Recent developments in Brazil's oil & gas industry: Brazil appears to be stemming the tide of resource nationalism.

• Author: Otillar, Steven P.

1. INTRODUCTION: BRAZIL'S PROMINENCE IN GLOBAL OIL AND GAS DEVELOPMENT II. BACKGROUND: CREATION OF A SAFE HARBOR FOR FOREIGN INVESTMENT A. Development of Brazil's Legal Infrastructure B. Petrobras & International Competition III. BRAZIL'S ENERGY MARKET: A SEA OF OPPORTUNITY A. Crude Oil: A Rising World Power B. Natural Gas C. Hydrocarbon Concessions: Attracting Foreign Capital IV. RECENT DEVELOPMENTS: A POTENTIAL BLOCKADE TO OIL AND GAS DEVELOPMENT A. Analysis of the ANP Bid Round 8 Suspension: The Supreme Court Tenders Pro Foreign Investor Decision B. Unitization: The ANP's Rising Storm C. Evolving Tax Incentives for Oil and Gas Development in Brazil: Will the Change in the Definition of Vessel Float with Investors? V. CONCLUSION: THE RESOURCE NATIONALISM SHIP HAS NOT SAILED, BUT IT MAY BE IN THE HARBOR I. INTRODUCTION: BRAZIL'S PROMINENCE IN GLOBAL OIL AND GAS DEVELOPMENT

   As the tenth largest energy consumer in the world (third largest in the Western Hemisphere after the United States and Canada), one of the world's largest ethanol producers and the country with the second largest crude oil reserves in South America, Brazil (1) is a critical player in the global energy market. (2) Only a year after becoming a net oil exporter, Petrobras's recent discovery in the Tupi field, off Brazil's southeastern Atlantic coast, could add as much as "5 billion [to] 8 billion barrels [of recoverable light crude]--equivalent to 40 percent of all the oil ever discovered in Brazil." (3) Further, the recent rumors surrounding the Carioca field in the Santos Basin, indicate that there could be another large discovery on the near horizon, but there have been no definitive announcements yet regarding such discovery. (4) In a time where high crude oil prices and internal politics have caused much of Latin America to look inward and focus on recapturing dominion and control over their natural resources, (5) Brazil continues to welcome foreign investment from international oil companies (IOCs) to increase direct investment in the hydrocarbon sector. (6) This is not to say that Brazil is a panacea for oil and gas development, as it has its challenges and uncertainties as well. Petrobras's Tupi discovery and the resultant withdrawal of "41 of the most promising blocks" (7) from Bid Round 9 introduced elements of instability and national preference that Brazil has heretofore avoided. This paper will highlight some of the more significant recent legal developments in Brazil and some pending concerns for investing in Brazil, principally in the upstream energy sector.

   First, this Article will provide a general background of the Brazilian energy market and briefly touch on the events that have led it to be one of the most attractive countries for foreign investment in South America. A review of the current status of Bid Rounds 8 and 9 follows thereafter, including an analysis of two injunctions that suspended Bid Round 8 throughout 2007. Then, the Article addresses the increasing likelihood of reservoir unitization in offshore developments and potential constitutional challenges that may result. Finally, the Article examines a pending tax dispute regarding the reclassification of certain offshore oil and gas platforms that will have a material impact on the way most international oil companies structure their exploration and development programs in Brazil.

2. BACKGROUND: CREATION OF A SAFE HARBOR FOR FOREIGN INVESTMENT

   1. Development of Brazil's Legal Infrastructure

      A little over 10 years ago the Brazilian exploration and production sector was essentially closed to foreign participation. (8) It was not until the National Congress enacted Constitutional Amendment No. 9 in 1995 that constitutional restrictions against private participation in the oil and gas sector in Brazil were relaxed by allowing private companies to invest and participate in the upstream sector. (9) Prior to that amendment, all such activities were reserved exclusively for the government-controlled enterprise, Petroleo Brasileiro, SA-Petrobras. (10)

      After the Constitution was amended, a variety of laws were promulgated over the succeeding years which led to the opening of the Brazilian upstream market. In 1997, Law No. 9,478 (the Petroleum Law) was enacted, creating, among other things, the Agencia Nacional do Petroleo, Gas Natural e Biocombustiveis (ANP) to regulate the oil and gas sector. (11) The Petroleum Law also created the National Council on Energy Policy (CNPE), founded to assist and advise the President of Brazil and the Minister of Mines and Energy in the development of Brazil's national energy policy. (12) Most importantly for IOCs, the Petroleum Law revoked Law No. 2.004, which created Petrobras and regulated its activities. (13) Petrobras is now purported to maintain the same status as new private investors in the oil and gas market. (14)

