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Wednesday, June 24, 2015

Changing The Way Brasil Exploits Its Oil

Changing the Way Brazil Exploits Its Oil

    
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Analysis

Forecast

  • A proposal to amend Brazil's pre-salt regulations appears to have enough votes to pass the upper house of Congress, but not enough to clear the lower house, ensuring substantial political wrangling in the months to come.
  • The politically influential Democratic Movement Party of Brazil backs the proposed changes, which are likely to pass, but Petrobras, the Brazilian Congress and the Energy Ministry will have to negotiate to work out the details.
  • Even if they pass Congress, Brazilian President Dilma Rousseff may ultimately veto the reforms.
  • Loosening Brazil's pre-salt regulations will provide investment incentives, but Brazil's high local content requirements and the unresolved Petrobras scandal could still deter future investors.

Brazil is gearing up for a legislative contest over energy regulations. On June 30, Brazil's Senate will begin discussing a proposed modification to the regulatory scheme governing exploration and production of the country's offshore pre-salt energy deposits. The new regulations would remove the requirement for state-owned energy firm Petroleo Brasileiro, or Petrobras, to have a 30 percent stake in each pre-salt project. It would also remove or amend legislation mandating Petrobras to be the sole operator of each project.
As Petrobras deals with the fallout from a corruption scandal and as the political clout of the ruling Workers' Party (PT) visibly weakens, most of the government's political opponents have chosen to move forward with the proposed regulatory changes, the most significant challenge to the country's pre-salt regulation since it was enacted in 2010. The bill's proponents are still short of the necessary votes in the lower house to pass the law, and there will likely be political wrangling over the coming months as the opposition attempts to gain votes. Loosening Brazil's relatively restrictive regulations governing the exploitation of pre-salt deposits could incentivize more companies to invest. But Brazil's high local content requirements and the unresolved Petrobras scandal remain, potentially deterring future investors.

Reasons for Change

The proposal slated for Senate debate, introduced March 23, is the result of longstanding opposition to Law 12.351, which mandates that Petrobras be the sole operator and hold a 30 percent stake in each pre-salt project. A previous bill, introduced by a legislator from opposition party Democrats in 2013, tried to reverse the production sharing schemes governing pre-salt exploration by converting them to concessions, but did not receive the necessary votes for approval. The current proposal, which was introduced by Jose Serra, the leader of the opposition Social Democratic Party of Brazil, will keep the production sharing contract scheme for pre-salt deposits intact but will remove Petrobras' mandatory stake in projects and its exclusive right to operate them.
According to proponents of the bill, Petrobras lacks the funds necessary to efficiently search for and produce hydrocarbons from Brazil's strategic pre-salt fields. Cash flow problems at Petrobras rig supplier Sete Brasil and the freezing of contracts following the Petrobras corruption scandal have, in fact, delayed the company's investment plans. The legal change intends to address this investment bottleneck by slightly easing restrictions on investment.
But many in the PT, including the president, are opposed to the regulatory changes. Under the current scheme, Petrobras has influence over how and where it partners with foreign firms for pre-salt production, which is a key source of funding for the education and social programs that have underpinned the popularity of the ruling government. What makes the proposal a viable threat to the regulatory scheme is the all-important Democratic Movement Party of Brazil (PMDB), the second-largest party in the lower house of the Brazilian Congress and the largest in the Senate.
The PMDB has been more successful in garnering support for its proposal this time around because of the Brazilian government's diminishing fortunes. The PMDB's support was crucial to securing PT's re-election in the 2014 presidential election. But the PT-PMDB alliance is increasingly strained ahead of the 2018 presidential election. As the popularity of Brazilian President Dilma Rousseff drops because of the Petrobras corruption scandal and the country's economic downturn, PMDB is likely reassessing its political strategy ahead of the next election. Major PMDB officials, such as senator Eunicio Oliveira, have said the party intends to contest the 2018 election independent of the PT. Though PMDB stood by the PT and resisted calls for Rousseff's impeachment earlier this year, the party has diverged from the ruling party on pre-salt regulation, even helping bring the proposed changes to a congressional vote.
The drop in global oil prices and the delay of investment plans have turned a once limited opposition plan to liberalize the pre-salt regulations into reform that could plausibly be passed. It has even gained traction among the president's former allies. If approved, the changes will not significantly reduce the Brazilian government's control over the energy sector; Petrobras will continue to be a major source of state revenue and the state will retain its influence over the company's activities. Instead, the changes will offset the heavy financial burden currently hampering the company.

What Change Could Cost

Though pre-salt fields raised Brazilian oil and natural gas production to 885,000 barrels per day in April 2015 from 504,000 barrels per day a year earlier, Petrobras has acquired massive debt, now around $170 billion, to finance exploration and production. Removing the operator requirement could offset some of the financial burden. It could also reduce Petrobras' monopoly over pre-salt production. Petrobras' experience with discovering and exploiting offshore energy deposits could, however, lead foreign firms to partner with it in offshore activities even if the legislature amends the law.
But removing the operator requirement will not completely solve Brazil's problem attracting foreign capital into the pre-salt areas. Furthermore, it does not appear that the coalescing congressional front is concerned with altering local content laws, even though high domestic content requirements have previously curbed foreign direct investment into Brazilian offshore oil deposits. An effort by the energy ministry earlier in the year to loosen local content restrictions for an auction of conventional offshore energy deposits in October 2015 did not receive regulatory approval.
Brazil's changing electoral landscape and Petrobras' mounting financial losses have apparently provided the opening needed for the PMDB and several opposition parties to amend the pre-salt regulatory model. To pass the legislative proposal, its proponents need a simple majority of the votes in both houses, which is 41 senators and 257 congressmen. The votes available to traditional opposition parties, assuming all of PMDB's lower house congressmen vote for the measure, total 243. In the Senate, the proposal has 59 potential adherents — well above the necessary total. The PT is firmly opposed to amending the pre-salt legislation and could try to use its position as the most popular party (albeit by a slim margin) in the lower house as well as its alliances with smaller left wing parties such as the Socialism and Freedom Party, Democratic Labor Party and the Brazilian Communist Party to oppose its passage.
Moreover, the president retains veto power, which requires a two-thirds vote from Congress to override. Over the coming months, the bill's proponents will continue negotiating to raise the likelihood of passing the law. Such negotiations could work compromises into the legislation. For example, a solution proposed by Energy Minister Eduardo Braga would allow Petrobras to have the option of being the sole operator of a project rather than obligating it. Ultimately, Brasilia will modify its pre-salt regulatory scheme out of necessity, but the details of those changes will be solidified through negotiation.