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Commodity, Pre-Salt and Development
Carlos Feu Alvim (*)
“Brazil is essentially an agricultural country” was the economical truism taught in school in the 1950s. The country was under the influence of the coffee cycle that has followed other ones based on extractive or agricultural products in successive cycles since the Colonial period: pau-brasil, sugarcane, gold, cocoa, rubber, etc. At the begginning of the fifties coffee was responsible for more than 70% of our exports. Presently commodities dominate our exports and one might ask: is Brazil essentially a commodity-exporting country? The recent publication of the government document “Productive Development Policy – Innovate and Invest to Support Growth” makes it oppotune to discuss the subject.
The Brazilian economy started to diversify its production as a reaction to the crisis of the 1930s. This reaction had as main milestones the installation of the São Paulo industries, the National Steelworks and the establishment of Petrobras (Vargas Administration) and that was followed by the imports substitution policy that was the premise of the Brazilian industrialization in the Juscelino Kubitcheck Administration and in the military regime. Aiming at the internal market, the Brazilian industry, practically dependent on external technology, took refuge in the protectionist barries and that limited its external competition capacity as well as internally, in case of a possible market opening.
In spite of these limitations, very often used to classify as unqualified the efforts made, the internal production change resulted in a significant change in the Brazilian exports profile during the military regime period in the sixties and seventies. In order to better understand the changes in exports it is worth while to examine its evolution by product classes, namely, basic, semi-manufactured and manufactured products. The SECEX/MDIC (Secretariat of External Trade of the Ministry of Industry and Commerce) supplies data from 1974 on to the last two classes whereas those regarding basic products,from 1964 on.
Figure 1 shows that basic products, predominant in 1964, were drastically reduced from 83% (1964) to about 25% in the nineties. On the other hand the share of manufactured products changed from 10% to 55% in the first twenty years of the period.
However, its manufactured products – that include now airplanes from Embraer – also include less sophisticated products such as refined sugar, alcohol, petroleum products, orange juice and rolled steel. Furthermore, the other products incorporate imported high-technology components, masking the indicated results. But considering that in the 1950s Brazil had more than 70% of its exports concentrated on only one basic products, one should aknowledge that the progress was considerable.
Figure 1: Share of Product Classes in the Brazilian Exports.
Presently Brazil is in the process of significantly increasing its exports but a considerable part of this growth is due to basic or semi-finished products . The evolution of the manufactured products share in Brazilian exports was halted at the beginning of the 1980s and has practically remained stationary since then. Since 2000 it has been decreasing from 61% to 53% in 2007. The basic products in the same period increased from 23% to 33%.
The relative growth of the basic products share has reinforced the concern, object of the present article, that Brazil, building its trade balance mainly on commodities, may become vulnerable when the tide of high prices of these goods will loose momentum. It might be reinforced a strong dependency on the market whose vulnerability is well known and whose prices have been decreasing until the year 2000.
A fact to be considered is that a good part of the increasing share of commodities is due to a phenomenum that is positive in what regards Brazil, namely the recovery of their international prices, which will be analyzed in the item that follows.
A The Evolution of the Commodities Prices
Historically the prices of commodities and of other basic or intermediary products have been strongly unstable; the main reason is because these are not elaborated products and their production depends on important investments as compared to the value aggregated to the product (high capital intensity) and that sometimes have a low capital productivity that is the most scarce resource in developing countries.
When investment is made, the production capacity is amplified, including energy and transport infrastructure. When the production capacity is installed and resources are commited to investments, production depends on the operational cost. If prices drop due to an incorrect projection of international demand, the companies involved and the peripheral countries where they are established are obliged to sell their production for a price that is insufficient to pay for their financial commitments. To make production viable from the enterpreneurial point of view it is sometimes necessary tax exemption or favorable tariffs that do not pemit the government to recover its infrastructure investments.
Figure 2 shows the evolution of commodities prices (including fuels or not) and intermediary goods correted by the consumer price index of the United States. First of all it should be observed that the price of intermediary products has a behavior profile very similar to that of commodities and so both types of products can be treated together. In what concerns fuel prices, they follow their own dynamics and presented in the period a series of “hot” and “cold” shocks. This did not prevent them, together with the other commodities, to have a coincident period of high prices (seventies), prices drop (eighties) and recovery at the beginning of this century.
Figure 2: The price of commodities dropped during 25 years and it is now 17% below the average value until 1990 (value close to that of 1982) and 24% lower than that of 1975.
