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Oil and Politics: Brazil’s Petrobras Scandal

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PetrobasLast month, we focused on Mexico and specifically the state-owned oil company Pemex as a risk for companies selling or investing into Latin America. We saw that Pemex represents a drag on Mexican fiscal accounts and is imposing losses on suppliers and investors. This month, we turn our gaze to Brazil: it is similar to Mexico in that it has a dominant, politically charged state-owned oil company, but different because the scale of the crisis is much more severe, as are the risks to suppliers and investors.

Brazil is undergoing a major economic and political crisis, and its state-owned oil company, Petróleo Brasileiro S.A. (Petrobras), is right at the center of the trouble. Petrobras shares some of the same challenges as Pemex: It started as an entirely state-owned firm, was used as an instrument of government policy from inception and took on enormous quantities of debt in recent times, exemplified by its $11 billion debt issue in 2013—the largest on record for emerging markets.

Brazil, however, recognizing earlier than Mexico the necessity of foreign investment for a viable oil industry, opened up the sector in 1997 and eventually reduced the government shareholding to 64% (direct plus indirect). Petrobras expanded into deepwater areas in Angola and the Gulf of Mexico and became one of the few national oil companies able to equally compete with companies such as Royal Dutch Shell and Total.

In 2014, information about the extent of corruption between Petrobras board members, various politicians and business executives not only came to light, but also sparked official investigations and arrests. President Dilma Rouseff has been temporarily removed from office pending a trial by the Senate. The official charge against her is manipulating the federal budget by directing state banks to support spending programs. She was the chair of Petrobras when the corruption allegedly occurred, however, and she and her party (Partido dos Trabalhadores or PT) are perceived by many as at least partly responsible for the scandal.

It is likely that Rouseff will be permanently removed from office within six months, but the uncertainty does not end there: As of this writing, two cabinet ministers have been removed from office, and six more are under investigation. Dozens of politicians and executives have been convicted in connection with the scandal, and prosecutors have recovered $795 million in stolen money. The economy of Brazil shrank 3.8% in 2015 and is projected to shrink another 3.5% in 2016. Moody’s downgraded Petrobras to Ba2 in December 2015, and S&P cut the sovereign rating to BB with a negative outlook in February. With the Zika virus now causing a global health emergency and the Olympics beginning in August, one wonders how many more stresses Brazil can take before serious political unrest breaks out.

Like with Pemex, the Petrobras crisis is increasing risks to suppliers already: There are trade credit insurance claims stemming from suppliers to Petrobras, and the wider Brazilian economic downturn (combined with the commodity price trough) is giving rise to other credit losses. But the Brazilian crisis goes well beyond trade credit risk. Brazil is a $2.2 trillion economy and one of the largest bond issuers in the emerging markets. As a result, this crisis has global implications: Eurasia Group has Brazil as one of its top 10 global risks for 2016.

Mexico and Brazil are not the only countries dependent on state-owned oil (or other natural resource) companies that are facing major challenges: Venezuela, Ecuador, Nigeria, Angola, Russia—the list goes on and on. In Brazil, however, there are some mitigating circumstances that reveal a silver lining. First, 85% of Brazil’s sovereign debt is held domestically, meaning it is less affected by currency depreciation and is easier to reschedule. Provided Brazil takes on some painful fiscal reforms, the country can dig itself out of the economic crisis. Secondly, so far, officials have been able to investigate and prosecute some of the parties responsible, despite the defendants being some of the more powerful people in Brazil.

There is hope that Brazil’s institutions will emerge all the stronger for being able to correct wrongdoing, which may set the stage for a more just Brazil and a better investment and credit risk environment in the long run. In the meantime, we are likely to see severe market and political volatility. It is a good idea to closely monitor your exposure in Brazil and in other countries dependent on highly indebted state-owned natural resource companies.

Predicting the World Cup Winner with Monte Carlo Simulation

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Soccer fans around the world are gearing up for the 2014 World Cup in Brazil, which starts tomorrow when the home team kicks off against Croatia in Sao Paulo. Many will be putting money on the various matches—basing their bets on national pride or gut feelings.

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There is another option, however.

