Debate on Brazillian Pre-Salt Royalties

Introduction

The Brazilian Senate voted on 19th October 2011 in favour of a proposal to change the allocation of oil revenues amongst Brazil’s federal government, its 26 states and 5564 municipalities. For this to become law, it now needs to be approved by Congress. The proposed reform will have the effect of redistributing royalties away from the oil producing states of São Paulo, Rio de Janeiro and Espírito Santo, in favour of non producing states and municipalities. It is estimated that Rio de Janeiro alone will lose US$2.42 billion in 2012 and US$4.23 billion in 2013. While, at first sight, the internal wrangling between states of the Brazilian Federal Republic may not appear to be of great importance and will not, for example, affect the level of royalties payable by oil companies, the completion of this debate is critical for the oil and gas industry in Brazil. Until this dispute is resolved and the accompanying legislation is put in place, the 11th licensing round, which was originally expected this year and is now scheduled to take place in 2012, may not be launched.

Historical Background

Ever since the discovery of the huge pre-salt oil reserves offshore Brazil, the government has been deliberating on exactly how to distribute its oil wealth. Most of Brazil’s oil is found in offshore fields located in its South-Central continental shelf, mainly in the basins of Santos, Campos and Espirito Santo. The state that benefits the most from the current arrangement is Rio de Janeiro, due to its extensive coastline and proximity to Brazil’s most productive oil fields. As a result, Rio is home to the majority of Brazil’s oil and gas industry.

An inter-ministerial commission was formed in 2008 with the specific task of putting forward suggestions as to how to reform the regulatory regime. The commission put forward proposals for a new regulatory regime in 2009, including plans which would require oil companies to share a percentage of production with the Federal Government, it held off from dealing with the allocation of tax revenues from oil production among Brazil’s states and municipalities. In part, this was due to the potential for a long, arduous and heated debate on the subject, with all stakeholders seeking to promote their interests. This type of inter-state and inter-municipality discussions are common in Brazil, where states and municipalities regularly feud over the distribution of tax revenues. The uneven geographical distribution of oil reserves within the Brazilian territory has further aggravated the political climate.

Current Dispute

As can be seen from the table below, the present distribution of royalties is weighted heavily in favour of the oil producing states and municipalities, with only 8.76% being distributed among the non producing states and municipalities. Under previous legislative proposals, it was hoped that the Federal Government would step in and give-up some of its allocation, (which currently stands 30% for royalties and 50% of the Participaçao Especial) in order to break the deadlock but this has not happened. Ex president, Luiz Inácio Lula da Silva, was initially in favour of equal royalties for all states but, under pressure from the oil producing states, he changed his mind to support their more favourable treatment. Lula’s proposal was not accepted by the political representatives of non producing states, who put forward an amendment, the “Emenda Ibsen”, named after its chief sponsor, Congressman Ibsen Pinheiro, which proposed that royalties would be distributed equally among all states without preferential treatment in favour of producing states and municipalities. The Emenda Ibsen extended this treatment to all exploration blocks, including those outside the Pre-Salt area, and retrospectively to blocks which had already been auctioned.

The Emenda Ibsen, however, was vetoed by Lula in the final days of his presidency. Consequently, the whole issue returned to the Senate for further deliberation, where the current bill was approved and now awaits the consideration of Congress, which may not take place until 2012. As a result, the political debate has now intensified. Congress is likely to vote in favour of the proposal, which would result in the oil producing states losing a significant share of oil revenues in favour on non producing states and municipalities, as shown in the table below. Both Sergio Cabral, the Governor of Rio de Janeiro, and Edison Lobão, the Minister for Mines and Energy, have indicated that if the previous veto by President Lula is annulled, they will initiate legal proceedings to stop the implementation of the proposed law. Indeed, things could get ugly; Senator Magno Alta, a prominent Rio politician, recently promised to paralyse the country in defence of Rio’s royalties.

Conclusion

There are valid arguments of a legal and political nature from both camps. On the one hand, the Brazilian constitution provides that the ownership and exploitation of oil reserves is a prerogative of the federal government, as opposed to individual states and municipalities. On the other hand, dividing oil revenues equally amongst Brazil’s states and municipalities, may limit the incentive and resources of local policymakers in oil producing states, for promoting the development of oil exploration, infrastructure and industry-friendly regulations within their respective territories.

Whichever way Congress votes, it is likely that the debate will continue for some time, with the possibility of legal challenges following any change to the law. This is relevant for the oil industry and the private sector, as will affect the timing of the next licensing round and the next wave of investment in exploration and production. Despite the announcement in August 2011 by Edison Lobão, that the next round would take place in 2012, this is by no means guaranteed until the ongoing political and legal wrangling is resolved. Brazil has not offered any offshore acreage since the 9th licensing round in 2007, so this continuing delay risks reducing projected investments and future oil revenues at a time when Brazil is seeking to attract inward investment to its oil and gas sector.

Table showing changes in the allocation of oil revenues under the current proposals