vale, Rio Tinto and BHP Billiton – sharply increased capacity, putting more iron ore in the market, and causing prices to fall. Many miners can’t cope with prices at this level – miners in China are halting operations and in Australia and Brazil too.” Given the vast scale of its operations, Vale is still able to make a profit with iron ore prices at the current $70 a tonne. However, the company is under even greater pressure to reduce costs to protect its margins, he says. Under Vale’s brash former boss, Roger Agnelli, the company came up with its most ambitious solution to the problem yet. At the height of the commodity

boom in 2011, the company decided that the best way to tackle its high logistics costs was to build its own fleet of very large ore carriers (VLOCs) known as Valemax vessels. Capable of carrying 400,000 tonnes of iron each, the vessels were designed to reduce or at least control the company’s shipping costs and help Vale compete better with its rivals. “With Carajás iron ore taking close to 40 days to reach China from Brazil, compared with 13 days for Australian producers, Vale concluded that it was in the interest of both the company and its clients to come up with a competitive solution,” the Rio de Janeiro-based company said at the time. However, in a significant blow to Vale, the ships were instantly barred from entering Chinese ports following opposition from the China Shipowners’ Association. In January 2012, China’s ministry of transport officially restricted ports’ rights to accept any large bulk carriers, effectively refusing entry to any of the proposed fleet of Valemaxes

Traffic control: Teluk Rubiah port terminal in Malaysia and forcing Vale to rely on nearby unloading bays in Malaysia and the Philippines. Chinese authorities have also expressed concern over the safety of the vessels after one developed a crack in its hull during loading in 2011. However, many analysts believe it was just an excuse to ward off competition from the Valemaxes, which threatened to reduce demand for China’s own shipping services. In April 2013 a port in eastern China finally allowed a Valemax to dock and unload a cargo of iron ore. However, the ban has largely remained in place. Faced with opposition from the Chinese and under greater pressure to reduce costs as iron ore demand slowed, Vale’s new chief executive Murilo Ferreira focused his efforts on what analysts see as a “Plan B” – a $1.4bn port terminal in Malaysia, which opened at the beginning of November.

— Mohd Darus bin Hasib/Flyborg Films

‘The distribution centre brings our mines closer to our customers in Asia’

Valemax ships are now able to transport iron ore from Brazil to the Teluk Rubiah terminal, where the cargo can be redistributed to other Asian countries in smaller vessels. While it is not as efficient as shipping iron ore in Valemaxes directly to China. it still cuts the logistics costs of the majority of the export route, says SLW’s Mr Galdi. Comprised of a deepwater wharf and five stockyards where different types of iron ore can be blended, the terminal also allows Vale to customise its iron ore shipments to the particular needs of each country in the region. Mr Ferreira says: “Teluk Rubiah is a cornerstone of Vale’s business strategy of investing in solutions that aim to enhance the company’s capability to supply iron ore more efficiently to Asian markets.” “The distribution centre brings our mines closer to our customers in Asia.”

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FINANCIAL TIMES

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New Trade Routes Brazil

Banks forced to move abroad in search of growth
Finance Faced with a slowing economy at home, institutions are expanding elsewhere, says Samantha Pearson

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or those who have followed André Esteves’ career over the past decade, the headquarters of his investment bank BTG Pactual could not be more fitting. São Paulo’s most ostentatious office building arches over an 18th-century cottage built by the Bandeirantes – the adventurers and fortune seekers from Portugal who carved out Brazil’s huge territory. Seen as a modern-day Bandeirante himself, Mr Esteves has pursued an equally aggressive expansion strategy since founding BTG Pactual in 2009, following his acquisition of UBS’s Latin American assets. After conquering parts of Latin America to become the region’s largest standalone investment bank, BTG Pactual bought Swiss private bank BSI in July in a move that doubled the Brazilian bank’s assets under management to more than $200bn.