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If you have the data and the inclination, you could also utilize a Monte Carlo simulation to place your wager. Recently, Fernando Hernández, a trainer and consultant at risk and decision analysis software provider Palisade Corporation, did just that, utilizing this computerized decision-making method to determine a more mathematically accurate pick for the 20th FIFA World Cup champion.

To create a model, Hernández gathered data from FIFA’s records of the past four years, which ranks over 200 national teams. Armed with the historic strengths and weaknesses of each team, he classified them into ranked categories (e.g., a fifth-ranked team is more likely to beat a tenth-ranked team). More specifically, in a match-up between a high-ranked and an intermediate-ranked team, the better team has an 86% chance of winning, a 7% chance of tying and a 7% chance of losing.

Hernández then modeled the first 48 games of the tournament—these are played in the “group stage,” in which eight groups of four teams play against each other in  round robin-style matches to determine who proceeds to the final 16 games. In this stage, a win garners three points, a loss gets zero points, and a tie gives one point to teach team. Teams advance by tallying these points.

If two teams end up with the same number of points, the team with the greatest number of net goals (goals scored minus goals received) will continue. If a tie persists, then the net goals scored in the head-to-head match between the tying teams are considered. Finally, a coin toss determines the final winner if a tie still continues. All those that make it past the group-stage go on to the single-elimination tournament which determines the final World Cup winner.

Hernández combined the group-stage rules with the game and team performance records, dating from January 2011 to present, into his model.

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He added the crucial element of home-team advantage by including data on all points scored at home games vs. away games for each team.

By running 50,000 iterations in a Monte Carlo simulation and mapping out the likely winners in a decision tree, Hernández created a model that depicts the probabilities of different teams winning at different stages, and calculates the overall odds of each team winning the championship.

The results vary, depending on whether home-field advantage is computed.

Without considering home advantage, Germany came out the most likely winner, with a 19.9% chance, and Spain as runner up with 16.1%.

However, when home-field advantaged is considered, a very different outcome emerges. Brazil—not surprisingly–comes in as the probable champion, with an overall 17% chance. Spain is again the runner up at a 12% probability. Germany drops all the way down to a 6 % probability of raising the trophy. Other high-scoring probabilities include:

  • Switzerland and Greece 8%
  • Colombia 7%
  • Argentina 6%
  • Uruguay 5%.

The United States, by contrast, is given just 2% chance at victory.

As a Costa Rican native, Hernández had to let the numbers guide his betting choices over nationalism. “I am still not sure whether I would bet on my country in the office pool,” he said. he calculated that his home country has only a 23% chance of making it to the second round, and a one-in-440 odds of winning overall.

Staying Safe at the World Cup

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Brazil is steadily moving into the international spotlight as it prepares to host the World Cup, which begins next week on June 12, and the Olympics in 2016, both of which are forecasted to showcase its status as an emerging economic power. On the other hand, these events are also likely to amplify security risks in the country.

The primary risk for travelers during the World Cup is the rise of common crime in host cities.

Often times, foreigners are perceived as wealthier and thus make attractive targets for pickpockets and armed robbers as well as express and traditional kidnappers. Risk managers should be aware that preparing travelers for these crimes is the best mitigation strategy.

Beyond crime, civil unrest is also a threat. Many groups already have plans in place to protest; the magnitude of their demonstrations and effectiveness of the government’s response are factors that are unpredictable. Widespread rallies may result in localized and violent clashes with police, especially in Sao Paulo and Rio de Janeiro, where they may be larger and more frequent.

These demonstrations can also routinely halt traffic, which can force an ambulance to take an hour to reach a hospital that may only be 20 minutes away. Risk managers are advised to plan an alternative route, especially in a medical crisis.

The Proactive Risk Manager
Due diligence and intelligence are every risk manager’s responsibility, but conveying this information to travelers is critical. This includes offering pre-trip training which teaches travelers how to be self-aware, and addresses visa requirements, language and cultural information, and any relevant medical and security threats. Simultaneously, all risks, mitigation strategies and contingency plans should be clearly communicated to relevant departments.

During trips to and within Brazil, risk managers should be aware of any itinerary delays and security incidents.

Knowing where travelers are at all times is vital; traveler tracking services, often offered by assistance providers, can help enormously in case of an emergency.

