Changes to Brazilian oil and gas industry regulations: better now than never

April 2016 | SPOTLIGHT | SECTOR ANALYSIS

Financier Worldwide Magazine

Brazil is facing one of the most difficult economic periods of the last few years, with the return of inflation, currency devaluation, an increase of public deficit and the downgrading of the country’s credit ratings by the S&P, Fitch and Moody’s contributing to the economic gloom.

Without going into details on the reasons why Brazil has reached such an exasperating situation after the considerable growth recorded by the end of the 90s, the Brazilian government is seeking means of aiding the country’s economic recovery.

In order to attract investments, the Brazilian authorities have been discussing necessary changes in the regulatory framework and restrictive policies for different sectors, including the oil and natural gas industry.

Back in 2010, the Brazilian government enacted Federal Law No. 12,351 which granted the Brazilian state controlled oil company Petróleo Brasileiro S.A. (Petrobras) a number of responsibilities and privileges with regard to the exploration and production of oil and natural gas in the Brazilian pre-salt layer. As announced at that time, the discoveries made in the pre-salt layer could make Brazil one of the main players in the global oil & gas industry.

In view on the above, Law No. 12,351 provides that Petrobras would be responsible for conducting and executing, directly or indirectly, all exploration, evaluation, development, production and deactivation of exploration and production facilities in fields within the pre-salt layer and other strategic areas defined by the Brazilian government. In order to accomplish such a task, Petrobras would be appointed the sole operator in any pre-salt layer and strategic areas with at least 30 percent interest participation.

However, amid a scenario of Petrobras’ growing indebtedness, corruption scandals and consequent reduction on its investment capacity, discussions emerged regarding the viability of maintaining Petrobras as the sole operator of all fields located in the pre-salt and strategic areas.

Therefore, to avoid the stagnation of the pre-salt layer exploration and development, Congress, with the support of the government, decided to propose Bill of Law No. 131/2015, which aims to extinguish the mandatory legal requirements allowing Petrobras to act as the sole operator.

On 24 February 2016, Senate approved Bill of Law No. 131/2015 stating that the National Council of Energy Policy should grant Petrobras the pre-emptive right to act as operator in the pre-salt fields and Petrobras would have the possibility to exercise or not such right for each offered block within 30 days. If Petrobras does not exercise this right, any other Brazilian or international oil company would be able to act as operator in the pre-salt layer. The Bill is now pending approval in the lower house of Congress and there is a strong chance it will be approved soon.

The preliminary approval of the Bill by the Senate was heralded by many within the Brazilian oil industry as an important step to attracting the return of investments by oil companies, especially foreign oil companies, to Brazil.

Another important step taken on the road to recovery was the recent approval of changes in the local content requirement for the oil industry. The local content requirement is one of the most difficult contractual commitments faced by Brazilian oil companies with regard to the national oil regulatory agency.

Due to the lack of technology, poor infrastructure and high costs, oil companies operating in Brazil have a hard time achieving their contractual commitments regarding acquiring services and equipment in the domestic market. Consequently, oil companies are subject from time-to-time to high fines imposed by the agency.

To minimise the difficulties faced by oil companies in relation to the local content requirements, the Brazilian government enacted Federal Decree No. 8,637, of 18 January 2016, creating a programme to incentivise production chain competitiveness. The key aims of the programme are the development and improvement of oil & gas sector suppliers which are trying to expand the chain of suppliers of goods, services and systems produced in Brazil, to increase the local content level of suppliers already established in Brazil, as well as to promote technological innovation in strategic sectors, consequently stimulating the creation of technology-based companies and, therefore, local engineering.

Such a programme will be implemented by a number of means. Notably, incentives will be offered to suppliers should they apply a higher valuation to the percentage of local content than the valuation applied to the goods, services and systems of strategic importance (including the potential to create quality jobs, promote exports and develop local engineering and technological innovation), as well as granting local content units to oil companies.

The new local content policy intends to establish an offset mechanism of local content credits, whereby oil companies will be allowed to use exceeding investments relating to a specific exploration field for the purposes of evidencing their compliance with other local content commitments.

In addition to changes in the regulatory framework mentioned above, it is also important to note that Petrobras, under its business and management plan of 2015-2019, intends to proceed with divestments of assets that are expected to yield US$15.1bn during 2015-2016. Thirty percent of assets in exploration and production are expected to be divested, with 30 percent of those assets sold coming from the supply area and 40 percent from the gas and energy sector. Petrobras’ divestiture plan also provides for business restructurings, demobilisation of assets and additional divestments in the sum of US$42.6bn for 2017-18, which will create new investment opportunities.

For instance, Petrobras’ subsidiary responsible for the network of gas pipelines is expected to be sold, which would represent major progress in the verticalisation of the Brazilian natural gas industry, which is dominated by Petrobras in the production, transportation and supply of natural gas. Any divestment in the gas transport division of Petrobras and the consequent decline of Petrobras’ market share in the natural gas chain represents a very different environment for investments in the Brazilian natural gas industry, since it would lead to more transparency in gas prices.

Finally, it is important to emphasise that Brazil is a standout market in terms of the oil & gas space. The country offers great opportunities in numerous sedimentary basins with potential for oil & gas, with only slightly over 4 percent of the area under concession for exploration and production activities. Furthermore, in 2015, Brazil’s production of natural gas reached a record. Oil production also increased 1.4 percent over the previous year. Changes to the regulatory framework and on restrictive policies will certainly enhance investments opportunities.

The above changes were expected for quite a few years and, with the ongoing crisis in the economy, they are most welcome; more now than never.

Luis Fernando Pacheco is a partner and João Victor Basilio de Barros is an associate at Veirano Advogados. Mr Pacheco can be contacted on +55 21 3824 4718 or by email: luis.pacheco@veirano.com.br. Mr. Barros can be contacted on +55 21 3824 1337 or by email: joao.barros@veirano.com.br.

Luis Fernando Pacheco and João Victor Basilio de Barros

Veirano Advogados