Brazil has become Latin America’s leading economic power over the past 25 years – exploiting its vast natural resources and huge labor pool, taking advantage of well-developed agricultural, mining, manufacturing, and service sectors, and rapidly expanding its presence in global markets.

National oil company Petrobras was created in 1953. A constitutional change in 1997 ended the company’s monopoly on E&P, liberalizing the oil and gas sector and opening it to competition.

The discovery of several potentially huge fields in the presalt layer offshore Brazil, beginning in late 1997 in the Santos Basin and since then extending into the neighboring Campos and Espíritu Santo basins, has opened a new frontier with tremendous opportunities and daunting challenges. These presalt discoveries have triggered a reassessment of the Brazilian regulatory model and a restructuring of the government’s role in the industry, bringing uncertainty for investors seeking to efficiently exploit the area’s opportunities.

The Brazilian government is looking to attract international funding, create a national development fund for social programs, and build a strong oil industry. Managing the complex interdependencies between these objectives will determine how successful Brazil will be in fully capitalizing on its presalt deepwater reserves potential.

Players and the market

More than 93% of Brazil’s oil reserves and about 80% of the country’s natural gas reserves are offshore. The area offshore the state of Rio de Janeiro (which includes most of the prolific Campos and Santos basins) accounts for about 80% of Brazil’s oil reserves and about 45% of its natural gas reserves. In 2009, about 90% of the country’s oil production and 70% of its natural gas production came from offshore basins.

While recent gains in Brazilian production and reserves have been substantial, more important is the role that new production is expected to play in the future. Conventional long-term forecasts of oil supply and demand see new production from Brazil as the single largest source of new oil supply outside of OPEC over the next 20 to 25 years.

Domestic energy conglomerate Petrobras currently accounts for about 95% of Brazil’s national oil and gas production, and its production is expected to continue rising steadily over the next few years. Most of the production growth over the short term is expected to come from the planned addition of new production modules to fields in the Campos Basin already in production and from more recent discoveries within the basin. Longer-term growth is expected to come from the presalt cluster in the Santos basin.

Under its most recent five-year investment plan (2010-14), Petrobras expects to spend more than US $224 billion (an average of almost $45 billion per year), with more than half of its total investment dedicated to upstream.

Petrobras was the nation’s sole oil producer until August 2003, when Shell became the first international company operating a field to start production. Although Petrobras lost its monopoly over oil exploration and production 14 years ago, many companies still choose to partner with the state oil company. Partners and competitors in the Brazilian upstream include many of the world’s largest international oil companies. In early 2009, as many as 36 foreign companies were involved in upstream activities in Brazil.

Megafields like Tupi indicate Brazil’s presalt deepwater reserves potential. (Images courtesy of Petrobras)

Brazil is attracting increased interest from Asian investors. Chinese national oil companies have been slower to enter the market but are starting to catch up following the signing of a strategic cooperation agreement in April 2010 that could pave the way for Sinopec to acquire part of Petrobras’ interests in two blocks and for Sinochem to take stakes in certain upstream operations.

Another emerging trend is the heightened activity of privately owned domestic companies. The activities of local companies apart from Petrobras were once limited to participation in incremental oil production projects in mature onshore basins, but newcomers like OGX Petróleo e Gás and mining giant Vale are now investing in offshore exploration as well.

Opportunities, challenges, risks

The positive drivers of the Brazilian business dynamic going forward are Brazil’s political and economic stability; expected massive investments in local and national infrastructure, particularly in oil and gas; and huge partnership/supplier opportunities. At the same time, there are some potential pitfalls.

Petrobras’ recent successful share offering gives it funding for the first phase of its development plan. In addition, the substantial acreage and potential reserves add to long-term production potential and broaden the company’s development options. However, in the recent share offering, the government bought almost two-thirds of the shares. As a result, the Brazilian government now directly or indirectly controls 64% of Petrobras common shares and about 48% of all shares, including preferred shares. The free float of Petrobras shares is now down to about 52% as opposed to 60% before the share offering, according to a September 2010 report by IHS Global Insight.

The positive business implications of the political stability of the Luiz Inácio Lula da Silva years and the prospects of political continuity with his successor, Dilma Rousseff, will likely offset any worries that foreign policy objectives and/or ideology could be detrimental to, or conflict with, commercial objectives.

The current fiscal structure, applicable to existing discoveries, is a tax/royalty regime. It operates through:

  • A flat royalty, typically 10%;
  • A special participation tax (SPT), which is a sliding-scale levy set with reference to field location, field vintage, and field production; and
  • A corporation tax levied at 34%.

While the intention is that this regime will be ultimately superseded by production-sharing contracts (PSCs), the PSC system has yet to be passed into law, and it does not appear that this will be applied to the resource that forms the transfer of rights. The exact terms to be applied when valuing the 5 Bboe transfer are unclear, although it appears likely that the existing tax/royalty system will be used without the application of SPT.

In 2010, the Brazilian Senate passed a bill altering E&P regulations in presalt and strategic areas.

There are existing bottlenecks in equipment and skilled personnel availability. The high local content provisions of the rights offer will further reduce the flexibility to import equipment and manpower. Existing rig tenders are running a year behind schedule, and Petrobras’ implied drilling plan for the rights offer areas could lead to significant mid-term rig shortages.

The scale of the required investment in Brazil’s infrastructure is enormous, with estimates approaching almost $1 trillion over the next 10 years. Almost half of the required investment is expected to be dedicated to oil and gas, including exploration and development of the massive presalt resources, expansion and upgrading of the country’s refining and petrochemical sector, and expansion of the energy transportation and distribution infrastructure.

The best prospects lie in ultra-deep water where water depth challenges are further complicated by high pressures and low temperatures and by the difficulties in drilling through the thick salt layer in many of the reservoirs. In addition, there are gas monetization and transport issues – such as moving gas to shore rather than flaring – as well as logistics issues with floating production, storage, and offloading units.

Brazil’s energy potential is enormous, and the country’s government is focused and working strategically to maximize that potential. Despite the challenges, US and international operators are eagerly poised to share in the opportunities of the new frontier.