Major Disappointment In Brazil’s Surplus Round

(Welligence, 6.Nov.2019) — Brazil’s Surplus Transfer of Rights round (6th November 2019), the biggest resource opportunity of the year globally, has ended in huge disappointment. Only two (Buzios and Itapu) of the four opportunities on offer were taken, there was no competition, no participation from the Majors, and the cash raised by the government falls US$9 billion short of expectations.

Simply put, the authorities misjudged the market and got the terms wrong – the cost of entry was too high, the compensation negotiations with Petrobras too complex and uncertain. Layer on top of that the execution and unitization risk associated with the projects, reserves uncertainty, and the lack of operatorship opportunity – with the government essentially pricing the assets as fully developed with little risk, the industry wasn’t willing to step up.

— Why did the Majors not bid?: Firstly this round was uniquely expensive – we estimate the bonuses required and reimbursement to Petrobras come to almost US$50 billion. Secondly, there was always going to be uncertainties around the compensation to be paid to Petrobras. Thirdly, none of the Majors are under pressure to bring new resource into their portfolios – for these companies, this is a buyers’ market. Finally, the Majors prefer to operate, an option not on the table in this round – they can accept a partner role, but the terms have to be right.

— Petrobras steps up to save the round: The Brazilian NOC was essentially the only bidder in the round, taking Buzios (90%) and Itapu (100%). It’s now on the hook for US$15.8 billion in signature bonuses – US$9.1 billion will come from the Transfer of Rights revaluation compensation agreed with the government in April, leaving it to find the remaining US$6.7 billion. One consequence of this could be a deepening of the company’s divestment program. Given the scale of the commitment that Petrobras is taking on at Buzios, balance sheet pressures could bring additional assets to the market, and incentivize the company to execute deals.

— The authorities need to rethink the terms: The results were a major blow to the government, which will take in US$17.5 billion in bonuses, short of the US$26 billion it had been expecting. However, the unawarded resource is still there and it is now incumbent on the government to rethink how they offer it in the future. Immediately following the result, they indicated that Sepia and Atapu could be offered in 2020 under revised terms, and indicated support for a change in the law to remove Petrobras’ preferential bidding rights on acreage within the pre-salt polygon.

Implications for PSC 6 tomorrow

With almost everyone keeping their powder dry, we could see increased competition for the best exploration acreage tomorrow. We predict strong bidding for Aram, the “hot” block of the round, with all the Majors taking part. And will Petrobras rethink its interest in the block? It’s exercised its pre-emption option, but now needs to find the cash to pay the US$6.7 billion bonus to the government for Buzios and Itapu.

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