Brazil’s oil industry is back in business

Brazil’s oil industry is back in business

Four years after the first pre-salt auction in 2013, Brazilians have a reason to celebrate. The country raised 6,15 billion reais ($1.88 bn) in the second and third rounds of auctions, proving that the country can still attract foreign investors.

In November 2007, state-owned oil firm Petrobras discovered large amounts of oil in the earth’s pre-salt layer, off the coast of Sao Paulo and Rio. These resources are located beneath about 4,000 meters of salt, sand and rock. The discoveries were seen as a turning point that would allow Brazil to emerge as a major oil producer.  

Ten years later, investment and development in these pre-salt areas is still lagging. However, the recent auction rounds of eight pre-salt blocks, which hold an estimated 12 billion barrels of oil, prove that the country is moving in the right direction. The first round, in the Libra area, came in October 2013. It took place under the previous auction model, which stipulated that Petrobras serve as the sole operator with a minimum 30% stake.

New rules and competing views

Due to significant energy reforms, the 2017 auctions are more market friendly and open to foreign investment than the previous auctions. The new rules for the auctions going forward are: 1) Petrobras is not required to be the sole operator in pre-salt production projects; 2) revision to local content rules; and 3) expansion of Repetro (Special Customs Regime applicable to the export and import of goods used in the exploration and drilling for oil and gas reserves). These pro-market regulatory changes have ultimately driven greater international interest in Brazil’s pre-salt blocks.

Currently, there are two competing views of how best to structure oil contracts with foreign corporations to maximize profit for Brazil. Under the concession model, the company that offers the highest signing bonus to the government is awarded the contract. Under the production sharing model, the company that offers the highest percentage of oil profits to the government is awarded the contract.

In general, foreign companies favor the concession model, viewing it as less complicated. Rodrigo Maia, the Speaker of the House, has expressed that he plans to arrange a full review of the current production sharing regime, as he believes that a concession regime would earn the government more revenue.

It is still unclear which model will earn the Brazilian government more revenue. While the initial payout under the concession model is higher than under production sharing, upcoming payments to the government in both cases are highly dependent on future oil production, prices and consumption.

Pre-salt auctions

The auction on 27 October was delayed due to a federal judge’s injunction, which claimed the auction would cause a loss to public assets. However, supporters such as the Minister of Mines and Energy, Fernando Coelho, expressed that it was a “tremendous success” upon completion.

The Brazilian National Agency of Petroleum, Natural Gas, and Biofuels (ANP) offered eight pre-salt blocks, in the Campos and Santos basins, and raised 6.15 billion reais, 20% less than the expected 7.75 billion reais. Two of the eight available blocks did not receive offers. Eleven companies from nine countries won blocks, while Petrobras and Shell each won three of the six as part of consortiums.

Two American companies participated, although only one won a block, and three Chinese companies won with consortiums. The number of foreign companies in the auction was surprising, given the current low price of oil, indicating that pre-salt areas remain attractive to foreign companies due to their potential for high productivity.

Source: Author with data from OGlobo and Valor

Under the current production-sharing regime, there is a fixed signing bonus for each area. The Brazilian government awards the contract to whoever offers the highest percentage of profit-oil above the required signing bonus. The percentage of profit-oil exceeded 200% of the minimum requirement, making the auction a success not only due to the high signing bonus, but also because of the level of foreign investment captured. 

Furthermore, even though two areas did not receive offers, this high percentage means the government will be able to collect more revenue in the future. The ANP predicts that the eight blocks will generate U$36 billion in investment and U$130 billion in royalties. The profits and income taxes generated from production will help with the government’s fiscal problems and create jobs for the local population.

Regulatory success

Brazil produces 2.6 million barrels of oil per day and is aiming to almost double that amount to 5 million by 2027, making it the world’s fourth largest oil producer at current rates of production. The ANP expects that all the wells offered in these auctions should enter production stage within 5-7 years from the auction date and that the blocks that did not receive offers will be auctioned off at the next opportunity.

Currently, foreign firms are responsible for 21% of total production of oil and liquefied natural gas (LNG) in Brazil, and their participation is expected to increase to 30% in 10 years. Despite this, Petrobras’ significant role in the auction indicates that it is unlikely to lose its predominance in Brazil’s oil sector. Still, the auction showed that the regulatory changes have been well received by the market and that foreign firms are once again willing to invest in Brazil.

Categories: Finance, Latin America

About Author

Lorena Valente

Lorena Valente is an Associate at Promontory Financial Group, an IBM company. Previously, she was a Consultant for the World Bank Macroeconomics and Fiscal Management Brazil Team. She has also held positions at the Inter-American Development Bank, Albright Stonebridge Group, and McLarty Associates where she performed political and economic risk analysis for Latin America, with a special focus on Brazil. She earned her MA in International Economics and Latin American Studies from Johns Hopkins SAIS, and her BA summa cum laude in Political Sciences from the George Washington University. Originally from Brazil, she speaks Portuguese, Spanish, and English. *Views and opinions expressed are the sole responsibility of the author and are not endorsed by Promontory.