BTG Pactual bought the wealth management bank from Italian insurer Generali for about $1.7bn – the largest overseas acquisition by a Brazilian company so far this year, according to Dealogic. While BTG Pactual’s ambitious expansion strategy partly reflects Mr Esteves’ vision, it also reflects the internationalisation of Brazil. As Brazilian businesses have expanded abroad, creating links with the rest of Latin America and beyond, the country’s banks have seen ever greater demand for their services outside Brazil – both from companies and wealthy individuals. Brazil’s own slowing economy, which is set to grow just 0.2 per cent this year, has given the country’s largest banks even more reason to diversify their revenue streams. Located across the road from BTG Pactual’s office, Itaú BBA is an even more dominant force in Latin America. Alongside its commercial bank, ItaúUnibanco, Itaú ranks as Latin America’s largest bank by market value. In January, Itaú announced the acquisition of Chile’s CorpBanca in a deal totalling nearly $3bn – the largest banking merger in Latin America since 2008. US activist investor Cartica has tried to block the deal, arguing that the

Ambitious plans: Andre Esteves, CEO, BTG Pactual investment bank — ManuCorreia/FT agreement undervalues CorpBanca. If Itaú can pull off the complex acquisition, it would mark a turning point for the bank in the region. Jean-Marc Etlin, chief executive of Itaú BBA Investment Bank, says the deal “is very important in supporting our mission in investment banking, which is to be seen by corporations in Latin America as the go-to bank for raising capital, for advice on debt and equity issues; and to be seen by people outside the region as the bank that can guide them through Latin America”. Itaú has also expanded aggressively into the key Mexican market, obtaining a broker-dealer licence in Latin America’s second-largest economy in the

middle of November, after opening shop earlier in the year under Alberto Mulas, Mexico’s first national housing commissioner. Furthermore, the expansion of its offices in Europe has helped the bank capture large cross-border deals. Itaú was chosen this year to advise Spain’s Telefónica on its $9bn acquisition of the Brazilian broadband unit of Paris-based Vivendi, GVT – the largest acquisition of a Brazil-based company in 2014, according to Dealogic. “That’s exactly the kind of deal we want to do: cross-border, a large transaction where a non-Latin American company invests into the region, and helping Latin American businesses developing abroad,” says Mr Etlin. Partly thanks to the deal, Itaú is now leading the regional and Brazil fee rankings compiled by Dealogic for the yearto-date, followed by Credit Suisse and then BTG Pactual. However, Mr Esteves also has ambitious plans in the region, especially in the Mexican market. In August, he told the Financial Times that BTG Pactual already has about 30 people working in Mexico, but is studying the possibility of making an acquisition in the country as a way to speed up the bank’s regional expansion.

However, he emphasised that the bank is not just looking to become a Latin American bank. “We don’t have a specific geographic agenda at this stage,” said Mr Esteves. “We consolidated our presence in Latin America and we think we still have plenty of space in certain parts of Latin America, like Mexico and Argentina, but we also have a strong presence in the US, Europe and Asia.” In fact, after the BSI acquisition more than half of BTG Pactual’s assets will now be outside Brazil. “[The BSI acquisition] is not a Latin American move, it’s a global move,” said Mr Esteves. “It’s got a global base of clients and it has an important franchise in Europe, Asia and the Middle East, and something in Latin America.” It is too early to say if such moves are really part of a Bandeirantes-type strategy to conquer other continents in the same way Itaú has done in Latin America, says Luis Miguel Santacreu at Austin Asis, a banking sector consultancy. “In time, we will be able to tell whether these acquisitions are turning [BTG Pactual] into a global player or whether they were being opportunistic and will later sell these assets to make a profit.”

Struggling with the transition
Continued from page 1 ad hoc tax breaks, stimulating lending by state banks and other means have created uncertainty. If the government can stabilise investor expectations and allow the real to settle at a more competitive level without sparking higher inflation, Brazil’s economy could begin to rediscover its competitive balance. “Brazil is a large economy with dynamic companies that are creative, aggressive and willing to grow and embark on projects,” says Lisandro Miguens, head of Debt Capital Markets for Latin America at JPMorgan. “We just need to have some sort of a clear horizon,” he adds. Mr Petry of Apex-Brasil says that, of the Fortune 500 list of largest companies, 490 are already operating in Brazil. The country held three big auctions for airport terminals over the past couple of years, selling for R$8.3bn the concessions for Rio de Janeiro’s Galeão international airport to Singapore’s Changi Airport alongside domestic conglomerate Odebrecht. In the same auction, the operators of airports in Munich and Zurich, together with a domestic infrastructure group CCR, committed to pay R$1.8bn for the rights to overhaul and operate Belo Horizonte’s airport in

