In April 2021, the Brazilian president signed the "New Gas Law," a milestone in the country's efforts to promote competition and vertical unbundling. Since then, several developments continue to shape the gas market landscape: more producers sign contracts with local distribution companies (LDCs), additional LNG regasification terminals reach the final investment decision (FID) stage, and a new offshore pipeline is expected to come online soon.

Nowadays, a prevailing question among many natural gas sector participants in Brazil is: Will the combination of available supply with a broader market reform trigger natural gas demand from large industrials?

IHS Markit recently published a report entitled "Brazil's gas market after reform: Exploring the opportunities for natural gas in the industrial sector" examining opportunities for natural gas use in four key industrial segments of Brazil's economy.

Domestic gas sources need offtakers with firm demand that accommodates production coming from large offshore gas associated fields

In the last 15 years, Brazil has increased gas production threefold after the discovery of large gas-associated oil fields in the presalt polygon. However, despite supply availability, less than half of gross production is actually marketed. Most reserves are associated with oil and are located offshore where large and costly infrastructure investments are required. Additionally, the power system relies on natural gas mostly when hydropower generation is low. Therefore, only the industrial sector can provide substantial and steady demand to bring additional domestic gas to market.

The industrial sector is a reliable consumer base that represents more than half of total demand in Brazil. However, industry demand has stagnated around 40 MMcm/d since 2010, as historically high gas prices in the country have prevented a broader usage of the fuel by large industrials. As an example, gas is less prevalent than firewood in important sectors such as food and beverage, and ceramics. It is also less consumed than coal coke in the steel segment.

Key industrial segments offer opportunities for natural gas

IHS Markit analysis focused in four key industrial segments of Brazil that could grow their gas requirements, or may benefit from fuel switching to natural gas if gas prices are indeed reduced as a consequence of market reforms. These sectors are chemicals, pig iron and steel, ceramics, and food and beverage.

The chemical segment is the largest industrial gas consumer in Brazil, accounting for nearly 6 MMcm/d of gas demand for feedstock and energy purposes in 2020. This segment has had little to no growth over the past 10 years, with domestic manufacturing losing space to imports from countries with access to inexpensive gas, such as the United States. Brazil is the second largest importer of urea in the world and methanol and fertilizers were at the top of Brazilian imports in 2020 (7.1%).

In the pig iron and steel segment, gas competes with metallurgical coal coke, the most used reducing agent in the iron ore converting. Industry studies have indicated that the influence of gas prices in the operational costs is the main factor that hinders gas usage in this segment.

In the food and beverage segment, natural gas comes at the fourth place in the energy mix, after sugar cane bagasse, electricity and firewood. In São Paulo state—the most industrialized state in Brazil—where gas production and imports are readily available, gas is used to a lower extent than diesel.

Finally, in the ceramics segment, firewood leads the energy mix, while natural gas comes in second place, with close to a third of share. This is because ceramics production usually takes place in the countryside, away from the pipeline network.

Different avenues are available to give a large industrial consumer substantial cost benefits from using gas and increase fuel switching

Whether to grow consumption for feedstock needs as in the chemical industry or to enable fuel switching in other industrial segments, a competitive gas price is a key factor to unlock industrial demand. A price comparison between the analyzed fuels in São Paulo state— in 2021 and out to 2023—indicates that natural gas is already quite competitive compared with diesel and even with metallurgical coke. An eventual price reduction driven by the success of market reforms could create even greater opportunities for gas in the pig iron and steel segment there.

However, gas prices are still far from the level at which the chemical industry claims they would enable growth. From a cost build-up approach, there could be room for lower commodity prices in Brazil compared with the historical average to end consumers. As more competition and liquidity build up along the Brazilian gas value chain, they may put downward pressure on producers' margins. For reference, switching half of the 2020 consumption of metallurgical coke, firewood, and diesel in the four industrial segments analyzed above would add nearly 17 MMcm/d of demand for natural gas.

Other factors that can contribute to shave final consumer gas prices in the future are lower transportation and distribution tariffs, regulatory harmonization around free consumers (consumers that can procure gas, without the obligation to acquire it directly from the LDC) and a taxation reform.

Learn more about our Latin American energy research.

Ísis Marinho is a research analyst with the Climate and Sustainability group at IHS Markit, with a focus on gas market fundamentals, gas prices, and policy drivers in the Southern Cone and Andean regions.

Posted on 6 January 2022

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.