Brazil’s 1st pre-salt auction

Claudio Paschoa

January 15, 2014

For Brazil’s first pre-salt auction, new production sharing rules changed the playing field, attracting fewer, but more substantial bids.

Brazil auctioned its first pre-salt field, Libra, back in late October. Libra, located in Block SS-AUP1, in the Santos Basin, has estimated recoverable oil volumes of 8 to 12 billion boe and in place volumes of between 25 and 40 billion boe. Supermajors such as Exxon Mobil, Chevron and BP and other players such as BG Group and Statoil, decided not to participate in the auction in part due to the new production sharing rules. Many industry analysts were surprised that state-owned players from China, India, and Malaysia dominated the list of companies that agreed to the controversial terms imposed by the Brazilian government, through its National Petroleum Agency (ANP).

Magda Chambriard, head of ANP, said that she had expected “more than 40 companies to bid for Libra,” expressing surprise at having only about a quarter of the expected interest actually materializing. She may well have been surprised, but it is highly doubtful that the policymaking nucleus in Brazil’s government was in any way surprised, as the state policy is to maintain tight control over pre-salt exploration and production. The new rules being implemented for this auction, such as Petrobras being the sole operator of the field and having a minimum 30% stake in any consortium, along with the highly-criticized decision to create another state-owned company, Pré-sal Petroleo S.A. (PPSA), to act as manager of the winning consortium, without imputing capital and having 50% vote in the Operational Committee’s deliberations, along with veto rights, are a reflection of the government’s policy.

Local industry analysts, who asked to remain unnamed, maintain that these and other new rules, such as the pro- duction-sharing scheme, were designed to attract other state-owned players, in detriment to the international supermajor players, which are mostly private companies. The reasons for this preference is that these state-owned players participating in the auction, having significantly less, if any, experience in operating deepwater pre-salt fields, are therefore more agreeable to Petrobras’ operational control, and the significant fact that these state-owned players are more interested in obtaining the physical oil than in the profits from oil sales, because they need the oil for their own national develop- ment. Petrobras still considers it impor- tant to have experienced players in the Libra consortium, and the operator has expressed its contentment that Shell and Total were in the winning bid, due to the vast experience these companies have in deepwater E&P.

Eleven companies agreed to the auction terms and paid the roughly US$1 million (R$2 million) participation fee, after which they received the data package concerning the Libra field. Of these 11 companies, seven can be considered supermajors because of their market value, according to Bloomberg/ PFC Energy estimates as of Dec. 12 2013. The fact that they paid the participation fee does not necessarily confirm that they would definitely participate in the auction and the payment fee was compulsory and individual to each company, even those wishing to submit bids through a consortium. Therefore, some of the companies listed could choose to forfeit the fee and not participate in the auction and some did just that, with Repsol pulling out of the auction at the last moment. Mitsui and Petronas failed to deposit financial guarantees and also didn’t participate. With the high investments involved, which include EWTs and other field development costs, along with around US$7.5 billion (R$15 billion) as bonus on signing the 35-year, non-renewable E&P contract, virtually guaranteed that the companies involved will form consortiums, with no company competing individually. The ANP has estimated that it could take as much as R$400 billion to develop the Libra field.

When the rules were changed in 2010, many local and international oil industry leaders and analysts expressed concern that the production-sharing model would reduce investment interest in Brazil’s presalt provinces, which include areas in the Santos, Campos, and Espirito Santo Basins. After the rules were confirmed for the Libra auction, more than 200 requests for changes were made and turned down by the ANP, who said the area’s size and potential meant that the government could charge almost anything it wanted for the rights. “Libra is beyond any possible comparison nowadays to other fields,” said Magda Chambriard during a global road show to promote the auction. “If companies participate, it is because they see potential value. This is the biggest auction in 30 to 40 years around the globe.” Brazil’s government expects to receive around US$300 billion in royalties and other taxes from Libra over 30 years. Oil rights in the rest for Brazil’s post-salt plays will continue to be sold on a concession basis, where oil companies own all the oil, but pay royalties of at least 10% on production.

Image Caption: ANP’s Magda Chambriard and President Dilma Rouseff

Photo: Alberto Stuckert Filho

João Carlos França, President of the Brazilian Petroleum Institute (IBP) had this to say: “What surprised me was Exxon not participating. But every company has its strategy. Libra is very large, it demands high investments, with high risk and many regulatory uncertainties in the sharing model. It’s not known how the PPSA will perform managing the fields. It’s a great doubt.”

The PPSA may be viewed with skepticism and considered a risk by some, but the fact is that the company was created specifically to manage the pre-salt resources efficiently. The risk is still there, yet by choosing a CEO with a technical background instead of a political appointee, Brazilian President Dilma Rouseff showed how seriously the PPSA is being taken by the Brazilian government. This is an important indicator that the government expects the PPSA to keep a tight managerial and supervisory control over the winning consortium in order to guarantee that the oil costs, in terms of CAPEX and OPEX do not skyrocket, which could adversely affect the amount of oil delivered to Brazil, and to the winning consortium.

