The Brazilian Mega-Auction Of The Surplus Of The Transfer Of Rights: Frustrating Or Strategic?
On Wednesday November 6th, the much anticipated auction of surplus areas acquired by the Transfer of Rights Round took place in Brazil. Despite huge expectations about the event, the outcome was far below those expected by the Federal Government and even the less optimistic analysts. The governmental expectations and press releases were over-optimistic since the highest amount was expected even before the beginning of the said bidding round. There were plans and decisions on how to use high signature bonuses across different governmental entities (especially to assist the government budget and measures to reduce deficits).
The collected amount was nearly USD 17.1 billion, 65.65% of the total offered. In spite of the fact that there was a large amount of money collected (probably the largest signature bonus in the history of the oil and gas industry), there are some caveats to be explored behind such a result and the reported sense of frustration. Firstly, the auctioned areas had massive participation by Petrobras but only a modest contribution of two Chinese state-owned companies in one of the blocks, Búzios, the largest of the event, where Petrobras won with a 90% share. The rest was distributed 5% to CNODC and the other 5% to CNOOC. Secondly, other areas awarded possessed only one bid from Petrobras without any other consortium member. Thirdly, the profit percentage offered in the two bid areas of the Federal Union were awarded with the minimum percentage. Fourthly, no other foreign company decided to participate in such bid round even though several were qualified. Although the Brazilian government managed to obtain large sums of investments with this bid round, around half of the said amount will most likely come from its own pockets due to governmental shares in Petrobras.
To understand the issues presented by this bid round, it is important to go back to the beginning of this process since this bid round was not “expected” to occur in the past.
The Transfer of Rights contract was signed between Petrobras and the Federal Government in 2010 and authorized the state oil company to explore up to 5 billion barrels of oil within six areas of the pre-salt region. However, due to technological improvements and further studies in the region, it was found that the volume contained in the contracted areas was significantly higher than the one agreed to in the contract. Due to this and relying on the expected review of the contract when the areas were declared commercial, it was decided to bid the remaining oil volumes of four specific areas: Búzios, Itapu, Atapu, and Sépia.
The timing was opportune from the government’s point of view since the incomes from the auction could significantly reduce the Brazilian primary deficit and thus contribute to the adjustment of the Federal Government's accounts. Therefore, a task force was initiated involving the main public and private industry players with the purpose of holding an auction in 2019. It was then necessary to review the original contract (2010), deciding whether or not Petrobras was a creditor of the contract and, if so, how much compensation would be required. The task force was also required to define and outline the distribution of the auction’s proceedings, which involved defining the bidding regime, the signature bonuses of the areas, the distribution of government stakes (such as royalties and special participation fees between the Federal Union, states, municipalities, and others).
Through significant efforts by the federal government, it was able to approve all the auction’s details—after intense articulation in both houses of Congress (Chamber of Deputies and the Senate)—as well as all the technical definitions and their respective audits. With the details set aside and under the current legal framework, the government had to proceed with the bid process under the production sharing regime for the surplus of the four areas previously mentioned, the same model for the blocks bid within the pre-salt polygon. It was also agreed that not only was Petrobras a creditor in the original contract (in the amount of USD 9.058 billion), but it should also be compensated for the exploratory activity carried out in the region (specifically in the four areas which received bids) without clarity on the maximum amount for such compensation.
On the eve of the auction, analysts were expecting opposing scenarios: some saw the areas as highly attractive from both technical and volumetric standpoint, and foresaw an absolute success of the auction, while others saw a series of obstacles, such as the high signature bonuses, the contradictory reimbursement that should be paid to Petrobras by the winning companies in these areas (the technical parameters that delimited the values were at least confusing), even the possibility seen by the companies to include the areas in future bids under slightly milder rules.
Those who bet on the least promising scenario were right. Only the two areas that Petrobras exercised a prior interest in were bid on, and the country ended up raising USD 17.1 billion of the total USD 25.9 billion put to the table. The frustration over the results opens the door for discussions about Petrobras's preference rights, the maintenance of the production-sharing regime, the revision of the compensation methodology for Petrobras’s exploratory spending, as well as the uncertainty regarding the areas that did not receive offers of how they will be auctioned. Despite the general frustration of not achieving the full goal of the auction, even with all the articulation and work done, the raised amount will be crucial for reducing the country's primary deficit and for demonstrating the capacity of many Brazilian entities to command the country in a greater good for society.
A similar story occurred during the 6th round of the Production Sharing Regime as it brought another hit for the Brazilian federal government. The single bid for just one out of the five offered areas enlightens that the government will have to do a better job at making pre-salt blocks attractive to IOCs. Aram was the only giant discovery available and the single one that received any bid, by Petrobras (80% stake and operation) and CNODC (20%). For future bidding rounds, the government will probably ease the requirements and make other decisions, such as if Petrobras will continue to have a preferential right or if the Production Sharing Regime will be the single one available inside the pre-salt polygon. Aside from the issues, the government locked another important USD 1.2 billion to its accounts.
So, the central questions that Brazilian authorities should consider after such bid rounds are the following: 1) Why foreign investors, other than certain Chinese national oil companies, ‘refused’ to bid in both of the large bid rounds; is it the production sharing agreement itself at issue? 2) If this is the case, then why do most of these international companies tend to work with some sort of production sharing agreement in a large number of countries in Africa and Asia? 3) Is the problem related to the precise terms and conditions of the said production sharing agreement with its excessive governmental participation through operations and decision making (e.g. Petrobras, PPSA and ANP)? Apparently, this was not of concern during other Pre-Salt Bid Rounds (e.g. especially Libra with other foreign companies like Shell and Total). 4) Or is the problem related to an excessive signature bonus with their “dying” desire to easy governmental deficits? Or maybe was there uncertainty about Petrobras’s past costs? Or maybe are foreign companies still waiting for a new framework with more attractive conditions? In fact, it could be a combination of all of the above and many would agree that the last three points clearly played a key role in combination with the previous factors.
In any case, foreign companies made their point clear to the Brazilian authorities; they did not believe these recent bid rounds were attractive enough to proceed with any offer. These companies will probably wait for developments and possible changes in the legal framework before participating in any new bid rounds. So, it will be interesting to follow up on this matter and understand how the Brazilian government plans to attract foreign investments in future bid rounds.