Brazilian Oil and Gas Industry: an Update
Brazilian Oil and Gas Industry: an Update
Marilda Rosado de Sá Ribeiro, Lobo de Rizzo Advogados
Marilda Rosado de Sá Ribeiro at Lobo de Rizzo Advogados assesses recent developments in Brazil’s oil and gas industry including changes to the regulatory framework, signs of recovery and expectations for the future.
Brazil went through a period of increasing expectations for economic growth and social development in the first decade after Law 9.478/97, the Petroleum Law. In those years, positive institutional changes and a series of successful bidding rounds created a cycle of stability and brought a diverse set of investors to the country.
In spite of some regulatory issues that risked the success of those early years, there were many positive developments. Since the approval of several bills in 2010 that modified the Brazilian regulatory framework, three structural changes have been carried out: the introduction of the production-sharing contract regime in the pre-salt area, by Law 12.351/2010 (the Pre-Salt Law); the setting-up of a new national oil company, the Pré-Sal Petróleo (PPSA); and 5 billion barrels of oil from the pre-salt layer being assigned to Petrobras, without public bidding.
In 2008, there were 35 foreign companies acting in the Brazilian E&P sector, almost matching the 36 Brazilian companies in the same sector. According to the Brazilian Central Bank, direct foreign investments increased by US$30 billion in 2010, and by US$23.7 billion in 2012. However, in 2015 it suffered a substantial downturn, decreasing by US$124 billion. Moreover, in the same year, the country recorded the largest decline of proved reserves in the world, falling by 3.2 billion barrels.
Two factors explain the difficulties that occurred between 2014 and 2016: the scandals that affected the national oil company, Petrobras; and the drop in oil prices that affected the global oil industry.
After the 10th bidding round of exploratory blocks, Brazil went five years without promoting oil and gas bids. During this period, some issues were discussed, such as the split of royalties and the legal and institutional aspects of exploring the pre-salt area. The 11th and 12th bidding rounds occurred in 2013, when the first pre-salt field was auctioned under the Pre-Salt Law; while the 13th bidding round happened only in 2015. Despite challenges, the pre-salt developments were perceived as as a positive outcome. The discovery made in the pre-salt area of Santos Basin gave the country, for the first time, the status of a big oil producer.
There are signs of recovery in 2017. This would be a good moment for a turning point in Brazil, further facilitating the exploitation of its huge, underexplored sedimentary basins. So far, less than 7 per cent of the total amount of basins are under concession.
After several years of uncertainty, the Brazilian government is finally demonstrating a commitment to resuming a regular agenda of bids. The Brazilian Petroleum Agency (ANP) announced the promotion of four bids this year. In addition, six are already approved by the National Board of Energy Policy (CNPE) for 2018 and 2019.
According to the ANP’s general director, the areas to be offered this year are among the world’s most attractive and the scheduled bids might generate indirect investments two-and-a-half times higher than direct investments. This means that, if successful, direct investments may reach around US$83 billion, while indirect investments will be between US$166 and US$207.5 billion.
In fact, the promotion of bids is followed by a microeconomic agenda supported by the government, and by some changes to the legal framework, which aim to generate a boost in investments. After all, it’s 20 years since the approval of the Petroleum Law.
A highly expected change was introduced in the Pre-Salt Law, in November 2016. Years of discussion in Congress were necessary to overcome the inherent controversy in this issue. This amendment did away with the obligation imposed on Petrobras to be the sole operator, holding a minimum 30 per cent stake in the consortiums for the exploration of the pre-salt area that had been set forth in one of the 2010 bills. Petrobras still has the right to exert this prerogative, but it must specify its interest in any area before a bid is made. This adjustment has clearly opened a door for investors, since Petrobras’ stake is no longer mandatory. According to the Brazilian Petroleum Institute (IBP), the simple adjustment of the legal framework has the potential to leverage investments worth US$120 billion over the next seven to 10 years.
Also in November 2016, a presidential decree set forth the investment partnership programme, in which projects may be treated as national priority.
The bidding rounds of 2017 are contained in this programme’s list, as well as the privatisation of various power distribution companies in the north and north-east regions of the country, currently held by the National Bank for Social Development (BNDES).
Another recent change regards the rules of local content in the E&P sector. The policy of mandatory local content is aimed at stimulating purchases from local providers. However, difficulties and distortions in the system saw an increase in the number of non-compliant occurrences, demonstrating the need for review of this framework.
The local content requirements have been under discussion since early 2016. Finally, in April 2017, new rules were approved by the CNPE. With a few exceptions, the main rule is that, for each bid, the ANP will set forth minimum percentages of mandatory global local content, so that concessionaires are free to choose the expenditures to be made at each stage. The ANP also intends to reduce royalties from 10 per cent to 5 per cent for the production of new frontier areas and mature basins with geological, logistic and economic risks. The establishment of only one exploratory phase is also under investigation, so as to exclude the obligation of drilling a second well in the second stage of the concessions. According to the ANP, the main goal of these changes is to reduce the cost of entering Brazil among companies and to simplify the contracts.
