Brazil Round 5: Where Next For the ANP?
|Friday, August 29, 2003
Brazil's fifth round of bidding for exploration acreage took place in Rio de Janeiro on the 19th and 20th August 2003. As had widely been anticipated, bidding was subdued and relatively few companies placed bids. However, as has also been the case in some of the four previous rounds, Petrobras stole the show and won large tracts of new acreage. In this article we review the implications that Round 5 has for the Government and the industry regulator (the ANP) and ask whether the current licensing strategy now needs to be changed? We also suggest some ways in which the Government and the ANP can continue to attract not only more local participation into Brazil's upstream sector but the all-important foreign investment as well.
Round 5: The Result
Round 5 marked a departure from the previous four licensing rounds held in Brazil in that a cell structure was introduced, covering most of the unlicensed sedimentary areas in Brazil's Atlantic Margin basins. Some 908 blocks (cells) spread across nine basins were put on offer in Round 5 (162 cells had to be withdrawn just a few days before the bidding date owing to litigation commenced by environmental groups). This is a much larger number of blocks compared with previous licensing rounds (157 blocks were offered in Rounds 1 to 4) but, conversely, the area of each cell was much smaller than previously. With the new bidding structure, companies were free to amalgamate the small cells into larger, contiguous blocks as they saw fit.
In the event, only 101 cells were awarded in Round 5 (11% of that on offer) covering a total area of 21,968 square kilometers . Shallow water acreage commanded most attention (68% of the blocks awarded and 58% of total acreage) whilst deepwater fell in importance (12% of blocks and 39% of the acreage). Petrobras was the only bidder for deepwater acreage, acquiring blocks in the Jequitinhonha and southern Santos Basins – two new provinces in which the company obviously has faith.
A second major difference was the fact that, in Round 5, companies bid their own work programme rather than having it pre-set by the ANP. Signature bonuses and local content also formed part of the bids in Round 5, as in previous rounds. However, the new Lula Administration is particularly keen to increase the local content of bids and, as such, greater weighting was given to this aspect of the bids than in Rounds 1 to 4 (up from 15% to 40%).
Table 1 summarises the main results of the five licensing rounds. Note that, although signature bonuses in Round 5 are well down, with the introduction of biddable work programmes and the increased emphasis on local content it is less relevant to compare Round 5 bonuses with Rounds 1 to 4. Round 5 work commitments amount to about US$120 million.
Round 5 will be remembered for its small turnout, the low level of competition and the predominance of Petrobras' bids. Indeed, Petrobras single handedly accounted for 88 of the 101 blocks awarded (85 of them with a 100% stake, 3 in partnership). This aggressive bidding tactic is an obvious attempt by the company to regain its acreage holding in Brazil in the light of the enforced relinquishments the company made on all 22 of its Round Zero exploration licences earlier in August. The company took advantage of the low interest in the round and spent less than US$8 million on signature bonuses for a considerable swath of acreage (21,000 square kilometers).
Was Round 5 a Success?
Without doubt, Round 5 was far more subdued than the previous rounds but this is probably not an entirely fair comparison, given the maturing of the sector and the inevitable drop-off in interest. In the run up to the bidding round taking place many industry commentators had been predicting a poor turnout and they have been proved correct. This is not surprising, as it is no secret that most quality acreage has already been licensed to companies. However, some went so far as to predict that Round 5 would signal the beginning of the end for the Brazilian upstream sector, which is a little premature to say the least.
In particular, the well-publicised disappointment in recent deepwater exploration drilling should not have had much of a negative impact on Round 5 as the acreage on offer was concentrated in shallow waters and onshore. This is because the ANP has a central aim to maximise the participation of local companies in the upstream sector and, other than Petrobras, these companies are going to be relatively small 'start-ups' for whom the deepwater is unlikely to be of immediate interest. Because of the emphasis in Round 5 on onshore and shallow water acreage, the interest from the (higher profile) IOCs was always bound to be smaller.
