ShareAfter the disclosure in the Brazilian press on 17 May of tapes of President, Michel Temer encouraging the payment of “hush money” bribes to Eduardo Cunha, a former speaker of the lower house of congress who is currently serving a 15-year sentence for his role in the Petrobras scandal, observers of the country are asking, “When will it all end and will Brazil ever be able to recover from the Lavo Jato investigation?”. Lavo Jato is the Portuguese phrase for Car Wash in English and refers to a wide ranging investigation, often called the Operation Car Wash Investigation – centered on corruption, bribery and contract price fixing by national oil company Petrobras. The investigation has been ongoing for more than three years now and has already led to the impeachment and removal of former President Dilma Rousseff in 2016 and is widely attributed as the main cause for plunging Brazil into its worst recession in 50 years.
Operation Car Wash Investigation
The Brazilian supreme court recently authorized investigations into eight members of Temer’s cabinet, as well as three governors, 24 senators and 39 lower-house deputies for allegations related to the Lavo Jato investigation. However, until now Temer had personally avoided the scandal. The story of the tapes of Temer was broken by the newspaper, O Globo, which said in March the president met local businessman, Joesley Batista. Batista is reported to have told Temer that he had been paying Mr Cunha to stay quiet, while Temer is reported to have responded, “You need to keep that up, OK?”. The tapes are now evidence in a plea-bargain deal that Batista has struck with prosecutors. The tapes also are reported to show Temer advising Mr Batista to contact a congressman from his party, the Brazilian Democratic Movement to resolve a problem with his company. The congressman then received 500,000 reais (US$ 159,000) from Mr Batista which was captured on film. One of Temer’s aides, Rodrigo Rocha Loures, surrendered a bag filled with part of the alleged hush money meant for Eduardo Cunha. Loures is suspected of being Temer’s courier and sending funds to Cunha. Prosecutors have already released a video of Loures leaving a Sao Paulo restaurant with the bag and tape where he identifies himself as Temer’s middleman. The tapes were part of an elaborate sting investigation by police which involved placing tracking chips into bags of cash.
Temer fiercely denies any wrongdoing and is resisting calls to resign. However, Brazil has been thrown into political turmoil by the recent news. Immediately after the news broke, the opposition party filed a motion for impeachment and hundreds of protestors hit the streets in several of Brazil’s large cities to demand a new election, Brazil’s currency, the Real, dipped and so did the local stock market index. The latest revelations have the Brazilian Supreme Court opening investigations into Temer for obstruction of justice and involvement in passive corruption.
The market is worried that the new scandal will set back some of the free market reforms introduced by Temer and considered vital to economic progress and a turnaround in the country. He has already passed a constitutional amendment to freeze government spending in real terms for 20 years. He was also pushing hard to overhaul the Brazilian pension system, which analysts have deemed to be unsustainable, and some of its rigid labor laws. These reforms are not popular but are deemed necessary by many analysts to keep the country solvent and internationally competitive. The latest revelations will delay these reforms at best and may stop them.
However, don’t expect that Mr Temer will soon be forced out of office. The motion to impeach must be accepted by the speaker of the lower house, Rodrigo Maia, who is a strong supporter of Temer. After that it would still need to pass through both houses of congress with two-thirds majorities while Temer still has strong support in congress. The Brazilian constitution does not allow for a new election under these circumstances. When a president leaves office with less than two years left in a term and has no vice-president to succeed him, congress is called upon to choose the next president and Temer currently has 19 months left to serve to the end of 2018 while no clear successor has yet to emerge. Temer’s approval rating was recently gauged at about 20%. The political atmosphere is bound to get more toxic before it gets better.
Reforms Here to Stay
In the oil and gas sector, reforms do not seem to be in danger of being repealed if Temer is removed. Since taking over permanently after the impeachment of Rousseff in August 2016, Temer has been working to institute reforms to the sector to make it more competitive and attractive to foreign investment. These include a reduction in local content requirements to about 50% of previous levels. However, the most significant of these changes passed by Temer is a revision of the pre-salt production sharing contract legal framework. The law previously required the mandatory participation of Petrobras as operator with a minimum of 30% in all new contracts within the pre-salt polygon covering large parts of the Campos and Santos basins.
