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Brazil's uncertain regulatory future

Edmilson Moutinho dos Santos

Associate professor - coordinator of the gas chair/University of São Paulo

Published  Friday, October 9, 2009

Brazil's proposed new oil and gas E&P framework for its prolific pre-salt oil areas has not been unopposed.

While the proposal does not affect prior concessions, the pending legislation is set to create a new company, Petro-sal, to regulate new pre-salt areas.

The country's current concession regime would also be changed to a production sharing agreement scheme in which federal energy company Petrobras would become the operator of every field in the pre-salt layers as well as other strategic areas with a minimum 30% participation.

The proposed legislation has faced opposition from industry officials, in additional to local political leaders. Brazil's government, however, seems set to pass the legislation despite facing several delays.

BNamericas spoke with Edmilson Moutinho dos Santos, a professor at the University of São Paulo, about the proposed legislation, the government's motivations and the effect the new regulatory environment could have on the country.

BNamericas: What is your opinion of the legislation currently being debated about the future regulatory environment in Brazil?

dos Santos: It is necessary to go back to 1995 when we approved the petroleum law and decided to go with a concession framework and a royalty compensation system. At the time, it was a very risky decision because it was not clear if Petrobras would be willing to pay royalties to the government.

NOC's [national oil companies] have a lot of strategies to avoid these payments, mainly by close political connections that give them a lot of power. So in that time it might have been preferable for some form of production sharing agreement [PSA] rather than a concession system with royalties. After 10 years of the royalty system, however, it has been working fairly well as a whole.

The concession system was a major advancement, so a move back to a PSA is pointless.

An alternative system may not be better and may be worse. The state has no experience as an oil trader, but only as a tax collector.

BNamericas: Petrobras is going to be the sole operator and will have a 30% minimum stake in every new pre-salt project. Do you feel as strongly about this as the PSA change?

dos Santos: Petrobras has managed to join every project it has wanted to. Okay, maybe it lost a few smaller tender offers. But do we need to protect Petrobras? Not at all. We have a company that is already powerful, and there is the risk that it becomes a kind of state within a state. We are proposing protection for a company that doesn't need it, and we should be doing the opposite to reduce the power of Petrobras, not to increase it.

It is normal that a new sense of nationalism presents itself after a big find such as the pre-salt reserves, but there is risk behind this naivety.

BNamericas: So this is a step back to a Petrobras before the reforms?

dos Santos: Absolutely, we spent 10 years trying to modernize the company and make it a different kind of NOC, changing the company culture, bringing in young people, all requiring investments, and now we are changing something that is not broken. We should be protecting the state from Petrobras, not the other way around.

BNamericas: How will the new Petro-sal company come into play here? Will it have a role?

dos Santos: It's still not clear what Petro-sal will control. Without definition, they could control everything. What is the difference between Petro-sal and [oil and gas regulator] ANP? Clear lines of jurisdiction are lacking. You can make a mess by putting an agent in the game that adds no value. And if there is incompetence in Petro-sal, in the end the government will probably put ex-Petrobras employees there due to their experience, and this would defeat the purpose of trying to control Petrobras.

BNamericas: What about the government's stance regarding the local content rules? It seems the government knows that this could slow up development considerably but it seems fine with it.

dos Santos: First of all, this is a cultural thing. We are a poor country with a lot of unemployment, so a link with job creation is a tradition, and this will not change with the new administration because all the candidates are more nationalistic than Lula.

Is this a major risk here? I would say no. First of all, if the pre-salt areas are as big as we believe, for sure there are not enough resources in Brazil to handle it.

There are not enough people with experience and industrial capacity. It will take time until we can increase these capacities, so we see an open market for everybody.

BNamericas: Going back to the political issues with next year's election, would anything change if the current governor of São Paulo, Jose Serra, wins? Could he try to reverse anything passed this year?

dos Santos: Whoever wins the election will be very careful in keeping balance in the sector.

If this law passes before the elections, I don't foresee it being changed in the next 10 years before a new major event will justify change. But if the law is not approved by election time, which is not impossible, some of the suggested changes may be taken off the table. For example, governor Jose Serra had created a state commission here to discuss state strategy on this regulation and stated that it should not be changed from a concession to a PSA system. So if this is not approved by the beginning of 2010, before elections come, the PSA component will probably disappear. But again the president will likely not use his political capital to reverse it if it passes.

BNamericas: This is supposed to be passed by March or April, according to what I have read. Is this true?

dos Santos: If everything goes fine. As I mentioned before, the mere appearance of action by the political actors is more important to them than the actual details of the change. And if this is delayed into election time, the blockage of the law could become a political platform for candidates.

BNamericas: Who is doing the fighting? Is this more of a left/right issue, or a state/federal issue? For example, there is a big fight over whether the non-oil states will receive any revenue.

dos Santos: Well, because of the size of this fight, it is difficult to say. There are parallel fights taking place and some may overlap.

The government is saying that the revenue should be split by all states. This is a good point. As we can see from Bolivia, not taking a federal view can be risky. The bounty must be split equally, not just for producing states. In the past there was a kind of balance. We had Rio de Janeiro that was producing about 80% of the oil, and then you had the consuming states, mainly São Paulo, that had no oil. So this balanced itself out. The producers took a share of the oil profits, but the consuming states were given a kind of relief or subsidy. The producing states are lobbying to keep this current system, but now the balance is no longer even because São Paulo will become a major oil producer.

If the sub-salt is that big, we certainly will have to change something, otherwise the federal government will be so powerful that democracy may be in danger because whoever controls the oil money will never lose elections.

BNamericas: Country officials have said that Brazil could be self sufficient in terms of gas by 2011. Could this be true?

dos Santos: This nationalistic motto of self sufficiency is sometimes taken too far. For a while, Bolivian gas was the cheapest available, and it will still be cheaper to continue importing from Bolivia rather than producing it from pre-salt areas or from elsewhere offshore.

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