Written by F. Jimenez - (Translator)
Source:
Brazilian Chamber of Deputies
The current findings from Petrobras and other companies in the province of the Pre-salt, located in the Brazilian continental shelf, can mean reserves of over 50 billion barrels of oil, a volume four times greater than the current national reserves, roughly 14 billion barrels.
In this province, there may be large oil and natural gas reserves located under salt layers that extend for 800 kilometers along the Brazilian coast – from the state of Santa Catarina coast to the coast of Espirito Santo – up to 200 km wide.
Some estimates give the total area of the Pre-salt as 122,000 km2. Of this total, concessions have already been granted for 41,000 km2 and 71,000 km2 have not yet been tendered.
Pre-salt oil is of good quality, although it is found in reserves that are in deep-sea areas and under thick layers of salt, requiring large-scale investment to extract it.
Since 2006, Petrobras has sunk 11 oil wells in the Santos Basin. All these oil wells have been successful, i.e., the success rate was 100%. At the prospects of Tupi and Iara alone, which are located in the BM-S-11 block, Petrobras already estimates that there are 8 to 12 billion barrels of recoverable oil. This block alone can almost double the current Brazilian reserves.
EXPLORATION AND PRODUCTION MODEL
Basic Choices
Governments have two basic choices to further oil and natural gas exploration:
1)creating a state-owned company to carry out research and production, as in Mexico, Saudi Arabia, and Oman;
2) Entering into contracts with state-owned or private companies, as in Brazil, the UK, and Canada.
It is also possible to mix the two systems, as in Kazakhstan and Nigeria.
Contract types
The contract types (concession, production sharing, joint venture or services) vary greatly in terms of how profits are split and costs dealt with. By and large, the high level of uncertainty about potential reserves, costs of production, and future prices of oil tends to affect the negotiations. Each contract type has its advantages and disadvantages, which will be analyzed below.
It is important to observe that in the model of production sharing the state can get the bulk of the production without running any risk (Bindemann, 1999).
1 Concession
The concession contracts assure sole rights for research, production, and the sales of oil extracted from a certain area in a certain period of time. Companies compete for the areas by offering bonuses to the government.
In the concession model, if commercial production occurs, payment, usually called “royalties,” will be made to the State as established in the contract. This payment can be based on gross or net sales.
All development risks, including the exploration costs, are the responsibility of the successful bidder.
The main disadvantage of this type of contract is commercial. Ordinarily, there is a lack of adequate knowledge concerning the potential for an area to be developed, since the seismic exploration tends to be partial. If the knowledge of the area is incomplete, the government runs the risk of not realizing the best possible profit.
2 Production sharing
In the production sharing model, the State maintains the ownership of the oil and negotiates a system for profit distribution. Unless otherwise agreed, governments will receive profits without having to make any investment because the government usually has the cost of its initial contribution paid by the companies. This cost is reimbursed to them from the government’s future profits.
Although the oil belongs to the State, the companies take the risks. However, the State also can take risks, by allowing part of its profit to be used to develop the area.
Nevertheless, the companies are entitled to recover their investment, operation and maintenance costs. In general, the investment costs are recovered along a certain number of years, and the operation and maintenance costs in the same year they are incurred.
The complexity of a production-sharing contract depends on the country’s legal framework. If the country has established the basic contract rules in law, contracts are simpler, since most of the content is already covered by the law. If the terms of a production-sharing contract are set by law, this offers more safety to companies. This is what happened in Azerbaijan and other ex-Soviet Republics. However, it makes the contract rather inflexible because only the Parliament can change it.
3 Joint ventures
In contrast to what happens in the case of concession and production-sharing contracts, there is no internationally established definition of those contracts termed joint ventures.
A joint venture contract merely establishes that two or more parties wish to create a clearly established “union”. Joint ventures, due to their “open” character, are less common than concession and production-sharing contracts. The main characteristic of joint ventures is that the costs, and usually the risks, are shared.