$52bn
Foreign direct investment inflows to the end of October

6.5%
The increase in foreign capital market investment

the state of Minas Gerais. “In a little while, Brazil should return to a better rate of growth,” says Mr Petry. In the auto industry, producers have total projects lined up worth $80bn, according to consultancy Roland Berger, although not all of this may be realised until the market recovers. Aside from luxury producers, such as BMW and Land Rover Jaguar, newcomers include China’s BYD, which plans to invest $100m in a facility to manufacture electric buses in the city of Campinas, São Paulo state. “Along with the buses and batteries, our dream is to build solar panels and energy storage systems here to help the region achieve its zero emissions goals,” says Wang Chuanfu, BYD’s founder and chairman.

Foreign investors are also participating in the Brazilian healthcare industry, with Siemens setting up a R$50m factory in Santa Catarina state, not far from BMW, for diagnostic imaging. Rivals Philips and GE are also investing in the same industry. Some Brazilian exporters remain keenly competitive. Embraer, the world’s third largest builder of aircraft, is planning to enter the military transport market. Its KC-390 transport jet is designed to steal market share from the C-130 Hercules military transport aircraft of Lockheed Martin of the US. In spite of falling prices and drought, agriculture remains a strong driver of Brazilian competitiveness, with national champions, such as JBS, the world’s largest protein company, making foreign acquisitions. Mario Veraldo, commercial director in Brazil for Maersk Line, the world’s largest shipping company, says: “When we talk to our clients, nobody in the agricultural export industry is bearish, everybody is bullish because the world needs to eat and the quality of what Brazil produces is good.” He says that, with commodity prices falling, clients were now talking about how to add value rather than just shipping raw grain to markets, such as Asia, which process the products there. “What we see is that our clients are talking differently about this than they were before. It is not for the next quarter, it is for the longer term, but it is there,” he says. Even in Brazil’s oil and gas sector, which has suffered negative news flow from a political kickback scandal at the country’s main operator, Petrobras, the state-controlled group, there is opportunity, says Mr Petry. The country’s giant pre-salt discoveries, so-called because they lie in ultradeep water under a layer of the compound, are gradually being prepared for production. “We are still seeing a lot of demand for the oil and gas sector,” says Mr Petry.

Contributors
Joe Leahy Brazil bureau chief Samantha Pearson Brazil correspondent Shawn Donnan World trade editor Thalita Carrico Editorial assistant Marcus Troyjo BricLab, Colombia University Aban Contractor Commissioning editor Steven Bird Designer Andy Mears Picture editor Graham Parrish Graphic artist Keith Fray Statistics journalist For commercial opportunities in print, digital and events please contact John Moncure at john.moncure@ft.com, or Ximena Martinez at Ximena Martinez at ximena.martinez@ft.com All FT reports are available on FT.com at ft.com/reports Follow us on Twitter: @ftreports

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FINANCIAL TIMES

Wednesday 3 December 2014

New Trade Routes Brazil

Companies see sunny outlook for renewables
Clean energy

Sector unlikely to cool as foreign interests eye attractive auction prices and ideal climate for alternative power, writes Thalita Carrico
Brazil is known for having one of the cleanest energy supplies in the world. With hydropower supplying more than three-quarters of the country’s electricity, there are many opportunities for companies willing to invest in the growing market of alternative energy. But the country is facing its second year of drought. To compensate for a reduction in electricity output, the government has had no option other than to turn on more thermoelectric plants. According to the Energy Research Company, the result was a decrease of 6.15 per cent from 2012 to 2013 in the share of renewables in the mix. Despite that, in the same period, solar and wind energy increased from 1.894MW to 2.207MW, a growth of 16.5 per cent. To have an idea of Brazil’s potential for solar energy, consider Porto Alegre,

