CRE Special Studies

Still in a festive mood from the announcement of a huge oil discovery in the Santos Basin, which can raise Brazilian reserves by 50%, the government made a controversial decision: it excluded 41 exploration blocks from the Brazilian National Oil Regulatory Agency (ANP - Agência Nacional de Petróleo) Ninth Bid Round set for November 27 and 28. Considered the most lucrative of the auction, these blocks are located on pre-salt rocks, in an 800-kilometer (approximately 497 miles) region between the states of Santa Catarina and Espirito Santo.

The news caught private companies having investments in the sector by surprise and many have decided to re-evaluate their participation in the bid round. The ANP will have to return R$5 million reals (US$2.92 million) to 24 companies that had been licensed to compete in the auction for the excluded blocks. This amount represents what was paid for acquisition of data on those regions. The number of blocks in the bid process fell from 312 to 271, with only 111 being considered as high level oil potential.

Engineer, Nelson Narciso Filho, one of the ANP directors, acknowledged that the round lost part of its attractiveness, but he discarded the possibility of legal actions that could be taken by groups which feel they were affected having a negative impact on the bid process. “The government’s decision is supreme.” According to General Director of the agency, Haroldo Lima, the measure was based on two bid notice clauses that allow blocks to be withdrawn due to “public interest” up till the moment the proposals are delivered. The official justification is that, as in the recently discovered Tupi reserve, the other blocks that would participate in the auction can be more valuable than is thought. “We withdrew everything that can be related to the discovery and left the other blocks for the auction," said Chief-of-Staff, Dilma Rousseff.

Although he agrees that the contract was not broken since legislation was not disrespected, the President of the Brazilian Institute of Petroleum, Gas and Biofuels (IBP - Instituto Brasileiro de Petróleo, Gás e Biocombustíveis), Joao Carlos de Luca, who also manages the Spanish company, Repsol-YPF, admits the decision affects anticipation of the processes. "Withdrawing the blocks does not contribute to the credibility we defend. We understand the government’s reasons, but this has an impact on the round,” he said. The repercussion from the decision also was negative for the Federation of Industries of Rio de Janeiro (Firjan - Federação das Indústrias do Rio de Janeiro), a state which has a greater concentration of the sector industries. “It was as if you invited a friend to dinner and then called off the engagement because you thought the food was too good," compared the organization’s president, Eduardo Eugênio Gouvêa Viera.

According to Jorge Camargo, president of the Brazilian affiliate of the Norwegian company, StatoillHidro and coordinator for the IBP exploration and production committee, the period for choosing to exclude was poor because it occurred right before the auction. “The ANP itself had already called attention to the area during a technical seminar some months earlier. It didn’t have to wait until November to withdraw the blocks,” he said, classifying the change as “serious and worrisome.”

Even with being in compliance with the law, there was a break in reliability, according to lawyer, Guilherme Vinhas, partner in a firm specializing in the oil sector. “One of the more important aspects for large businesses is the stability of the rules, which were negatively affected by the withdrawal. The companies invested in research and were ready to send their proposals,” he says, believing that the government lost a great opportunity. “The Tupi discovery could have been used to increase profits through higher proposals. Now, there will be a delay in the exploration of these areas. This is extremely damaging to the country, and even more so with scarce energy resources.”

Consultant, David Zylbersztajn, ex-director for the ANP, believes the withdrawal is a warning signal. “The government was elected democratically and it has the right to change or propose changes to the law. What I find complicated is changing the rule in the middle of the game. It was the stability of these rules in the last 10 years that attracted private investment to the oil and gas sector in Brazil. The right thing to do now would be for Petrobras to participate in the auction for these areas, competing with other companies. Simply passing on the control to the state cannot be done, unless the law is changed," he said.

The 41 blocks excluded from the Ninth Bid Round will be explored using other exploration model contracts to be defined in future bid processes. The ANP general director believes in the need for more liberal legislation with more flexible forms of permission for exploration, such as production distribution or a service contract. Currently, only a concession basis is used. The investors are unsure. “It would be important for the government to decide these issues as quickly as possible. News of reviewing the model and changing the law, with speculation that they could serve in the interests of the oil sector returning to a state-owned business causes a lot of apprehension for private initiative. It has created an undefined legal situation,” said Vinhas.

One of the speculations that appeared was the exclusion of 41 areas could have been motivated by the presence of ex-Petrobras managers acting as consultants for OGX, a subsidiary of the gas branch in the EBX group, belonging to businessman, Eike Batista. These technicians would have privileged information on pre-salt layer reserves. In interviews with newspapers, the businessman denied access to exclusive data and confirmed he was going to participate in the auction. According to him, OGX was classified by the ANP as a B operator and could only make bids for onshore blocks or in shallow water. The company, Companhia Vale do Rio Doce, which disclosed it was still evaluating its participation in the bid after the exclusion, confirmed that it was going to participate in the bid round also as a B operator.

At the same time the blocks were withdrawn, the ANP announced that it would hold the Eighth Bid Round, which had been suspended by the courts last year, in the first quarter of 2008 The bid process continues at the point it was stopped, with the same rules and blocks announced in the bid notice, including those located in the pre-salt layers. According to Nelson Narciso Filho, the bid limitation for each company, which was the reason for cancelling the auction, will also be maintained This limitation will not allow a competitor to acquire as many blocks as it wants in a sector. As an example, the rule limited Petrobras participation in the Santos Basin.

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