By Marcelo Oliveira Mello & Monique Thuller
Brazil’s business environment, and particularly the oil industry, is living the most serious challenging period of its recent history since 1997, after the opening of such sector by means of a constitutional reform. Since 2014, the country and its oil industry is being adversely affected by the political and economic crisis, coupled with the effects of international oil and other key commodities price fall and the unpredictable effects of the large on-going anti-corruption operation that is being conducted by the Supreme Court, Federal courts and police department and prosecution office, known as Operação Lava Jato (Operation Car Wash), that brought Petrobras, Brazilian energy state-controlled company, main Brazilian company groups and business men, the Government, several Congressmen into the largest country’s criminal case that has multiple negative and hard consequences for country’s economy, society and political stability, including the potential impeachment of the President Dilma Roussef that is now being discussed and evaluated in the Congress.
In 1998, the law 9.478/98 that established the new oil and gas regulatory framework as a consequence of such constitutional reform, adopted the concession contract model for exploration and production and created the Brazilian National Petroleum, Natural Gas and Biofuels Agency (“ANP”). The ANP was responsible for organizing and conducting public auction to grant concession contracts and supervise and regulate oil up, mid and dowstream sectors.
Until now, ANP organized and conducted 14 public auctions (bidding rounds) under law 9.478/ 98 (Concession Contracts model), including the so-called “Round 0” that granted PETROBRAS concession contracts to cover exploration and production blocks where PETROBRAS had already developed its operations at the time the law was passed. In the 12th Round, ANP offered shale gas blocks, however the Federal Public Prosecutor filed a public civil action against six awarded oil & gas companies and the ANP. One federal court judge issued a temporary injunction that suspended the execution of the corresponding concession contracts, claiming that shale gas exploration and production activity was not duly regulated in Brazil yet. The Prosecutor’s main arguments are that shale gas operations have a potential risk to cause material environmental damages and that such risk had not been properly evaluated by ANP, Federal Environmental Agency (IBAMA) and other applicable federal authorities.
In 2010/2011, the above concession contract based framework was largely modified as a result of the new policy applicable to the pre-salt and strategic area exploration and production activity designed and supported by President Lula’s Government and his successor, Ms. Dilma Roussef. The Federal Government announced the Law nr. 12.351/2010 that established the petroleum sharing contractual regime as the only contract model to be used for the exploration and production of giant pre-salt hydrocarbons reservoirs.
According to such pre-salt new regimen, being Petrobras must be designated to act as the only Operator and hold 30% participating interest at least in any consortium with national and foreign oil investors to whom participating interests were granted through specific public pre-salt areas auctions carried out by ANP. The Government also incorporated in 2013, the 100% state-owned company, Pre Sal Petróleo (PPSA) to manage the production sharing contracts signed by the Government and carry out oil trading operation related to the oil and gas production portion that is owned by the Government as a result thereof, among other key issues.
The first pre-salt round made by ANP happened in 2013. There was only one consortium as bidder, which was the winner. The production sharing agreement was signed between ANP and Petróleo Brasileiro S.A. (10%), Shell Brasil Petróleo Ltda. (20%), Total S.A. (20%), CNPC International Ltd (10%), and CNOOC International Limited (10%). The offered area was the block of Libra, within Santos Basin. Libra is one of the most important pre-salt area and state-owned Chinese oil companies that had no operations in Brazil at that time took this opportunity to step into pre-salt exploration and production area in Brazil through this bidding round.
However, Brazil’s petroleum and energy industry are waiting for the consequences of the impeachment proceeding against President Dilma Roussef that are under discussion at Brazilian Congress. As a consequence of such political and economic crisis and corruption scandal, Petrobras investment capacity was reduced to US$19 billion and faces increasing difficulties to manage its estimated debt in the amount of US$ 170 billion with banks, bondholders and financial market.
What’s the future? Some ideas and perspectives
Under such scenario, and whatever the result of the impeachment proceedings is, some actions need to be evaluated and implemented by Brazil to continue attracting investments in the medium and long terms. Among such actions, oil industry regulations should be more flexible and competitive by:
(1) allowing other oil companies being operators in the pre-salt area, other than Petrobras as the sole operator as it is today;
There is a project of law (PLS No. 131/2015) in progress at the Federal Senate which foresees some changes in the Law No. 12.351/2010. One of these changes is that Petrobras will not be the sole operator anymore, but the company will have the first option to be that. The PLS is now submitted to the House of Representatives. The evaluation of this PLS has urgency in its conclusion.
