On 21 October 2013, the Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (ANP) of Brazil released the results of its first licensing round for the vast pre-salt reserves of the Libra oil field located in the country’s Santos basin.  The auction was won by a consortium consisting of Petrobras (40% and operator), Shell (20%), Total (20%), China National Petroleum Corporation (CNPC) (10%) and China National Offshore Oil Corporation (CNOOC) (10%).

The field, which is located in ultra deep water offshore South East Brazil, is estimated to have recoverable reserves of up to 12 billion barrels of oil. Unlike previous bid rounds, rights were awarded under a production sharing agreement (PSA) rather than a concession contract, which will give the state a greater share of revenues and more control over the development of the field.  This new regulatory regime was introduced by the government specifically for pre-salt and strategic areas due to the high volumes of predicted reserves and supposedly lower exploration risk.

Under the new regime, the winning consortium was obliged to partner with state-controlled energy giant Petrobras, which was required to take a minimum stake of 30% and be the field’s operator. The consortium will bear exploration and development risks, and as and when production commences, their expenditures will be reimbursed from a percentage of the revenue generated by oil sales (the cost oil), and the remainder of the production (the profit oil) will then be divided between the consortium and the state.

The terms of the PSA were considered relatively onerous and risky, and were criticised by the Instituto Brasileiro do Petróleo (IBP) which represents exploration and production companies in Brazil.  The consortium will be expected to spend approximately 175 billion reais (£50 billion) to develop the Libra field, including 610 million reais (£174 million) on exploration alone, over the 35 year duration of the contract.  The signature bonus alone is 15 billion reais (£4.5 billion), one of the highest ever paid worldwide.  The consortium must commit to procuring a minimum percentage of goods and services from Brazilian suppliers.  This imposes additional costs and may result in delays given the limited capacity of the local market.  Most problematic for bidders, the cost oil percentage was set at 50% of the total production value for the first two years and 30% thereafter.  This is lower than usual in international PSAs and worrying given that costs are not escalated by reference to an index or interest rate between being incurred and being recovered from cost oil.

Some bidders were also worried by the level of operational control retained by the state.  As well as Petrobras’ compulsory operatorship, a new state oil company, Pré-Sal Petróleo S.A. (PPSA), has been established to manage the state’s interests.  PPSA holds 50% of voting rights on the operating committee, as well as a casting vote and right of veto.  This may become an issue given that the term of the PSA is limited to 35 years and all assets developed by the consortium revert to the state upon its expiry.  Although this seems like a long time, considering the volumes of oil and scale of investments anticipated, it may not be possible to exhaust the reservoir within this time, and the state will have no incentive to accelerate production, at least towards the end of the contract term.

As a result of these potentially unfavourable contract terms, this round was less contested than previous rounds. Only 11 companies registered, and notably this did not include a number of major oil companies with operations in Brazil, such as BP, BG Group, ExxonMobil and Chevron. In the end, only one bid was made, offering the government the minimum share of profit oil permitted by the tender rules, 41.65%.  Despite the lack of competition, Magda Chambriard, the director general of the ANP, insisted the result could not have been better given that the consortium was made up of the 2nd, 3rd, 7th, 8th and 10th largest oil companies in the world by market capitalisation.  Local reaction to the result was broadly positive, with emphasis placed on the mixture of private and state ownership, companies from three continents with vast experience, and the fact that around 80% of oil produced from Libra will be owned by Petrobras and the Brazilian state. The share price of Petrobras rose 5% within minutes of the result being announced.

It remains to be seen how Petrobras will finance its share of the massive costs involved.  The Brazilian giant’s finances are looking strained, as it is already committed to a massive capital expenditure programme, while it is forced by the government to sell fuel at below market value to keep inflation under control.

After years of discussion and debate, the tender of Libra should trigger a significant acceleration in the development of Brazil’s pre-salt fields.  However, the process has not been straightforward and there is still much to do in the coming years.  We have yet to see whether these fields are worth the high prices demanded for them, and there is increased uncertainty regarding the eventual recoverable volumes given that only two wells have been drilled in the area.  On the one hand, industry is critical of the government’s interventionism and tight fiscal terms, while on the other, certain elements of Brazilian society reject the Libra auction as a privatisation of Brazil’s natural wealth.  Petrobras workers called an indefinite strike organised by the National Oil Workers Federation to demand immediate suspension of the auction, and there were violent demonstrations outside the hotel where the bid round took place.

This is a contentious issue precisely because of the importance of the reserves and investments involved. Given the criticisms received from the private sector over the past few months, the Brazilian government has decided to review the current PSA model for the development of other pre-salt fields in the future. A consultation period will run until 2015 and the ANP have admitted that they are unlikely to recommend any further auctions of pre-salt areas in the meantime. If such discussions can reduce the unreasonable risks faced by private oil companies, the Brazilian government should be able to create conditions for more competitive tendering for future pre-salt blocks, while maintaining a significant or even increased share of revenues.  Such a move could benefit not just the oil industry, but the government and Brazilian society generally.