After many weeks of heated discussion between different branches of government and industry bodies, on 22 February 2017, the Brazilian government announced its proposed changes to the rules on local content requirements for goods and services used in the exploration and development of oil and gas, indicating that the rules will be simplified and current levels will be relaxed significantly. This alleviates one of the oil companies’ main problems with the Brazilian oil and gas regime, and should pave the way for a return to attractive and competitive licensing rounds in 2017 and 2018.

Local content requirements oblige operators of oil and gas blocks to procure a certain level of goods and services from Brazilian sources as a condition of their concession or production sharing agreements. Since the first competitive licensing round in 1999, one of the bid criteria for Brazilian concession awards has been the minimum percentage of local content that the bidder commits to achieve. If they fail to achieve that percentage, they are subject to steep fines, although the Brazilian Petroleum Regulator (ANP) may waive the requirement in certain circumstances. There have been various evolutions in the rules over the years, but the tendency has been towards ever more complex and stricter requirements, with increasing minimum percentages, the creation of around 90 different categories of services and equipment, each with different requirements, and the requirement for certification by accredited agencies.

Over recent years, these requirements have been widely criticised for their complexity and the additional costs they have imposed on the industry. The mechanism has been politically motivated to protect sectors of Brazilian industry from competition, which has resulted in local content being associated with a hefty premium over international prices in many cases. Operators have been forced to try to anticipate the levels of local content that they will be able to secure in the development of a field at the bidding stage, when they do not know what kind of reservoir they may discover, nor what technology will be available, nor what capacity local suppliers will have at that time, which may be five to ten years after bidding.

These difficulties have become increasingly clear in the wake of the “Lava Jato” corruption scandal and resulting financial crisis for much of the oil and gas supply chain. These factors have led to delays and cost overruns in many Brazilian projects, particularly in offshore construction and many operators have accepted that they will not be able to achieve their local content commitments; paying fines or applying for waivers from the ANP. One Minister suggested that the potential value of fines is between R$60bn and R$80bn (c. £15bn - £20bn), but the ANP has yet to give clear guidance on how requests for waiver will be assessed, and claims have been piling up.

The government is keen to avoid these problems in future, and to prevent doubts about the feasibility and cost of local content requirements from undermining its planned, upcoming bid rounds.

Proposed changes

For the 14th bid round for oil and gas concessions, local content will no longer be a bid criterion. For this and the 3rd round for production sharing agreements, both planned for this year, the minimum local content levels will be fixed at levels around 50% lower than the minimum required in recent rounds. Instead of almost 90 different categories and sub-categories of goods and services with different requirements, the local content obligations will be broken down into a maximum (for offshore blocks) of four “macro-segments”. See table below:

13th Concession Round

New Requirement

Onshore

Exploration

70%

50%

Development

77%

50%

Offshore

Exploration

37%

18%

Well construction

55%

25%

Subsea equipment

55%

40%

Platforms

55%

25%

The government has also proposed less stringent minimum and maximum fines for companies that are unable to fulfil these local content requirements. On the other hand, there will no longer be the possibility of applying for a waiver.

These new requirements were announced following a meeting of representatives from various government ministries, and are yet to be formally approved by Brazil’s National Council of Energy Politics (CNPE), with approval expected to be confirmed in March. They represent a compromise between divergent interests of Brazilian industry and oil and gas companies, and even between different ministries within the federal government. However, we consider that they represent a considerable step forward and are likely to achieve the stated aims of the Minister for Mines and Energy, Fernando Coelho Filho - to create a “more realistic” set of requirements and to improve certainty around investment in the sector.