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Sep 20, 2013 | 15:59 GMT

Brazil's Lackluster Pre-Salt Auction

Brazil's Lackluster Pre-Salt Auction
VANDERLEI ALMEIDA/AFP/Getty Images
Summary

Amid scandal and high expectations, the first Brazilian pre-salt auction scheduled for Oct. 21 has had a slow start. The Brazilian government had expected as many as 40 firms to participate in the auction for Brazil's most prolific and technically challenging hydrocarbon deposits, but the National Petroleum Agency announced Sept. 19 that only 11 firms had registered. Among the registrants are many powerful state-owned oil companies — including China National Offshore Oil Corp., China National Petroleum Corp. and Malaysia's Petronas — alongside European supermajors Total and Royal Dutch/Shell. Notably absent were any U.S. companies. 

Though this showing can hardly be called a failure, the small number of participants could be an indicator of doubts about Brazil's untested pre-salt regulatory system. The pre-salt layer is a geological formation off the continental shelf of the coast of Brazil that holds significant petrochemical resources. The poor showing is a political embarrassment to Brazilian President Dilma Rousseff's government, which is still dealing with the repercussions of leaks associated with the defection of former U.S. National Security Agency contractor Edward Snowden.

Until the May auction of conventional offshore deposits, Brazil's energy regulatory sector had been frozen since 2008, when the last round of auctions was held. At stake in the interim was how the country would manage revenues from prolific pre-salt offshore oil fields discovered in 2006 and first proved in 2007 that lay below several thousand meters of water and seabed, plus 2,000 meters (about 6,560 feet) of solid salt deposit. The technology required to extract oil and natural gas from these deposits is at the cutting edge of offshore oil drilling. 

Brazil's Pre-Salt Oil and Gas Basins

Brazil's Pre-Salt Oil and Gas Basins

First, Brazil wanted to ensure that the revenue from the oil recovered from the pre-salt deposit would be spent on national priorities. To that end, pre-salt profits have been promised to fund education and health care (a commitment that was reaffirmed in response to recent widespread social protests). After that, Brazil's many states began clamoring for a more equitable distribution of oil wealth, and although a supreme court decision is still pending, it seems that oil-producing states like Rio de Janeiro have been pressured into transferring funds to poorer states. Finally, Brazil wanted to ensure that the technological advantages of being directly involved in exploration and production in the pre-salt deposit would accrue to state-owned oil company Petroleos Brasileiros (better known as Petrobras). For decades, Petrobras has placed a premium on indigenous technology development and has emerged as a leading state-owned oil company in the process.

These two primary goals — securing as much revenue from pre-salt deposits as possible and keeping Petrobras deeply involved — have figured prominently in shaping the terms of Brazil's October pre-salt auction. Pre-salt production sharing agreements require participating companies to give at least 41 percent of the profits to the Brazilian government. At the same time, they require that Petrobras be the main operator of the concession and that the company have a minimum 30 percent stake. High local content regulations require companies to use a high percentage of local resources to complete exploration and production activities. All of these terms put a premium on profit transfers to the government and put a huge logistical and financial burden on Petrobras as the main operator. These relatively restrictive terms are probably a factor in the low turnout for registration for the auction. Compared to the standard offshore concessions bid on by 71 companies in the May auction of conventional deposits, the pre-salt terms may be prohibitive, particularly taking into account the high costs associated with pre-salt hydrocarbon extraction. 

While the technical details likely led to low registration for the auction, the political climate is also in turmoil. With the release of information detailing U.S. surveillance of Rousseff and Petrobras, there has been speculation that Brazil might take punitive action against U.S. energy companies. Rousseff has rejected such actions in favor of supporting the success of the auctions, but she did cancel her Oct. 23 trip to the United States, which had been planned for several months. Part of the problem facing Rousseff and foreign investors who could get caught in the aftermath of the National Security Agency scandal is that the constant stream of allegations against the United States could spoil relations between Brazil and the United States in the near future. This uncertainty could have played a role in the decision of U.S. companies to abstain from participating in this auction. The next auction will likely be held in two years, at which point the government may have had a chance to review restrictions that may have limited foreign participation, and the National Security Agency scandal will have blown over.

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