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Brazil prepares for a big win

The Transfer of Rights Surplus Bidding Round promises to attract a bevy of international players and generate enormous rewards for the government

Brazil has significantly liberalised its upstream sector and established a far more investor-friendly business climate since the Lava Jato-led corruption investigation sparked regime change. Brazil held six bidding rounds during 2017-18 alone, including five that focused on the prolific pre-salt region. These six auctions resulted in the sale of 72 blocks and achieved $7.5bn in signature bonuses.

The Brazilian regulator, the National Agency of Petroleum, Natural Gas and Biofuels (ANP), estimates the combined auctions added 2.5mn bl/d to peak oil production and $112bn in new investments across the country.

The government has scheduled a further three auctions to be held before year-end. The Transfer of Rights Surplus Bidding Round—certainly the highest profile and most lucrative for both government and industry—will be joined by the 16th concession bid round and the sixth production sharing round. Combined, they promise to generate a minimum of R$117bn ($28.4bn) in signature bonuses.

"The government needs these fields to be auctioned as soon as possible, both to see the signing bonus cash entering government accounts in the short term and to unlock investment potential. These are among the largest E&P offshore projects in the world—and have the capacity to put Brazil among the largest oil producers in the world," says Felipe Feres, partner at Brazilian law firm Mattos Filho. "In view of the energy transition, it might be the last opportunity to monetise these projects and see long-lasting benefits to the country's population."

Unique opportunity

The Transfer of Rights Surplus Bidding Round is scheduled for 6 November. It is a highly unusual auction because the reserves are entirely proven, so no exploration is required, and an incumbent operator will remain heavily involved. The four pre-salt fields—Buzios, Itapu, Atapu and Sepia—form the basis of what looks set to be Brazil's largest ever hydrocarbon auction.

“Buzios is definitely the jewel in the crown” Feres, Mattos Filho

Signature bonuses across the four fields, all available under production sharing regimes, are fixed and would generate R$106.5bn. An estimated R$52bn (depending on the result of legal proceedings) will go to the federal government, which it says will be used to pay down the national debt, with the remainder split between states, municipalities and state oil giant Petrobras.

The Brazilian government had discussed a surplus auction for the Transfer of Rights region ever since exploration in the area revealed hydrocarbon reserves in excess of the 5bn bl oe guaranteed to Petrobras. But for several years the government and the national oil company had disputed contract terms and compensation owed, which led to potential auctions being shelved. The two parties finally reached a settlement on the contract revision in April when the government agreed to compensate Petrobras $9.1bn. Companies taking part in the bid process will also be required to reimburse Petrobras for the investments it has made in the fields on offer.

Buzios and Itapu

The largest field available at auction is Buzios, in the Santos Basin. "Buzios is definitely the jewel in the crown, being by far the largest field on offer and one of the largest ever offshore E&P projects in the world," says Feres.

In 2010, Petrobras was granted the rights to produce 3bn bl oe from the field. It operates four platforms in the field, each with the capacity to produce 150,000bl/d of oil and 7mn m³/d of natural gas. Petrobras plans to add a fifth unit by 2022 and has committed $9bn of capex to develop the field through to 2023.

“Some of the majors could be frustrated with how the unitisation framework… was set-up” Romeo, Macquarie

The Brazilian state-owned oil company exercised its pre-emptive right to a 30pc share of the field and could yet increase its stake during the auction. The signing bonus for the field hugely exceeds all others at R$68.2bn—almost two-thirds of the Transfer of Rights total—and interested parties must offer a minimum of c.23pc profit oil to the government.

Petrobras also optioned a 30pc interest on the Santos Basin's Itapu field, the smallest available. The field was included in the company's 2019-23 business plan and a floating production storage and offloading (FPSO) vessel tender will be submitted after the auction. The FPSO will have oil capacity of around 120,000bl/d, as well as 3mn m³/d of natural gas, and is planned to be operational by 2023. The signing bonus for the field stands at R$1.8bn and bids must include a minimum c.20pc of profit oil.

Atapu and Sepia

The final two fields available in the Santos Basin are Atapu and Sepia, which differ in that Petrobras has waived its pre-emptive rights. Petrobras has already contracted a P-70 platform to enable the Atapu field to begin first production by 2020 and committed $2.7bn of capex before 2023. The field has been unitised with the surrounding Berbigao and Sururu fields, which are controlled by a consortium of operator Petrobras (42.5pc), Shell (25pc), Total (22.5pc) and Portuguese firm Galp (10pc). In its business plan, Petrobras pledged $1.7bn of capex to the Berbigao and Sururu fields. The signing bonus for Atapu stands at R$13.7bn, with minimum profit oil of c.25pc.

