The tupi discovery and possible impacts on the Brazilian Legal Framework
Amanda L. Cunha*
Abstract
As reported by PETROBRAS, the giant Tupi discovery may place Brazil among the largest oil and gas producers in the world. As a result, new challenges to the Brazilian regulatory framework for oil and gas exploration and production have appeared on the horizon. The current legal system concerning E&P activities in Brazil, which has been in fore for 10 years since the enactment of Act n.9.478, of August 6, 1997 (the so-called “Petroleum Act”), is widely recognized for its stability and for its success in attracting both foreign and national investors. It is particularly noticeable, however, that this system was envisaged in a scenario of high geological risk. Once the risk underlying E&P activities is reduced, modifications in the regulatory framework may also be expected. This article aims at giving an overview of the Brazilian legal framework for E&P operations and the possible impacts of the Tupi discovery on the existing rules.
1. The Tupi Discovery
On 8 November 2007, Petróleo Brasileiro S.A. – PETROBRAS, the Brazilian mixed economy company, issued a press release informing the results of its analysis of the tests for the second well (1-RJS-646) in the area referred to as Tupi in Block BM-S1, located in the Santos Basin. According to PETROBRAS, the giant Tupi field has recoverable light oil (28º API) and natural gas reserves estimated at 5 to 8 Bboe. Petrobras is the operator in the area holding 65% of working interest, with the remaining interests being held by BG (25%) and Petrogal – Galp Energia (10%). Also based on its analysis, PETROBRAS believes that the subsalt area, where the Tupi field is located, extends from the Espirito Santo Basin to the southern end of the Campos Basin. As informed by PETROBRAS, the formation is more than 800 kilometers long and up to 200 kilometers wide, and lies beneath ultra-deep waters of between 1,500 and 3,000 meters and burial between 3,000 and 4,000 meters. Experts speculate that the entire subsalt area could hold up to 56 Bboe reserves of light oil. That would significantly increase Brazil’s petroleum reserves and put Brazil among the countries with the largest oil and gas reserves in the world.1
2. The Brazilian Legal Framework for E&P Activities: an Overview
Under the original wording of Section 177 of the Federal Constitution, enacted on October 5, 1988, the monopoly of the Federal Government over oil exploration, production, transport, refining, import and export encompassed not only such economic activities per se, but also the risk and the economic results they involved. Therefore, the Federal Government was prevented from giving third parties any sort of participation, in kind or otherwise, in the exploitation of oil reservoirs. Also, according to Section 2 of Act n. 2004, enacted on October 3, 1953, the monopoly of the Federal Government over the aforesaid economic activities was exercised through PETROBRAS and its subsidiaries only, as bodies entrusted with the accomplishment of the policies established by the National Council of Petroleum (CNP). Hence, PETROBRAS was the only company allowed to undertake oil exploration, production, transport, refining, import and export on behalf of the Federal Government.
In November 1995, with the enactment of the Constitutional Amendment n. 9, the scenario changed dramatically. Brazil’s Federal Constitution was amended so as to enable the Federal Government to hire companies other than PETROBRAS to carry out the aforementioned activities. So, in the current legal framework, though the Federal Government still holds the monopoly over oil exploration and production, the Federal Government is free to hire foreign and national private companies to undertake such activities. Moreover, according to the amended version of the Federal Constitution, an Act would provide for the terms and conditions under which PETROBRAS or other companies would be hired by the Federal Government to perform the activities subject to the Federal Government’s monopoly. Finally, that Act would also provide for the structure and competences of a regulatory agency in charge of the regulation of such activities.
