Brazil: getting Petrobras out of the way

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On February 24, the Brazilian Senate voted to pass a bill to eliminate the requirement that Petrobras, the Brazilian state-owned oil company, be partner and sole operator of all investments in the Pre-salt oil and gas deposits off the coast of Brazil. If the bill successfully passes the lower House and avoids a presidential veto, it may be breathe some fresh air into a financially troubled company at the center of a severe political crisis.

Recent history

The state’s monopoly over hydrocarbon resources and the exclusive role for Petrobras in extracting, refining, and commercializing them was established in 1953. This ownership regime was first altered in 1995 with a constitutional amendment that allowed other companies to be contracted to work in the oil sector, and entirely replaced with a new Petroleum Law in 1997 that eliminated the state’s monopoly and introduced a system of concessions for exploration and extraction of hydrocarbons (Law 9478/97).

Starting in 1999, the national regulatory authority (Agência Nacional do Petróleo, ANP) has held annual tenders in which private firms participate freely. Though Petrobras continues to be a dominant player, major international oil companies, as well as newly formed Brazilian oil companies, now participate in exploration and production. In the decade that followed the passage of the Petroleum Law, Brazil experienced a hydrocarbon boom that placed it among the top 10 producers in the world. Production nearly doubled from 850,000 to 1.8 million barrels per day, as did employment, rising from 140,000 to 350,000, and the oil sector came to represent 10% of GDP.

New offshore discoveries

In 2006 Brazil achieved its dream of oil self-sufficiency and to top it off, new and vast discoveries of oil were made in the Tupi field under a thick layer of salt 1,500 meters under the continental shelf. Other “Pre-salt” discoveries followed, with several more fields of oil and gas identified off the coast of Rio de Janeiro, São Paulo, and Espírito Santo states. Combined, these fields promise to produce a dazzling 50 bboe. Brazil had finally arrived: oil prices  were starting to climb, as was the market valuation of Petrobras, the economy was performing well, wages were rising, and President Lula was beginning his second terms with renewed popularity.

The magnitude of the bonanza prompted the government to rein in some of the deregulation passed in the 1990s and seek greater control over production and revenues. In the final days of Lula’s second term in 2010, and amid the euphoria of an electoral victory for Lula’s party, the PT, that awarded the presidency to his Chief of Staff, Dilma Rousseff, the Congress passed a new a production sharing system that reinstated Petrobras’ monopoly over exploration and production in the Pre-salt fields.

Under law 12.351/2010, Petrobras may be awarded a field directly, dispensing of a bidding process. If an area is open for bidding, the winner must enter a joint-venture in which Petrobras holds a minimum 30% stake, and which is operated by a committee controlled by Petrobras and Petro-Sal, a special-purpose state-owned company that also holds an undefined stake in the venture. The legislation also creates a new fund which earmarks revenues for education, health, and other areas of social spending.

Fast-forward to 2016

Even before the crash in oil prices and the eruption of the Lava-Jato scandal in 2014 linking Petrobras to a vast corruption scheme that included embezzlement of public funds, overcharging on contracts with suppliers, and money laundering for political campaigns, the performance of the Brazilian oil sector started to wane. Petrobras became financially overextended, undertaking large investments in refining capacity while abiding by price controls at the pump imposed by the government to tame inflation. Like other oil firms operating in Brazil, Petrobras has been affected by currency fluctuations and burdened by high costs due to local content requirements. In 2012 Petrobras posted losses for the first time in 13 years (Financial Times).

The rest of the oil sector has been declining along with Petrobras. Overall production stopped increasing after 2008 as the government postponed and cancelled planned tenders while it sought to leverage the new discoveries towards greater state participation and profits. International prices of oil have certainly not helped. So far, only one Pre-salt field, Libra, has been bid out to a consortium composed of Shell, Total, CNPC and CNOOC, but it’s not expected to reach production until 2020.

Those favoring the new legislation approved by the Senate argue that Petrobras is in no financial condition to assume 30% of all investments necessary to develop the Pre-salt fields. Its debt continues to grow as the currency depreciates, and it will be hard pressed to come up with the resources to develop the fields it already has: for the first time ever, last October, Petrobras did not participate in a tender for new fields.

The new law, introduced by the opposition party PSDB, maintains the production sharing system, but eliminates the obligation of having Petrobras as a partner and operator, while giving Petrobras the right of first refusal on all tenders. This latter provision was a last minute amendment that sealed the agreement between the opposition and the government and allowed the bill to be approved in the Senate. The bill faces another battle in the House, where simply the number of deputies makes agreement harder to reach, but the expectation is that the bill will pass, and that the beleaguered president will have little political capital left to produce a veto.

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