However, the general negative publicity that Brazil has been cultivating over its petroleum taxation will certainly have warned off some potential investors who might otherwise have bid in Round 5. Companies are particularly nervous about any Government (in this case, the Government of Rio de Janeiro State) that seems willing to retrospectively change the goal posts to the detriment of private investors in the country. In the case of Rio de Janeiro State (whose jurisdiction covers almost the entire Campos Basin and the most prospective part of the Santos Basin) two initiatives have been introduced over the past year that could radically increase the payments of a value added tax (ICMS) for upstream producers. Both these initiatives are being challenged, politically and legally, but the eventual outcome is uncertain and this obviously leaves both existing and potential investors very wary.
What is more certain is that Round 5 signals the end of the initial state of high excitement that the opening up of the Brazilian upstream sector provoked in the late 1990s and first part of this decade. Many IOCs now have extensive portfolios in Brazil with sizeable existing commitments and hence there will inevitably be less appetite for more acreage. Petrobras is a glaring exception but it has major strategic reasons for continuing to bid aggressively, not least its acute desire to maintain its dominant position in the country. This maturing of the sector is inevitable and simply marks a new stage in the development of Brazil as an upstream province.
What is more important now is that at least a good selection of the companies that have picked up acreage in Brazil find some kind of success so as to continue their interest in the country in the years and decades ahead.
How Successful has the ANP been at Attracting New Players to Brazil?
Given that the whole rationale of breaking the Petrobras monopoly was to open up Brazil's upstream sector to competition, the number of companies entering Brazil via the ANP's licensing rounds has been a crucial test to the success or otherwise of the policy. A parallel aim of the Government (and the ANP) has been to foster an indigenous industry and hence Brazilian investors (most of which have no previous upstream experience) have been encouraged to participate in the bidding rounds. It is interesting to analyse the trends of the past five rounds to see if this strategy has been a success.
Chart 2 shows the number of new entrants that have picked up acreage in Brazil as a result of each of the five licensing rounds, split between foreign and local players.
As might be expected, after an initial surge of interest from the foreign companies the number of new players coming into Brazil has fallen off sharply in the last two rounds. No new foreign entrants even participated in Round 5 (let alone won blocks). In total, some 31 foreign oil companies have won acreage in Brazil during Rounds 1 to 5. In addition, nine other foreign companies have picked up acreage solely via the farm-out of Round Zero acreage by Petrobras (rather than via the ANP's licensing rounds) although four of these have since relinquished their blocks. However, this 'gain' in the number of players has been offset by industry consolidation, which has seen some Brazilian players buying others (e.g. Eni/British Borneo, Chevron/Texaco, Shell/Enterprise and Devon/Ocean Energy). The net result is that there are still 31 foreign companies with acreage in Brazil today.
Local participation in the licensing process was more cautious and there were no takers (other than Petrobras) in Round 1. This was a major blow to the ANP and resulted in a substantial relaxation in qualification criteria and the cost of data packages. Subsequent rounds have been more successful and, to date, eight local companies (other than Petrobras) have won blocks. In order of entry to the upstream scene these are: Ipiranga, Odebrecht, Queiroz Galvão and Marítima (now PetroSynergy) in Round 2; Petroserv in Round 3; PetroRecôncavo and Starfish in Round 4; and Aurizônia Empreendimentos in Round 5. Odebrecht has since sold its upstream assets to Enterprise.
Another three local companies have entered the sector either by buying some of Petrobras' marginal fields (W. Washington) or by farming into Round Zero acreage of Petrobras' (SOTEP and TDC Engineering). Hence there are a total of ten local companies (other than Petrobras) currently active in upstream Brazil. However, as with the foreign companies, new players are becoming harder to attract.
Where Now for the ANP?
Now that the number of new entrants coming into Brazil seems to be petering out, one question for the ANP must be whether or not a different strategy needs to be pursued? We consider that efforts will need to be re-directed if both local and foreign companies are to be attracted to future bidding rounds in Brazil.