This more flexible attitude was regulated by the Petroleum Act. Since then, any company, regardless of the origin of its capital, can undertake oil exploration, production, transport, refining, import and export. The Petroleum Act is paradigmatic in the sense that it marked the change-over from monopolistic mixed economy company to a competitive free market status, thereby facilitating private capital coming into this sector of the economy. PETROBRAS itself has been greatly benefited since it is now free to associate with other oil companies and share the risk underlying exploration activities. Consequently, PETROBRAS has been developing a widespread program of partnerships with other companies in the exploration and production area as an integral part of its business strategy. These joint ventures correspond to a widely adopted practice in the international oil scene where companies endeavor to share the risks inherent in E&P projects, which also characteristically involve heavy investment.2 An illustrative example: PETROBRAS and its partners BG and Galp-Energia invested nearly $ 1 billion in order to drill 15 testing wells in the Tupi area. The first well cost approximately $ 240 million and took more than one year to be drilled.3
The Petroleum Act revoked Act n. 2004/53 and provided for the creation of the National Agency for Petroleum, Natural Gas and Biofuels (ANP) and the National Council for Energy Policy (CNPE). As established by the Petroleum Act, the CNPE sets forth the policy for the energy sector, while the ANP is in charge of enforcing such policy, setting rules and promoting regulatory measures, contracting and monitoring economic activities. The current system is governed by concessions, preceded by bids and implemented by agreements. The ANP grants petroleum rights and administers licensing arrangements. That is to say, the ANP, on behalf of the Federal Government, enters into concession contracts with oil companies for the exploration and production of oil and gas.
The Brazilian Concession Contract is based on the royalty/tax model. Shortly, following a public bid and being awarded with a Concession Contract, the concessionaire undertakes the risk of exploration. If successful, the concessionaire is the sole owner of the production, subject to payment of the relevant fiscal burdens, such as the corporate income tax, and legal or contractual participations, as already acknowledged by Brazil’s Supreme Court.4
The Brazilian Federal Government has no right over the production but only to the payment of the relevant taxes and the following fees, as determined by the Petroleum Act and also by the Presidential Decree n. 2705, enacted on August 3, 1998: (i) royalties (payment of a sum amounting to 10% over gross production, which may be reduced to 5% in the case of a marginal field); (ii) a land owner participation from 0,5% to 1% calculated over the same basis as royalties; (iii) special participation fee (levied in case of high production volumes, it varies between 0% to 40% over net revenue, depending on the location of the field, production level and number of years it has been exploited). Though not directly related to oil production, it is worth noting that the concessionaire is also required to pay: (i) a bonus fee, which is one of the items assessed by the ANP during the public bid for the awarding of Concession Contracts; and (ii) a fee for the retention of the area where exploration and production activities are carried out.
3. Possible impacts of the Tupi Discovery on the Brazilian Legal Framework
Given the giant Tupi discovery, some changes in the Brazilian legal framework may occur. It is noteworthy that the current system was envisaged in light of high geological risk. Once it becomes widely known that the country has much more promising perspectives (in volume and quality) than what had been thought until then, it is expected that the Government tries to get a larger slice of the cake, as commonly observed in similar circumstances.
The first step taken by the Brazilian Government was to announce the removal of 41 high potential blocks from ANP Round 9. On 8 November 2007, the CNPE released Resolution n. 6, determining the removal of such blocks from the 9
th Round in order to preserve the national interest and the rational utilization of the country’s energy resources. The withdrawn blocks lie close to the Tupi field or in analagous areas with similar subsalt geology.5 Despite the heavy criticism direct at the Federal Government for doing so, the truth is that, at the present stage, such decision cannot be taken as part of the nationalist wave which has wiped out other Latin American countries. Faced with a discovery of such magnitude, it seems fair that the ANP, based on a decision of the Executive, decides to “freeze” the offering of such areas so as to avoid the risk of unitization.6 Notwithstanding the withdrawal of subsalt areas from the ANP 9th Bid Round, the sum collected as bonus fees was of approximately R$ 2,109 billion, superseding the record of R$ 1 billion collected in the 7th Bid Round. However, despite the apparent success of the 9th Bid Round, it is worth noting that many of the biggest players, whose activities are concentrated in deep waters, did not make any offers. National companies, on the other hand, had a prominent participation in the Bid. OGX, a Brazilian company controlled by Mr. Eike Batista, an aggressive Brazilian businessman with many companies in the energy sector, made its debut in ANP Bid Rounds and took 21 blocks for R$ 1,479 billion.
