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Discouraging investors

25th October 2013

By: Keith Campbell

Creamer Media Senior Deputy Editor

  

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On October 21, Brazil should have auctioned the first element of its rich new “pre-salt” offshore oil resources, the Libra oilfield. (“Should have” because this column was written before the scheduled date of the auction.) Libra is estimated to hold between 8-billion and 12-billion barrels of oil and it could have an output of up to one-million barrels a day at full production. Currently, Brazil’s total annual oil production is some two-million barrels a day (ranking the country as South America’s – not Latin America’s – second-largest producer, after Venezuela).

The pre-salt oilfields are so-called because of their location. They start some 3 400 m beneath the seabed, or about 5 500 m below the sea surface. On top of the oil reservoirs lies a layer of salt which is about 2 000 m thick. Above the salt layer is a roughly 2 300 m thick layer of sediments. Because the oilfields are below the salt layer, they are older than that layer, and so came before it – hence, pre-salt. The Libra field covers some 1 500 km2, but forms only a small part of the pre-salt oil resources.

Excited by the rich possibilities of the new resource, whose discovery was announced by Brazil’s predominantly State-owned petroleum group Petrobras in 2007, in 2010, the centre-left government (then led by President Luiz Inácio Lula da Silva of the Workers Party) changed the law and regulatory framework for the country’s oil sector. Under the new model, Petrobras gets a compulsory minimum 30% share in all the pre-salt oilfields and has to be the sole operator of the fields. All pre-salt production contracts will be production-sharing contracts, in which the oil extracted belongs to the State but investing companies make their money through selling a share of the oil produced. The winning bidder will be the company that proposes the biggest share of production for the State.(The previous model used in Brazil, and – it is essential to note – still in force for the country’s other oilfields, was and is a concessionary model in which the oil is the property of the company extracting it and the State receives revenues through taxes and royalties.)

Further, there are strong local content requirements that the winning bidder must fulfil. In the exploration phase, 37% of equipment, goods and services must be acquired in Brazil, rising to 55% in the development phase. Moreover, as Libra has already been partially explored and is thus regarded as a less risky proposition than the other pre-salt fields, the winning bidder must pay a $6.8-billion “signing bonus” to the State. The contract period is 35 years.

The Brazilian authorities confidently expected some 40 oil companies to register for the auction. They got 11. Of the global major private-sector multinational oil companies, only Royal Dutch Shell and Total are taking part. No US oil companies are bidding, nor is BP. Strikingly, the UK’s natural gas major, BG Group (which was one of the two companies created by the demerger of British Gas, the other being Centrica), which already has a major presence in Brazil and started production from the country’s Sapinhoá offshore oilfield in January, also declined to bid for Libra. (BG holds 30% of Sapinhoá and Petrobras 45%, with the remaining 25% belonging to Sino-Spanish joint venture Repsol Sinopec Brasil.)

The only other private-sector bidder for Libra is Japan’s Mitsui. The remaining eight are all State-owned companies, including all three of China’s oil majors, namely the China National Petroleum Corporation (PetroChina), CNOOC (pre- viously known as the China National Offshore Oil Corporation) and Sinopec (through Repsol Sinopec Brasil, in which the Chinese company has a 40% share). The other bidders include Malaysia’s Petronas, India’s ONGC Videsh and Colombia’s Ecopetrol.

There is no doubt that the Brazilians have been disappointed by the response. But local and international observers of the oil industry have noted that the conditions imposed by the Brazilian government were just too demanding. Private-sector companies have to make a profit. These pressures are less severe for State-owned companies, especially if they are mandated to firstly seek and secure energy sources and secondly make profits.

This is all clearly of direct relevance to the announcement by the South African government that it would take a ‘free- carry’ 20% share in all future shale gas operations in the country’s Karoo region. Moreover, the State would have the right to buy another 30% (at market prices), allowing it to have 50% of any or all such operations. Now, extracting shale gas from the Karoo is much simpler and cheaper than getting oil out of Brazil’s offshore pre-salt fields. But the South African government seems to have fallen into the same mental trap as its Brazilian counterpart – assuming that the country’s hydrocarbons resource is so attractive that foreign companies will have to bid for concessions and that there will be a long line of contenders eager to get access to the oil or gas. So, in consequence, government can impose strict conditions that will enrich the State, and sit back and let the money come rolling in.

The pre-salt auction disappointment shows that this is nonsense. Oil and gas companies have plenty of alternatives in friendlier regulatory regimes. In particular, rich shale gas resources are being discovered in many countries. Companies will not be able to invest in them all. They will pick and choose. South Africa is busy making itself one of the less attractive options.

Of course, bids will be made for the country’s shale gas, but, most probably, these will be mainly from State-owned companies. Now, State-owned companies can and do have considerable financial resources and expertise. But dealing with foreign State-owned businesses can involve political complications, especially if things go wrong, which is usually not the case with private-sector enterprises. How willing will Pretoria be to have an argument with a major Chinese State- owned company?

Finally, one other point: if the South African government is such a significant shareholder (and 20% is significant) in all the country’s shale gas operations, how will national regulatory agencies actually be able to regulate the industry? Is it credible that one part of the govern- ment will be able to regulate another? Pretoria’s shale gas plan will create a huge conflict of interest.

Edited by Martin Zhuwakinyu
Creamer Media Senior Deputy Editor

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