How to Boost Local Participation
The pre-qualification criteria and bidding rules have been made successively more lenient in each round so as to make it easier for smaller (predominantly local) companies to participate. This trend has probably now run its course and it is unlikely that any further tinkering will attract significant numbers of new local players. Indeed, in Round 5 only one new player entered the fray.
The key to increasing local participation in the upstream sector now probably lies with Petrobras. This is because the company has an extensive array of small, mature, onshore and generally marginal fields that are dwarfed by its huge deepwater developments in the Campos Basin. Petrobras has attempted to sell off some of its smaller fields but the effort has, so far, been half-hearted and rather unsuccessful. One tender was held in 2001 but the fields on offer were poor and the bidding criteria (including the minimum asking prices) were too onerous. Only two companies picked up fields (W. Washington and Marítima). A second round was scheduled for 2002 but it has been continually delayed.
The Government and the ANP need to encourage (and facilitate) Petrobras to make more of its 'tail end' of fields available to the industry. A key part of this will be reassuring politicians and unions over the large numbers of jobs that might be at stake, especially as most of the fields in question lie in the economically deprived north-east part of the country. Ultimately there is no reason why Petrobras should not extricate itself almost entirely from the onshore arena (with the exception perhaps of some larger strategic projects such as Urucu) as the myriad of small fields simply does not fit within the portfolio of a major international oil company.
How to Boost Foreign Participation
There is still considerable potential for attracting new IOCs into Brazil. As previously stated, only 31 foreign companies are currently active in Brazil, a very small number considering the size and potential of the country (although this is on a par with countries such as Angola and Nigeria). One slightly odd characteristic of the bidding rounds in Brazil so far (especially Rounds 1 to 4) has been that a similar 'hard core' group of companies has tended to participate each time (and most of these companies have won at least some blocks). The result of this is that large numbers of companies have, it seems, yet to seriously look at Brazil.
Some of the more notable IOCs that have had little or no enthusiasm for Brazil to date include Apache, Burlington, Canadian Natural Resources, CEPSA, EOG Resources, Marathon, Murphy, Norsk Hydro, Noble, Occidental, PetroCanada, Pioneer, Talisman, Vintage, Woodside. Some have pre-qualified for one or two licensing rounds (including, for the first time, Occidental in Round 5) but none have made any bids. Other groups of companies notable by their absence include the Argentine companies (such as Pluspetrol and Tecpetrol) and the aggressively internationalising Russian and Far Eastern oil companies (such as LUKoil, CNPC, CPC and Petronas, for whom the lure of 'big oil' in Brazil's deepwater should have been appealing).
It could be that many of these companies are continuing to maintain a 'watching brief' on Brazil - most foreign companies should by now have examined Brazil in at least some detail and ascertained its attractiveness. If this is the case, then Round 6 in 2004 will be the real test for Brazil as that will undoubtedly represent the best opportunity for accessing quality acreage since the Round 1 blocks were offered in 1999. That is because Round 6 will recycle large tracts of prospective Round Zero acreage that Petrobras was forced to relinquish on 6 th August 2003, after a relatively rushed 5-year exploration effort.
There are a number of ways in which the Government could make future licensing rounds more attractive, especially for bigger, foreign players. It may need to re-analyse its emphasis in the bidding process on local content. In Round 5 the weighting of this was increased to 40% and, in addition, minimum requirements were stipulated (for instance, 30% for deepwater blocks in both the exploration and development phases). It is likely that these restrictions deterred foreign investors and the risks and benefits need to be studied in more detail. Indeed, the smaller cell structure is also perceived as being less attractive to foreign players looking to pick up more meaningful chunks of acreage.