(2) giving Petrobras the right option not to act as mandatory 30% investing party to all the production sharing contracts;
According to the PLS mentioned above, Petrobras is no longer obliged to participate in all the exploration consortia for the pre-salt area with a minimum of 30%. This mechanism may help Petrobras to give priority to invest in exploration and production, midstream and downstream project portfolio that still have very significant and challenging projects.
(3) expediting the environmental licensing procedure for the exploration and production areas;
As well known by the companies in Brazil that needs to initiate a procedure of environmental licensing, this step generally takes a long time to be concluded. This is not a positive factor for all the agents involved in the process, including the company and the government. As the environmental license still takes a long to be approved, it represents more time without obtaining profit and income. So, a healthy measure it would be the creation of a specific and fast-track licensing proceeding by IBAMA (Federal Environmental Entity) and the other State Environmental Authorities for the oil industry.
(4) making more flexible the current local content rules during this moment in which economic conditions are making the exploration projects almost economically unfeasible or highly cost ones;
Recently, on January 2016, the Brazilian Government published the Decree No. 8.637/2016, which implements the Programme to Stimulate Competitiveness of Supply Chain, Development and Supplier Enhancement of Oil and Natural Gas Sector (“Pedefor”). According to the Ministry of Mines and Energy (MME), the program seeks to encourage suppliers to invest in productive capacity, technology and innovation in the country. The decree establishes a mechanism for bonus consortia or exploration and production companies that enable the installation or expansion of suppliers in the country, investing in technological innovation, realize the export of domestic equipment or the acquisition of pioneering batch of domestic products. Such investments will be converted into local content Units - UCL, which may be used for reduction of local content commitments of exploration and production contracts of oil and natural gas signed with the National Agency of Petroleum, Natural Gas and Biofuels - ANP.
(5) promoting under specific regulations the increase of oil mature and marginal field private investments through new joint ventures and production enhancement agreement models between independent medium and size oil companies with Petrobras. Such program might also consider the transfer of concession rights from Petrobras to such companies in the medium term under regulated divestment programs and the use of its existing oil infrastructure by such new oil investors and producers under conditions supervised by the ANP;
Petrobras has approved, in 26 February 2015, the review of the divesture plan for 2015-2016. The total approved divesture program is in the amount of US$ 13.7 billion, distributed between the Exploration and Production in Brazil and out of the country (30%), Supply (30%) and Energy and Gas (40%). This plan is part of the financial planning of the company which aims to reduce leverage, preserve cash and focus on priority investments, specially of oil & gas production in Brazil and other areas of high productivity and high financial return areas. In April, the company estimated U$1,769 billion (R$6,194 bilhões) losses of corruption and reduced the value of its assets in U$12.65 (R$44.3 bilhões).
(6) expand the current oil tax incentive regime REPETRO to other areas of the oil industry by creating a new and competitive tax to new investments for the mid and downstrean sectors and improving oil tax and royalty regime applicable concession contracts and oil production sharing contracts to make them more attractive vis-à-vis other oil producing countries in the Latin America, West Africa and other Asian countries that compete with Brazil for investments oil companies’ investment portfolio;
On March 2016, the National Energy Policy Council (CNPE) released the Resolution No. 2 of 3 March 2016. It aims to encourage oil and natural gas exploration and production in Brazil, as follows: (i) the expansion of the special tax regime for the oil sector, REPETRO, beyond 2019; (ii) the expansion of contracts of Round Zero, which happened in 1998, within 27 years. Such expansion is only for fields whose length of the production term seems to be viable beyond the original contract period. The deep-water oilfield Marlim is among these ones that may have extended contracts, besides other deep-water oilfields in Campos Basin. The Minister of Mines and Energy said that expects to unlock an amount of US$120 billion of investment in the oil sector. The resolution also stipulate that concessionaires should start production of fields that are not producing in spite of its oil production capacity. Concessionaire should take action to start the oil production or transfer its concession rights to third parties interested in making investments and put them into production. The Ministry sustains that the lack of production in such fields affects the rational use of energy resources, the creation of new jobs and the collection of royalties and oil taxes by the Federal Government, states and municipalities.
(7) making technology programs more ambitious, with new technology joint venture rules, material tax incentives and new intellectual property regulations aiming at stimulating the local production and transfer of high technology.
Conclusion
We cannot forget that oil industry and sector cannot be seen and conceived by a country without taking into account long-term strategies and goals. Although the local Government’s credibility and political capacity is being challenged and highly affected by the crisis and the country’s oil industry and Petrobras need to be reorganized, Brazil’s natural resources potential cannot be ignored and will survive because of the strategic importance and role of its tremendous oil, mineral reserves and commodities supplies in the long-term run.
