Brazil has turned a corner. The country is on a path to ramp up oil and gas production to propel the economy forward. The blocks have been auctioned, the contracts signed, and productive investments are coming on line. Remarkably, more blockbuster auctions are coming. Many of us have been writing about the prospects of the pre-salt petroleum bonanza for some time, but it will become undeniable in 2019. The ninth largest producer of liquid fuels is a hop, skip and a jump away from entering the top tier of crude oil producers.
Brazil’s 2018 elections consolidated the political movement to liberalize energy production and distribution. The country’s compounding political and economic crisis may not be over yet, but oil and gas production will increase by significant increments in the coming years and push Brazil over the top to become a major world producer. The ultradeep offshore pre-salt fields now produce more than a half of the country’s oil and gas. The pre-salt exploration and production (E & P) will increase as a proportion of national production but will also accelerate growth behind the increasing deployment of productive investments in the abundant oilfields of the Santos Basin. Pumping up oil and gas production will continue to depend on Petrobras but expect increasing numbers of IOCs and Brazilian private firms to join the push.
The new government of conservative-nationalist president Jair Bolsonaro and his allies support downstream oil and gas liberalization and signal their intentions to move ahead with the previously scheduled blockbuster pre-salt auction rounds slated for 2019, 2020 and 2021. The left leaning national-developmentalist crowd, previously led by the Workers Party (PT) of former presidents Lula and Dilma Rousseff, are searching for a refreshed image and are considering options to slow down the new government’s plan to downsize government and open the doors to foreign direct investment in downstream oil and gas refining and distribution. This source of opposition may complicate Petrobras’ plans to sell off majority stakes in pipeline subsidiaries and refinery installations, but the move to liberalize will make advances in the coming 24 months. Moreover, E & P liberalization will deepen because the non-recurrent revenues streaming from the gigantic signing bonuses of the pre-salt auctions and the ensuing royalties can play a pivotal role in rectifying Brazil’s fiscal crisis at all levels of government. It is unlikely that anyone, even the Workers Party (PT) and the Federation of Petroleum Workers (FUP), can stop energy policy liberalization in the current fiscal and political context.
Oil and Gas Production
The Brazilian government, including the National Petroleum and Biofuels Agency (ANP), is actively pushing up oil and gas investments in the most promising oilfields with diminishing list of political and regulatory obstacles. Today, the highest producing oil and natural gas wells are all offshore and increasingly in the ultradeep-water pre-salt Lula and Sapinhoá fields in the Santos basin and the Jubarte field in the Campos basin. The evident abundance of the Santos fields now trigger ever greater E & P investments and deployment of commercial production assets, including a record number of FPSOs.
The 2018 numbers disappoint, but the trend is outstanding. Brazilian crude oil production dropped by 1% last year, due in large measure to delays in the deployment of equipment, but pre-salt production continued to march upwards to 1.888 Mboe/d and nwo comprise 55.4% of total national oil and gas production. The Lula oilfield in the Santos basin now leads with some 987 Mbbl/d of crude oil and 38.5 MMm3/d of natural gas. Marlim Sul of the Campos basin features the most offshore producing drill rigs at 88, but the most productive wells are in the Lula field. For example, the Lula field wells 7-LL-27-RJS, 9-LL-12D-RJS, and 9-LL-2-RJS and the 7-SPH-17-SPS in the Sapinhoa field now produce over 39,000 boe/d each. In 2017 only two wells produced over 30,000 bbl/d of crude oil, but in 2018 this number reached seven. Also, the FPSO Cidade de Maricá located in the Lula field is the largest floating crude oil producer with 5 interrelated well producing 150,620 bbl/d, followed by the Cidade de Ilha Bela and Petrobras 58. Brazilian offshore oilfields now host 27 FPSOs. The caravan of FPSOs headed toward the Santos basin will push production over the top during the new government’s term in office (2019-2022).
