Brazil’s Libra PSA – first anniversary

November 2014  |  SPECIAL REPORT: ENERGY & NATURAL RESOURCES SECTOR

Financier Worldwide Magazine

November 2014 Issue

November 2014 Issue


On 21 October 2013, the winners of the first Brazilian bid round made under the new regulatory regime were announced. The regime is based on the Production Sharing Agreement (PSA) that was developed especially for the pre-salt block called Libra. Since the enactment of the Federal law creating this new model, which coexists with the longstanding concession regime and the recently created onerous assignment, the characteristics of the Brazilian PSA triggered plenty of discussion and queries among E&P players in Brazil, especially international oil companies (IOCs). As its first anniversary approaches, Libra’s PSA still raises a lot of doubt and scepticism about its implementation and the capacity of the Brazilian market to attend to its requirements.

Brazilian history regarding the exploration of blocks in the pre-salt area is relatively new. As a matter of fact, it all started seven years ago, in 2007, when Petrobras made one of the most important announcements in its history: the discovery of a giant oil reservoir, located in the Tupi field, a region defined as a pre-salt area (which consists of prospective oil that is located about 7000 meters below the water’s surface, crossing a salt barrier). Further studies forecast that the estimated volume of recoverable oil and gas of the pre-salt rocks will significantly increase Brazil’s petroleum reserves.

As a consequence of the pre-salt discoveries, the Federal Law was enacted in 2010, adopting not only the PSA, but also the possibility of a direct contract provided by the government to Petrobras (which may be considered as a sort of a national oil company, although it has shares traded in the international market) of any given block in the pre-salt layer, and the incorporation of a special company to manage the financial aspects of the exploration of oil in the pre-salt area, named Pré-Sal Petróleo S.A (PPSA). The concession system for areas not under the pre-salt region, and exceptionally for the pre-salt blocks that were already granted under the regime, were preserved.

For the first PSA bid round, the field selected by the government was Block BM-S-11, located in the Santos Basin, called Libra. This was based on the impressive numbers associated with the field. Libra is situated approximately 230km offshore from Rio de Janeiro, at the north of the Tupi field. It is classified as an ultra-deep water pre-salt field and covers a surface of 800 kilometres long by 200 kilometres wide, with 2000 metres of water depth and 7000 metres total depth. First estimations suggest Libra holds between 8 billion and 12 billion barrels of recoverable reserves, with a best quality light crude oil associated with gas, so it is certainly one of the most important discoveries of recent decades.

The Brazilian PSA has been frequently challenged about its characteristics and it ability to attract investors, mainly due to the fact that its nature is quite different from production sharing agreements elsewhere. Brazil’s PSAs have components frequently associated with other types of regimes, such as royalties on production and establishing Petrobras as the sole operator. Besides those particularities, the main challenge for investors is the fact that PPSA will not run any regulatory risk or cost, nor will it make investments, but it will have seats on the operating committees that will manage the activities to be carried out by the consortia. It will also have both the right to cast the tie-breaking vote and decision veto powers. Therefore, PPSA will not be responsible for carrying out the activities of exploration, production and marketing of oil and gas in the pre-salt, but it will manage sharing contracts and financially represent the federal government in the consortium formed for the PSA’s performance.

Pursuant to the law, in addition to permanently holding operatorship, Petrobras will be guaranteed a minimum 30 percent stake in each area that is bid for, and may also play a part in the bidding processes with the aim of increasing its stakes. Considering that the winner of the bid will be the player that offers the highest profit oil percentage to the Union, Petrobras will have to abide by the winning bid.

The first Brazilian PSA bid was held in October 2013 and had only one consortium presenting a proposal. The winning consortium comprised Petrobras (40 percent and operator), Shell (20 percent), Total (20 percent), China National Petroleum Corporation (CNPC) (10 percent) and China National Offshore Oil Corporation (CNOOC) (10 percent). Some say that Petrobras’ sole operatorship and PPSA’s rights on the consortium were the main reasons behind the lack of interest from some of the major IOCs and the fact that there was only one single proposal. Besides that, Brazilian PSA terms and conditions were considered relatively onerous, expected to demand from consortium members around 175bn Brazilian reais (approximately £44bn) to develop Libra, including 610m Brazilian reais (approximately £155m) on exploration alone, over the 35 year duration of the contract. In addition, the commitment to procure a minimum percentage of local content of goods and services from Brazilian suppliers also increases implementation costs and raises a lot of questions about the capacity of local suppliers to meet this demand.

The consortium had to pay a signature bonus of 15bn Brazilian reais (approximately £4bn), certainly one of the highest ever paid worldwide, and guarantee as profit oil for the government, 41.65 percent of production. The cumulative production of the field, in the event of favourable expectations, will be constrained by the maximum duration of the contract of 35 years. This may ultimately require the consortium members to analyse how they will ramp up oil and gas production, considering the local content rules and the uncertainties associated with technologies that are necessary for this unique field, along with the aggressive financial demands.

To date, Libra’s Exploratory Program approved by the consortium and sanctioned by the government sets forth the drilling of six wells (four firm wells and two contiguous). The whole project is forecast to have around 12 stationary production units. In August, drilling of the first exploratory well began, and the second is expected by the end of this year, besides the pre-existing well drilled by the government for the bid. The consortium expects to have around five long-duration tests of one year each. The first Libra long-duration test will start by 2016 and is expected to use associated gas reinjection in the well for optimisation. The FPSO for the first long-duration test will have a capacity of 50,000 b/d.

The main challenges for Libra’s PSA future rely on the capacity of the Brazilian industry to provide, in a timely fashion, the quality and quantity of goods with the advanced technology required, all at a market price within the international range. They also depend on whether the consortium members will be capable of supporting the financial demands of the project overall. In this respect, in recent years Petrobras has made a global divestment of some assets to focus more on the pre-salt blocks, and recently both Shell and Total announced worldwide divestment programs. Shell, which in the last two years raised between US$10bn and US$15bn by selling its assets, is seeking a further US$10bn by 2017, while Total recently announced an additional divestment program of US$10bn with the goal of addressing cost growth in the oil sector, focusing on investments in more profitable projects, which certainly includes Libra.

Based on the above, it seems that we could assess Libras’ success in two scenarios: the technical and the contractual or regulatory. Although there are still questions about the fruitful implementation of the Libra PSA in terms of regulatory and contractual matters, the technical side of the project seems to have been successfully implemented.

Nonetheless, given the ongoing criticism of some of the contractual and regulatory characteristics of the Brazilian PSA, changes are expected next year, depending on the results of the Presidential elections in November 2014. Those changes will mainly affect Petrobras’ role as the unique operator for any PSA and the PPSA’s power in consortium meetings.

The coming years will be crucial to deciding whether or not the PSA regime will become a reality in Brazil and whether it will continue to have the same characteristics as Libra.

 

Luis Menezes is a partner at Villemor Amaral Advogados. He can be contacted on +55 21 3806 3495 or by email: luismenezes@villemor.com.br.

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