As shown in Figure 2, the prices of intermediary goods and of commodities (February, 2008) are far from full recovery. The values are relative to those of 1982 that were chosen because they coincide with the average value of commodities in the period from 1964 to 1990. Even with the observed recovery, the price is still 17% lower than that of 1982 and 24% lower than that of 1975. It should be added that the recovery occured in dollars which was considerably devalued in the last year relative to different currencies (including the Real) and that is not entirely reflected on the CPI (consumer price index) of the United States, the index used for correction. Furthermore, as can be seen in the “without fuel” curve, a considerable part of the recovery is due to petroleum and the recovery of the “without fuel” commodities price is about half of that of the whole set.
The drop of commodities prices along the two past decades has had deep economic and social consequences in the Third World countries. The present price increase can have a really positive economic and social effect for most of these countries. Naturally, countries that do not have income resources will have difficulties due to increase of food prices. The FAO has conducted studies showing that low agricultural product prices maintained by subsidies in developed countries have caused billion dollars losses to developing counties. Obviously, price recoveries of these goods does not bring only negative consequences to less developed countries, as it has been disseminated by the media, since their exports prices could then compete with subsidized prices of many developed countries
Commodities and Brazilian Development
The seventies, with high prices of commodities, was a decade of fast development in Brazil (Brazilian miracle), followed by the lost decades of the 1980s and 1990s when the commodities prices were low.
However, the analysis of data from Figure 3 contradicts the possible cause of growth, namely the commodities price growth. Actually, growth at the end of the sixties (due in part to the recovery of the political-military crisis) and at the beginning of the seventies preceeded the price growth of this type of goods. The growth rate of the Brazilian gross domestic product begins to drop from the 1974 commodities price drop on (including petroleum). The present recovery also preceeds the start of prices increase in the year 2000.
It is important to remember that in the case of Brazil there has been an ambiguous relationship between the price of commodities and the Brazilian Exchange terms. In fact, the gain due to the increase of the exported commodities price was opposed to the loss due to oil imports. The drop of GDP rates in 1980 is strongly associated with the increase due to the oil price shock of 1979 followed by the increase of the international interest rates in 1982. The oil price shock of 1973 also cancelled part of the disadvantages relative to commodities price increase.
Figure 3: The commodities price increase cannot be identified as the cause of neither the growth periods in the 1970s nor of the present phase.
The big problem regarding growth in the 1970s (and there is a risk to be repeated now) is that investments were concentrated on the production of commodities and on the infrastructure to produce them. This caused a sharp drop of capital productivity . The heavy investments of the 1970s (140% increase in the capital stock between 1974 and 1984) were sterilized by capital productivity loss, increasing the GDP only 50%. As a consequence of the capital productivity loss, it was necessary to invest twice as much in the subsequent years in order to increase the GDP 1%.
In Brazil, a better correlation can be obtained in terms of exchange that measures the purchase power of exports relative to imports (see figure).
Terms of Exchange:
Figure 4 shows that the GDP growth is closely related to the terms of exchange even though the precedent that could indicate causality is not evident.
Figure 4: The terms of change seem more directly associated with annual growth of the GDP even though the causality relationshipcannot be pointed out
Regarding the growing demand for food and other commodities in the world market, there are two possible attitudes:
· Brazil could use extra resources to increase the production of these goods without aggregating value larger than that implicit in prices variation and take advantage of the possible extra resources in order to simply increase the internal consumption of other goods.
· Brazil could benefit from the opportunity to increase the technological content of its products and take a decisive step for its development.
In the economic cycles associated with exported basic products - the most emblematic are those of cocoa and rubber – the path adopted was the easiest one. Brazil used the extra resources without caring about facing competition by investing in technology and agricultural research and it was outdone by countries that had made technological progress or that simply had better cultivation conditions.
To continue this policy would be, for example, the case if Brazil would profit from the present positive impact of iron ore prices in order to increase investments in its production and in the heavy investments of infrastructure for the transportation of these goods. There are in the country comparative advantages (ore quality) and disadvantages relative the distance of the markets. In the last years iron ore (fines) increased from US$ 31/t to 132 US$/t. According to EconStats (http://econstats.com), the futures market indicates prices around 200 US$ per tone. However, considering the relative abundance of ore at the world level it is possible to increase production and consequently decrease the price. This situation could lead to a sterilization of investments as it occured in the seventies. Briefly, all wealth that could be produced because of high prices of the Brazilian ore could be non existent due to the low capital productivity. In fact, Brazil would have invested a lot in order to make cheaper the price of the exported product.
Anyway, the Brazilian enterprises, mainly Vale, have the world leadership in the sector and have now the conditions to play, an important role in the world, including preventing the low prices of the last decades. It would also be fair to hope that the price surplus will be used in investments in order to aggregate more technological value to the products.