The law, enacted in 2010, was intended to support Petrobras but wound up placing a huge debt burden on the company and placing it in an untenable position where it could not control its own budget. The situation became much worse when the company was hit with both the Operation Car Wash scandal and the steep drop in oil prices in 2014. Petrobras now has the option of whether it want to participate or not in any of the offered blocks in the pre-salt polygon and can choose its level of participation.
Temer signed it into law in November 2016. The new legislation was eagerly anticipated by both oil and service companies in the sector based on the belief that the relaxed rules would bolster investment in the sector as well boosting Petrobras by saving them from financial obligations that they cannot always afford. Industry experts predicted that after the passage of the bill, annual investment in the oil sector would rise from around US$ 20 billion in 2016 to about US$ 50 billion. Temer’s administration was hoping that the reforms would boost the economy, pull the Brazilian economy out of a severe recession and reduce a large government deficit. Industry observers believe that other reforms are still needed such as reinstating the Repetro special customs regime which exempts companies from high taxes on specialized equipment used in oil exploration and production. While the market reforms of Temer may not be in danger of repeal, there is a definite risk that they will not progress further or that the country could descend into chaos, gridlock or even a collapse of the government.
Before the latest scandal with President Temer, Brazil was in the process of testing the waters regarding these reforms with the holding of an unprecedented four different bids rounds in 2017 and there is no reason to believe these rounds will not proceed as scheduled. The first of these has already been conducted. Marginal Fields Round Four was held on 11 May and was deemed a big success raising US$ 2.54 million in signature bonus funds with an average premium of 1991.52%. It was the highest total ever for a marginal round in the country. In addition to the bonus, investments of US$ 2.9 million are forecast for the eight of the nine claimed bid blocks in round. The winning bidders were Brazilian entities, achieving another goal of the country to open the sector to smaller and medium sized operators. However, in the grand scheme of things this is all small potatoes and does not compare to the other three rounds which are currently in launch process.
On 18 May 2017 the ANP published a draft of bidding rules for ANP Round 14. 27 September 2017 is the bid due date and the round offers 287 exploratory blocks in nine sedimentary basins covering 122,600 sq km. The published draft rules for Round 14 allow companies to make suggestions and comments as part of the consultation process until June 19, with a public hearing to be held eight days later. For onshore exploration, the local content for Round 14 will be 50%. For the offshore blocks, the minimum local content required will be set to 18% in the exploration phase, 25% for well drilling and construction, 40% for collection and drainage systems and for offshore platforms local content will be 25%. Some changes in the draft rules are a single period of exploration, five to seven years in length and a reduction in minimum commitments which are biddable.
The round will offer blocks in the Campos and Santos basins for the first time in ten years. The Santos basin has 76 offered blocks, Campos basin 10 blocks, Sergipe-Alagoas offshore basin 11 blocks, Pelotas basin 6 blocks and Espírito Santo basin 7 blocks. The onshore basins include the Parana with 11 blocks, Parnaiba 12 blocks, Potiguar 62 blocks, Sergipe-Alagoas 46 blocks, Reconcavo 27 blocks and Espirito Santo 19 blocks. The draft rules also call for the removal of local content as a biddable item and a reduction in royalties for frontier areas with higher risk. The minimum signature bonus required has also been significantly reduced. The ANP also incorporated the idea of offering blocks with an exploratory upside near areas that are already partially explored or developed by Petrobras. This round is meant to appeal to some of the world’s major oil companies with ExxonMobil, Shell, Total and Statoil among the interested companies.