These recent increases in the number of high productivity wells and FPSOs spurred on increasing production levels in December of 2018 to reveal a measurable trend moving forward. December’s month on month increase was 4.8% and 3 percent in comparison to December 2017. Natural gas production is also expanding at more modest levels with a month on month increase of 1.2 percent and an overall annual growth rate of 1 percent.
48 E & P firms now operate in Brazil. Petrobras remains the largest oil and gas producer, recording national production of 2.556 boe/d in 2018. Petrobras also operates 16 of the largest 20 oilfields and 19 of the 20 principal natural gas operations. Shell Brasil follows with 414,438 boe/d with Petrogal Brasil in third place with 114,561 boe/d. Repsol Sinopec, Equinor Energy and Equinor Brasil, Sinochem Petroleo, Queiroz Galvão, Total E & P Brasil, Dommo Energia, Chevron, and PetroRio O & G follow. The numbers of E & P firms operating in Brazil is expected to grow as the risks decline and ANP’s permanent “open acreage” auction system gains traction among smaller firms.
Production increases in the coming years will be propelled by the deployment of drilling vessels, production platforms, and FPSOs deployed to the rich Santos pre-salt fields, but recent and future pre-salt auctions will drive Brazil toward the top ranks of oil and gas producers during the next decade. The speed of Brazil’s oil and gas ramp up depends on world price scenarios and production costs, but the writing is on the wall.
Recent Pre-Salt Auction Rounds
Last year’s 5th pre-salt production sharing auction round offered up four blocks worth $1.705 billion USD in signing bonuses and a commitment of US$250 million in planned investments in the exploratory phase. Bidders raised the government’s take on profit oil by 170% of the minimum established by the ANP. The table below reports the blocks, signing bonuses and profit oil offers. The most interesting result of the auction was the absence of strong bidding by Petrobras. The company won the rights to the Campos basin Sudoeste de Tartaruga Verde block with a minimum trigger ever larger profit oil bids but was shut out from the more promising fields tendered in this bidding round. Shell Brasil, Chevron, ExxonMobil, and BP Energy came away with the largest stakes by jacking up their profit oil bids. Also, QPI Brasil, EcoPetrol and CNOOC tagged along as junior consortia partners. These results indicate that E & P liberalization through regularly scheduled bidding rounds over the pre-salt fields is increasing confidence and triggering massive investments by the major IOCs and significant investments by a growing number of E & P operators in general. These results should not lead anyone to conclude that Petrobras is retrenching from pre-salt E & P, but that the size and falling production costs of these offshore reservoirs are near the center-stage of global oil and gas production.
Table: 5th Pre-salt Auction Round Results
The upcoming 6th pre-salt auction round scheduled for November 1, 2019 could place Brazil at the forefront of every IOC investment plan for a decade. The upcoming round features five blocks, 3 of which Petrobras has already registered its preference to hold a 30% stake. The company will apply its preference option on:
the Aram block with a $1.36 billion USD signing bonus and a minimum government profit oil take of 24.53%;
the Sudoeste de Sagitário block with a signing bonus of $135 million and a minimum profit oil bid of 26.09%;
and the Norte de Brava block with a $162 million and a minimum profit oil bid of 36.98%.
The remaining two blocks, Bumeranque and Cruzeiro do Sul, come with signing bonuses of $148 million and $310 million respectively.
Prospects for the 6th Pre-salt Auction Round
The sixth pre-salt bidding round features the continued central role of Petrobras as the prime pre-salt E & P operator, but also opens the door to such IOCs as BP, Chevron, Equinor, ExxonMobil, and Shell to raise the stakes. The auction round offers Shell the opportunity to consolidate its second position in the ranking of oil and gas producers in Brazil, but it also opens the door to one of the other companies to seize the moment and place its own future in the Santos basin’s ultra-deep-water pre-salt reservoirs for decades to come. Moreover, the final resolution of the 2010 Transfer of Rights (TOR) agreement between the government and Petrobras could launch even bigger opportunities for IOCs and thereby accelerate Brazil’s emergence as a top tier oil and gas producer.
