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New laws place Brazil's oil and gas firmly under state control

Policy decisions hand Petrobras significant control of Brazil's offshore oil resources, pushing private-sector explorers to look to shallower waters

BRAZIL'S government has passed long-awaited legislation that will enhance the state's control over the country's oil industry. The Senate passed two important bills last month that will transform the industry.

Despite predictions of roadblocks – with President Luiz Inácio Lula da Silva's term set to end on 1 January 2011 and much of the football-mad country brought to a halt by the World Cup – the ruling party was able to muster enough votes to pass a law authorising the government to transfer drilling rights for up to 5bn barrels of oil equivalent to state-controlled Petrobras, as well as participate in the company's planned rights-issue. Petrobras says it will continue talks with the government over the transfer of drilling rights, but provided few details.

Congress also passed a bill that scraps the concession system used to bring foreign companies into Brazil's offshore sector, replacing it with production-sharing contracts. The law also guarantees Petrobras the operatorship of all new blocks offered and a minimum 30% stake in each area.

The legislation increases state control over the pre-salt areas in the Santos and Campos basins, where big discoveries may transform Brazil from a large oil producer to potentially a significant crude exporter. A 200 km wide, 800 km long stretch of ocean floor along Brazil's coast has become one of the hottest new oil provinces since the discovery of the Tupi oilfield in 2007, which was followed by several other finds.

Brazilian officials claim the pre-salt could hold 50bn-100bn barrels of recoverable oil, although much of it is at great depths and so far from the coast that it is beyond the range of the supply helicopters normally used in offshore oil and gas operations.

Petrobras continues to drill exploratory wells in the area to firm up resource estimates and is approaching early production from Tupi. However, its pre-salt oil discoveries have been successful enough to prompt a change in government thinking – eschewing a policy of attracting private-sector investment and instead giving Petrobras privileged access to a region that is now talked of as having little exploratory risk.

As a result of Petrobras's discoveries, the government withdrew non-licensed areas from proposed lease rounds and is now looking at new development models.

Further pre-salt discoveries

In December, the country's upstream regulator, ANP, contracted Petrobras to drill two wells in the non-licensed part of the pre-salt that have already affirmed the extension of the oil trends. The Franco and Libra wells both tapped into large fields near Petrobras's 3bn-4bn barrels of oil equivalent (boe) Iara discovery and, in the space of two weeks in May, ANP said Franco had found 4.5bn boe and said Libra might be bigger. The agency is already describing the two fields as the biggest discoveries since Tupi and is planning two further exploratory wells, which will probably be contracted to Petrobras, given limited interest in the work from other companies operating in the area.

In addition, although the regulator is sticking – for now – with its estimate of recoverable pre-salt reserves of 50bn barrels, ANP officials say drilling evidence indicates the pre-salt province may occupy an even larger area than previously thought. Signs that the pre-salt could go beyond the prolific Campos and Santos basins continue to emerge.

In April, Petrobras said it had detected signs that the pre-salt province may even extend north, after detecting salt layers off the country's northeast coast. Further studies are planned to determine if source and reservoir rocks lie beneath the newly found salt layer. Petrobras is drilling an exploratory well in its 100%-owned block BM-SEAL-10, in the northeastern Sergipe-Alagoas basin, and China's state-owned Sinopec has been invited to farm-in to some blocks in the area to reduce the exploration risk.

The company is also working to ramp up production at Tupi, where it should conclude an extended well test – from which production amounts to 18,000 barrels day (b/d) – later this year. Petrobras will formally declare Tupi a commercial discovery by the fourth quarter after it completes three delineation wells, but has already secured production facilities to boost output from the area. When the so-called pilot production phase is complete, Petrobras will install a 100,000 b/d floating production, storage and offloading (FPSO) vessel at the field.

But production is set to grow significantly beyond that level. Last month, Petrobras said it had signed a letter of intent with a SBM Offshore and Brazilian group Quiroz Galvao Oleo e Gas (QGOG) for a second FPSO to be deployed at Tupi in 2013, producing up to 120,000 b/d of oil and 5m cubic metres a day of gas. SBM said the 20-year contract would generate $3.75bn in revenues over its life.