It seems that this is exactly the view of the Chinese Government that continues granting financial support through oil secured loans from China Development Bank (CDB) and other Chinese banks to Petrobras. In February 2016, CDB announced a US$10 billion loan to Petrobras that makes Brazil an increasingly key oil supplier to China and Chinese companies are also looking this moment to increase their participation and presence in the oil and power sectors in Brazil.
In 2015, the two countries signed 35 trade cooperation agreements involving investments of US$53 billion in eight sectors during the visit of Chinese Prime Minister, Li Keqiang, including the power oil and gas, environmental, technology and other natural resources related sectors.
Additionally, Brazilian federal government controlled energy planning and research company, EPE, announced the Brazilian 10 Year-Plan for Energy Expansion 2024 (the so-called PDE 2024), whose final report was released by EPE and the Ministry of Energy and Mines in December, 2015. In turn, in December 2015, China released the 13th Five-Year Plan introducing its green and low-carbon energy policies and investments. According to such plan, Chinese companies will be oriented to invest and pursue the development of renewable energy projects in China and overseas.
The concept of sustainability, increasing energy efficiency and increasing the use of renewable energy are concrete measures that are expressly contained in Brazilian PDE 2024 and Chinese 13th Five-Year Plan. Brazilian Government says that the increase of renewable energy sources “allows the country to reach the greenhouse gas targets (GHG) established the National Policy on Climate Change - NPCC and international agreements on climate. The Decree 7.390/10, which regulates the NPCC provides that, in the energy sector, the sectoral plan for mitigation and adaptation to climate change is the 10 Year Energy Plan itself." China may get benefits of both plans and also becomes a strategic business and technology partner for the development of Brazilian large renewable energy sources.
Facing a complex political and economic crisis, Brazil and Petrobras may have in China a short-term investment source to meet partially Petrobras investment needs and to expand its power sector, including country’s renewable energy sector. However, Brazil still needs to review its oil regulatory and tax framework to stimulate new investments, create competitiveness that may allow the country to attract other key international players and investors and help the country to achieve its strategic objectives.
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Marcelo Oliveira Mello is the founding partner of Mello & Travassos Advogados (MMA) headquartered in the city of Rio de Janeiro. His practice encompasses mergers, acquisitions, and sales of energy and petroleum companies and assets; petroleum acquisition, construction, project finance, and leasing; and drafting and negotiating industry agreements.
Prior to forming his own firm, Mr. Mello was senior partner with a global law firm and the law division manager for Brazilian national energy company for nearly 20 years.
Mr. Mello has been advising several national and cross-border transactions and joint ventures, including participation in public tenders for the acquisition of oil and gas exploration contracts and rights, M&As, joint operating agreements, shareholders agreements, farm-ins and farm-outs, oil services contracts, EPCs, BOTs, BOOs drafting and negotiation, claims negotiations, renewable energy projects, infrastructure related construction projects and arbitration cases in Brazil, other countries in the Americas, Europe, Asia and Africa. He advised on legal affairs related to upstream, midstream and downstream energy and petroleum projects in almost 30 countries.
Since 2008, Mr. Mello has been ranked and selected among “leading lawyers in their field” (Energy and International Business) by the most distinguished global lawyers directories, such as Chambers & Partners (Chambers Global and Chambers Latin America), International Who’s Who of Business Lawyers, Legal 500, Best Lawyers and IFLR 1000.
Mr. Mello is a frequent lecturer and speaker at a number of conferences, seminars, MBA programs on energy/petroleum law, international, and economic law, arbitration in Brazil and abroad. He holds a J.D in Law (Universidade Federal do Rio de Janeiro- UFRJ) and MSc in Management, with focus on environmental management (LATEC, Universidade Federal Fluminense - UFF).
Monique Thuller is associate lawyer since 2012 of Mello & Travassos Advogados (MMA), and developed her legal practice in renowned full service law firms. She currently advises national and multinational clients and investors on various legal matters in Brazil and Latin America, focusing on regulatory law, energy, oil and gas, natural resources, technology, and infrastructure projects, involving Brazil and other countries in Latin America and Asia.
Ms. Thuller also advises clients on the establishment of local subsidiaries and local branches for local and multinational companies, preparation of qualification documents for foreign investments, registration before public bodies, eligibility and qualification in public auctions and tenders for the granting of oil concessions and oil production sharing contracts, power generation and transmission, concession handling of administrative proceedings before regulatory agencies and analysis of contractual and legal issues related to commercial contracts, joint venture agreements, technical assistance agreements, oil exploration and production contracts, oil services contracts and energy utilities EPC and Turn-Key construction projects.
Monique Thuller holds J.D. in Law from Federal University of Rio de Janeiro, and studies LL.M in Business Law with enphasis in Contracts at Fundação Getúlio Vargas.
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