On 10 November 2016, a new law was approved in Brazil’s lower house allowing private oil companies to become operator of Brazil’s giant ‘pre-salt’ oil reserves, thereby paving the way for new bidding rounds and the divestment of certain fields by state-owned Petrobras.

Petrobras and the sole operatorship

The new law amends the provisions enacted in December 2010, regulating the exploration and production of oil, natural gas and other hydrocarbons under the production sharing regime, in the pre-salt and other, so called, strategic areas.

At that time, the Brazilian parliament created a new regime for these areas due to the perceived low exploration risk and high oil and gas production potential. Under this 2010 law, concession contracts were replaced by production sharing agreements (PSAs) in the pre-salt area and Petrobras was granted the sole operatorship, being responsible for conducting and executing, directly or indirectly, all activities relating to the exploration, evaluation, development, production and decommissioning of exploration and production facilities. This same law determined that Petrobras would hold a 30% minimum share in any consortium formed for the exploration and production of these areas.

The problem

These rules have been heavily criticised for slowing down the development of Brazil’s oil industry. The last couple of years have been tough for Petrobras, despite the pre-salt discovery, due to a number of factors; including (i) the “Car Wash” scandal, Brazil’s biggest-ever corruption case, in which dozens of major Brazilian companies stand accused of paying bribes contracts with Petrobras; (ii) the dramatic fall in oil prices since 2014; (iii) Brazilian political uncertainty and interference. These and other issues have culminated in a US$130 billion debt and the downgrading of Petrobras’ credit rating, which have required Petrobras to postpone investments and deleverage through a US$35bn divestment plan.

This downsizing has delayed exploration and development plans for the pre-salt and required Petrobras to shrink its organisation and offer early retirement to many employees. Petrobras has focussed on near term production in an effort to increase cash flow, but other projects have been put on the back burner. It has been clear for some time that Petrobras was not able to fund the huge capital investments necessary to develop the pre-salt. The previous, leftist government took this as a cue to slow down the process of auctioning off new areas, despite the negative impacts on FDI, government revenues and economic growth.

However, in the midst of a deep and prolonged economic slowdown and fiscal crisis, the new government of President Michel Temer has recognised the need to stimulate investment in the oil and gas sector, and has supported a parliamentary initiative to remove this bottleneck.

Bill 4567: the solution?

Bill 4567, which has already been passed by the Brazilian Senate, and now by the lower house, will relieve Petrobras of its obligation to hold a minimum 30% operating stake in future pre-salt projects. In accordance with the new Bill, instead of being obliged to participate, in these terms, Petrobras would have a right of preference.

It is not expected that Petrobras would exercise this preferential right, at least until its finances improve, which should give international oil companies and Brazilian private players the opportunity to operate developments of these very significant reserves.

It is worth noting, however, that the Brazilian Government would still have a degree of control over production operations, as the PSAs provide for the involvement of Pré-Sal Petróleo S.A. (PPSA) - a public company set up to manage the state’s interests in these areas.

Upcoming Opportunity

The government is keen to capitalise on this change of law to bring in new revenues as soon as possible. Marco Felix, the new Secretary for Oil and Gas of the Ministry of Mines and Energy, has recently announced plans to hold the next auction of pre-salt rights during the first half of next year. This bid round is likely to offer four blocks containing fields that overlap into already licensed acreage, and which will therefore require unitization.

This requirement for unitization has been another obstacle to the development of these pre-salt reserves, because some of the existing interests are subject to concession contracts, while others are subject to the PSA regime or were unilaterally awarded to Petrobras in exchange for a capital increase in favour of the Brazilian state (the so-called “Cessão Onerosa). Different blocks are therefore subject to different rules, including regarding minimum local content requirements. This complicates the creation of a set of rules to govern production of reserves spanning different blocks. However, the National Energy Policy Council (CNPE) is also expected to issue guidelines on how this unitization process should be conducted.

Together, the issue of these guidelines, the enactment of the law and holding of a pre-salt bid round, should unlock multi-billion dollar investments in one of the most prospective oil and gas regions on the planet. Even at this early stage, these pre-salt opportunities have been included in the agenda of some big players of the oil sector, which have confirmed an interest in expanding in Brazil.

Conclusion

Bill 4567 has just been approved by the Lower House of Congress and will now pass to President Temer to receive presidential sanction. It is widely expected to receive this sanction, as Temer’s government have been vocal supporters of the measure. This enactment and the publication of the unitization guidelines are a long-waited milestone for the oil and gas industry in Brazil, and are expected to accelerate the development of the pre-salt reserves.