December 11, 2017 – This post was written by Boyang Xue, FSG’s Research Intern for Latin America
The ephemeral excitement in Brazil when it discovered the biggest offshore oil reserve in the Western Hemisphere seems like distant memory. Soon after, the country was entangled in its longest economic recession in history, ongoing political turmoil, and corruption scandals involving the country’s top leaders and its biggest oil company, Petrobras. Both public and private investment in oil and gas evaporated and foreign investors’ confidence faded in front of the strict local-content regulation and poor business environment.
However, recent reforms in the oil and gas (O&G) sector and successful auctions of Brazil’s Pre-Salt blocks to international consortiums have reaffirmed Brazil place as a major global oil producer for years to come. These are the key reforms that multinationals should consider:
- Lower local content requirements: Local content is scrapped from being a bid factor and will only be applied in contractual terms. Moreover, local content table is reduced from over 90 items to 4 macrosegments, and the local content requirements were lowered significantly (from 37% to 18% for exploration, 55% to 25% for wells construction, 55% to 40% for subsea equipment, and 55% to 25% for platforms)
- Role of Petrobras in oilfield explorations: Ended the exclusivity of Petrobras as the required operator in all blocs with more than 30% stake; foreign companies can operate in Exploration and Production (E&P) in Pre-Salt oil without Petrobras.
- Extension of preferential customs regime for the oil industry for 20 years: The lower house renewed the REPTRO scheme to suspend export and import duties on goods used in E&P activities in the oil industry.
These reforms have made the Brazilian O&G field attractive again, with the government in September selling more than 37 blocks in offshore oilfields to 17 companies, equating to signing bonuses of more than US$ 1 billion. A month later, during the Pre-Salt auction held on October 27, 11 companies showed their enthusiasm with recent developments by submitting six winning bides, of eight Pre-Salt blocks on offer. In total, the pre-salt round results in US$ 1.88 billion in signing bonuses for the Brazilian government.
O&G reforms will boost government revenues
The investment from major oil companies and the enrichment of Brazilian government’s coffers came at a crucial time when Brazil is struggling to come out of a two-year recession. The signing bonuses helped reduce Brazil’s fiscal deficit in September and October, and it is expected that the new exploration will bring in at least US$ 80 billion in new investment, and once production begins the new output should result in US$ 100 billion in royalties. Moreover, companies offered profit oil share as high as 80% to win the bid, far above the minimum requirement offered by the government. This will generate tens of billions of dollars from oil production in decades to come, apart from royalties and taxes paid by investors.
Multinationals from all sectors will benefit from oil and gas reforms in Brazil
Brazil’s O&G industry has proven reserves of 15 billion barrels, half of it in Pre-Salt, and its average daily production has reached 3.3 million barrels. This makes Brazil the 10th largest producer in the world, and the biggest oil producer in Latin America. The liberalized O&G market in Brazil exposes multinationals with opportunities from all sectors for the next few decades, as the boom in O&G and related infrastructure will have a massive spillover effect on the economy.
- B2G companies will benefit from higher spending on public services. Higher oil revenues and royalties will boost tax collection at the federal, state, and municipal levels. This will increase government funding into health and education, as established by Brazilian law requiring 15% royalties from each barrel of oil produced to be earmarked for these two social services. This will likely create opportunities for government contract in other sectors as well, such as IT and infrastructure.
- B2B companies can expect a boost in demand from O&G and construction companies. Increased offshore oil exploration activities in the next few years will stimulate demand for infrastructure projects and inputs due to construction of refineries, roads, land transportation equipment as well as shipping equipment and repair. Apart from oil companies that will invest in the E&P sector, offshore activities will create demand for companies involved in both the downstream and upstream oil production chains. Thus, suppliers of machinery and equipment, in addition to other industrial inputs can benefit from the booming construction and oil industry in the coming years.
- B2C companies can generate higher revenue from the boost in consumption driven by O&G job creation. In the long run, robust public investment in infrastructure and public services will lead to job creation and boost income for Brazilian workers in the sector. According to a study conducted by Abespetro and IBP, the O&G sector is going to add 500,000 jobs to the Brazilian economy, in fields such as steel production, metallurgy, machinery and equipment production, chemical industry and ship building. Furthermore, the stimulus to jobs growth will also have significant spillover effect for the rest of the economy: higher employment rates and higher income will translate into higher activity in the retail, transportation, and business services sectors. Though most states will receive funding from the royalties for healthcare and education, the spillover effect from private sector activities will be more significant in Southeastern coastal states which are closest to the offshore oil fields such as Rio de Janeiro, Sao Paulo, and to some extent Espirito Santo.
Apart from conventional offshore and pre-salt exploration activities, the government is aiming to revitalize onshore activity for SME and increase exploration activities in the northeastern coast off Pernambuco and the Equatorial Margin in the north. The auctions in October were only 2 of 9 auctions the Brazilian government has planned to hold between 2017 and 2019. The next two rounds will be held in March and June of 2018, including 70 conventional offshore oil blocks and five blocks in the Pre-Salt region.
While the Brazilian O&G revival is just beginning, it is important to point out that the presidential elections in October 2018 present a risk to the continuity of more liberal policies that have been implemented under the current government of Michel Temer. While production will likely continue to increase under any political scenario, multinationals should consider scenario and contingency plans for any new investments made prior to the elections in the case of roll-backs of recent policy changes.