An EU Hope: Sourcing Critical Raw Materials from South America

In light of the Russian-Ukraine conflict, European countries have been facing a raw material supply crisis. Disrupted supply chains have significantly contributed to the rise in the price of critical minerals, causing lithium and cobalt to double and other essential energy commodities such as gas to increase 14-fold in price over the span of 3 years. The EU has sought new trade partners to mitigate price rises and reduce their dependence on countries such as China and the US, aiming to secure a sustainable supply chain of critical raw materials. The prime candidates for this venture have been South American countries, a region with cultural and historic ties to the EU. Countries in this region are characterised by an abundance of natural resources and arable land, and their economic reliance on commodity exports provides an incentive to create trade partnerships. As a consequence, recent years have seen efforts to develop bilateral relations and trade in goods and services with the EU.

Recent Developments

The most recent development in the EU’s bid to secure critical raw materials has been intensified cooperation with Argentina. President Alberto Fernández and European Commission head Ursula von der Leyen signed a memorandum on June 13 to expand cooperation between Argentina and the European Union in sustainable value chains of critical raw materials. The goal of the agreement is to guarantee a steady and sustainable supply of commodities needed to ensure the clean energy transition, namely minerals, for European countries. The agreement is collaborative in nature, as the EU plans to invest in research and innovation in Argentina, with a special focus on minimising the climate footprint of extractive activities such as mining. While the EU secures a steady inflow of commodities, Argentina profits from quality job creation, increased sustainability, and economic growth from commodity exports, boosting its staggering economy.

Mercosur

Argentina, along with eleven other South American countries, make up the regional trade bloc Mercado Común del Sur (Mercosur). Trade between the EU and Mercosur is plentiful, with the EU being Mercosur's largest trade and investment partner. As of 2021, the EU exported €45 billion to and imported €43 billion from Mercosur. The EU imports mostly mineral and vegetable commodities and exports machinery, appliances, chemicals, and pharmaceutical products. In 2019, the EU sought to intensify this partnership by establishing a political agreement with decreased trade frictions, namely tariffs for small and medium sized enterprises, creating stable rules for trade and investment, and establishing environmental regulations and policies in all Mercosur countries. This agreement, however, has remained in a provisional stage ever since, as efforts to reach a consensus have been stunted by certain conflicting interests.

Graphical Representation of Main EU Imports from Mercosur from 2011 to 2021 

Source: Eurostat

Cooperation Friction

There are various conflicting interests that prevent this deal from going through. For one, Brazil, Mercosur's largest economy, has plans for intensified cooperation with China, one of its main trade partners. Argentina has also increased cooperation with China in recent years, adding to tensions in EU relations. Brazilian President Luiz Inacio Lula da Silva, the current Mercosur president, has also expressed his disapproval of the proposed agreement. Brazil has had intense deforestation in recent years, and although the current Brazilian presidency has decreased these efforts, policies proposed by the EU in the agreement would interfere with domestic policy and development in their agricultural production. Various clauses prohibit the export of products from deforested areas, demand strict labour laws, and provide public procurement rights to EU and Mercosur companies, limiting the Brazilian government's agricultural and industrial policies and weakening its ability to control domestic production autonomously. Lula has taken a stand against this interference and denounces the agreement for reducing South American countries to indefinite commodity suppliers to Europe. 

Various producers in European countries have also voiced their discontent with the deal. With lower commodity prices arising from reduced tariffs and trade restrictions, farmers and raw material producers in these countries would face extremely low prices and struggle to remain competitive. In France, local farmers fear losing profits as a result of an inflow of cheap imported beef. Despite expressing their interest in creating exceptions for agricultural products, farmers know these provisions would be unpopular with Mercosur producers and are thus unlikely to be included in the agreement. Although these farmers’ influence is not as prominent as that of other actors, protests and disruptions have been a cause for concern in the past. There is the possibility of further aggravating the current clashes over pension reforms, which place the French government in a delicate situation. EU member states could face scrutiny if the pact goes through for neglecting local producers and destroying domestic markets, although this might be a risk governments are willing to take in order to secure energy commodities.

Environmentalist organisations also oppose the agreement. Greenpeace has encouraged protests in Brussels against the "poisonous treaty" that aims to increase trade in environmentally detrimental commodities. A particular disapproval of the lower export prices of pesticides was cited in their protests, along with the more pressing matter of deforestation for cultivation in Brazil. These perspectives are shared by various member states in the EU, and their combined efforts have provided advances in the vein of sustainability. In various dealings, member states such as Austria, France, Ireland, Luxembourg, and Belgium have advocated for enforceable provisions regarding environmental issues, and their veto power places pressure on other member states to comply.

Future Prospects

The EU’s most recent supply acquisition, Argentina, will soon face political change that could affect their cooperation. Unlike Lula, who has three years left in his term, Argentine President Alberto Fernandez will be out of office as of December of this year, and the new government could increase friction in the agreement. Various candidate parties in Argentina have ideologies that differ greatly from Lula’s left-leaning policies, and their contrasting economic plans could decrease both bilateral relations and cooperation in Mercosur. Furthermore, the Mercosur deal, along with the bilateral agreement between Argentina and the EU, stipulates environmental policies and regulations for the country’s extractive activities that could slow their development. With Argentina planning on hastily developing oil and gas extraction in Vaca Muerta, these stipulations could very well be violated and harm both deals with the EU. This applies to many Mercosur countries that rely on primary activities but also want to develop other sectors that may have negative environmental impacts, namely industrial production. With economic growth being the main focus of Mercosur states, it is unlikely that they will accept a deal that would hinder development of any kind.