However, the real hot properties in Brazil will be bid on 27 October 2017 when the ANP holds the 2nd and 3rd Pre-salt Bid Rounds offering eight areas. The 2nd pre-salt bid round offers four utilizable areas and could raise between US$ 379 million and US$ 1.5 billion in bonus payments, according to a government forecast in early March 2017. Areas adjacent to the Carcara (Norte de Carcara), Sapinhoa (Entorno de Sapinhoa) and Tartaruga Verde fields (Sudoeste de Tartaruga Verde) operated by Petrobras and the Gato do Mato field (Sul de Gato do Mato) operated by Shell will be offered. The second round blocks consist of fields that require unitization and are open area blocks adjacent to existing field and discovery concessions. The ANP 3rd Pre-salt Round will offer the areas of Pau Brazil, Peroba, Alto de Cabo Frio-Oeste and Alto de Cabo Frio-Central. Both offerings will be held under a modified version of the production sharing contract (PSC) framework. The winner of the bids in this scenario is the company that offers the government the highest share of profits.
The terms and conditions for the rounds have not received final authorization yet. On 27 April 2017, the CNPE published preliminary bidding terms and conditions for the 3rd Pre-salt Bid Round. The signature bonuses were set for the round totaling US$ 1.36 billion including US$ 469 million for Pau Brasil, US$ 625 million for Peroba, US$ 109 million for Alto de Cabo Frio Oeste and US$ 156 million for Alto de Cabo Frio Central. If Brent oil has an average price of US$ 50 per bbl and the average production per active well is 12,000 bo/d, the government’s minimum profit shares will be 14.4% for Pau Brasil, 13.89% for Peroba, 22.87% for Alto de Cabo Frio Oeste and 21.88% for Alto de Cabo Frio Central. The ANP in 2014 revised upwards recoverable oil reserve estimates for the pre-salt Pau Brasil prospect in the Santos Basin. The estimate was increased about five fold from about 500 MMbo to about 2.5 Bbo. With an effective date of 10 February 2014, Petrobras relinquished the Peroba Block back to the ANP. The undrilled Peroba Block was held in reserve by Petrobras which still holds six blocks in the contract often referred to as either the Transfer Rights area or Onerous Assignment contract. The Peroba Block contains an estimated 360 MMb of recoverable oil.
The pervasive scandal uncovered by Operation Car Wash has hurt Brazil economically as well as being a source of shame and anger for its citizens. But it can also be argued that the scandal is a good thing and that cleaning up the country on the political and corporate levels, despite the pain in the short term, will make the country a better place. This represents the way many Brazilian feel about the investigation. Whatever direction the scandal and investigation takes in the next few years, two things seem to be a good bet. One is that Brazilian society is no longer willing to tolerate the systemic corruption uncovered by Operation Car Wash. Another is that Brazil has just begun its history as a major oil producing country.
Land of the Giants
The Brazilian pre-salt polygon, covering most of the Santos and Campos basins contains at least 176 Bboe of undiscovered, recoverable resources according to a 2015 study by the National Institute of Oil and Gas (INOG) at Rio de Janeiro-State University. The figure is more than four times the 30 to 40 Bboe already discovered in the area. It is classified as P90 meaning there is a 90% chance that the true amount is this much or higher. A second P10 figure was also given as 273 Bbo. The pre-salt has already yielded some of the world’s largest oil discoveries in recent years and wells drilled there typically flow at rates between 10,000 and 40,000 bo/d with almost no drop in reservoir pressures or water cut, even for wells that have flowed for years. The INOG study estimate is the only major public assessment of the subsalt polygon’s potential and the 2015 INOG study estimate is 54% higher than the previous study the group did in 2010 which estimated a P90 of 114 Bboe and a P10 of 288 Bboe. The study uses industry-accepted methods and also determined the average field size in the pre-salt polygon was 246 MMboe using the most conservative estimate methods. With numbers like these, it is easy to see why the pre-salt has attracted the attention of the majors and the Brazilian pre-salt is one of the few remaining places in the world where the elusive giant field is not only present but expected.
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