As risks and costs are shared, the government has a direct responsibility over the exploration of oil and natural gas, and becomes a potential agent of damages, including environmental ones.
4 Services
There are two types of service contracts: a provision of service one and a risk service one. In the case of a provision of service contract, the companies are paid to explore a field, but all oil produced belongs to the State. In the case of a risk service contract, the company undertakes all the investment and is afterwards reimbursed by the production of the field. The company may receive either money or oil for the services provided, as set out in the contract. At present, service contracts are very rarely used.
Risks and rewards
Risks and rewards from the main contract types used in the oil industry are very different, as Table 1 shows:
Table 1 – Risks and rewards.
Contract
Company
Government
Situation in which it usually exists in
Concession
All risks and high reward
Reward is function of production and price
Countries with a low relationship between reserves and consumption, and high exploration risks
Production sharing
Exploration risk and part of production risk
No risk and part of production
Countries with large reserves and low exploration risks, e.g. Brazil after pre-salt discoveries
Provision of service contract
No risk
All risks
Countries with large reserves, low exploration risks, and very low production costs
Joint ventures
Participation in the risks and in the production
Participation in the risks and in the production
Norway adopts, in strategic areas, contracts similar to joint ventures
It is important to note that many countries adopt mixed models.
Table 2 shows the contract types used in various countries (Azevedo, 2008)
Table 2 –
Contract types in various countries.
CONTRACT TYPES
COUNTIES
• Licenses
• Norway
• UK
• Production-Sharing Contracts
• Angola
• Bolivia
• Colombia
• Ecuador
• India
• Libya
• Mozambique
• Nigeria
• Pakistan
• Senegal
• Tanzania
• Turkey
• Venezuela
• China
• Malaysia
• Employment Contract
• Concession Contracts
• Argentina
• USA
• Peru
• Portugal
• BRAZIL
• Service
Contracts
• Risk Contracts
• Iran
• Mexico
• Contracts Without Risks
(Reimbursement and Payment in Currency
Any country makes use of this type.
???
PETROBRAS AND THE PRE-SALT
Petrobras was created by Law No. 2,004, dated 3 October 1953, and it was endowed with the monopoly of the activities of oil exploration and production. Only from 1997 other foreign or national companies start participating in oil production and research in Brazil. Despite being a state-owned company, Petrobras has 60% of its joint stock held by private investors.
In its Business Plan for the 2009-2013 period, Petrobras announced that US$ 104 billion will be invested in the exploration and development of areas already bid for. In this period, US$ 28 billion will be invested in Pre-salt areas. Petrobras’ total investments will be RS$ 174.4 billion in the next five years.
Production
Petrobras estimates that in 2013 the province of Pre-salt will already be producing 219,000 barrels of oil a day. In 2020, the company and its partners may be producing 1.8 million barrels a day in the Pre-salt. In the development for Pre-salt production alone, the state-owned company foresees investing US$ 111 billion from 2009 to 2020.
Today, Petrobras’ production is roughly 2.7 million barrels of oil a day, adding up the oil and natural gas production in Brazil and abroad. In 2010, Petrobras estimates its total production will be roughly 5.7 million barrels of oil equivalent a day. Within 12 years, the company will more than double its production (Azevedo, 2009).
Investments
Even without mentioning Pre-salt areas not bid for yet, Petrobras has already to face huge investments to be made in the future. These investments will be funded by the company itself and by third parties. The Brazilian National Bank for Economic and Social Development (BNDES) will be an important source of resources for Petrobras investments in both the production and refining of Pre-salt oil.
On 30 July 2009, the BNDES and Petrobras signed a loan contract worth R$ 25 billion. This was the biggest financing operation ever undertaken by the BNDES. It was also a pioneering operation because of its financial characteristics. It involves the first bank loan to be paid with government bonds. To achieve this, the BNDES raised R$ 25 billion from the National Treasury in government bonds, which will be transfered to companies in the Petrobras group.