the capital city of the southern state of Rio Grande do Sul. The city lies in a region in the country that receives less intense sunlight, but more hours of sunlight than other regions. Seeing big opportunities, the Chinese electric carmaker and battery manufacturer BYD decided on Campinas, in the São Paulo region, to open the company’s first South American manufacturing facility, with an investment of R$200m ($80m). The company plans to build solar panels and energy storage systems. In the first phase, BYD will produce electric buses and recyclable iron phosphate battery packs. It then plans to build a research and development centre for its photovoltaic, smart grid and LED lighting businesses. Brazil is enjoying a great moment for renewable energy, says Adalberto Maluf, BYD’s marketing director: “With short-term issues such as drought and less generation of conventional energy, we think solar energy will grow 70 per cent for large auctions and 30 per cent for smaller projects.” The ministry of mines and energy predicts a 15 per cent fall in the installation cost of solar power by 2015. By 2020, the ministry expects a cut of

30-50 per cent, because of industrialscale production and improved performance. BYD plans to produce 1,000 electric buses a year from 2015. The bus can travel 300km a day on a single charge and has a battery that is charged in two hours and has a life expectancy of 40 years. Consumption is 1kW per kilometre at a cost of R$0.20, while a conventional bus requires 1 litre of diesel per 2km, at a cost of R$2.50. The falling cost of renewables means they can, at times, compete with fossil fuels. Lower energy costs also mean greater competitiveness. Since auctions were introduced, prices have dropped to a record low. At the last auction in October, the solar energy price was settled at £54 per MWh; a few years ago it was £127 per MWh. Last year, the cost of onshore wind was as low as £27 per MWh, against £95 per MWh in the UK. Brazil’s secretary of energy planning, Altino Ventura, says wind and solar energy receive no government subsidies. “Because of our climate, wind farms have greater potential of electricity per unit of installed capacity than elsewhere,” he says. The farms have a capacity of 60-65 per cent, against a globalaverageof40-45percent. On the other hand, the UK think-tank

The falling cost of renewables means that they can, at times, compete with fossil fuels

Policy Exchange says that despite auctions, unusually high wind speeds and a surplus of discount wind turbines, the cost reductions in Brazilian wind power reflect hidden incentives in grid charging structures. In 2009, GE won its first contract for a wind energy project in Brazil. “Despite initial challenges, we are making equipment at a competitive price,” said Sergio Souza, head of sales for Latin America. Since 2011, GE has manufactured equipment in Campinas. In 2012, it developed a turbine specifically for the Brazilian market. This year, it celebrates its 1,000th hub produced locally. The company has invested R$1bn in a research and development centre in Rio de Janeiro. Analysts predict that wind will account for 9.5 per cent of Brazil’s installed capacity by 2022. GE forecasts the market will grow 40 per cent by 2016 and that 900 GE wind turbines will be installed by the end of the year. Mr Souza says Brazil is consolidating as one of the main wind power markets in the world. In addition, it is one of the few countries that produces 2GW a year. “There is no way this sector will cool down in the next few years,” he says. “Its future is bright.”

