Brazilian upstream activity reflects potential mixed with uncertainty

A lot of progress has been made in the Brazilian upstream sector in the past few years.

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New rules for rounds

Mauro Andrade
Luiz da Rocha

Deloitte and Touche

A lot of progress has been made in the Brazilian upstream sector in the past few years. Most noteworthy is the diversity of exploration companies and the successful bidding rounds. The Brazilian upstream has 42 players and a fairly open market where companies, other than major player Petrobras, have the opportunity to hold a concession area and to explore and produce hydrocarbons through transparent and competitive bidding rounds. A new government is now questioning the power and authority of the regulatory agency, however, and there are new rules in place for the bidding rounds, providing a degree of uncertainty in the sector.

The formation of Agência Nacional do Petróleo in 1998 marked an attempt to provide open management of the Brazilian upstream sector. At that time, there was a lot of debate between the regulator and the industry about the solution of critical unresolved issues. The early entrants faced an environment of high exploration risk, with scarce datasets (limited 2D regional datasets were available), and a huge disadvantage in knowledge of the Brazilian basins compared to Petrobras. Conversely, Petrobras lacked funding to fully explore and develop their existing assets, which became the blue blocks when Petrobras, through its right of first refusal, entered into a concession contract plan regulated by ANP.

In a mutual beneficial relationship, Petrobras established several partnerships with companies such as BP, Chevron, YPF, Texaco, Exxon, Unocal, and Amerada Hess. Those partnerships were made in the blue blocks from round zero. Further companies were awarded blocks in rounds 1 and 2, including Shell, Agip, and Kerr- McGee. By round 3 in 2001, the players had a better understanding of the sector and access to extensive sets of data, including 2D/3D seismic surveys, gravity/magnetic data, and geochemical studies, making possible the identification of prospects in a regional context. More companies were granted a concession in the E&P sector by the tender process or through joint ventures (JVs), creating a highly competitive scenario. These entrants included Phillips, Statoil, Wintershall, and Mærsk.

The opening of the petroleum industry in Brazil has increased exploration investment and competition in the sector. Spreading its portfolio risk using JVs and freeing funds for developments partially compensated for Petrobras' loss of the upstream monopoly. The company's portfolio risk also made possible an increase in their international presence in South America and the West African coast to secure more reserves or markets. The other concessionaires gained more knowledge about the Brazilian sedimentary basins and some of them had success in their drilling campaigns.

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The opening up process also included the creation of a new legal framework and fiscal regime. Changes included adjustments to indirect tax relief treatment and equipment importation (Repetro), and the streamlining of the environmental review process.

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Average rates of minimum local content for rounds 1, 2, 3, and 4 vs. round 5 minimum requirements.
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E&P activities and investments

So far, the majority of drilling activity has focused on round zero blocks. This intense exploration was driven by the relinquishment deadline of the blue blocks in August 2003. After the deadline, commercial discoveries must be ring-fenced, with the remaining area returned to the ANP. Petrobras and its partners have drilled 168 wells on these blocks since 1998.

On blocks awarded in other rounds, the drilling campaign has been much more conservative, as most of the blocks awarded up to now are still in the first exploration phase, which does not include an obligation to drill exploration wells.

As a result of the early aggressive exploration campaign, some discoveries were made in blocks operated by Petrobras and by international oil companies (IOCs). As the relinquishment deadline for the blocks approaches, more discoveries will be announced because only prospective areas around finds can be retained. Key discoveries include:

  • Jubarte and Cachalote fields in BC-60 Campos basin with estimated reserves of 1.5 Bbbl of 17° API
  • BS-400 in Santos basin with estimated gas reserves of 440 MMboe
  • A potentially giant field in Santos basin on BS-500 block with light oil.

International companies and some small Brazilian oil companies have made some progress in blue blocks BS-4, BC-2, and BC-10, although the discoveries have been mostly heavy oil from 15° to 20° API. Among those, the most important find has been in BC-10, operated by Shell, which identified several accumulations with total estimated reserves around 440 MMbbl.

Two other discoveries were made in Camamu – one at block BCAM-40, where Queiroz Galvao has a 55% stake and another discovery in BM-CAL-4, operated by El Paso – that seem to suggest the existence of a new gas province in that basin. The BCAM-40 find, named as the Manati gas field, has estimated reserves of 700 bcf. The El Paso gas discovery in adjacent block BM-CAL-4 is still under evaluation, but one of the reservoirs identified extends to BCAM-40, which will result in the first unitization case in Brazil. Petrobras and IOCs made other technical and sub-commercial discoveries.

Since 1998 the IOCs have invested $4-5 billion in exploration and development activities. During the same period Petrobras has spent almost $3 billion in exploration activities. The estimate for Petrobras investments in the E&P sector up until 2007 amount to a further $18 billion.

Given these investments, a degree of competition, and some discoveries, Brazil should be regarded as a province with enormous untapped potential. However, a number of important issues have created a degree of uncertainty.

The transition period

Most of the established players in Brazil have characterized the past six to eight months as a transition period for the industry. Uncertainties involving fiscal and regulatory regimes, and the new rules for the fifth bidding round to be held in August 2003 have created a complex scenario.