Expectation is that the withdrawn blocks may be offered later in time on different grounds. The Federal Government may require higher minimum bonuses and royalties. Also, the special participation fee, which is already levied over large fields with high production rates, might be increased. In the case of royalties, that would require changes in the Petroleum Act.7
Another possibility, but a less likely one, in our view, is that a new sort of contract, maybe one based on production sharing, is applied to the subsalt area. In this respect, it is important to note that the Federal Constitution does not provide for any specific kind of contract for oil and gas exploration and production. This is a political decision, as already stressed by Brazil’s Supreme Court.8 In other words, that means that the concession-based model is not rooted on the Federal Constitution. Thus, generally speaking, any changes in the aforementioned model would merely require the modification of the Petroleum Act. Nonetheless, there might be some difficulties in doing so, as showed below.
First, production sharing agreements are usually adopted in countries where the national oil company (“NOC”) is wholly owned by the state. Briefly, the NOC enters into such agreements with international oil companies (“IOCs”) on behalf of the government and is in charge of supervising the activities carried out by the latter as well. Also, IOCs are often required to associate with the NOC, which is frequently entitled to the largest participation in the undertaking. Furthermore, the NOC is given part of the production. In a few words, the NOC is not only a player in the market but also plays the role of the regulatory agency. Even where one does exist, the true fact is that it ends up being superseded by the NOC. In practical terms, the regulatory agency is a mere formal entity, with the NOC being the one which actually regulates the sector. It is clear that such framework is the diametric opposite of what we have today in Brazil, where the ANP is not only formally established as an independent arm of the Executive which is entrusted with the regulation of the oil and gas sector in the country, but is also an active and real entity whose regulations are enforced against all players, including PETROBRAS.
Second, as to the possibility of PETROBRAS being directly awarded with contracts for the exploration of the subsalt area, it might be challenged on constitutional grounds. This is mainly because Section 173, paragraph 1, II of the Federal Constitution states that the so-called “mixed companies”, a category in which PETROBRAS is included, are subject to the same laws as applicable to wholly private companies, including civil, commercial, labor and tax rights and obligations. In addition, reinforcing the constitutional provision, the first paragraph of Section 61 of the Petroleum Act states that PETROBRAS will conduct its activities on an equal footing with other companies, within market conditions. About PETROBRAS, it is worth noting that, unlike other statecontrolled companies, PETROBRAS is a publicly traded company.
The Petroleum Act states that the Federal Government must retain a controlling interest in PETROBRAS of at least 50% plus one voting share. Although the Federal Government owns 55.7% of PETROBRAS’ voting shares, it holds only 32.2% of the company’s total capital stock with private shareholders holding the rest. Approximately 40% of PETROBRAS’ capital stock is in the hands of foreigners, the majority of them holding ADRs, since PETROBRAS is a NYSE listed company. Moreover, although the Federal Constitution does not expressly provide for the type of contract applicable to the exploration and production of oil and gas, section 37, XXI of the very same Federal Constitution states that all agreements to be entered into by the Public Administration for the purchasing of goods and hiring of works and services will be subject to a public bid process where all participants will compete on a equal basis. Hence, even if the Federal Government adopts a new sort of contract, there must be a pubic bid process where all participants, whether private or state-owned companies, compete on equal grounds. Third, there might also be difficulties deriving from technical concepts found in the Petroleum Act. For instance, the Petroleum Act is based on the concept of Block, defined as “part of a sedimentary basin, formed by a vertical prism of indeterminate depth, with a polygonal surface defined by the geographical coordinates of their vertices, where petroleum and natural gas exploration and production activities are carried out.” That is, the concessionaire is entitled to undertake exploration activities in a vertical prism of indeterminate depth, including subsalt areas.