Bureaucratic quagmire is the cost of doing business
GUEST COLUMN

Marcos Troyjo
A group of tourists was taking a helicopter tour of the beautiful seaside region of Angra dos Reis, south of Rio de Janeiro. The area is made up of hundreds of tiny islands – a tropical paradise favoured by Brazil’s wealthiest for their second home on the beach. One of the passengers marvelled at a sumptuous mansion that stood alone in an islet. He asked the pilot: “Does it belong to a dotcom billionaire?” “No,” the pilot replied, “to a tax lawyer.” This anecdote is indicative of the complex web of winners and losers that results from one the most distinctive traits of doing business in Latin America’s largest economy, the socalled “Brazil cost”. The notion represents the end result of the many different factors that make it so expensive to produce and consume in the country. Brazil cost essentially stems from the confluence of heavy bureaucracy, over-regulation, meagre infrastructure and lack of policy vision. For most of its 500-year-plus history, Brazil’s connection to the world economy was essentially that of a provider of raw materials, setting the tone for the country’s economic cycles: gold, rubber, sugarcane, coffee. All infrastructure was orientated to the export of those commodities. Consequently, not a lot was done in terms of transport interconnecting Brazil’s regions. And when commodities cycles were gone, so was the infrastructure. There are fewer than half the railway miles in service in Brazil today than there were in the US at the end of the Civil War. Another consequence of an economy specialising in a few low value-added goods is that everything else was imported at high prices that were made even more dear by local import taxes. This was true in 1808, when the Portuguese royal family, fleeing Napoleon’s wrath, made Rio de Janeiro the capital of its empire. And it is true today. Despite talk of regional economic integration under Mercosur, a bottle of good Argentine wine is sold in New York at half the price you would pay at a supermarket in São Paulo. The structure of relative prices is so absurd that one of the priorities of middle-class pregnant couples is flying to Miami for a week to buy as many baby-related products as they can – not only clothing or strollers, but also diapers. This situation did not necessarily improve when Brazil’s industrialisation picked up after the second world war. Capital formation was mainly aimed at strengthening the manufacturing sector and was obtained through foreign loans, printing money and taxes accruing from the high cost of entry for multinational corporations into the Brazilian market. That is why foreign debt, inflation and an onerous tax burden as a percentage of GDP have occupied prominent positions in enlarging the Brazil cost for the past 50 years. Government meddling in everyday business life – a legacy of Brazil’s Portuguese state heritage – has been made all the more complicated by a tendency to over-regulate. In the past 10 years, In the past 10 years, Brazil Brazil approved approved about 4m laws at federal, state and municipal about 4m laws at level. That is more than 800 federal, state and a day. One law every two minutes. municipal level. No wonder the country is a paradise for legal That’s more than decipherers. Many have 800 a day. One law made a living out of this extra layer that erodes its every two minutes capacity to compete. The “Brazil cost” is further explained by a political economy model that never really favoured investment as a driver of growth. This helps explain the poor and outdated infrastructure that makes logistics so expensive. Bureaucracy tops it all. In Brazil, for each public worker devoted to classical tasks performed by government (foreign policy, defence, education, health) there are 60 employees doing something else. The more regulations are enacted, the larger the demand for more bureaucrats to execute, judge and audit them. According to World Bank data, Brazil is one of the most difficult countries to start a business. It takes 13 procedures for the legal establishment of a company and about 119 days until the process is complete. Add to that the high cost of credit and a tax burden at 37 per cent of GDP and you will understand what Brazil cost is. Understanding its genesis is the first step towards curbing the Brazil cost. Next, it takes enormous political will, technical expertise and vision on the part of those leading the country to do so. Structural reforms would unchain enormous wealth-building potential for all. The writer is director of BRICLab at Columbia University, where he teaches international affairs

Country becomes an international hub for research and development
Oil Rio centre attracts companies from around the globe keen to explore deeper waters, says Joe Leahy

COLOMBIA

VENEZUELA

S U RI N A M E G U YA N A
AMAPÁ

Brazil's trading partners
Per cent of total trade
EU China US
RIO GRANDE DO NORTE MARANHÃO CEARÁ PARAÍBA PERNAMBUCO ALAGOAS SERGIPE