Furthermore, important guidelines concerning energy policy were introduced by the CNPE. These cover such topics as: attracting investors; adopting international good practices; reducing transaction costs; respect for the pacta sunt servanda principle; stimulating competition; and the formation of short-term and secondary markets. Other measures include non-discriminatory access of third parties to gathering lines; natural gas production units and regasification terminals; improvement of the natural gas sector’s tax structure; harmonisation between federal and member-states regulation; and the promotion of diversity among agents. Such changes aim to promote dynamism and access to information, integration between the natural gas and electric energy sectors, and greater transparency.
With respect to the prioritisation of investments, the ANP is facing a challenge. In the midst of this unstable economic scenario, there has been a discussion about the use of fracking, specifically in the concessions from the 11th and 12th bidding rounds. In order to properly channel the investments, the ANP is internally discussing the possibility of extending the exploration phase of these concessions. While the decision has not yet been made, the concessionaires were asked to state which contracts must be suspended and which must be extended.
The Brazilian oil and gas industry is undergoing a deep transformation, and the change in Petrobras’ role has strong effects on the upstream, downstream and natural gas sectors.
This has been the greatest crisis faced by Petrobras in all its history. The company’s gross debt reached US$126 billion by the end of 2015: the highest debt faced by any public oil and gas public in the world. In an attempt to reverse its fortunes, the company created the partnership and disinvestment programme, which consists of a strategic, business and governance plan for the 2017–2021 period.
All the judicial efforts and public awareness in the country have had positive consequences. Petrobras’ 2016 results showed a few significant improvements. The operational profit was 17 billion reais and the net debt/EBITDA ratio was reduced by 31 per cent, from 5.11 to 3.54. Petrobras’ average production in Brazil reached 2.144 million oil barrels per day. Almost half of that comes from operations in the pre-salt area, where most of the company’s efforts are concentrated thanks to its knowledge and experience. Production (including natural gas) in all countries in which Petrobras performs totalled 2.79 million barrels a day in 2016.
The company’s new CEO, Pedro Parente, believes that, besides being essential for Petrobras’ financial recovery, strategic partnerships are a great opportunity to increase relationships with global companies and thus share risks, discharge investments, promote the exchange of technology and strengthen corporate governance. This makes the partners more competitively equipped to face industry challenges. By the end of 2016, the announced transactions reached a value of US$13.6 billion. The bids scheduled for the next few years are a good measure of the position Petrobras will occupy when this difficult period is over.
Regarding bids planned for 2017, the 14th bidding round will offer 287 blocks in the maritime sedimentary basins of Sergipe-Alagoas, Espírito Santo, Campos, Santos and Pelotas; and in the onshore basins of Parnaíba, Paraná, Potiguar, Recôncavo, Sergipe-Alagoas and Espírito Santo. The ANP is now working across 29 sectors, aiming to offer blocks with high potential, new frontiers and mature basins. This bid is expected to expand Brazilian oil and gas reserves and production; to increase knowledge regarding sedimentary basins; to decentralise exploratory investment; and to develop the small oil industry – thus keeping Brazilian and foreign companies alike in the country, providing a demand for local services and goods, and creating jobs and granting income distribution.
In fact, a small bid has already happened this year: the fourth bidding round of areas with marginal accumulations. The companies that place bids for such areas are usually independent, and new players have applied. The other two bids scheduled for this year are the second and the third production-sharing bidding rounds: both will offer areas within the pre-salt polygon, specifically in Santos and Campos basins.
The bids planned for 2018 are the fourth production-sharing bidding round, offering blocks at Santos and Campos basins; the fifth bidding round of onshore mature fields, with areas still to be defined; and the 15th bidding round of exploratory blocks, with onshore and offshore areas (including blocks in deepwater outside the pre-salt polygon). For 2019, the CNPE has approved the promotion of the fifth production-sharing bidding round; the sixth bidding round of Onshore Mature Fields; and the 16th bidding round of exploratory blocks.
One could stress the ANP’s expectations for a direct investment of US$83 billion in the Brazilian oil and gas sector. The ANP also calculates that more than 300 wells might be drilled, indicating a need for 17 new platforms and simultaneous operation of more than 20 drilling rigs.
For these expectations to be realised, it will be necessary to confirm the potential of the areas after the bids. Also, the Brazilian government must implement governance measures that restore investors’ trust in the country.
It is true that what Brazil is currently experiencing is still far from ideal; but we can, finally, see clear signs of recovery and strong indications of an imminent turning point.
The author thanks Jorge Pedroso and Patricia Winter, both associates of Lobo de Rizzo Advogados, for their contribution to this article.