The transfer-of-rights legislation (PL8939/17) would activate this process by allowing for the auction of “excess” oilfields not contemplated under the original 2010 agreement between the government and Petrobras. Congress is now considering approval of PL 8939/17 with amendments to frame a resolution to the current impasse between the federal government and Petrobras over the 2010 accord. However, the new administration faces notable political obstacles to passage, including addressing the fiscal concerns of Brazilian state and municipal governments.
In 2010, the government announced a plan to sell off a record number of Petrobras shares and struck an agreement with the company to develop and produce 5bn boe from the pre-salt fields. Petrobras paid $42.5bn for the rights, valued at $8.50 per undeveloped barrel of oil at that time. The agreement permits renegotiation depending on the commercial viability and value of the fields in question. According to estimates by the government-hired independent consultancy Gaffney, Cline & Associates, this excess oil could amount to 9-15bn barrels of recoverable hydrocarbons. If tendered, these oilfields could reap over $30bn in signing bonuses for the federal government as it tries to close the budget deficit and bail out failing states and municipal governments.
Congressional approval for the transfer of rights related auction is one of the government’s top 35 priorities for the first 100 days. Mines and Energy minister Bento Albuquerque remarked that he would focus on seeking passage of TOR legislation to trigger both the final agreement between the government and Petrobras as well as the scheduling for a special pre-salt auction round later in 2019. The final agreement between the government and Petrobras could result in a $14 billion USD payment to the company. The minister noted that the auction (possibly the first among several) could be held in the second half of 2019 and the government’s take would play an important role in smoothing out the impending and very difficult fiscal adjustment. The ANP estimates that a final agreement could surrender up 17.2 billion boe for future auctions.
The move to resolve the TOR agreement once and for all is also accompanied by congressional efforts to eliminate the production sharing regime, or at least provide the National Energy Policy Council (CNPE) with the option to use either concession or production sharing contracts given each tendered block. Last year federal deputies Mendonça Filho (DEM) of Pernambuco and Eli Correa (DEM) of Sao Paulo introduced legislation, PL 1191/2018 and PL 11211/2018, aimed at eliminating the pre-salt polygon production sharing auctions. Mendonça Filho also introduced PL 11192/2018 to eliminate the production sharing regime altogether and allow existing PS contracts to be converted into concessionary agreements. This legislative strategy may end up distracting policymakers away from the task of passing the TOR legislation, but it does open up the possibility of enacting greater flexibility for the government to decide between concession and PS contracts in future auctions.
Priming the Pump
The Brazilian government is lucky. Policymakers do not need to do too much now to attract E & P investment, just keep on the policy path and make the necessary rule changes to mitigate the risks and maximize the return to Brazil and its citizens. Some argue, including former presidential contender Ciro Gomes (PDT), that the liberalization of the pre-salt production limits Brazil’s developmental opportunities. This penchant places great burden on Petrobras and understates the developmental potential of a mixed E & P profile that features Petrobras, the largest IOCs, and dozens of smaller companies that rely on innovation to scale the value chain. Populating the value chain and increasing the competition over resources and markets may also prime the pump of development in Brazil. The sheer reach of E & P investment in the coming decade will set Brazil apart and create a value chain rich in opportunities and jobs. The Brazilian government should work with all stakeholders to guarantee that Brazilians get their fair share of these opportunities and jobs through investment and merit. Increasing opportunities and jobs may never eliminate Brazilians opposition to the complete privatization of Petrobras but pumping up the country’s oil and gas production will provide the political foundation for future increments of liberalization. The real question is whether Petrobras remains content with its central role in E & P, or whether it parlays its gains from the pre-salt production into innovative, low carbon energy production-systems that will transform Brazilian development in the long term.