The Sepia field is projected to begin producing first oil by 2021 and Petrobras has agreed to lease a platform from Japanese floating platform firm Modec. Both the Sepia and Sepia Leste fields have been unitised into a single project within the BM-S-24 block, which is controlled by a consortium of operator Petrobras (80pc) and Galp (20pc). The signing bonus for the field is R$23bn and the minimum profit oil is the highest among these fields at c.28pc.

Petrobras has often declined to bid on a field where it had previously waived its pre-emptive right. Felipe Boechem, partner and head of oil and gas at Brazilian law firm Le Fosse Advogado, notes that "in the third PSC bid round, Petrobras bid for the two blocks in which it had exercised its preferential right and did not bid for the remaining two" for which it had not.

Source: ANP

In the fourth PSC bid round, Petrobras again submitted a bid on three blocks where it had earlier exercised its right but shunned the remaining one where it had not. It was only during the fifth PSC bid round that it chose to bid on a block it had previously opted not to exercise its right on.

International interest

Several major oil companies have indicated potential interest in the surplus auction. Neil Chapman, senior vice president of ExxonMobil, speaking on the company's Q2 results conference call, pointed to Buzios as the most tempting field on offer. "Because it is so large, everybody in the industry will have a look at it," he said. "I would be very surprised if they did not."

“I do not expect to see a large number of competing bids for each block, and potentially to see Petrobras involved in all of them” — Rhodes, CMS

But ExxonMobil is not interested in bidding based on size alone. "The way I look at it, we have to bring an advantage versus everybody else in the industry… a way where we can bring a significant advantage, get more value for our shareholders and not just get into a bidding war versus other players. We want to be able to bring an advantage to that resource, should we want to participate," says Chapman.

In February, Norway's Equinor stressed the potential opportunities presented by the Transfer of Rights auction and the growing importance of its Brazilian assets. The firm is targeting 300,000-500,000bl/d by 2030 and by 2025 four of Equinor's highest net present value assets will be in Brazil, according to Margareth Ovrum, executive vice president of development and production at Equinor Brazil. "The Transfer of Rights Surplus volumes could be an opportunity this year, if commercially attractive," she says.

Bidders will most likely seek to be in a consortium with Petrobras, in the view of Ted Rhodes, managing partner at law firm CMS. "We saw in the first production sharing bid round for the Libra field that many of the potential bidders sought to negotiate a joint bid with Petrobras, and the round ended up with a single bid for the minimum profit oil allocation to the government," he says. "It is possible that something similar could happen this time. I do not expect to see a large number of competing bids for each block, and potentially to see Petrobras involved in all of them."

Cost concerns

Recent comments from senior figures at majors suggest high entrance costs are tempering excitement. Bob Dudley, CEO of BP, said during the company's Q2 conference call that the fields on offer "look very expensive". "We are just going to remain very disciplined [and] within our capital framework," he says. We have not made a decision—we are still in discussions with Petrobras and looking at it. But we are going to be really, really careful."

Similarly, Galp, which has assets adjacent to the Atapu and Sepia fields, has concerns over the high fee. "Brazil starts to become relatively expensive, you can see by the bonus that has been released by the regulator," said CEO Carlos Nuno Gomes da Silva on the company's Q2 results conference call. "We have to do it in a prudent way, ensuring at least two or three elements that are relevant for us, so that we will be able to have reasonable returns. We will be capable of implementing strong partnerships that will get [us] access to assets of the right size." Brazil is now contributing around 98,000bl/d to Galp's upstream portfolio.

$7.5bn — signature bonuses 2017-18

Rhodes thinks the government sacrificed some of its revenue generation potential in order to maximise early revenues and help reduce its budget deficit. "The minimum profit oil share percentages for the government appear relatively low, and the cap on cost oil recovery of 80pc is relatively high," he says. "For companies with cash reserves, a low cost of capital and long-term vision, these blocks may prove attractive." In particular, he is looking towards Chinese state-owned companies, which are keen to secure long-term energy supply.

A further complication is the challenge of complying with three different fiscal regimes: the onerous assignment agreement, production sharing agreements and concession agreements. "The areas on offer are certainly attractive from a geological standpoint," says Boechem. "However, the overlap of different E&P regimes in the same area, which is very new and unique, gives rise to questions and risks with which bidders have never dealt." In addition, some of the issues can only be resolved after the auction, such as negotiation of the co-participation agreement and definition of the compensation owed to Petrobras for investment already made.

"Some of the majors could be frustrated with how the unitisation framework within the existing Transfer of Rights resources was set-up," says Romeo Giacomo, senior analyst at Australian bank Macquarie.

Rhodes agrees, cautioning that "the very significant cash outlays, the need for incoming private participants to negotiate a co-participation agreement with Petrobras, and potentially to unitise with other areas held by Petrobras, may make oil companies reluctant to bid except in a consortium with Petrobras".

Source: Petroleum Economist
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