WASHINGTON, DC (September 3, 2009)—Calling Monday, August 31 the “new independence day”, President Luiz Inacio Lula da Silva presented the Brazilian Congress with his proposed reform of the hydrocarbon regulatory framework. His ambitious program demonstrates the importance of the pre-salt developments to his political legacy. According to PFC Energy, the national discussion is just beginning to heat up and will intensify between different factions of the government. “If enacted, the four different bills that constitute the new proposal, will dramatically reorganize the country’s oil and gas institutions, affecting all players in the burgeoning sector,” said Claire Wong-Low, Manager, Markets & Country Strategies at PFC Energy. 
 
At the heart of it, these major changes are driven by the government’s desire to control more of its lucrative sector. The state wants to maximize domestic value added of the oil and gas sector through an active industrial policy, and direct pre-salt revenues to social development, such as poverty reduction, education, culture, the environment and science and technology. All of which have widespread implications for the private sector and for Petrobras, the Brazilian National Oil Company (NOC).
 
The reform proposal, in effect, envisions a mixed regulatory regime. Previously signed contracts would be upheld, but the country would introduce production-sharing contracts (PSCs) for previously unlicensed pre-salt areas and others that the state considers strategic. The government would be able to award contracts directly to Petrobras, or use a competitive licensing process to award them to companies offering the most profit oil to the state. These companies would bear exploration risk and, in the case of success, be reimbursed in “cost oil” for their expenses up to pre-established limits. Petrobras would be the operator of every PSC, with a guaranteed minimum 30% stake, and have the ability to participate in the bidding process for the remaining 70% stake.
 
One aspect of the proposal that seems to have taken many by surprise is the plan for the government to boost its stake in Petrobras and help fund Petrobras’ investments in the pre-salt and other strategic areas. The bill allows the government to transfer the rights to 5 billion barrels of oil equivalent at a mutually agreed price that is preliminarily estimated at around $50 billion. “These changes underscore the growing role of the state and its NOC, Petrobras, in Brazil’s energy sector moving forward,” said TJ Conway, PFC Energy.
 
An area that will cause unease in the sector is the proposed creation of a new state vehicle, Petro-sal, who will administer production-sharing contracts on behalf of the Ministry of Mines and Energy (MME), manage sales of the state’s share of oil and gas, and represent the state in unitization proceedings. The implementation of such a vehicle, which will have an active role in project operational committees, could create potential unease with Petrobras, as the operator, opening up the possibility of operational uncertainties.
 
The proposed reform augments state control and strengthens the Executive. It gives the federal government more discretion over the level of competition in the sector and weakens the role of the independent regulator, the National Petroleum Agency (ANP), in favor of the MME and National Energy Policy Council (CNPE). Finally, even though the current decentralized revenue distribution system will remain, control of the revenues that do accrue to a new Social Fund—proposed to be funded by oil revenues from PSCs—may emerge as a potentially controversial topic. 
 
Brazilians of different political camps have long shared the goal of safeguarding Petrobras’ dominance, so there is likely to be wide support for the initiatives that strengthen Petrobras. But the Brazilian government is facing a difficult balance between the desire for state control and providing sufficient regulatory certainty and reward to encourage private investment, which it does need for the development of its immense pre-salt resources.
 
As PFC Energy expected, Lula announced that the legislation will be fast-tracked under constitutional urgency in the interest of passing legislation before his term ends. This could result in passage of the reform as early as the first quarter of 2010. However, the congressional opposition as well as governors from the powerful oil states of Rio de Janeiro, Sao Paulo and Espirito Santo have voiced strong reservations against this—The opposition has threatened to withhold its votes if fast-tracking is instituted. In either case, it remains unlikely that any pre-salt licensing rounds will take place in the next couple of years.