Firstly Keep Your Own House In Order
Despite the continuing potential for attracting more IOCs to Brazil, the ANP cannot and should not rely on Round 6 to revive a flagging licensing policy. Round 6 will have some attractive, relatively under explored acreage on offer but the fact will remain that much of the choice acreage will still be under licence. And even though Petrobras' exploration efforts have been very rushed over the past five years, its unrivalled experience means that its efforts will have been well directed, hence most of the best prospects will have been drilled. Moreover, another factor to consider is that Petrobras will be using its vast knowledge to craft its bidding strategy for Round 6. If the last five rounds are a guide, the company will bid very aggressively in Round 6 and it will be the major competitor for all the other participants.
What the Government and the ANP must do now is to switch its attention to encouraging those players who are already in Brazil to stay. The 31 foreign and eight local companies that are in Brazil today have already invested considerable time and money in the country and they are therefore, by definition, the most committed. Efforts should be made to make sure that those companies that have made (or might make) discoveries can actually develop them and thereby actually start to make money - not only for themselves but also for Brazil itself. The alternative will be a mass exodus with oil and gas being unnecessarily left in the ground.
There are a number of ways in which host governments can encourage the industry to invest, but most hinge on maintaining an open and flexible fiscal and regulatory regime that can respond to the changing needs of the industry.
As the Brazilian upstream sector matures (as it seems to be doing as evidenced by the declining participation in licensing rounds) other measures need to be taken to ensure opportunities continue to arise. In this respect the ANP has done well to ensure rapid turn over of acreage, as the blocks licensed during each of the five bidding rounds all have a tight work schedule and mandatory relinquishments.
The maturing of the Brazilian upstream sector is also demonstrated by the fact that the secondary market for acreage is growing and there is now a reasonable portfolio of acreage on offer for farm-in opportunities. The ANP seems to be facilitating this by streamlining the approval process, and this is encouraging the asset market. Many more companies have participated in farm-ins recently than participated in Round 5.
One major issue in Brazil at present is the fiscal terms, including the thorny issue of indirect taxation, and this is an example of an area where the Government needs to be more flexible. In a study published by Wood Mackenzie in June 2003 ("Brazil Stands At the Crossroads") we discussed in some detail the recent exploration efforts in deepwater Brazil and the discoveries that have been made there. Our conclusion was that the prevailing fiscal terms are too harsh and the majority of the fields (discovered by both Petrobras and foreign companies) are unlikely to be developed, at a big loss to both companies and to Brazil.
In this respect, the recent changes introduced by the State Government of Rio de Janeiro send out exactly the opposite message to that which should be being heard. It is particularly tragic that the upstream industry seems to be getting caught in the crossfire of what is predominantly a political issue.
The message being sent out by the IOCs that are currently participating in Brazil could not be clearer. Exploration efforts to date have been disappointing and the industry needs help if it is to monetise what it has found. The low interest in Round 5 is but one of many signals that the existing players are now less optimistic about their future in Brazil. Many companies are in the process of radically downsizing their operations in the country and several have even put their entire portfolio up for sale.
The subdued interest in Round 5 is not a surprise considering the more mature stage at which the opening of the Brazilian upstream sector has now reached and the generally poor quality of acreage that was on offer. However, the extremely low turn out of companies is more extreme than expected, especially amongst the smaller players at whom the ANP was unashamedly targeting the process.
Because of this it is probably time for a re-think in strategy for the Government and the ANP. Continuing to offer onshore exploration acreage to small companies is unlikely to attract many new players and we suggest that Petrobras should be encouraged to offload more of its vast portfolio of small, peripheral onshore producing properties so as to give the fledgling local industry a much needed kick start.
Larger foreign players should also not be neglected, as ultimately they will have the biggest impact on sustaining Brazil's reserves and production base. In this respect, perhaps the best strategy for the Government is to show that it is willing to be flexible enough to those existing Brazil players to warrant their staying. This strategy will not only avoid an exodus that is already beginning to manifest itself, but it will also convince the (long list of) IOCs that are still wary of Brazil that, once here, you will be welcomed and encouraged to make the best of the opportunities that you have. Ultimately this will benefit both the companies and, most of all, Brazil itself.