The most profound changes promoted by the ANP for round 5 were related to:

  • New grid system
  • Higher requirements for minimum local content
  • Reduction in the exploration periods
  • Exploration program to be offered in working units by the companies
  • Restriction for companies interested in operating onshore blocks in specific sectors.

Changes were also made in the criteria for winning bids, with 40% based on the local content commitments, 30% based upon the working units offered, and 30% based on the signature bonus (compared to an 85% weight in previous rounds), making the local content a decisive component in a winning bid.

In this new bidding model, ANP is offering areas that are divided into 21 sectors in nine basins. These sectors are further divided into cells of 30-32 sq km if they are onshore, 171-192 sq km if they are in less than 400 m of water, and 646-768 sq km in deepwater. The resulting blocks from the new cell system, to be designed by the companies, will be smaller compared to the average size of blocks in previous rounds (from 5,000 sq km in round 1, to nearly 2,000 sq km in other rounds). The total area offered by these sectors (subdivided into more than 1,000 cells) is 190,000 sq km.

Some companies have criticized the cell system, while ANP has allowed companies to design their own blocks. They argue that the cells are too small to guarantee the discovery of possible huge plays/prospects. There is always the chance of one or more cells being assigned to a competitor, and a higher probability of a requirement for unitization if commercial quantities of hydrocarbons are discovered. Furthermore, some companies are concerned about the importance assigned to the minimum local content commitment. Although the Brazilian government believes that those targets can be achieved, many companies, including small Brazilian players, have suggested that this decision represents an old-fashioned protectionism, rather than an incentive for local industry, and that the values to be offered will always be at the lower limit. It is important to note that the minimum target stated by ANP for local content is, with one exception, greater than the average of the local content offered in previous rounds.

The local content should be, according to some players, an industrial development policy for the sector rather than a way to increase local purchases on a short-term basis. Companies understand their social responsibility, especially those with activities in other countries with similar local industry content expectations, but maintain that the country rules must be attractive compared to other areas in the world.

ANP has also reduced the length of the exploration phase. Most of the blocks now have an exploration phase of up to six years, some of them just two years – divided in two periods – compared to eight or nine years in previous rounds. Although considered as a measure that could add more risk to exploration activity, companies will offer the first period exploration program, through work units, as part of the bid proposal, and only if companies decide to go further into the second period must a well be drilled as minimum requirement.

In fact, the implementation of working units as a significant part of the final bid will accelerate block evaluation. Therefore, the reduction of the exploration phase should not represent an additional difficulty to companies because of the exploration program previously set by companies and the smaller size of the blocks in the cell system.

Restricting the presence of operators in more than two blocks in specific sectors on Espirito Santo, Potiguar, and Recôncavo basins, however, counteracts the advantage of the free design of the blocks and brings uncertainty to the award of cells in onshore basins because there are a limited number of smaller companies in Brazil able to fully develop these areas.

Legal framework changes

The exploration phase of round zero terminates in August 2003, and plans for new exploration in these areas are dogged by uncertainty. Rumors that this phase may be extended for areas where extensive exploration work has been undertaken have circulated, as Petrobras, who operates the majority of those blocks, would like to have more time to explore and evaluate those assets. If true, this could threaten the consolidation process of the E&P industry in Brazil.

Even Petrobras' partners in these blocks are not likely to favor such an extension, as they are waiting for these areas to be released. Companies maintain that the relinquishment of those areas will benefit the exploration scenario, bringing new drive to the E&P environment in Brazil. The relinquishment for Petrobras is extremely significant. If this process occurs as planned in August 2003, Petrobras will face a reduction of nearly 35% in its exploratory acreage, being compelled to bid aggressively, either internally or internationally, to restore their portfolio.

From the existing 23 blue blocks under concession, Petrobras has 100% equity in 15. In the remaining eight blocks Petrobras has JVs with six IOCs and two Brazilian companies. A total of 168 wells were drilled on those blocks with mixed results, but far from a disaster, with almost 2 Bbbl added to Brazilian reserves.

Conclusions

The competitiveness of the Brazilian sector will be a major concern if some of the issues outlined above are not resolved. Federal authorities and the regulatory agency must recognize that under these new terms, Brazil may lose investments to other sectors, especially Nigeria and Angola, where the deepwater exploration success rates have been higher than in Brazil since 1996.

Specific fiscal terms are still needed, mainly for challenging fields, which combine ultra-deepwater, heavy oil, and a complex reservoir, as well as for the development of those fields considered marginal (about 300 MMbbl in deepwater). Measures are necessary to match risk and reward for Brazil's competitiveness with other countries.

The results of the next round will not only rely on the issues outlined here but also on the fact that some companies already have heavy exploration commitments from previous rounds in Brazil.

Round 5 will also face competition from round 6 in 2004 when the relinquished blue blocks are expected to be offered, although a recent 1.5 Bbbl discovery made by Petrobras and a better understanding of the Brazilian basins will influence some potential players. The future success of the Brazilian sector remains uncertain, and the upcoming rounds will be an important indicator of attractiveness of this sector for oil and gas exploration companies.

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