In a critical case for oil companies investing in Brazil, a Federal Court Judge has issued an injunction preventing a consortium, formed by Petrobras, BG and Petrogal, from arbitrating against the Brazilian National Petroleum Agency (“ANP”) in relation to its decision on whether a discovery should be classified as one or two fields. The reason given by the judge was that it is not appropriate to deal with administrative law issues through international arbitration. Although this is not a final ruling on the issue, the judgment may have important implications for companies doing business in Brazil that are subject to decisions by the ANP. With a value at stake of R$30 billion, this case will doubtless be followed carefully by oil and gas companies participating in offshore Brazil.

The BM-S-11 consortium, formed by Petrobras, the Brazilian state-controlled oil company (65%), BG (25%) and Petrogal (10%), has had another setback in its attempt to separate the Lula Field into two (Lula and Cernambi), after the 1st Federal Court of Rio de Janeiro granted an injunction in favour of the Brazilian National Petroleum Agency – ANP, on 8th May, requiring the International Chamber of Commerce (ICC) to refrain from starting an arbitration on the matter.

I. The Issue

In summary, the consortium alleges that it has discovered two distinct fields, named Lula (formerly prospect “Tupi”) and Cernambi (formerly prospect “Iracema”). Therefore, it has issued to the ANP two distinct Development Plans and two Declarations of Commerciality for the reservoirs, treating them as geologically separate fields - they contend that there is no lateral continuity between the fields, based on differences between the oil/water contacts, the pressure gradients and the fluids discovered.

The importance of this question arises from the rules for calculation of a government levy called a “Special Participation”, which is charged on larger fields, at different rates depending on cumulative production levels. According to ANP calculations, the division of the Lula Field in two would save the consortium at least R$30bn during concession period.

The ANP has therefore challenged the consortium’s interpretation and required the reservoirs to be treated as a single field, claiming that: (i) there are doubts as to the lateral continuity of the reservoirs; (ii) the definition of “field” set out in the Petroleum Law (Law 9.478 of 06/08/1997) allows more than one reservoir without lateral continuity to be grouped under the same field; (iii) the ANP has discretion in defining the development areas requested by companies; and, last but not least, (iv) the ANP is required to exercise such discretion to protect the country’s interest in maximising its revenues from the concession.

II. The Administrative and Judicial Dispute

After exhausting the administrative procedures with the ANP, including proposing a settlement agreement that would appoint a task force to jointly evaluate the question, the consortium filed for arbitration before the ICC, mainly based upon the assertions that: (i) the concept of “field” in the Petroleum Law does not authorize discontinuous and laterally separated reservoirs to be included in the same field; (ii) the ANP has no discretion in establishing the limits of the area to be developed; and (iii) the impact on state revenues should not be an argument for denying the separation request.

Counter-attacking, on April 29th, ANP filed an annulment motion before the Federal Courts of Rio de Janeiro, with an interim injunction, to block the arbitration.  The ANP asserts that submission of such demand to the arbitration tribunal is outside the scope of the arbitration agreement, since the matter relates to its constitutional role as a regulatory agency.

From a legal standpoint, there are two main issues.  The first relates to the ANP’s role in relation to requests for the separation of fields and, consequently, the definition of a field for the purposes of the Petroleum Law.  Whatever the outcome of these proceedings, it seems unless there is clear technical evidence of the existence of two distinct fields, the use of such mechanism as “financial planning” (i.e., to reduce the payment of royalties) will be strongly rejected.

The other issue has been discussed for some time in the Brazilian oil and gas industry: to what extent the ANP and oil companies are bound by the arbitration agreement in concession contracts (and more recently production sharing agreements) and the limits of arbitral competence. It is important to note that all existing contracts for oil and gas exploration and production in Brazil, whichever nature they are, contain an arbitration clause.

For some experts and existing Brazilian case law, this matter is subject to the “kompetenz-kompetenz” principle, whereby if an arbitration agreement exists, the parties are required to submit their conflicts to arbitration and it is up to the arbitral tribunal itself to determine whether it is competent to hear the matter in question.  In this case, the courts would be excluded from hearing the case while an arbitration procedure is ongoing.

The main argument of those defending the arbitration is that the applicable legislation already provides for such mechanism and if it is stated in the contracts it should be respected: Article 43 of the Petroleum Law provides “Art. 43 - The concession contract shall duly reflect the conditions of the tender bid and the winner proposal and shall have the following essential clauses: (…) X - the rules for conflicts resolution arising out of the contract and its execution, including by conciliation and international arbitration” and the recently enacted law regulating the production sharing agreements in Brazil sets forth in its article 29: “The below listed are essential clauses in the Production Sharing Agreements: (…)XVIII - the rules for conflicts resolution, which may foresee conciliation and arbitration”.

Nevertheless, and although not stating a final positioning, the Federal Judge ruled the arbitration clause should be applicable only to matters arising out of the performance of the concession contract itself and, since the definition of an oil field is aligned with the regulatory prerogatives of the ANP, ruled in favour of the ANP.  He said the consortium’s argument “seems, in my understanding, an attempt to discuss the enforceability of Administrative Acts before the arbitration tribunal”.

Due to the costs involved in resolving the matter through arbitration, the Judge granted an injunction in favour of the ANP demanding the ICC to cease the arbitration until the merits of the action are duly evaluated. As the judge himself expressed in the decision, the consortium will likely appeal against this injunctive relief and this story is likely to have more chapters before it is finally resolved.

III. Comments

Despite the case being quite far from a final decision, oil and gas companies acting in Brazil may certainly infer from this case that they should not assume all disputes arising under concession contracts (or PSAs) will be determined by arbitration, and that important issues affecting amounts due to the government may end up being determined by Brazilian courts.

For further information on the court decision please click here.