   2. Petrobras & International Competition

      While competition from foreign investors continues to increase, Petrobras remains the dominant player in Brazil's oil sector, holding a majority position in up-, mid-, and downstream activities. (15) Since the enactment of the Petroleum Law, Petrobras has become the fourteenth largest oil company in the world with 2005 net revenues of $47 (U.S.) billion. (16) Petrobras has become an internationally respected, integrated energy company that operates throughout the world and possesses technical expertise and capabilities that rival any IOC, especially in deepwater exploration and development. (17)

      Since December of 1998, the ANP has been holding licensing rounds whereby all interested companies, including Petrobras, can compete for oil and gas exploration and production concessions in specific exploration blocks. (18) The bidding process established by the ANP created an even playing field that has allowed open competition among IOCs and has historically fostered a favorable framework in Brazil for foreign investors. (19) In addition, from a political standpoint, Brazil is stable and in all but the most recent bidding rounds has continued to pursue a transparent, open process focusing on high bonus payments, significant local content, and substantial minimum work programs. (20) In order to foster transparency in the bidding process, the ANP announces winning bids publicly and discloses the economic terms of all bidders and the resultant bid score. (21)

3. BRAZIL'S ENERGY MARKET: A SEA OF OPPORTUNITY

   1. Crude Oil: A Rising World Power

      Without consideration of the Tupi discovery, Brazil has an estimated 11.7 billion barrels of proven oil reserves and is one of the fastest growing oil producers in the world. (22) When combined with the Tupi discovery, Brazil would have at least the eighth largest proven oil and gas reserves in the world. (23) In 2003, Royal Dutch Shell was the first foreign operator in the country, operating a single small field in the Campos basin. (24) In mid-2007, "Devon brought its Polvo project (50,000 bbl/d) online ... representing the [first major] oil project without any Petrobras participation." (25) More recently, companies such as El Paso Energy and ChevronTexaco have announced that they intend to commence commercial production in 2008 or 2009. (26)

   2. Natural Gas

      Development of natural gas has become a priority for Brazil, which currently has approximately 10.8 trillion cubic feet of proven natural gas reserves, 90% of which are controlled by Petrobras. (27) Although Petrobras enjoys the majority control of the natural gas reserves, there are other important foreign participants in the natural gas industry, including Sulgas and BG Group. (28) Currently, natural gas is a minor contributor to the overall energy supply; however, recent difficulties with Bolivia and other trading partners have highlighted the risks associated with relying on third party suppliers for the bulk of Brazil's natural gas. (29) As a result, Brazil is concerned with developing its internal natural gas reserves, and its recent focus on developing this area becomes evident upon analyzing the properties made available for Bid Round 9, which notably included many gas-prone areas. (30)

   3. Hydrocarbon Concessions: Attracting Foreign Capital

      Both IOCs and national oil companies that are interested in acquiring the rights to explore, develop and produce hydrocarbons in Brazil must participate in a transparent and public bidding process (each a bid round) that is established under the Petroleum Law and related regulations. (31) Typically, the bidding process involves: (a) delivery of an "expression of interest"; (b) payment of a "participation fee"; (c) withdrawal of the "information package"; (d) legal, technical and financial qualification; (e) presentation of the required guarantees; (f) tender of the bids; (g) judgment of the bids; (h) the ratification of the judgment of the bids; and (i) execution of the concession agreement. (32) In the first seven bid rounds, Brazil successfully granted 610 exploration blocks; however, the results of Bid Round 8 are still pending. (33) In Bid Round 9, which concluded on November 27, 2007, 117 blocks were awarded. (34)

4. RECENT DEVELOPMENTS: A POTENTIAL BLOCKADE TO OIL AND GAS DEVELOPMENT

   Notwithstanding the relative optimism in the Brazilian upstream market when compared to the rest of Latin America, there are a number of concerns which make doing business in Brazil challenging. While there are many challenges to any successful exploration and development project, the constraints of this Article do not allow a full discussion of all of the complexities that will be encountered in Brazil, such as the environmental permitting process, difficulties with customs and importation, and multiple layers of taxation. This Article focuses only on a select group of issues where current legal cases or disputes are pending or have recently been resolved. This section of the Article will address concerns regarding several of the recent bid rounds, including...