As seen, the political inclinations and plans for economic development of each Mercosur country have vast implications for the bloc’s ability to close a deal with the EU. With Lula’s rise to power, a change in government policy, in this case a decrease in deforestation, favoured the EU’s intention of creating a clean energy supply chain and reinvigorated expectations for cooperation. Nonetheless, the environmental implications of most Mercosur countries’ production models and their cooperation with countries like Russia and China create distrust between both blocs and stunt advances in the agreement. It seems that the EU’s inability to renegotiate environmental policy due to pressure from environmentalist organisations and specific member states will require a complacent Mercosur to finalise dealings. Although the possibility of splitting the agreement into two different parts exists, thus circumventing sustainability policy, it is unlikely the bloc will follow this path as it would aggravate various member states. Mercosur’s strong conviction for sovereignty will prevent them from accepting the stringent regulations currently proposed by the EU, and the EU’s apparent unwillingness to cede certain stipulations will further aggravate tensions between blocs and cause dealings to remain stagnant. With many South American countries undertaking long-haul projects on agricultural production and extractive activities with potential environmental implications, such as Argentina’s 10-year oil pipeline investment, the agreement will likely continue to face conflicts for the next two to five years. Although Lula promised at the July summit with the EU to deliver a definite proposal that is “easy to accept” soon, his declarations against the last draft’s stringent nature put into question whether this version will comply with the requirements stipulated by the EU. As demand from alternative countries like China grows, Mercosur will be less inclined to accept terms that harm its development, causing dealings to drag on until the EU complies.

Petrobras: Balancing Risk and Opportunity in Brazil's Oil Industry

Petróleo Brasileiro S/A - or simply called Petrobras - is the leading player in oil and gas production in Brazil. The majority-state-owned company has a net revenue of R$ 452 billion (approx. USD$90bn), outputs approximately 2.77 million barrels of oil equivalent per day, and is a publicly-listed company traded on the New York Stock Exchange (NYSE:PBR), Nasdaq  (NASDAQ:PBR), and the London Stock Exchange (LSE:0KHP), and several others. Despite its relevance to the global energy markets and its considerable growth potential, investors’ sentiment towards Petrobras usually contains extra grains of salt. The company is often embroiled in domestic wrangles and power struggles that shed uncertainty about its corporate governance and was at the centre of a major corruption scandal involving high-rank Brazilian policymakers in 2015.

After the election of Lula da Silva as president, markets again reacted badly due to a perceived high potential for undesired political influence over the appointment of Petrobras’ Board of Directors, for changes in its dividend distribution, and a revision of the company’s pricing policy (which currently follows a parity with international import prices). One year later, a scanning of those three issues and of the newly appointed Board might still prove revealing of Petrobras' future and better prepare investors to hedge against associated risks.

Currently, the State-owned Companies Act (2016) prohibits figures with a potential conflict of interest due to previous positions inside public administration from being appointed to the Board for a period of 3 years after leaving the previous function, which is also endorsed in Petrobras’ statute. A Bill reducing the “quarantine” period to 1 month is stalled in the Upper House of Congress since 2022, prompting many to wonder if the Bill’s approval could be pushed to ensure greater coalition support in times of political turbulence. Despite being a possible strategy, it is far from being the likely one. A Supreme Court decision has already suspended the proposed 3-year quarantine period of the Bill, and 3 of the government’s 6 appointees were confirmed on the Board despite alleged concerns about their ties with partisan politics. However, other bills and reforms are among Lula's top priorities with Congress, making it unlikely that he would create an unnecessary conflict with the Upper House over Petrobras, especially when  opposition forces are strengthened.

Acting as Petrobras's CEO is Jean-Paul Prates, who has vaguely commented on the possibility of changing the dividend distribution policy, but both Lula’s and Bolsonaro’s defence for greater taxing in dividend yield distributions likely does little to appease markets. Still, a recent judicial attempt of halting Petrobras’s dividend distribution shed even more uncertainty about how alternative ways of interference - ones that do not even involve the Board’s discretion - can be overreaching, indicating a high likelihood of taxation in the future.

The potential for a change in the company’s policy of maintaining parity with international oil prices also cannot be discarded, as key figures inside the Board have signalled they desire its revision. Nevertheless, in a continued scenario of high oil prices due to external shocks, the Board is likely to be interested in retaining a part of Petrobras’ profitability by not announcing major changes in the parity policy for the near future.

While the prospects for stable dividend yield distributions and insulation from rent-seeking dynamics appear less optimistic, posing increasing risks for investors, Brazil's potential to become a major player in clean energy production presents an opportunity. Petrobras is actively exploring cutting-edge technologies in renewable energy markets, such as wind-powered energy and green hydrogen production, which could enhance its long-term profitability. While the company’s issues span across multiple incumbencies and require careful assessment of long-term tolerance for loss, the most risk-appetite investors can still find creative ways to offset the balance and - with some stroke of luck - profit from the undertaking.

Photo credit: Global Business Outlook