Brazil back on track
This year should see Brazil's recovery deepen, but also holds the risk of a presidential election derailing it
After a promising 2017, this year looks set to be a busy and productive one for Brazil's oil industry. The market re-opening will be consolidated with new acreage offers, important pre-salt projects are coming onstream, and additional oil reforms should boost competition in the country.
After President Dilma Roussef's impeachment and the rise of Michel Temer to the presidency in 2016, the National Petroleum Agency (ANP) and Ministry of Mines and Energy (MME)—the two top oil regulators—started a turnaround, introducing rule changes and improvements in order to enhance Brazil's attractiveness.
These changes came after years of stagnation, when previous administration policies proved to be detrimental to the development of the sector and spooked foreign investors. Such past decisions, focused on increasing state control of huge offshore discoveries, drove up costs, limited production and generated a giant debt load for state-owned Petrobras of around $125bn. Nationalist measures taken included requiring Petrobras to operate all blocks in the prolific pre-salt province, high local content requirements, and the suspension of bidding rounds.
Market confidence came back quickly as these measures were chipped away. Petrobras is no longer required to participate in the bids for all blocks under the production sharing contract system, which reigns in the pre-salt. Local content rules were simplified and relaxed and some tax relief measures were adopted. Bid rounds returned in 2017, and an ambitious three-year calendar of further auctions was announced. Brazil, as a result, was back on international oil companies' radars in 2017.
This was evident in the three bid rounds held last year. Oil majors Shell, Total, ExxonMobil, BP and Statoil all snapped up new acreage in the country despite the recent troubles.
In 2018, three new bid rounds will keep up the industry's momentum. In March, Brazil will host its 15th round for acreage under the tax/royalty system, offering up blocks in frontier and established basins. That will be followed in June by the hotly-anticipated 4th pre-salt round, which will offer up production sharing contracts in one of the world's most sought-after oil provinces. Another bidding round dedicated to marginal fields should also take place in the second half of 2018. The government hopes to take in a minimum of $1.4bn in signing bonuses in the first two rounds, but in reality the figure should be much higher.
The three co-existing tax regimes
Investors will have to navigate Brazil's complicated oil tax regimes. Until 2010, all upstream projects were awarded under the tax/royalty system. After the pre-salt province was discovered, the government introduced the production sharing contract for specific areas that were believed to have greater geological potential and less risk—notably the pre-salt. Before last October, only one block had been awarded under this PSC system, the Libra block in 2013, which is operated by Petrobras in partnership with Shell, Total and state-owned China National Offshore Oil Corporations and China National Petroleum Corporation.
2.6m b/d—Brazil's production, the highest in Latin America
Besides these two systems, there's another specific area of the country that is ruled by the Transfer of Rights ("Cessão Onerosa" in Portuguese) agreement. The Transfer of Rights is an agreement signed in 2010 between Petrobras and the Brazilian government, in which Petrobras paid for the right to explore and produce up to 5bn barrels of oil equivalent in a specific area in the Santos Basin pre-salt cluster.
This controversial agreement will be in the headlines again during 2018, with major potential implications for Petrobras' finances. The state oil company paid the government $42.5bn for the right to develop the reserves, an average of $8.50 per undeveloped barrel of oil. Since then, Petrobras discovered several oilfields in the area, including Buzios, which is expected to start commercial production in 2018.
However, the contract allowed for a renegotiation based on changes in the oil price and the two sides have been in talks for months. Given that oil prices have decreased sharply since 2010, the price revision would benefit Petrobras and give the company a substantial windfall. On the other hand, the volume of oil discovered by Petrobras has far exceeded the original 5bn-barrel-agreement, so the company technically owes the government for this oil excess. Exactly how much oil has been discovered, though, is in dispute and will ultimately decide who will pay whom and how much. A deal should be settled in 2018.
New projects, flat production
For all the troubles in recent years, Brazil surpassed a major milestone in 2017 when it became Latin America's largest crude producer at around 2.6m barrels of oil a day. Pre-salt production is already half of the total, and its share will only grow. In fact, from November 2016 to October 2017 country total production was roughly flat at 2.6m barrels per day, while the pre-salt share grew from 45% to 50%, reflecting declines from mature Campos Basin fields.
The most important new project to begin producing in 2017 was the Mero field, in the Libra block, last November. It is the first commercial field under the PSC regime and the second-largest oilfield in the pre-salt province—estimated to hold 3.3bn barrels of recoverable oil. It is surpassed only by the 6.5bn-barrel Lula field.
In 2018, Brazil's production should remain stable, according to Petrobras' forecasts, but with an increase in pre-salt's share. The company plans to deploy 19 new production systems between 2018 and 2022, seven of them in 2018. It's a major challenge but most of them are more than 90% completed.
The giant Lula field, operated by Petrobras alongside Shell and Portugal's Galp Energia, will see two new production systems start sucking crude from its vast reservoir-—Lula Extremo-Sul and Lula Norte, the eighth and ninth floating production storage and offloading vessels at the field. Berbigão, also operated by Petrobras alongside Total, Shell and Petrogal, is another important pre-salt project coming online. The 3bn-barrel Buzios field, which sits in the Transfer of Rights area, will see its first three FPSOs deployed. The smaller Tartarugas Verde e Mestiça will also start flowing in 2018. In total, around 1m b/d of new production capacity is being added.
Beyond the oil patch, Brazil will elect a new president in October 2018, which holds important ramifications for the oil industry. It's still early in the race, but preliminary polls indicate two frontrunners: Luiz Inácio Lula da Silva and Jair Bolsonaro.
Lula was president from 2003 to 2010, representing the Workers Party, and has been a staunch defender of keeping Petrobras' strong grip over the oil industry. During his mandate, the production sharing contract system was implemented and another state-owned company (PPSA) was created to represent the government in the PSC joint ventures with the operators.
In 2018, three new bid rounds will keep up the industry's momentum
Bolsonaro, a conservative congressman, still hasn't put forward any detailed views on the oil industry, but says he's against the privatisation of Petrobras, a topic that is always on the table when it comes to presidential elections in the country. He also recently voted against the extension of Repetro, a special customs regime that allows tax benefits for oil companies on the export and import of goods used in the E&P sector. Despite his vote, the tax benefits were extended until 2040.
Regardless of who wins, nothing should change in the short-term, especially in 2018. Whatever the next president's intentions for the oil industry, new regulatory changes would take some time to be implemented, so we shouldn't see any radical changes in 2018 or 2019.
Whoever wins the presidency will have to consider not just Brazil's domestic situation but the region's shifting oil politics. For instance, Brazil's recent reforms and successful bid rounds have helped it keep up with other nearby rivals like Mexico that are competing for investment dollars. Recently, Mexico's state-owned Pemex had to delay a deep-water project farm-out due to low interest from foreign oil companies. It blamed competition from Brazil, which attracted investments from previously interested majors like ExxonMobil and Shell in an auction around the same time.
Brazil also has some intrinsic advantages in comparison to other countries. Its strategic position for exports and low geopolitical risk are definitely a bonus when it comes to investment decision by foreign oil companies. It has also proven its below-the-ground resources are abundant. There's more deep-water oil still to be produced off Brazil's coast than in the Gulf of Mexico and off West Africa combined.
But the recent past has shown that Brazil can't rest on these laurels. At the end of the day, it will all come down to above-the-ground issues. The government's recent reforms have paid off and it seems determined to continue, in 2018, putting the Brazilian oil industry back on track.