The year began inauspiciously for Brazil’s oil and gas industry, which had been starved of new exploration opportunities since the last licensing round in 2008. Political wrangling continued regarding the allocation of oil revenues. A controversial new royalties bill was passed in late 2012, increasing the share of oil revenues allocated to non-producing states and municipalities. However, the President vetoed parts of that bill, which would have applied retroactively, thereby placating the major oil producing states, such as Rio de Janeiro, which stood to lose billions of Reais in lost revenues and were threatening legal action. With this issue finally parked, the way was clear for a much needed resumption of licensing activity.
The long wait since the last Brazilian licensing round had caused a slow down in exploration activity in Brazil and the oil and gas industry had not lived up to the hype generated by its early pre-salt discoveries. With less than 5% of Brazil’s huge sedimentary basins under concession, and large areas with relatively little drilling history, the sector certainly has plenty of potential, even outside of the much vaunted pre-salt areas. In the face of lacklustre oil and gas production and economic growth, in January, it seemed that the Brazilian government recognised the importance of renewed private investment in the oil industry and they announced a series of licensing rounds to take place throughout the year.
The first was the 11th round, which took place on 14th May, offering 289 blocks, totalling 155,800 km² in 11 sedimentary basins, onshore and in shallow and deep waters offshore. 142 of these blocks were awarded, covering 100,300 km² for a record total of R$2.82 billion (US$1.38 billion), surpassing all previous rounds and the government’s predictions. The successful bidders pledged to invest approximately R$7 billion in minimum exploration commitments.
The fiercest competition was for blocks in deep water areas of the equatorial margin off Brazil’s north east coast, which are understood to contain geology analogous to highly prospective areas of West Africa. Although a new record of 64 companies had qualified for the bid round, including many newcomers to Brazil, most of these blocks were awarded to international majors with an existing presence in the country. Petrobras, once again acquired the most blocks and offered the highest combined signature bonus, but this time they took more non-operated interests in consortia with a number of different international operators. Total, BG Group and Statoil all bid strongly and picked up a significant number of operated blocks. The onshore and shallower waters provided richer pickings for new entrants, with a number of Brazilian start-ups acquiring blocks, along with new British entrants GeoPark and Chariot Oil & Gas.
OGX surprised the industry with a strong showing, picking up 13 blocks. However, the year has been very difficult for the former jewel of Eike Batista’s corporate empire. The company was once Brazil's second largest oil company after Petrobras, but this year it admitted to major difficulties in producing from its offshore fields and had to cancel orders for a number of production platforms. OGX eventually relinquished the nine blocks that it acquired 100% and disposed of interests in other assets before filing for judicial recuperation (akin to administration) in October.
1st Production Sharing Round
In July, the ANP published the initial tender protocol and draft production sharing contract for its first auction of the vast pre-salt reserves in the country’s Santos basin. The pre-salt area originally hit the headlines with the Lula (formerly Tupi) discovery in 2006, which provoked a national debate about how the reserves should be exploited. This resulted in the enactment in 2010 of a production sharing regime for pre-salt and strategic areas, as an alternative to the concession regime which will continue to be used elsewhere. It also sparked the prolonged tussle between different states and municipalities regarding distribution of production revenues, which caused the suspension of licensing between 2008 and 2013.
The “Libra” field auctioned in October is estimated to contain recoverable reserves of 8 to 12 billion barrels, but the terms of the production sharing agreement (PSA) were widely considered risky and were criticised by oil companies through the Instituto Brasileiro do Petróleo (IBP). The signature bonus alone was 15 billion reais (£4.5 billion) and the consortium will be expected to spend approximately 175 billion reais (£50 billion) to develop the Libra field, including 610 million reais (£174 million) on exploration alone. This was only a round for the big boys!
However, the cost oil percentage was set at 50% of the total production value for the first two years and 30% thereafter. This is lower than usual in international production sharing agreements and worrying given that costs are not escalated by reference to an index or interest rate between being incurred and being recovered from cost oil. What is more, some players were undoubtedly put off by the level of state control. Petrobras was required to become operator, with at least a 30% stake, and a new state oil company Pré-Sal Petróleo S.A. (PPSA), was established to manage the state’s interests. PPSA holds 50% of voting rights on the operating committee, as well as a casting vote and right of veto. This may become an issue given that the term of the production sharing agreement is limited to 35 years and all assets developed by the consortium revert to the state upon its expiry. This could obviously lead to conflicts of interest between PPSA and private consortium members in relation to scale and pace of investments and production.