RORAIMA
Negro Am azo nas

Argentina Japan Rest of world

PARÁ
Ma de ira

AMAZONAS

33.1

26.2

ACRE RONDÔNIA

BRAZIL
TOCANTINS MATO GROSSO

PIAUÍ

2000
4.7

2.0

BAHIA

PERU BOLIVIA

Brasília
GOIÁS MATO GROSSO DO SUL MINAS GERAIS SÃO PAULO

22.7 11.3

ATLANTIC OCEAN ESPÍRITO SANTO

38.9

20.5

PACIFIC OCEAN
CHILE

PA RAGUAY
PARANÁ SANTA CATARINA

RIO DE JANEIRO

Rio de Janeiro São Paulo

2013
3.1

17.2

I

ARGENTINA

t is easy to see why BG Group of the UK is an enthusiastic investor in Brazil. The company hit the landmark 100,000 barrels a day mark in October in its projects in Brazil and averaged 81,000 bpd during the third quarter, making the country its secondlargest contributor after the UK. The strong promise of Brazil, in which the company has invested $8bn over two decades and plans to invest another $3bn annually in the coming years, has led it to base its chief technology officer Richard Moore in Rio de Janeiro. “We were prompted to come to Brazil by the success of our exploration activity here,” says Mr Moore, who has a PhD in sedimentology from the University of Leeds. BG Group and other international oil groups have been drawn to Brazil by the discovery of some of the largest offshore oilfields in recent history off the southeast coast. Known as the pre-salt, these fields lie 5km or more below the surface of the ocean, buried under a 2km layer of salt. Petrobras, the operator of the pre-salt fields and BG Group’s partner, says the average daily production of the pre-salt fields has risen 10-fold from 2010 until May this year, reaching 411,000 bpd. “This currently represents approximately 20 per cent of our total production, and in 2018 it is expected to reach 52 per cent of the company’s oil production,” Petrobras says. Just as the original discoveries were made possible only by sophisticated technology, so the exploitation of the pre-salt is requiring research into how to operate at depths that are

equivalent to the height of a Himalayan mountain. The ultra-deep nature of the pre-salt wells means they face higher pressure and heat, while the salt causes greater corrosion. To handle the research requirements of the discoveries, Petrobras has set up a research centre near a technology park hosting most of its main partners and contractors. The park includes oil services provider Schlumberger, oil equipment, software and services supplier Baker Hughes, their rival Halliburton, underwater technology group FMC, specialist in pipes Tenaris Confab, BG Group, as well as Siemens, General Electric and EMC. The presence of the research and development centres of these multinationals is attracting other partners, such as software services and consultancy firm, Capgemini, which is developing big data with EMC at the park. “We work together on the oil and gas sector,” says Walter Cappilati, head of the Latam region for Capgemini. BG Group is planning to open its global technology centre at the park next year, reinforcing its research base in Brazil. As a partner of Petrobras, with interests in five big discoveries and with five floating production, storage and offloading platforms in operation in Brazil, BG Group is obliged to invest 1 per cent of its revenue a year in R&D under local regulations. Mr Moore manages a global team of 40 in four countries from his base in Brazil. They are researching subjects such as the behaviour of carbonate rock reservoirs. These are notoriously tricky

RIO GRANDE DO SUL
URUGUAY

1000 km

7.5

12.8

Brazil’s GDP growth
Annual % change 8 6 4 2 0 1991 95 2000 05 10 15

Growth compared
Real GDP, rebased 180 Brazil Mexico US 160 140 120 100 1991 95 2000 05 10 15

Brazilian trade

Merchandise trade, sum over previous 12 months, ($bn) 250 Exports 200 150 Imports 100 50 0

2000 02 04 06 08 10 12 14

FT graphic. Sources: Thomson Reuters Datastream; IMF

The project is being powered by one of the fastest supercomputers in the region

sedimentary rock formations that account for much of the pre-salt and indeed global oilfields. “There are some excellent outcrops of carbonate rocks that are analogous to the pre-salt,” he says. The team also co-ordinates with universities in Brazil to harness their brainpower. The company is establishing a national centre for studying carbonate rock at the Federal University of Rio de Janeiro, for instance. “We are trying to create a world-class facility for understanding carbonate reservoirs,” says Mr Moore. BG Group is also working with a technical institute in the northeastern state of Bahia, Senai Cimatec-BA, and another northeastern educational facility, the Federal University of Rio Grande do Norte, in co-operation with Imperial College, London, and the University of British Columbia in Canada

on a “full waveform inversion project”. The technology will allow scientists to build detailed images from 3D seismic data of underground geological formations, including the pre-salt oil reservoirs of the Santos Basin. The project is being powered by one of the fastest supercomputers in the region. Another project is a partnership between Imperial College and the universities of São Paulo and Campinas to study gases. In particular, the project is looking at capturing and reinjecting carbon dioxide into reservoirs to help production, along with other measures to mitigate greenhouse gases and harness them for productive purposes. “What we are doing is again leveraging the opportunity to address in a significant way a problem that is facing the whole industry,” says Mr Moore.

