On 9 July, the Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (ANP) of Brazil published the initial tender protocol and draft production sharing contract for its first licensing round for the vast pre-salt reserves in the country’s Santos basin, which will be auctioned on 21 October in Rio de Janeiro. This auction follows the success of the 11th licensing round of oil and gas rights in May and continues Brazil’s ambitious licensing programme, with an auction planned for unconventional oil and gas rights, including shale, in November, and another round for marginal fields planned for February 2014.

However, only the pre-salt round will award rights under production sharing agreements rather than concession contracts. The pre-salt area hit the headlines with the Lula (formerly Tupi) discovery in 2006. This 8 to 12 billion barrel field opened up a new petroleum province that is estimated to contain between 70 and 100 billion barrels in ultra deep water offshore Brazil.

This discovery provoked a national debate about how these reserves should be exploited, which resulted in the enactment in 2010 of a production sharing regime for pre-salt and strategic areas, as defined by the government, as an alternative to the concession regime which will continue to be used elsewhere. It also sparked a prolonged tussle between different states and municipalities regarding the distribution of production revenues. This regulatory uncertainty prevented any licensing from taking place between 2008 and 2013, but seems to have been resolved by new legislation allowing non-producing states a greater share in oil revenues. This has paved the way for the resumption of licensing and this first auction of pre-saltrights, which will cover an area known as “Libra” with estimated reserves of 12 bn barrels.

Access to such huge reserves will not come cheaply, with the Brazilian government demanding a signature bonus of 15 billion reais (£4.5 billion) from the winning consortium. By way of comparison, the total of the signature bonuses for the 142 blocks awarded in the 11th licensing round was 2.8 billion reais (£833 million). Even bidding is expensive, with each bidding company required to pay a participation fee of R$2,067,400 (£615,000), which will give them access to the relevant data packages.

Bidding

The tender protocol for the first licensing round sets out pre-qualification requirements, bid procedures and the main commercial terms of the production sharing contracts on offer, with pre-qualification documents to be submitted by 9 September 2013. Interested companies are required to pre-qualify and must provide evidence that they hold the requisite technical and financial capabilities. Pre-qualified companies may bid individually or in consortia of up to five members, with at least one member satisfying the highest levels of technical and financial criteria (“Level A”). The ANP has attempted to simplify the process for companies which have recently been through the licensing process, so that companies who qualified as Operator A or B for the 11th licensing round may request that the ANP refer to the documents previously submitted.

Petrobras, the state-controlled oil company, may decide to enter the auction individually or as part of a specific consortium established before the bidding takes place. In any case, it is a requirement of the pre-salt legislation that Petrobras becomes operator, and acquires a minimum 30% interest in any winning consortium. It will also be required to pay its relevant proportion of the signature bonus.

Production Sharing

Under a production sharing regime, private companies bear exploration and development risks and only recover their costs if they make and develop commercial discoveries. When production commences, those companies are reimbursed for expenditures from a percentage of the revenue generated by oil sales (cost oil). For this round, the cost oil percentage is subject to a maximum of 50% of the total production value for the first two years and 30% for all years thereafter.

The remainder of the production (profit oil) is then divided between the private companies and the state. Under the Brazilian production sharing agreement the split of profit oil will vary according to (1) the price per barrel and (2) the average daily production per well, subject to a minimum government share of 41.65%. Wells suffering from technical and operational issues that cause them to fall below the average will not be included in the calculation. For the purpose of bidding, companies will indicate the percentage of profit oil they are offering on the basis of an oil price of US$100.01 to US$120 per barrel and an average daily production of between 10,001 bpd and 12,000 bpd. The winning bidder will be the one which offers the greatest percentage of profit oil to the government. In the event of a tie, the joint highest bidders will be invited to submit a further bid. If they are still tied, the winner will be selected at random.

The production sharing agreement will have a term of 35 years, with an exploration phase of four years and a development and production stage of up to 31 years. Bidders are required to source at least 37% of goods and services in Libra’s exploration from local sources (known as “local content”), with that figure rising to 55% during the production phase. Local content commitments have been a feature of every licensing round since the seventh round in 2006 and have been one of the criteria for determining the winning bids. For the pre-salt auction the local content percentages are fixed and not a bidding criteria, although the required percentages are broadly in line with those levels bid for offshore acreage in the last licensing round. This is important to bidders because prices for most oil and gas supplies manufactured in Brazil remain considerably higher than the equivalent produced internationally.

The announcement of this round has been anticipated for some time and a number of details have been released over recent weeks. The auction of the pre-salt rights is expected to prove prohibitively expensive for smaller companies but should attract the sector’s major players, including a number of Asian national oil companies, which are likely to be comfortable with a non-operator role alongside Petrobras, and many of which qualified for the 11th round with Operator A status but chose not to bid in that round. In any case, the acreage on offer is considered highly attractive and the bid round is expected to be competitive. New pre-salt bidding should also trigger an acceleration in oil and gas investment in this important region, and, in the medium term, help Brazil to sustain strong production growth.