Following Best Practices
As we approach the World Cup, travelers and risk managers should expect a heightened security presence of police and other law enforcement officials, especially in all 12 host cities. That said, it is easy to fall into a false sense of security. Using common sense safety precautions can help to mitigate risks and ensure peace of mind:

  • Avoid exposing flashy jewelry or high-price items such as cell phones, laptops, cameras, etc.
  • Always carry extra medications with you.
  • Choose an indoor ATM so you don’t fall prey to express kidnappers or muggers.
  • Carry only a small amount of cash with you.

    Leave passport and credit cards in your hotel’s safe.

  • Do not walk alone at night. It is best to travel in groups.
  • Avoid public transportation. Hotels can assist in hailing “radio taxis” (taxis you call ahead of time to arrange a pick-up rather than cabs on the street).
  • Take out comprehensive travel and medical insurance before your travel.
  • Remember the local equivalent to “911″ is divided up into three services: 190 – Policia (Police), 192- Ambulancia (Ambulance), and 193- Bombeiros (Fire).
  • Carry the number of the nearest English speaking hospital and an emergency contact on you.

For more on staying safe at the World Cup, read our cover story in this month’s issue of Risk Management.

The Risks and Opportunities of Doing Business in Brazil

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China and India get the lion share of the headlines when it comes to emerging markets. But Brazil presents plenty of opportunities for the right companies.

Bryan Tedford, senior vice president of foreign casualty for ACE, gave a presentation on the nation’s potential and challenges for businesses today at the RIMS 2013 Conference & Exhibition in Los Angeles.

He noted that, as the world’s fifth-most-populous nation and seventh largest economy, Brazil is in a “fantastic position for economic growth over the next few years.” It has a strong, growing middle class that fuels a large domestic demand, which separates it from some of the other oft-discussed emerging markets. Tedford also highlighted the nation’s strong trade relationship with the United States, which he said actually sells about $11 billion more in goods and services to Brazil than Brazil sends back.

The nation also weathered the economic downturn better than most and has very little natural disaster exposure relative to many other growing economiesStill, there are plenty of challenges.

With a land area that is nearly as large as continental Europe, there is an imbalance of economic distribution in cities. This means that the opportunities for foreign companies reside mostly in crowded markets full of established competition. There is also a large informal economy in areas both urban and rural that can limit sales potential.

It doesn’t help that the legal and regulatory environment is very protective of Brazilian companies. In practice, new entities are very difficult to set up. “You really need to have some friends in Brazil … before you can really go after it,” said Tedford. “Having strong personal and business relationships seems to be the key for U.S. companies succeeding in Brazil.”

One way to make friends, says Tedford, is to give a small gift or token at a first meeting. Even offering something that may seem trite can be seen as a welcome gesture.

But don’t expect even friends to be punctual. “The conception of time is, I’ll say, liberal,” said Tedford. Don’t be surprised if an 8 a.m. breakfast meetings doesn’t start until 9:15. Perhaps it’s the traffic. Transportation and logistics can be a nightmare, so don’t expect to get anywhere quickly. The drive from the airport to São Paulo, for example, can take hours.

As far as more-business-related concerns, Brazil has strict liability rules that can make it difficult to deal with issues like a defective products and employment practices. There is also a short statue of limitations compared to the rest of South America, which can make it tricky to find time to deal with issues that must be addressed quickly.

In at least a few sectors, however, these are all mere inconveniences compared to the wealth of opportunity.

The agriculture industry has been booming in recent years, and this is only likely to increase. Sugar cane is especially enticing given the growth of the ethanol market.

The expansion of Petrobras, a Brazilian oil conglomerate that Forbes lists as the world’s 20th-largest company, may present even more chances for foreign companies to cash in. It is estimated that the nation will spend some $250 billion on contracts after the massive off-shore oil deposits discovered a few years ago, said Tedford. There will be a ton of new rigs and construction projects to be had.

There is also a tech boom. Brazilians are one of the largest purchasers of mobile phones, tablets and electronics among the emerging markets, says Tedford. This surging demand means more IT jobs and more infrastructure.

They also have another tendency: responding to direct-mail marketing offers. Brazil has a very good postage system, and it is helping move some of the economy outside of the cities. Companies in on the secret are able to make direct sales and raise brand awareness.