By Arthur Souza Rodrigues*
Brazil liberalized its oil & gas exploration and production (“E&P”) sector in 1997.  Until 2010, the concession regime was the only legal framework regulating the sector. However, even after a decade of opening the market, the participation of Petrobras, Brazil’s national oil company (“NOC”), remained pervasive; despite, officially, being just one more player in the market. After the discovery of vast “pre-salt” deepwater oil and gas reservoirs, the populist government of President Luiz Inácio Lula da Silva decided to introduce a more nationalistic approach. This new approach resulted in a production sharing agreement (“PSA”) for the pre-salt areas, in which the Petrobras would be the mandatory operator of the fields.
When Lula’s protégée, Dilma Rousseff, was impeached in 2016, the financial situation of Petrobras was already severely deteriorated, which made the single-operator rule unfeasible without additional subsidies or capital. To balance the interests of the new government, which wanted to increase private capital in the sector, but also protect national interests, several changes in the program were made to open it up to market pressures while still maintaining Petrobras’ dominance. While the reforms attracted much needed private, i.e. foreign, investment, almost all “new” participants are old players in the Brazilian market. Even though some changes seem small, such as the new focus on profit oil instead of the signature bonus and more moderate local content rules, they resulted in significantly different results after the bidding process. These changes resulted in increases in both competition and government share. This post will discuss the results of these changes, Brazilian experience, and how countries with limited capital or expertise may increase production and revenue.
II. THE PSA REGIME AND THE 2016 CHANGES
a. The Production Sharing Agreement Regime in Brazil
Under the concession regime, the company that is granted rights to exploration and production of an area (called “blocks”) owns the results of its activities in the area. The government receives royalties and some other fees in exchange. This regime remains the legal framework for areas other than the pre-salt, and pre-salt areas already auctioned.
Under the original PSA regime, private companies could enter into a consortium with the federal government (the “Union”) and Petrobras, giving in exchange a share of the results. The original PSA regime established Petrobras as the sole operator. Petrobras is a listed company controlled by the Union, and its capital is spread among the government and private entities. International companies were able to participate in the consortium on equal footing with other local companies, but Petrobras remained the sole operator. The consortium is formed by a non-operator, the Pre-Salt Petroleum Corporation (PPSA), the operator (Petrobras), and other stakeholders. All members of the consortium are joint members. PPSA receives the profit oil in the name of Union and administers the PSA. Cost of production is deducted, and is called “cost oil.” “Profit oil” is the surplus production, owned by PPSA. It is important to note that the government owns all the oil produced. In comparison, in the concession agreement, the concessionaires pay royalties and a special participation fee, and they subsequently own the oil after extraction.
The primary modification in the system after 2016 is to allow Petrobras to choose its role in the pre-salt E&P areas freely, while allowing competition. Petrobras still has the chance of being the sole operator, and it can even decide to join the bidding round later. Currently, the Union, through its National Council for Energy Policy (CNPE in Portuguese), still decides whether an area should be available for E&P purposes. Petrobras has the right of first refusal for thirty days, having either the option to refuse or accept to be an operator. If the company decides to participate in a consortium, its share in the consortium should never be less than thirty percent, whether it is an operator or not. When Petrobras exercises its right, the remaining stake in an area will be subject to a competitive bidding procedure (“bidding rounds”), whereby other companies can choose to participate as operators or not. If Petrobras initially refuses to participate in the round, it can still decide to participate later. Winners are decided by who offers the highest profit oil, as a percentage of total oil produced.
b. The Bidding Rounds After the 2016 Legislative Change
Overall, the new changes resulted in a higher share of the profit oil, while requesting substantially smaller upfront investments with signature bonuses. They also resulted in increased competition, and foreign companies’ participation. The first bidding round in 2013 offered a single block (called Libra) in the Santos basin. Petrobras’ share was 40%, with the remaining distributed among Shell, Total, CNPC, and CNOOC. Profit oil reached 41.65%, from a government established minimum of 40%. The consortium paid BRL 15,000,000,000.00 in signature bonus, a fee paid at the moment an area is granted. A higher signature bonus and lower profit oil mean higher investment upfront, but lower profits in the court of the E&P activities.
The second and third bidding rounds occurred in October 2017. Initially, the third round was scheduled for early 2018, but this was moved earlier to increase government revenue. Both rounds had healthy competition, and both offered four high potential blocks. The twelve different companies (ten of them foreign) were well-known from previous bidding rounds (by the concession regime). In the second round, in one area profit oil reached 76.96%, with Petrobras operating in two of the three blocks auctioned. Minimum profit oil ranged from 10.34% to 22.08%. In the third round, profit oil reached 80.00%, and Petrobras would be the operator of one out of three blocks auctioned. Minimum profit oil ranged from 14.40% to 22.87%. While the government obtained an even higher share of profit oil, the signature bonuses decreased substantially. For the second round, the bonus was BRL 3,300,000,000.00, and for the third round, the bonus was BRL 2,850,000,000.00.