To guarantee the success of the current business plan of Petrobras concerning both exploration of areas already granted and expansion of the refinery complex, all possible forms of aid should be sought from the government, even if that implies an increase in federal public debt. However, the exploration of areas not already bid for must be reconsidered, so that they should be source of revenue and not of expenses.
Time is Money
If Brazil does not explore the Pre-salt in the next four or five decades, it runs the risk of most of the recoverable oil from this province never being produced. The government revenues from exploration of the Pre-salt are urgently needed because Brazil is still fighting against problems such as extreme poverty, social inequality, and functional illiteracy.
In the current framework of climate change it is likely that 50 years from now oil will lose its value because the planet is showing clear signs of the worsening of the greenhouse effect. Furthermore, new technologies are being developed. The energy model for the goods and personal transport sector, based on trucks and cars powered by oil by-products, may change in the coming decades.
If Brazil, in fact, opts for a minimum participation of 30% in Petrobras in all the Pre-salt areas not yet bid for, the rate of exploration could be limited by the firm’s ability to invest, which can mean a slower increase in the potential revenue of the state.
According to carmakers, in 2025, 30% of new cars could be electric. If the USA and Europe invest heavily in new technologies, the importance of oil in the industry could be reduced.
Thus, under the State’s strictest control, international companies should be encouraged, so that the rate of exploration of the Brazilian Pre-salt may be speeded up, and different ideas and concepts applied. We know that the capital and technology for oil exploration of such companies are being attracted by countries such as Angola and Norway.
NEW LEGAL FRAMEWORK
Such situations indicate that a new legal framework should be created, in which oil and natural gas can be explored directly by the Union, allowing services to be contracted for either with concession contracts or production-sharing contracts.
In this new context arising from discoveries that have been made in the province of Pre-salt, the current model of oil research and production, as set out in Law No. 9.478/1997, needs to be reviewed. Nowadays, the concession model is the only instrument for prospecting for and producing oil and natural gas in Brazil. The current Law limits the exercise of a constitutional monopoly, as stated in Article No. 177 of the Federal Constitution because it obliges the Union to sign concession contracts in order to prospect for and produce oil or natural gas in Brazil.
Thus, Law No. 9.478/1997 needs to be made flexible enough to allow the Union to draw up service contracts and, mainly, production-sharing contracts, which are very suitable for developing countries that have large reserves and where the exploration risk is low, as in the province of Pre-salt.
Sharing contracts
The main advantage of sharing contracts as opposed to service contracts is the fact that all investments and all risks are the responsibility of the oil company, and not of the State. Thus, oil exploration is just source of revenue, not representing any expense for the State.
In the production-sharing contract, the Union enters into contracts with private or state-owned companies to carry out research and production activities. These companies and the Union share profits by means of the hydrocarbons produced or their monetary value.
In contracting services, Petrobras itself would be able to carry out activities related to research into and the production of oil and natural gas, being paid by the Union for the work done.
Individualization of production
Another shortcoming of Law No. 9.478/ is that it does not address the individualization of the oil production of fields that extend from licensed to unlicensed blocks. The Union, as holder of rights and duties of unlicensed blocks, has to be a party to agreements of individualization in blocks that extend beyond the areas already licensed.
In this case, the new legal framework should foresee this kind of agreement among the Union and holders of rights and duties in the licensed area.
These agreements and the production-sharing contracts can speed up the rate of Pre-salt production. If Brazil does not explore this new oil province in the next four or five decades, it runs the risk that most of the recoverable oil in the Pre-salt area will stay there for ever.
Text summarized from the white paper “The Pre-salt and the new legal framework,” by Legislative Adviser Paulo César Ribeiro Lima, from Area XII (Mineral, Water, and Energy Resources), from Legislative Consulting Services of the Chamber of Deputies.
