It is important that the Brazilian government continues to look at what it needs to change from a regulatory perspective to enable new investment to come in.

Ted RHODES Office Managing Partner CMS

Brazil heads in the right direction

July 9, 2018

Ted Rhodes, office managing partner for CMS, talks to TOGY about the development of Brazil’s oil and gas industry, the country’s resource potential, the impact of the Operation Car Wash corruption scandal and the significance of certain industry regulations and policies. CMS is a global law firm that has worked with oil companies, contractors and financiers in the domestic market.

• On market outlook: “At the moment, Petrobras has five ongoing FPSO bids, and it has never had that many simultaneously. The company is looking to tender another FPSO later in 2018. There is a lot of catch-up investment to be done by Petrobras as well, so across the supply chain, there are different opportunities in different assets for the different players, and the outlook is far rosier than it was a few years ago.”

• On breaking down barriers: “Other conversations need to happen, such as access to offshore field infrastructure, so Petrobras is required to allow other nearby field owners to tie back into its offshore pipelines and infrastructure. That would reduce the breakeven level for new offshore field developments.”

Most TOGY interviews are published exclusively on our business intelligence platform, TOGYiN, but you can find the full interview with Ted Rhodes below.

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What attracted CMS to Brazil?
CMS decided to come to Brazil in 2009, following some of our multinational clients that were either beginning to invest here or expanding their operations, particularly on the back of the pre-salt oil discoveries.
At the time, we found that there was an emerging independent Brazilian scene in oil and gas. We found ourselves working considerably with local Brazilian players that were looking for financing outside of Brazil and contracting for goods and services outside of Brazil. We also worked with companies involved in international arbitrations in an increasingly international environment where the Petrobras way of doing business didn’t necessarily fit this new profile of Brazilian companies.
Whereas Petrobras could impose the terms it liked because it controlled 90% of the industry and was a client that you could not do without, the same was not true of emerging Brazilian independent oil companies. They were required to make themselves more attractive to international financiers, suppliers and potential partners.

How would you assess the development of Brazil’s oil and gas industry over the past two years?
It is a very important industry for the government and the country. At one point, it reached 13% of GDP.
The government has taken some important steps. In the wake of the Operation Car Wash investigations, and considering the damage that had been done financially to Petrobras and its local suppliers, it would have been very naive to believe that Petrobras could carry the entire Brazilian industry as it had been doing, insist upon the levels of local content that had previously been required and still allow the development of the industry at the required rate.
With the state of public finances in Brazil, the government could not let the oil and gas industry stagnate any longer, and it recognised the need for foreign and private investment. Removing the sole-operatorship requirement for the pre-salt was very important. Recognising the difficulties of the local supply chain in meeting the levels of demand required to get us back on track and reducing local content requirements was also important in attracting foreign investment and allowing projects to be developed at the needed pace. The extension of the Repetro regime was also crucial.

 

What is the situation with Repetro in Rio de Janeiro?
The Repetro extension is in relation to federal taxes. Prior to this latest extension, state governments, including Rio de Janeiro, applied similar suspensions of taxes in relation to ICMS, which is the state-level tax. Because of the state of its public finances, Rio de Janeiro is now challenging that. They have not yet approved an extension to the suspension of ICMS for Repetro importations, which could be a huge shot in their foot. On the one hand, they have this huge public deficit within the state, but on the other, their economy is very reliant on oil and gas investments. I think that not extending Repetro is going to reduce – not increase – their revenues, but the state assembly does not seem to have recognised that yet.

Is the country moving to take advantage of pre-salt resources quickly enough?
The pre-salt is a spectacular success in all respects. It is living up to even some of the very ambitious predictions that were made back in 2009 and 2010, with Lula producing 1 million boepd already. And yet, for two or three years, Petrobras was just not investing and not tendering for new FPSOs because it was dealing with internal issues arising from Operation Car Wash, and because of its cashflow constraints and deleveraging.
In the higher oil price environment, having already deleveraged to some extent and resolved its internal issues, Petrobras is now in a position to accelerate those investments again in its existing assets, and because of the hiatus in those investments, there is a lot of pent up demand.
At the moment, Petrobras has five ongoing FPSO bids, and it has never had that many simultaneously. The company is looking to tender another FPSO later in 2018. There is a lot of catch-up investment to be done by Petrobras as well, so across the supply chain, there are different opportunities in different assets for the different players, and the outlook is far rosier than it was a few years ago.

Is enough attention being paid to onshore areas and mature offshore fields?

