Last week I described my unplanned stop in Brazil, part of my recent jaunt through South America. Where a plane breakdown, an unfolding corruption scandal, and a massive strike by Brazilian workers all conspired to make an unforgettable three days.
That experience drove home the problems Brazil is facing right now. The drive to root out corruption has unveiled a massive web of wrongdoing — it may not be exaggeration to say a majority of Brazil’s politicians could be implicated in the expanding probe.
That’s a huge issue, not easy to set right. And it’s coming at a time when Brazil is already struggling to deal with an economic collapse and a currency meltdown.
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Oil is one of the few bright spots left in Brazil right now. With the offshore subsalt and presalt plays here still representing some of the highest-potential projects on the planet.
That’s attracted tens of billions in investment over the last decade. And the total would have been higher — had it not been for a slew of protectionist policies that made investment here much more complex than other parts of the world.
That included measures like local purchasing requirements. But the biggest albatross was state participation — with national E&P Petrobras getting a 30% right in every offshore project. And guaranteed operatorship.
That’s why the petro-world was thrilled late last year when Brazil’s government scrapped the requirement for Petrobras to participate in offshore projects. It appeared that, for the first time, international firms would be able to fully own and operate blocks.
That made a lot of sense for everyone. E&Ps could get the upside and operational profile they wanted — and Brazil could attract more investment, helping to boost the floundering economy.
But things aren’t quite that simple. With reports suggesting that the move to full foreign ownership of licenses triggered a backlash of national sentiment in certain circles of Brazil’s business and government communities.
Last month, the government caved to that protectionist crowd, and reintroduced preemptive rights for Petrobras in the offshore. Although state participation is not guaranteed, Petrobras is now allowed to single out fields where it wants to take a stake — with the government then required to give the state E&P at least 30%.
There are some wrinkles in the new system. Because going forward, Petrobras will have to declare interest in blocks before they actually go out to bidding. With the bid round then taking place, and Petrobras theoretically joining the winning bidder(s) in a consortium on the project.
That means some unusual situations could arise. For example, if Petrobras nominates a block that ends up getting a rich bid from other operators.
In such a case, Petrobras might find itself facing higher-than-expected financial terms on the license. So the government has given the state firm an “out” — with Petrobras able to withdraw if the winning bid terms end up being higher than the minimum required.
That could lead to international bidders gaming the system. Putting in higher than normal bids on blocks where Petrobras has declared interest, in order to discourage the state company from exercising its rights.
The issue of operatorship is also complex. Under the new rules, the government petroleum agency CNPE, has the final decision on whether Petrobras will be granted operator status on blocks where it declares interest.
But it’s not clear whether the regulator actually has a legal right to deny Petrobras of operatorship. With the enabling legislation appearing to require that the state firm be given this preference.
All of that raises some big questions around how bidding will actually work. The upcoming Q3 licensing round will thus be a major test run — showing whether the inclusion of Petrobras will drive up competition for blocks, or whether bidders will simply stay away because of the confusion around the abrupt rule changes.
The outcome is a critical one for the global oil sector. There’s almost certainly many more big discoveries to be made in Brazilian waters — and we could see a surge of activity here if bidders find a way to make the new system work. Or, we might see a lot of missed upside if the government’s nationalist gamble backfires.