In fact, the Brazilian society has not yet assimilated the new reality of the commodities high prices. Among other things, the Brazilian legislation continues to stimulate exports of primary products through the Kandir Law (Complementary Law № 87 of 09/13/1996) that obliges the Federal Government to compensate the states (in practice with heavy loss to the Central Government) by exempting the circulation goods taxes in this type of exports. This Law was established in a period when the country was badly in need of foreign exchange and therefore it was necessary to stimulate any exports and the prices of commodities were moderate. Now the situation is different with high external demand and high profit to the exporters quite different from the previous one.
The lack of entrepreneurial initiatives should be compensated by a fiscal policy that would give priority to investments that would aggregate technological content to exported products.
The present increase of oil prices is fundamentally different from what occurred in the 1970s: Brazil, due to the successful efforts of Petrobrás that has made heavy investments in the exploitation and production of oil at 20 US$ the barrel, is now self-sufficient regarding this strategic commodity which was the one that affected most the Brazilian imports. This emphasizes the potential positive effect on the Brazilian economy of prices increase of exported goods. One question should be analized: is it possible?
Furthermore, there is the concret perspective that with the pre-salt discoveries Brazil will have an important role in the world panorama regarding oil production and exports.
These circumstances give rise to discussions about the Brazilian future if it becomes an oil exporter of some importance. One issue should be analyzed: is it possible for an oil-exporter country (or of commodities in general) do become a developed country in the present globalization phase?
In the XIXth century and in the first half of the XXth century, the existence of natural resources was considered as one of the conditions for development. The existence of coal and iron in England and of petroleum in the USA are clearly associated with the extraordinary development cycles of these countries and whose consequences are present today.
What happened in these countries is that the existence of commodities in their territories and their own or exclusive (colonies) huge market gave them conditions to develop the technology associated with the production and use of goods. The existence of coal and iron in England made possible the development of the steel industry that, associated with steam engine, permitted the industrial revolution in the XVIIIth century. In the USA (end of XIXth and beginning of XXth centuries) the exploitation and production of petroleum were developed along the development of new technologies to deepen the oil wells. The Americans were also pioneers in the modern oil refining techniques that, associated with extraction techniques, permitted important business to the Americam industry in the country and abroad along the whole century. As a consequence of this environment the car industry was born and it became the North American modernization engine and in this integrated context it developed later the petro-chemical technology, also one of the big vectors of progress in that country.
In the second half of the last century, the development of Japan and Korea and of some European countries was considered as evidence that there was no more relationship between development and possession of natural resources. Educated people and technological development were considered the fundamental elements for development.
The opposite theory was true, namely the existence of natural resources would inhibit full development. In effect, among the oil-exporting countries there are rich countries but the only developed one is Norway that already was or was close to that before the discoveries that would transform it in an exporting country.
A peripheral country that discovers a reasonable oil reserve can easily use the resources from selling it to buy all equipment it needs. This is what happens with most of the oil exporters, even the most rich ones. It is interesting to note that this attitude is common even in government-owned company as in most of the big exporter countries.
The situations of Argentina, Mexico, Venezuela and practically all Asian, African and Arab exporters are emblematic. They did not entirely develop the technology they needed in the value chain of the oil industry not even the tecnologies that are essential for the advanced exploitation and production. Many countries had foreign currency surplus but not the economic and social wealth. Many observed the exhaustion of their abundance cycle but were unable to change it.
Norway, Englad (heavy exporters in the post 1979 oil crisis), Canada and before all of them the USA created a vigorous oil industry, with the complete value chain very well developed, and they offer the world goods, services and advanced technology that levers the national economy. Without oil reserves, France and Italy have also made the oil business a factor for national development, proving that more important than having raw material was the development of technology and knowledge in order to master the cycle of this industry.
When a country has the perspective of accumulating a dollar surplus, it has , in the medium-term (some years) the option of sending abroad these dollars in the form of reserves or other type of investments. In the long-term, it has to choose what it will import. For China, which is the most recent example, the initial option was to accumulate reserves and apply on foreign bonds but later on it made direct investments abroad. In the present phase, China is a big importer of commodities in order to supply to its huge population and the industry needs.
Why Petrobras and Brazil have (at least until now) escaped from this destiny that has condened most of the oil-exporting countries to underdevelopment in this industrial sector is a phenomenon that shall keep busy in the next years and beyond those few that dedicate themselves to study national development. During some time, the fact that Petrobras was exhilerating for discovering petroleum in more and more deep waters was considered as paradoxal. In effect, it would be better if it could find an abundant quantity and in shallow land.