Petrobras raising capital

The large costs involved in developing the pre-salt horizon are part of the reason why Petrobras is continuing to raise capital. But its efforts are being complicated by the hold-up in approving the so-called capitalisation segment of the new oil legislation. The government's plan calls for Petrobras to receive new drilling rights in the pre-salt area to support an equity infusion from the state as well as other shareholders. But Petrobras officials say there is now considerable uncertainty about when – or even if – this will occur.

Nevertheless, the company intends to go ahead with a large capital increase through a rights issue this summer, whether or not the drilling-rights transfer occurs. Petrobras's board approved the issue of new ordinary and preference shares in May in the first step towards raising up to $25bn in new equity to fund its $220bn investment plan for 2010-14. The government has indicated it may use the rights issue to raise its overall shareholding in Petrobras to increase its exposure to the pre-salt reserves. Petrobras hopes to close the funding in August.

The excitement over the pre-salt area has pushed other exploration successes in Brazil, which elsewhere would widely be greeted with enthusiasm, into the background. The country's shallower waters continue to yield large finds and privately owned companies are cautiously optimistic that they will gain a freer hand in these areas with Petrobras busy in the pre-salt.

OGX, a shallow-water-focused company, is among the most prominent of the players outside the pre-salt. Although it produces no oil yet, OGX has shot to prominence with a number of discoveries that have transformed the firm from a minnow on to Brazil's main stock-market index. Owned by billionaire Eike Batista, OGX has benefited from a strong management team led by Petrobras veterans, which has provided an advantage over competitors.

OGX has made five discoveries since it was founded in 2007; and another seven wells have shown signs of hydrocarbons and may yet prove to be commercial. First production is expected in early 2011 from an FPSO leased under a 20-year contract. The company aims to lift output from 20,000 b/d in 2011, to 0.73m b/d by 2015, and to 1.38m b/d by 2019. As oil production ramps up, exploratory and appraisal drilling will be cut back. OGX plans to drill 27 exploratory wells this year, the bulk in the Campos basin, but has only three prospects slated for drilling by 2013 under present plans.

Campos basin revisited

OGX's success has already encouraged other companies to take another look at the Campos basin, although it may be some time before more acreage is leased in the area. Petrobras is also having success in its traditional areas, finding reservoirs beneath existing fields by testing deeper strata.

Petrobras's success with the drillbit is likely to further strain the regional oilfield services industry – already under pressure because of the government's insistence that more of the equipment used offshore be owned by Brazilian firms, or built in Brazil. While some companies have begun speculatively building drillships, most are relying on contracts offered by Petrobras to underwrite their entry into the business.

Delba Drilling, for instance, which won contracts in 2007 and 2008 to supply Petrobras with six deep-water drilling units, has been struggling to meet its commitments because of the global financial crisis of 2008-09. Only one is nearing completion – a year after it was scheduled for delivery – and Delba recently brought in QGOG to take a majority stake in at least two of the units on order. Chinese state-owned Sinopec has also agreed to take a stake in another drilling unit to bolster Delba's financial situation and to gain experience for itself in deep-water operations.

Petrobras admitted in late 2009 that 12 ultra-deep-water drilling units it had ordered for delivery in 2012 were unlikely to be completed on time. As few as two may be available in 2013. The delay bodes poorly for a second package of up to 28 rigs that Petrobras is seeking for delivery by 2017. These are being built in Brazilian yards and are designed to operate in water depths of up to 3,000 metres to support the development of the pre-salt fields.

Some executives at international drilling companies have expressed doubts that Brazilian-built rigs will be profitable, given the significantly higher cost of constructing the units locally than through a large, established manufacturer in, for example, South Korea. However, the government's determination to keep the bulk of construction work in Brazil should overcome these doubts.

Petrobras appears to be adapting its plans to take account of difficult economics: the company may end up taking ownership of as many as 21 of the new drilling units, instead of leasing them. And it has also relaxed its penalty clause to allow yards to fall as much as two years behind schedule before it will cancel contracts.

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