Competitive Embraer spreads its wings at home and abroad
Aviation

The government hopes to build on aircraft maker’s success, reports Joe Leahy
Parked on the tarmac at Embraer’s Gavião Peixoto airport, with its slightly drooping wings, is the prototype of Brazil’s latest proposed export product – the KC-390 military transport plane. A queue of people in military uniforms and civilian dress from around the world waits to enter through a passenger side door to assess whether they will buy the plane for their air forces. With capacity to carry three jeeps or 80 soldiers and to be used as a tanker for in-flight refuelling, the jet transporter will replace the Hercules C-130 from Lockheed Martin of the US in Brazil’s

military. Five other countries are also said to be interested in the aircraft, including Colombia, Portugal and Argentina. The ambitious project is typical of a company that is Brazil’s highest-profile industrial exporter. Aside from defence, Embraer is the world’s third-largest commercial aircraft maker. It has placed Brazilian aviation on the map through a willingness to tap into global supply chains rather than seek protection from them. “Philosophically, we are for more free trade,” says Frederico Fleury Curado, Embraer chief executive. “Embraer is a living example of how free trade works.” Brazil has long been a country with a vibrant aviation industry. Aside from manufacturing and exporting aircraft, the domestic market is one of the world’s most active for jet liners, executive aircraft and helicopters. Brazil has

the second-largest fleet of executive jets in the world and the second-largest of agricultural aircraft after the US, according to the government. The country could also become a focus for international airport builders and operators. The government has auctioned off concessions for the main airports in São Paulo, Rio de Janeiro, Brasília and Belo Horizonte, the capital of the populous state of Minas Gerais, to domestic and international private sector operators. President Dilma Rousseff is now in the process of trying to upgrade more regional airports by encouraging private investment. “There are about 700 airports in Brazil, but those operating on commercial terms number only 100. We want to reach 270,” says Wellington Moreira Franco, minister of civil aviation. In a country in which businesses and

investors groan about the “Brazil cost” – the country’s overwhelming burden of taxes, bureaucracy, inefficiency and corruption that increases overheads – the aviation industry has been able to show it is still possible to compete. Indeed, the sector is too global and competitive for a single company or even country to attempt to go it alone and try to develop all its own technology, says Embraer’s Mr Curado. A presentation on the KC-390 to Congress shows the array of global partners involved in the project, from German company Liebherr, which is supplying the air-conditioning system, to

700
The number of airports, but only 100 operate commercially

$2.9bn
The sum the government hopes to raise for regional airports

US-based Rockwell Collins, which is providing the basic avionics. Proof that Embraer is globally competitive is that it is ranked third in its own market, Brazil, and therefore not dependent on protection or local content rules imposed on airlines in the country. “We don’t believe in protectionism. We would not have survived if we had depended on protectionism,” says Mr Curado. “Brazil has to be part of the global supply chain.” The country’s airport building programme could go some way to helping internationalise further the aviation industry, says Cesar Cunha Campos, director of FGV Projetos, a consultancy. In a paper on the government’s regional airport programme, he says the aim is to attract $2.9bn, mostly from the private sector, to upgrade the 270 regional airports in the first phase. If the government can mobilise the

investment, the benefits to the economy will be immediate. “In 2010, according to the Airports Council International of North America, airports accounted for 8 per cent of US GDP and for 7 per cent of jobs growth, demonstrating, a significant return on investment,” he says. Proper planning is crucial. Kuala Lumpur began building a new international airport with a projected cost of $2.5bn. This blew out to $4.4bn because of constant changes in design and delays. Mr Moreira says it is important to create an attractive investment environment, so Brazil can overcome its limitations in terms of transport infrastructure. Outdated regulations, such as one limiting foreign direct participation in airports to 20 per cent, need to be changed. “The regulations will have to be clear and respected,” he says.

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