The fact that it had to invest in deep waters in a period when investments were not interesting due to the decrease of oil prices meant a technological challenge to Brazil and that it would have to face with its own means. Petrobras was looking for oil in the sea since the 1960s and its first discoveries in shallow waters occurred in 1968 and the second one, in deep waters, in 1974. So, the deep Waters saga and the national technological development in this field have just started during the 1973 oil crisis. The technological progress of this period have permitted Petrobras to continue investing after the oil price decrease in 1986, due to reduction of exploitation and production costs and the growing capacity of a better evaluation of its sedimentary basins.
It is clear that there were alternative options of association with foreign companies and this was not entirely discarded in Petrobras’ strategy. Maybe the difference was the practice of always associating development with the external help with a national effort, like a mirror image. The circumstances that conducted Petrobras to give privilege to the technological variable deserves an analysis that is beyond the objectives of the present essay. Among the important factors to be considered certainly is strengthening research sectors whose most visible point is CENPES but that includes also a close link with universities with which several excellence centers were established.
Subsequently, the Fernando Henrique Cardoso Administration established a series of mechanisms that made the company apply on reasearch part of its production revenues. This compulsory application has multiplied the resources to be applied on R&D and made possible already in the present administration to establish permanent research networks linked to universities that have strengthened this enterpreneurial option for technology.
Other interesting details in the case of petroleum is that the maximum horizon envisaged in the national dreams is self-sufficiency. This has led Petrobras to go abroad where it made the first large discovery (in Irak) and after a period exploiting mainly the Brazilian platform it has operated abroad using the technology developed here and confirming its position in the vanguard of the oil industry.
That is, the apparent initial disadvantage of finding much oil only in deep waters has motivated Petrobras to insist on the technological development path, adding critical mass to the research effort that started since the beginning of its establishment. This development is already an important factor in its business and it can make a difference in the new phases.
The pre-salt oil was discovered in the Lula Administration and its story should not only be told but built as well. This Discovery is certainly a consequence of the technological progress achieved in the previous period of intense action on the sea since the Discovery of the Campos Basin in 1974. Of what is known, the technological factor was important for this discovery: due to progress in geo-chemical and geo-physical analysis, the evaluation technology of reservoirs and rocks, the undestanding of the national sedimentary formations as a function of exploratory research, among others it was possible to formulate the hypothesis that the characteristics of the discovered oil did not fit the geological environment where they were situated and that it must had come from another geological layer from which the oil should have escaped. The discovery of oil covered by a saline layer of about two thousand meters and depth down to five thousand meters (in the soil) and also the confirmation of this hypothesis (and the discoveries) would not be possible without mastering the best prospecting and exploitation techniques by Petrobras. A new technological challenge involves the oil exploitation and production in this particular environment of large depth in the marine soil with a thick salt layer.
Contrary to what happened with deep waters in the 1970s, the present panorama of high oil prices and the market opening can be unfavorable to the national technological development at least in what regards the national fabrication of equipment. On one hand it stimulates the companies to search solutions wherever they are (much resources) and on the other hand it has shown that the foreign exploiting companies confer privilege to the external market and naturally the technologies developed in their research centers.
As it is already happening in Brazil relative to the good phase of iternational prices of its products, the exports surplus depresses the exchange rate. This turns attractive imports of machines, equipment, platforms and ships. It runs the risk of loosing the opportunity of using the commodities wealth to generate development that will make wealth permanent.
Norway, an oil-exporting developed country together with Canada and England adopted a series of measures (like the establishment of a National Fund) to protect their economy from oil affluence. This experience should be studied by Brazil.
The Challenge of the Commodities.
The present recovery of the commodities prices and its consequences in the economy can be an antecipation of what could occur if more important Brazilian oil discoveries are confirmed
In case of an increase of exported products prices or of a large availability of a valued product, one runs the risk of addopting a comfortable attitude, namely enjoying the circumstances as was the case in the case of the rubber and cocoa cycles. Taxing the exported primary products can make a better distribution of the generated resources.
The attitude that leads to development is to face the technological challenge of aggregating value to the goods produced from primary or semi-manufactured products, participating in the whole technological cycle. Addopting this attitude, the iron production would lever that of steel that would give impulse to mechanical and naval industry that would permit the use of equipment designed and fabricated in Brazil in the oil exploitation and processing. Uranium exploitation (whose prices have increased) would be used to finance the amplification of isotopical enrichment and the construction of power plants. And progress in all the value chain of oil and gas would reach all industrial sector in the country as it is, by the way, the objective of PROMINP
This attitude that leads to development has already be taken by agriculture where Brazil was “lucky” to be practically alone in the agricultural development in the tropical area where the Embrapa technology is starting to find applications in tropical regions abroad. This is also happening in the alcohol sector where the isolated experience of using it in vehicles has generated an acting industry that is now facing (with large external competition) the technological challenges of producing plastics and using cellulose for alcohol production.