Given these difficulties, a number of major oil companies stayed away, including BP, BG Group, ExxonMobil and Chevron. In the end, only one bid was made, offering the government the minimum share of profit oil permitted by the tender rules, 41.65%. The winning consortium consisted of Petrobras (40% and operator), Shell (20%), Total (20%), China National Petroleum Corporation (CNPC) (10%) and China National Offshore Oil Corporation (CNOOC) (10%).
Magda Chambriard, the director general of the ANP, insisted the result could not have been better given that the consortium was made up of the 2nd, 3rd, 7th, 8th and 10th largest oil companies in the world, but the small pool of qualifying companies and uncontested bid must raise questions regarding the attractiveness of the new PSA regime and the conduct of the auction process. In fact the ANP announced shortly afterwards that it would be reviewing this model over the course of the next year and before any further PSA bid rounds.
Brazil’s 12th oil and gas licensing round was initially touted as a round for unconventional gas, and offered 240 blocks in onshore mature and frontier basins. However, when the bidding took place on 28 November interest was muted and large areas received no offers at all. The round was dominated by state-controlled giant, Petrobras, with participation from a few smaller independents.
The round received interest from just 25 companies and the international majors stayed away, with most blocks receiving just a single bid. However, one positive outcome was the participation of several new independents. GDF Suez also acquired acreage in its first Brazilian licensing round, having recently acquired Vale’s interests in two exploration blocks in the Parnaiba basin.
The round raised concerns regarding the viability of Brazil’s shale gas reserves. Environmental licensing bottlenecks, elevated operating costs, local content requirements and lack of gas transportation infrastructure all present obstacles to the development of these reserves, which are concentrated in some of Brazil’s frontier basins, and are thought to have contributed to the subdued interest in these blocks.
2013 was also a busy year for Brazil’s largest company, Petrobras. On the one hand, Petrobras has had a number of exploration successes, including in deep water areas of the Ceara and Potiguar basins in the Atlantic margin, and has delivered a record nine platforms during the course of the year. The company also acquired the largest number of blocks in both the 11th and 12th rounds and a 40% interest in the 1st pre-salt auction.
On the other hand, the company is going through its worst financial crisis since its formation 60 years ago. Its market capitalisation has fallen 45% since its 2010 peak and its debt has increased 17% over the last 12 months. In this context the company has been undertaking a programme of disposals, particularly of international assets.
In the 11th round, Petrobras acquired mainly non-operated interests in consortia with a number of different international operators. This may indicate a change of direction for the company, which has struggled to bring its huge portfolio of projects online as quickly as forecast and seen its cash flow position deteriorate due to low local fuel prices. Despite a number of price rises over the course of the year, wholesale prices of diesel and gasoline are still below the international market value, due to government pressure to keep inflation under control. With the resulting strain on its finances and a massive capital expenditure programme, it remains to be seen how Petrobras will finance its costs of developing the Libra field.
In an effort to control costs, Petrobras has deferred a number of projects and launched a massive programme to reduce operating expenditure at its ageing Campos basin fields. However, this in turn has put considerable pressure on the supply chain, which is overly reliant on Petrobras as the predominant end customer, with many companies struggling to recoup large investments in local capacity, in a high cost environment.
2014 and beyond
These problems will continue in 2014, but it is to be hoped that the resumption of licensing in 2013 will eventually lead to an upswing in exploration investment and that the entry of a number of new operators will lead to a more diverse and sustainable oil industry. Unfortunately, the government seems to be indicating that there will be no further licensing rounds in 2014 and have backtracked on a round for marginal and independent producers that was set to take place in February 2014.
In this context, 2014 seems set to be a year of consolidation, during which new entrants will establish themselves in the Brazilian market and begin the process of seismic acquisition, while Petrobras and its partners in the pre-salt ramp up production from existing fields. It is to be hoped that Petrobras will be able to bring its pricing policy into line with the international market, so as to relieve financing restraints and maintain its momentum as the driving force behind the industry.
The industry’s lukewarm response to the Libra auction should encourage the Brazilian government to re-assess the current PSA model. It should think about abandoning the requirement for Petrobras to be sole operator, giving consortium members more operational control and re-balancing the economic terms away from the signature bonus and towards a higher profit oil share. Likewise, it should consider what policies are required to create conditions for a viable shale gas industry, including streamlining of environmental licensing, encouraging investment in pipeline capacity and relaxing local content requirements. Whether it will take such steps is doubtful, but the success of the 11th round shows that where the conditions are right, there is plenty of interest from private industry and huge potential to turn Brazil into a major oil and gas producer.