Increased competition alone cannot explain these boosts in the profit oil. In addition to its percentage of profit oil, and the signature bonus, each bidder is required to fulfill a minimum local content percentage of total E&P activities. Local content is the amount a company would have to buy from local service providers. While there is disagreement whether some of the more ambitious minimum local content requirements can ever be met, there was a substantial reduction in each stage of the E&P process from the first to the second and third rounds. Minimum percentages for the first bidding round were 37%, 55%, and 59% for exploration, and for two other development stages, respectively. For the second round, minimum local content for the exploration phase ranged from 35% to 38% among the auctioned areas. An additional block that did not receive an offer, Sudoeste de Tartaruga Verde, had a minimum percentage of 55% during the exploration stage. For the development stage, the percentage ranged from 30% to 60% among the auctioned areas, and 65% for Tartaruga Verde. The government reduced the minimum local content even more radically for the third bidding round. For the exploration stage, all blocks had 18% minimum local content, and 25%, 40%, and 25%, for the last three development stages, respectively.
The changes in the way the government receives its share of the E&P activities and lower local content requirements indicate an increased opening of the market, and more realism to what and how much can be hired locally. So far, this has also resulted in a bigger slice of the cake for the government.
Behind a thin veil of continuity, substantial changes occurred in practice following the extinction of the single-operator rule in the Brazilian PSA regime. Aside from allowing Petrobras to concentrate on the most profitable areas and reduce its leverage, it also had the result of increasing the participation of other companies from four to twelve other players. The effective change in the government share is substantial: instead of focusing on high signature bonuses, it decided to increase its share in profit oil. This could result in more money in the long run. As mentioned above, the large signature bonus may have reflected more politics than science, as the first bidding signature bonus was considered unrealistic to many commentators. However, after the changes, competition among players and more realistic local content rules resulted in higher profit oil levels for the government. No new participants have entered the market, which may reflect uneasily upon the new rules, or alternatively may mean entrants are cautious about Brazil’s political and economic situation. These results offer thought-provoking data for countries looking for changes in their legal E&P regimes. They can also provide information about the trade-offs between concentrating exploration in the hands of a sole government-controlled operator and additional players.
*Arthur Souza Rodrigues is a Junior Editor on MJEAL. He can be reached at email@example.com.
The views and opinions expressed in this blog are those of the authors only and do not reflect the official policy or position of the Michigan Journal of Environmental and Administrative Law or the University of Michigan.
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 See, e.g., Bruno Rosa & Ramona Ordoñez, Governo estuda rever modelo de exploração do pré-sal, O GLOBO (Dez. 2, 2017 7:11PM), https://oglobo.globo.com/economia/governo-estuda-rever-modelo-de-exploracao-do-pre-sal-14832871 (in December 2014, discussing how low oil prices and the crash in the company’s valuation may result in a change of the legal regime).
 AGÊNCIA NACIONAL DO PETRÓLEO, The regimes of concession and production sharing, http://www.brasil-rounds.gov.br/ingles/regime.asp (last visited Nov. 15, 2017).
 “In the Oil and Gas industry, Operator means the individual, company, trust, or foundation responsible for the exploration, development, and production of an oil or gas well or lease. Generally, it is the oil company by whom the drilling contractor is engaged.” USLEGAL, Operator (Oil and Gas) Law and Legal Definition, https://definitions.uslegal.com/o/operator-oil-and-gas/ (last visited Nov. 15, 2017).
 Supra, note 5.
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 Supra, note 5.
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 Id.; AGÊNCIA NACIONAL DO PETRÓLEO, EDITAL DE LICITAÇÃO PARA A OUTORGA DO CONTRATO DE PARTILHA DE PRODUÇÃO – DISPOSIÇÕES APLICÁVEIS ÀS ATIVIDADES DE: EXPLORAÇÃO E PRODUÇÃO DE PETRÓLEO E GÁS NATURAL – PRIMEIRA LICITAÇÃO DE PARTILHA DE PRODUÇÃO (2013), http://www.brasil-rounds.gov.br/arquivos/Edital_p1/Edital_autorizado_030913.pdf.
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 Supra, note 16.
 AGÊNCIA NACIONAL DO PETRÓLEO, TENDER PROTOCOL – AWARD OF THE PRODUCTION SHARING AGREEMENTS FOR EXPLORATION AND PRODUCTION OF OIL AND GAS – SECOND PRODUCTION SHARING BIDDING ROUND (2017), http://www.brasil-rounds.gov.br/arquivos/RoundP2/edital/ingles_edital_lpp2_alterado_19102017.pdf.
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 Ramona Ordoñez, Bônus de assinatura para a área de Libra, no pré-sal, será de R$ 15 bilhões, diz ANP, O GLOBO (Nov. 15, 2017 10:59 PM), https://oglobo.globo.com/economia/bonus-de-assinatura-para-area-de-libra-no-pre-sal-sera-de-15-bilhoes-diz-anp-8916091.