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 Date:9/15/2009

 

World News
Underwater Gold
Jose L. Valera explains Brazil’s proposal for development of massive oil reserves.

On Aug. 31, Brazil’s President Luiz Inácio Lula da Silva announced a package of legislative proposals to create a new legal and contractual framework for the exploration and development of hydrocarbons in pre-salt areas and in “strategic” areas. The pre-salt areas are geologic formations found in as much as 15,000 feet below the bottom of the ocean in water depths of up to 6,000 feet. These areas are described in a supplement to one of the bills as covering 149,000 square kilometers and located offshore the states of Santa Catarina, Sao Paulo, Rio de Janeiro and Espiritu Santo.

The pre-salt in Brazil contains the largest oil reserves discovered in the Western Hemisphere in the past 30 years, and this potential new supply should be a source of relative stability in global oil markets in the short- to medium-term. By 2020, Brazil is expected to double its current production of 1.9 million barrels per day with production from only the areas in the pre-salt currently under concession.

This region was first found to contain oil in 2006 and the first field, Tupi, was discovered in 2007. Tupi alone is estimated to contain five billion to eight billion barrels of oil. Other discovered fields are Iara (three-four billion barrels) and P. Baleias (one-two billion barrels). In all, the entire pre-salt area is currently estimated to hold total reserves in the range of 50 billion barrels. The “strategic areas” are defined as areas outside of the pre-salt that, in the estimation of the government, present low exploratory risk and high production potential. Under the new legislation both the pre-salt and the strategic areas will be subject to being redefined by executive decree from time to time.

The industry’s development and operational standards currently in place in Brazil are based on a long-standing concession agreement, under which the concessionaire owns all production in consideration for the payment of royalty and taxes. The proposed legislation represents a change in requiring that hydrocarbon operations in the pre-salt and strategic areas be carried out pursuant to production sharing contracts directly with the Brazilian government. Existing concessions in these areas would be grandfathered, and the concession regime would remain in effect in the rest of the country. Currently, 28 percent of the pre-salt region is under concession. Petrobras owns a participating interest in 24 percent of these existing concessions.

These production sharing contracts would be entered into by Brazil’s Ministry of Energy and Mines, represented by a proposed state-owned company to be called Petro-Sal. A portion of the production would be allocated to the contractor to reimburse costs and the remainder would be split in kind between the contractor and Petro-Sal based on terms set forth in the contracts. At the discretion of the government, the contractor would be only Petrobras or there may be other companies selected through a competitive tender process. In the latter case Petrobras must have a minimum participation of 30 percent and would always be the operator. Petro-Sal would have a tie-breaking vote in meetings of the operating committees under the production sharing contracts. Subject to final government approval, these committees make decisions concerning exploration work, budgets, declarations of commercial discoveries and development programs.

In addition to owning a portion of the production under the production sharing contracts, the government would realize revenue from signature bonuses and royalties.

The government of Brazil is proposing these changes for the stated purpose of obtaining a greater economic benefit from an extraordinarily abundant resource with low perceived geological risk. Petrobras has already drilled 31 wells in the pre-salt so far, with a success rate of 87 percent. Thirteen of these wells have been drilled in the Santos Basin, with a success rate of 100 percent.

The government is also proposing the creation of a special social fund based on all of the economic revenues anticipated from the new production sharing contracts. The statutory purpose of this fund would be to implement programs to combat poverty and make investments in education, science, technology and environmental sustainability. Other objectives of the government are to contribute to the industrial expansion of Brazil through ambitious, local-content requirements for the facilities, goods and services that will be necessary for companies in developing operations in the pre-salt.

Assuming legislative approval of these proposals by year-end, the government anticipates that incremental production attributable to the production sharing contracts could commence by 2019. The government is predicting investments to the tune of hundreds of billions of dollars during the next three decades and expecting the development of new technologies to tackle the immense technical difficulties and costs involved. Many are already envisioning new oil towns, industrial complexes, and research centers springing up in Brazil.

The pace of development under the proposed new regime, however, will be somehow restrained by the government’s parallel objectives of substantial local content and the obligatory participation by Petrobras as operator under all new contracts. In order to be effectively used, the logistic and technological abilities of local-support industries will have to be enhanced through joint ventures with and investments by global service and infrastructure firms. In turn, Petrobras will require greater financial resources and managerial capacity. The government has announced that it will address the financial needs of Petrobras through a planned equity capitalization program in the range of about $50 billion. A portion of the proceeds from this capitalization would be used to acquire up to 5 billion barrels of oil reserves to be assigned by the government.

Jose L. Valera, of the Houston office of Thompson & Knight LLP, focuses his practice on domestic and international energy transactions. Mr. Valera has more than 25 years of legal experience representing oil, gas, and electric energy companies throughout the United States, Central America, South America, Africa, Asia, and the Caribbean.