Brazilian local content under review: sit tight and wait

This is a collaborative article by Carlos Rocha and Mariana Anjos.

2017 has been a decisive year for Brazil local content requirements changes. The government halved the local content requirements for this year's bid rounds (14th and 3rd presalt bid round) in order to attract more investments to the country. However, there was still missing a solution for the local content (LC) in the pre-existing contracts to guarantee the sustainability of the industry until the results of the next bid rounds arise, after 2025.

The waiver would be the solution, but the first attempt of serious adoption, for Libra's floating production, storage, and offloading (FPSO) unit is still under consideration. The pledge result has not yet been announced by the National Agency of Petroleum, Natural Gas and Biofuels (ANP), given the level of arguments that it has created, but the last initiative could end most of the discussions.

ANP is making available for public hearing the draft of a new decision that will allow changes in the LC rules of older contracts. ANP justifies the proposition to allow concessionaries to switch from the LC terms of old contracts (the 7th to 13th bid rounds, including the first production-sharing agreement [PSA] and transfer of rights) to the standards presented in the 14th bid round.

These changes will benefit a large number of projects until at least 2030, when yet-to-find resources will become available for the majority of the projects and will have positive consequences for the upstream sector:

• This change could potentially reduce the size and amount of fines issued to field operators.
• If the change is accepted, the main bottlenecks in offshore drilling and floating production, storage, and offloading (FPSO) construction will be solved, allowing more projects to enter the development phase.
• The local offshore construction industry of FPSO platforms and drilling rigs will be downsized to the 2012 level.

The new measures will have a deeper impact than the Libra waiver because they help to resolve lingering issues in other items, such as drilling, that could result in fines large enough to compromise the feasibility of some projects (up to U$4.5 million until 2025), making the fleet of Brazilian-built drilling rigs unnecessary.

LC requirements have been reduced to more realistic numbers and divided unevenly among the segments: for onshore projects, the overall requirement for both exploration and development is 50%; for deepwater projects, the overall requirement for exploration is 18%, while for FPSO and well construction, it is 25%; and for collection and offloading systems, the requirement is 40%. Also, LC fines have been reduced from the 60-100% range to 40-75%; however, waivers have been ended owing to these changes. The new rules that can now be adopted in all the contracts have values 50% lower than the previous requirements and are simplified for large items. According to IHS Markit analysis, these required values can be achieved with the installed capacity of the Brazilian industry without too much impact on costs (assuming the maintenance of the current exchange rate) or schedules.

Even for FPSO construction, we believe that existing cases demonstrate the feasibility of these LC values proposed for the next bid rounds (see Figure 1). Only the adoption of new technologies could compromise the achievement of these values.

Figure 1: Estimated cost and LC for a presalt FPSO with different procurement strategies

Considering a procurement strategy that adheres to LC values of 25% for the presalt (150,000 b/d) FPSO, 40% for the subsea with satellite wells and flexible flowlines and risers, and 25% for the drilling construction, IHS Markit estimates that LC fines according to the existing contract would be US$1.8 billion. Using a simplified calculation in which this fine is considered as a cost, the break-even price increases by 14% when compared with the same case. But the new proposed rules would eliminate LC fines and have a break-even price of US$51/bbl.¹

Another pitched battle is likely between some local industry segments, the ANP, and oil companies, as happened during the approval process for the changes to the new bid rounds and the waiver of the Libra FPSO. However, as before, there are good chances that the new regulatory drive will prevail and the latest changes will be implemented. This public discussion is apparently started in the last launch window still far enough ahead of the next national elections, when the appeal of the usual rhetoric about the exportation of national jobs and wealth to foreign companies is strongest.

This proposed change to LC requirements would represent the deepest and most effective shift in Brazil's upstream energy market so far and represents the best chance to revitalize this segment.

1. Break-even analysis reflects the final investment decision, which includes government take, development drilling, facilities, equipment, subsea, and operating expenditure with a 10% allowance for return on capital.

For more detailed analysis of Brazilian upstream cost analysis, clients can find the IHS Markit Insight Bitter Medicine: The healing of Brazil's upstream sector and the IHS Markit Event Brazilian Upstream Market: All bets are off, on Connect. Not a client yet? Explore our upstream cost solutions.

Carlos Rocha is an Associate Director with IHS Markit.

Mariana Anjos is a Senior Associate with IHS Markit.

Posted 26 July 2017

Mariana Anjos, Senior Associate with the IHS Markit Cost and Technology group, covers Brazilian E&P costs an d strategies and regional markets. Her experience is in planning and control, scheduling, renewable energy (specifically hydrogen), engineering, and research. Prior to joining IHS Energy, she worked at Petrobras and Doris Engineering, where she developed projects including front-end engineering and design for the presalt platforms and risk analysis for oil and gas enterprises. Ms. Anjos holds a bachelor's degree from the Fluminense Federal University and a specialization in oil and gas supply chain from Brazilian Petroleum Institute.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.