Petrobras’ divestment plan is not being implemented as quickly as the company would have liked, and it is not being helped by various injunctions that have been obtained in courts to prevent or delay its disposals, the latest being the suspension of Engie’s proposed acquisition of the TAG pipeline network.
Petrobras has slowed or basically stopped new investment in most of its assets onshore, as well as many of its older shallow-water assets, because it wants to offload them. The sales process is not progressing very rapidly, so those areas are not receiving the investment that they should have. Petrobras is very much focused on pre-salt and it needs to find new players to develop some of the other assets.
It is quite sensitive when you talk about mature assets because they are reaching the end of their field life. If they do not receive the kind of investments they need in EOR and maintenance, then the costs of those investments go up and the potential returns come down, and there comes a point where it makes no more economic sense and the fields simply need to be decommissioned.
If you take a field such as Marlim, which has several billions of barrels in place, there are potentially hundreds of millions of barrels that can be produced through continuous investment, and investment in EOR. At large fields such as Marlim, there is a field redevelopment plan that has been approved by the ANP [National Agency of Petroleum, Natural Gas and Biofuels], and Petrobras is making those investments, but the same is not true of some of the smaller fields.

What other factors have become obstacles to further activity in Brazil’s mature fields?
One big issue so far is in relation to new companies acquiring assets from Petrobras. Late-field-life assets come with an additional liability to decommission, which is potentially worth hundreds of millions of dollars, and the revenues between now and end of field life may just about cover that. Now, the ANP is insisting on guarantees of 100% decommissioning liability upon the transfer of the asset, which is a huge amount of money to take out of somebody’s balance sheet and designate for that purpose, or require an on-demand bank guarantee for those purposes. This has scuttled a number of those deals.
It is important that the Brazilian government continues to look at what it needs to change from a regulatory perspective to enable new investment to come in. This is something that has been done very well in the North Sea, the Gulf of Mexico and certain mature provinces. In the North Sea they have reduced the qualification criteria for new operators and they have become more flexible in the licensing terms offered to attract new operators. They have significantly reduced taxes to extend the time for which these fields are going to be economically producible.
Brazil is very much at the beginning of having that discussion, because not many fields are currently at that point, but it is becoming an issue. There are proposals to reduce royalties for late-life fields, and that conversation needs to happen and expand.
Other conversations need to happen, such as access to offshore field infrastructure, so Petrobras is required to allow other nearby field owners to tie back into its offshore pipelines and infrastructure. That would reduce the breakeven level for new offshore field developments.
There are many steps that could be taken to allow the maximisation of eventual oil recovery and allow the industry to diversify further and bring in specialist companies that will focus on late-life field developments, EOR and marginal accumulations. Those are not going to be Petrobras’ focus.

Are the ANP and Ministry of Mines and Energy likely to address this issue any time soon?
That depends on a lot of political factors. The current ANP and government have been trying to push things in that direction, but there has recently been a backlash against the liberal, competitive direction that Petrobras is taking, perhaps a regression to more populist, interventionist policies. That tendency could well take over in the next government.

What have been the impacts of the Operation Car Wash corruption scandal?
Before Operation Car Wash, there was a feeling that you could get away with most things in this country. Things have changed very rapidly. Brazil did not have specific anti-bribery legislation until the start of 2014. Most of the Operation Car Wash cases are being prosecuted under other legislation.
It has been quite a shock to the business community to see some very high-profile names imprisoned and some very important businessmen brought down by this scandal.
There is a spotlight on corruption in Brazil at this moment. Many companies have invested in compliance policies and are taking steps in the right direction, but it is also important not to be complacent. Many of the most culpable businessmen, although they have been sentenced, have also struck plea bargains and have been let off quite lightly.
Meanwhile, the political class that created a system in which corruption was sometimes the only way to do business in Brazil are relatively unscathed, and the prosecutions against the politicians in particular are progressing quite slowly. There is still a risk that, if the public perception is that justice has not really been done, then the old ways of doing business will return, particularly if there is no real renewal in the political class, which I do not see happening yet.

Will local content regulations and tax regimes such as Repetro change much after the October 2018 general elections?

I think that Brazil has a very good track record in respecting existing contracts. I do not see that any of these candidates would change existing contractual rights and try to renegotiate or expropriate, so some of the more extreme forms of resource nationalism that you see in other countries do not present a significant risk.
In terms of changes going forward, it depends on who is elected. If a left-wing candidate is elected, then there could be a return to higher levels of local content, or increased intervention in Petrobras.
A majority of the candidates and members of Congress understand and are coalesced around the benefits of the reforms that President Michel Temer has made, although they would not come out and support them vocally at this stage.
The other point is that the majority of changes that would be required for anything more dramatic would require a congressional majority to push through. Even if one of the left-wing presidential candidates were to come in, unless they had that kind of majority, which I do not think they would, the more dramatic changes to this regime are unlikely.

For more information on the development of Brazil’s oil and gas industry, see our business intelligence platform, TOGYiN.
TOGYiN features profiles on companies and institutions active in Brazil’s oil and gas industry, and provides access to all our coverage and content, including our interviews with key players and industry leaders.
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