What A Mammoth Oil Auction Means for Brazil

(Americas Quarterly, Naki Mendoza, 5.Nov.2019) — A pre-salt auction 20 years in the making could have broad repercussions for the economy and Jair Bolsonaro’s government.

Since its first pre-salt auction in 2013, Brazil has grown accustomed to blockbuster oil deals. But the upcoming Nov. 6 auction of prime offshore acreage known collectively as the “Transfer of Rights” (TOR) area promises to be of a different class entirely.

That’s partly because of the sums on offer. If all the blocks up for auction are awarded, the government will collect close to $27 billion in signing bonuses alone – a single day’s cash earnings just shy of the total GDP of neighboring Paraguay.

Production on the blocks, along with blocks auctioned off on Oct. 10 and from two other bid rounds on Nov. 6 and Nov. 7., could yield another $20 billion per year in annual investments, according to government estimates. If that is the case, not only would the long-awaited bid round give Brazil’s oil sector a boost – it would provide a major economic boon for President Jair Bolsonaro.

Fourteen firms have been approved to participate in the auction, including ExxonMobil, BP, Royal Dutch Shell, China’s CNOOC, and Qatar Petroleum. In a televised auction, the bidders will present percentages of their profits, measured in oil production, that they’re willing to give to the government in exchange for drilling rights off the coast. Contracts will go to the highest bidders.

The assets up for grabs are among the country’s most desirable oil resources. Off Brazil’s southeast coast, vast deposits of oil sit beneath thick layers of salt under the ocean floor. Geologically, Brazil’s pre-salt reservoirs are abundant, tightly concentrated and flow at prolific rates when tapped – all highly desired traits by international investors.

Pre-salt oil accounts for more than half of state oil firm Petrobras’ 2.3 million barrels per day of production. And because of operational efficiencies, it costs the company on average just $5 to produce a barrel of pre-salt oil. By rough comparison, in the vast Permian Basin in West Texas – the engine of U.S. shale oil activity – ExxonMobil is aiming to lower its average production costs to $15 per barrel.

The auction has been many years in the making and speaks to Brazil’s rollercoaster economic ride in the last decade. “Transfer of Rights” derives from a 2010 deal struck between Petrobras and the Brazilian government. Petrobras held an initial public offering that year and, to retain its majority control, the government in Brasília granted Petrobras exclusive rights to develop up to five billion barrels in designated pre-salt fields in exchange for company stock.

Through subsequent appraisals, Petrobras discovered much more oil in the TOR area than the volumes it was sanctioned by the government to develop. But as it became enmeshed in Lava Jato proceedings, the company was unable financially and operationally to shoulder those additional loads.

The government and Petrobras became locked in a prolonged stalemate over compensation from the original 2010 deal, an impasse that was finally resolved this year. But in many regards, the TOR auction is the fruit of a cycle that traces back to the original opening of Brazil’s oil industry more than 20 years ago. Brazil’s Hydrocarbons Law of 1997 established the Brazilian National Agency of Petroleum, Natural Gas and Biofuels (ANP) as an independent regulator, opened the country’s upstream to private participation, and paved the way for competitive bid rounds two years later. While Brazil was still largely the domain of Petrobras, it fostered best practice-sharing between Petrobras and international oil majors and engendered a pro-business environment that contributed to the discovery of the pre-salt itself.

Lava Jato and the scandals that afflicted Petrobras splintered some of those connections. But the encouraging takeaway is the course correction done by subsequent administrations in pre-salt governance. The guiding principle is that there are more than enough resources to go around between Petrobras and the rest of industry. Rather than legislate a pre-salt monopoly for the state firm, which can feed corruption, the government has opted to offer those options to the market.

The result is the Nov. 6 auction for surplus oil in the TOR area beyond Petrobras’ share. ANP estimates that additional volumes range between six and 15 billion barrels. Upping their appeal, the fields on offer have been largely de-risked because of the extensive exploratory work already conducted by Petrobras.

For the government, the relatively safe bet of the TOR fields, by industry standards, justifies the high signing bonuses and contract structures.

Officially, four areas will be on offer: Atapu, Búzios, Itapu, and Sépia. Signing bonuses for the four zones are $3.4 billion, $17.1 billion, $427.5 million, and $5.7 billion, respectively. And minimum offers of profit oil range from 18.15% for Itapu to 27.88% for Sépia. Participating companies would have to compensate Petrobras for the exploratory work it has carried out and cede operational control to the company in the Búzios and Itapu fields. Despite those and other caveats, the TOR fields are considered an industry prize.

Current trends in the region and broader industry are also working in Brazil’s favor. By suspending private oil auctions and adding more on state firm Pemex’s plate, Mexico is seemingly taking the opposite course of Brazil. In Argentina, the election of a leftist president has raised the possibility of interventionist policies that could discourage private investment. Colombia has abundant shale oil resources, but public sentiment is widely against fracking. Globally, for companies looking to allocate investments based on stability and potential, very few geographies can compete with U.S. shale or Brazil’s pre-salt.

The strategic question now is how Brazil will manage this new wave of resource revenues. By 2030, Brazil’s annual oil output could hit 5.5 million barrels per day, putting it in the top-five of world oil producers. That has sparked interest in Bolsonaro of the country joining the Organization of the Petroleum Exporting Countries (OPEC).

A practical next move would be to accelerate similar market-based reforms for the country’s natural gas sector to unlock investments for the power, manufacturing and transportation sectors. Brazil has on its agenda several large structural reforms, from pensions to tax codes, to foster higher and more sustainable growth. The gains from its energy investments are primed to contribute.  

Mendoza is director of the energy program at AS/COA

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