If the Government decides for a special contract regarding subsalt areas only, that will require the modification of the definition of Block contained in the Petroleum Act. Generally speaking, we do not foresee drastic changes in the existing rules for E&P operations in Brazil, although it might be too early to tell. In our view, the current framework does already provide the Government with the necessary tools to get a larger participation in the results of new discoveries in the subsalt area. There is no need of resorting to dramatic legal modifications, particularly the replacement of the Concession-based model with a Production-Sharing one. As stressed above, the modification of the rate of the special participation fee would require only the enactment of a Presidential Decree. Nevertheless, there should be special regard to the high costs underlying E&P activities in the subsalt area. Though the geological risk relating to exploration in the subsalt area might be reduced, the costs of carrying out E&P activities in this area are extremely high. In the present context, where the oil price nears $ 100 per barrel, carrying out E&P activities in the subsalt area may be economically viable. Nonetheless, Government Authorities should be aware of the risk of inhibiting such activities if oil companies are subject to an unreasonable fiscal burden.
Finally, the Petroleum Act is widely known for its success in encouraging investment in the oil sector in Brazil. Changing the rules of the game now may not be a wise decision. In either case, the key issue is that any eventual changes have due regard to the contracts already in place. In this regard, the CNPE has emphasized in its Resolution n. 6/2007 the safeguarding of any rights related to the current contracts.
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1Please refer to PETROBRAS press release of November 8, 2007. Version in English available at https://www2.petrobras.com.br/ri/spic/bco_arq/FR-AreaTupi-Ing.pdf [access on November 15, 2007]. See also: Petrobras - Santos Basin - {3-RJS-646 (3-BRSA-496-RJS)} - Confirms Super-Giant oil & gas Discovery - BMS- 011 Contract Block 1. Global E&P Reports (GEPS). Available at https://pgeps.ihsenergy.com/DisplayPage.aspx?ItemId=79b5fe6b-29bb-49dd-a3b2-ab6a12083267&Index=9&TotalItems=118[access on November 15, 2007].
2Please refer to PETROBRAS website. Version in English available at https://www2.petrobras.com.br/ingles/ads/ads_Negocios.html[access on November 15, 2007].
3Petrobras deve instalar projeto-piloto em Tupi entre 2010 e 2011. Portal Exame. Version in Portuguese available at https://portalexame.abril.com.br/negocios/m0143028.html [access on November 15, 2007].
4Please refer to the Supreme Court decision in the Direct Action of Unconstitutionality (“Ação Direta de Inconstitucionalidade” – ADIN) n. 3273. Official Gazette of March 2, 2007. Version in Portuguese available at www.stf.gov.br. The Supreme Court asserted the constitutionality of Section 26 of the Petroleum Act, which states that the Concession implies, as for the concessionaire, his/her obligation to explore, at his/her own expense and risk, and in case of success, produce petroleum or natural gas in a given block, entitling it to the property of the goods once produced, subject to the relevant fiscal burdens and legal or contractual participations. Furthermore, the Supreme Court declared the constitutionality of Section 60 of the very same Petroleum Act, according to which any enterprise or consortium of enterprises complying with the relevant provisions of Brazilian Law may obtain from the ANP the authorization to import and export petroleum, petroleum products, natural gas and condensate. Specific mention is made of the CNPE’s directives concerning oil and gas exports.
5Brazil weighs up oil law rejig. Gareth Chetwynd. Available at https://www.upstreamonline.com/live/article144142.ece[access on November 21, 2007].
6Tupi or not Tupi? Febeabá no petróleo brasileiro. Jean Paul Prates. Version in Portuguese available at https://oglobo.globo.com/blogs/petroleo/default.asp [access on November 27, 2007].
7 Please refer to ANP - Round 9 - 41 blocks removed from round - Now 271 blocks on offer - To be held 27, 28 November 2007. Global E&P Reports (GEPS). Available at https://pgeps.ihsenergy.com/DisplayPage.aspx?ItemId=c29de915-46e6-4790-bbaa18e74d85011c&Index=1&TotalItems=118 [access on November 15, 2007].
8Please refer to the Minister Eros Roberto Grau’s opinion in the Direct Action of Unconstitutionality (“Ação Direta de Inconstitucionalidade” – ADIN) n. 3273. Official Gazette of March 3, 2007. Version in Portuguese available at www.stf.gov.br [access on November 15, 2007].
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*Amanda L. Cunhais an associate lawyer of the energy group of Araújo e Policastro Advogados.
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