It is important to notice that this attitude already exist in the Brazilian petroleum sector where Brazil operates in all the productive chain and where the technology and the national enterpreneurial capacity open doors for Petrobras and other Brazilian companies abroad.
But imagine that Brazil with the pre-salt layer becomes an oil exporter of say 3 million barrels per day. Its revenue of hard currency would be about more US$ 100 bilion per year. One can envisage what would happen to its economy if a progressive plan for using this surplus would not be very well prepared. If nothing is done, this dollars surplus would simply disarticulate the economy.
Summarizing, Brazil’s challenge is to use the wealth from oil and from other commodities to foster development and permanent wealth of the country. This will only happen if there is a coherent planning that breaks the comfortable attitude. It is necessary to establish an intitutional and enterpreneurial structure that permits the fair economical development and allows the payment of the huge social debt accumulated during centuries in the country.
For the worse and for the best, the Brazilian economical future depends on how it will use its commodities.
(*) Carlos Feu Alvim, PhD in Physics and Editor of the Economy and Energy - e&e - periodical, Consultant at COPPE e_mail: email@example.com
(**) Engineer José Fantine, Consultant at COPPE, former Director of Petrobras and former Superintendent of Planejamento at Petrobras. Membro da Academia Nacional de Engenharia, e-mail: firstname.lastname@example.org _______________________________
 “O Declínio dos Manufaturados” Análise IEDI 10/07/2004 em Abril de 2008 em http://www.iedi.org.br/cgi/cgilua.exe/sys/start.htm?1=6&infoid=2940&sid=73&tpl=printerview
 “A Importância da Produtividade de Capital para o Crescimento” Economia e Energia e&e No 65, Dezembro 2007
 From 1964 to 1974 the data used, assigned to the same source, are from the Bimonthly Bulletin of the External Trade Analysts Association, May / June, 2004.
 Brazil is making efforts aiming at including alcohol in the commodities market.
 However this does not mean exports of high and medium high technology products have remained stationary. Between 2000 and 2006 the exports of these products have grown 140% (more than twice its value) whereas their share in total exports decreased from 36% to 29%.
 Capital productivity (aggregated value per investment stock) is low on the average in the country (when the necessary infrastructure investments are included) and strongly dependent on international prices.
 Terms of exchange express the ratio between the export price and the imports price indices.
 In practice, long-term contracts make prices more stable in the medium term. The adjustment negociated between Vale and the Japanese buyers, for example, meant an increase of 65% in ore price, therefore lower than that of the free market. It is also probable that the long-term prices would offer favourable conditions to Vale when the market was low.
 Normally, to aggregate value is to instal plants to process the ore - (iroworks). Actually, ironworks are not necessarily the installation that produce the best capital productivity for the country (except during the peaks of high prices of commodities), but rather the subsequent steps that depend on higher technology, as well as the technological development itself in the value chain, from mining to the production of the more elaborated steel. This technological development will produce the conditions for costs reduction and increase value by continuous evolution, in order to supply new products, processes and services that are competitive in the national and world market.
 In the 1973 and 1979 oil crisis prices rose from US$ 2/b to US$ 12/b (six times) and to US$ 40/b (twenty times) respectively. If these prices are corrected 2008 they would be respectively US$ 10, US$ 50 and US$100, therefore still below US$120/b limit reached in May. The present price rise has multiplied by six the oil market price.
 In Brasil, rigorously speaking, the most probable destination of the surplus dollars, in the medium term, is for paying revenues or the withdrawal of external investments that have been multiplied by the high interest rates paid in Brazil.
 Examining supperficially commercial trade between the USA and China one could arive at the inverse conclusion regarding the development scale of the two countries. In effect, according to the US Census Bureau data (http://www.census.gov) 49% of its exports are to China consisting of food products and intermediary goods while these items correspond only to 8% of exports from China to the USA. Consuming and capital goods correspond to 82% of exports from China to the USA.
 Up to now, the facts are demonstrating that the problem of not finding oil in land was a geological question and not of competence as, by the way, has been already anticipated at the beginning of the sixties in the controvertial Link report.
 Many details of the development reached were not closely studied. This is due, in part, to the minor concern regarding the development issue in the last decades or because the company itself is not interested in revealing details of the important factors of its successful business.
 Associated, in Brazil, with its Exchange rate policy.
Graphic Edition/Edição Gráfica:
Thursday, 11 August 2011.