Local content requirements for equipment and services also pose serious concerns to major players. According to executives from major oil companies operating in Brazil, there is a growing fear that local industry will not be able to fulfill demands and meet deadlines, thus slowing down Libra’s development, possibly even delaying Libra’s production startup, which would also delay any profit gains. By contract, the minimum local content during the exploratory phase is set at 37%. During the EWT, this drops to 15%. For the development phase modules to begin by 2021, local content requirements reach 55% and for development phase modules beginning in 2022 this increases to 59%. President Dilma Rouseff announced in September, that the development of the Libra pre-salt field would require between 16 and 18 new rigs or FPSOs in order to reach the goal of producing 1 million boe/d. This goal has since been raised to 1.4 million boe/d. Between 60 and 90 support vessels are also forecast to be required.

Libra Auction Result With the first pre-salt auction scheduled to take place at a hotel located in Barra Beach on the west side of Rio de Janeiro during a commercial holiday on Oct 21, 2013, the Brazilian government made comprehensive security plans in order to impede demonstrators from reaching the event venue. Workers and Teacher’s demonstrations have been commonplace in Brazil during the last six months and although they usually end in some form of confrontation with security forces, the fact that these demonstrations are allowed shows that democracy in Brazil is solidly rooted. Before the bidding round started, there were demonstrations by oil workers and others totaling around one hundred persons, about 500m from the venue, where the security cordon was placed. There were also confrontations, with some demonstrators and also some of the 1,100 soldiers used as security suffering slight injuries. All this happened as holiday beachgoers sunbathed and surfed along the beach. Which highlights the fact, that even will all of its social problems, Brazil is a solid democracy.

Back at the event venue at the Windsor Hotel, there was a bit of an anticlimax, as in the end only one consortium deposited its bid in the ballot. With the lack of competition, the consortium comprised of Petrobras (10%), Shell (20%), Total (20%), CNPC (10%) and CNOOC (10%) offered the established minimum 41.65% in profit oil to the Federal government, winning in the first pre-salt bidding round held by the Brazilian National Petroleum Agency (ANP). With this result, the consortium has acquired rights and obligations to the Libra block. As set forth under the law, the National Council for Energy Policy (Conselho Nacional de Política Energética - CNPE) established a 30% stake to be acquired directly by Petrobras. Therefore, with the auction results, Petrobras’ total participation in the consortium will be 40%. A signature bonus of around US$7.5 billion (R$15 billion) is to be paid by the winning consortium in a single payment and the total amount payable by Petrobras will be around US$3 billion (R$6 billion) relative to its participation in the consortium. The Libra block is located in Santos Basin ultradeep waters in the pre-salt polygon and is considered a prospect of high potential. The total extension of the area is 1,547.76sq km, and was discovered by well 2-ANP-0002ARJS, drilled in 2010. Petrobras has stressed that recoverable oil volume estimates, costs, investments and schedule of the production systems of this block, will be progressively released in a timely manner, as the minimum exploration program is developed.

Petrobras believes that the integration of expertise and experience of the European partners, Shell and Total, with their expertise in deepwater development and their long experience in managing the design and implementation of large projects, will contribute to achieving good production results in Libra. The participation of the Chineses companies, CNPC and CNOOC, complements the requirements for a strong and active consortium, leveraged by the financial strength of the Chinese companies.

Shell commented that, “The Libra oil discovery in Brazil is one of the largest deep water oil accumulations in the world. We look forward to applying Shell’s global deep water experience and technology, to support the profitable development of this exciting opportu- nity,” said Peter Voser, Chief Executive Officer, Royal Dutch Shell.

Total explained that this acquisition is part of its strategy to increase its presence in Brazil. “This stake in a block close to the very prolific block BM-S-11, where the Tupi, Iara and Iracema oil fields were discovered, will enable Total to participate in the promising exploration of the pre-salt area of the Santos Basin,” stated Marc Blaizot, Senior vice President, Geosciences at Total E&P.

Mr. Li Fanrong, CEO of CNOOC com- mented, “Libra field in Brazil is one of the largest deepwater oil accumulations in the world. The participation of CNOOC Limited in Libra project not only signifies the milestone of a strategic entry into ultra-deepwater field for the Company, it also aligns with our philosophy of seeking partnerships to expand our global footprints.”

After the auction proceeding were completed, Brazilian President Dilma Rouseff, defended the production sharing model used for the Libra auction and also the much contested fact that foreign companies were allowed to participate. “The two Chinese (companies) are big international oil companies, and it is good to say, in Brazil, in order to end this absurd xenophobia, that they are great international partners and that the two private companies (Shell and Total) are great oil producers,” President Rouseff said. She also explained that the oil in Libra is of high value and that the concession model implies high exploration risks in order to discover the oil, and that production sharing is the best way to go in the presalt. “The concession model entails many risks to discover the oil. You don’t know where the oil is and the success rate is low. In the production sharing model, we know that there is oil there and how much there is. We can estimate what will be produced,” said President Rouseff. She also highlighted that 75% of the oil will go the Brazilian state, while 25% will go to the companies doing the E&P. She also said that by official projections, in 35 years the Libra field will generate around R$1 trillion (roughly US$500 billion) for Brazil. OE