With BG purchase, Shell takes on Brazil partnership challenge

By Stephen Eisenhammer and Marta Nogueira

RIO DE JANEIRO (Reuters) - Royal Dutch Shell's agreed purchase of smaller rival BG Group will create a powerful player in Brazil's budding subsalt region with the money and technology to drive forward delayed projects with troubled partner, state-run Petrobras.

Buying BG will make Shell by far the second-largest producer of oil in Brazil, with a dominant position in one of the globe's hottest offshore prospects. Analysts expect BG to produce nearly 500,000 barrels of oil and gas equivalent in Brazil by 2020.

The development of the deep-sea subsalt, heralded as the world's largest oil discovery in decades when found eight years ago, has disappointed with delays and cost over-runs.

These hit BG's cash flow in recent years, helping to make it vulnerable to the type of takeover announced Wednesday.

"BG has struggled to shake off the perception that, in developing Brazil and Australia, it bit off more than it could chew," Investec analyst Neill Morton wrote in a note to clients.

Shell, as the world's second-largest oil company, certainly has the teeth to chew and swallow BG's Brazil assets, but the challenge will be its relationship with Petroleo Brasileiro SA, as the state-run company is formally known.

"The wrinkle in this (deal) is that Shell would be the non-operating partner of Petrobras, which is currently in turmoil," Iain Reid, analyst at BMO Capital Markets, said in a note.

Things look set to worsen before they improve, with Petrobras ensnared in a massive corruption scandal that has implicated the firm's executives, politicians and Brazil's largest construction companies.

The fallout has already started for partners, with Portugal's Galp Energia saying last month that four of its major offshore oilfield projects will be delayed at least a year due to the corruption probe.

Tensions are also likely to be exacerbated due to differing break-even costs, said Carlos Rocha, cost and technology director at research firm IHS in Brazil.

Rocha estimates that while Petrobras has a best-case-scenario breakeven price of $42 per barrel in the subsalt, those of its partners are just above $50 due to greater exposure to the international oil price and higher local costs.

With a diverse portfolio and healthy cash flow, Shell can be patient, but it also has the size and experience to push things along. "Shell has a long history in Brazil. It knows what it's getting into," said a source who works with the company in Brazil.

(Writing by Stephen Eisenhammer; Editing by Ted Botha)