BRAZIL

On a March day half a millennium ago, Pedro Alvares Cabral sailed west from the mouth of the Tagus River in Portugal. The intrepid captain and diplomat commanded 1,200 men in 13 ships. His flagship, Nau Capitania, crammed with a crew of 165, was a fragile wooden vessel that measured just 28 meters. Cabral's mission was to follow up on Vasco de Gama's exhilarating discovery of a sea route to India. On April 22, 1500, the Portuguese seafarers encountered what is now Brazil. The voyagers at first believed it to be an island; they had no conception that their landfall would eventually emerge as Portugal's wealthiest and most vibrant colony. Indeed, Brazil even served as the seat of the Portuguese Empire during Napoleanic times, when warfare in Europe drove the ruling family to decamp to Rio de Janeiro for 13 years. Today, Brazil commands Latin America's largest economy, with a 1999 gross domestic product of $554 billion. The country is recovering nicely from the devaluation of its currency in January 1999-the real has regained some of its strength, inflation has been kept in check, and interest rates have dropped. Surprisingly, Brazil even grew its GDP 3.1% in the fourth quarter of last year. Overall, the economy expanded 0.8% in 1999, defying widespread predictions of a contraction. As the fifth largest country in the world, Brazil spans an area larger than the continental United States. Its 163 million people mainly cluster in urban areas not far from its 4,600 miles of Atlantic coastline. The economy has been geared toward agriculture and industry. One of Brazil's cherished national goals is self-sufficiency in oil production. The country produces about 1.2 million barrels per day, but consumes 1.9 million per day. Imported crude, mainly from Venezuela and Argentina, makes up the gap. Yet, Brazil's vast area is very lightly explored. The country has just over 7,000 active wells, some 600 of which are offshore producers. Petrobras, the state oil company, reports that 3,534 onshore and 1,539 offshore exploratory wells were drilled in Brazil from the beginning of oil exploration through 1997. At the end of 1998, Brazil's proven reserves stood at 7.4 billion barrels of oil and 226 billion cubic meters of gas; total reserves were 17 billion barrels of oil equivalent. The much-anticipated opening of Brazil's exploration and production sector is finally a reality. Since 1954, Petrobras had reigned as the state monopoly, charged with handling all activities concerning petroleum. Foreign companies did participate to some degree in Brazil between 1976-1985, when Petrobras held eight bid rounds that offered risk service contracts to foreign and domestic firms. About 250 risk contracts were signed in all; Petrobras reports that companies under risk venture contracts drilled 122 onshore and 74 offshore wells, investing about $1.8 billion (in current dollars) in exploration. Unquestionably, exploration to date has determined that the bulk of Brazil's petroleum wealth lies underneath its Atlantic margin. Petrobras began offshore exploration in the late 1960s; discovery after discovery propelled the company into ever-deeper waters. The company has long been recognized as a world leader in deepwater drilling, completion and production technology. In the early 1990s, however, Brazil realized that it urgently needed investments in sectors such as energy, transportation and telecommunications to keep it competitive in world markets. Its vital infrastructure was deteriorating, and privatization was seen as the best way to attract capital. In 1995, the country began the tortuous process of delineating the terms for foreign participation in its precious petroleum resources. That effort culminated in the signing of the New Oil Law in August 1997. The government created the Agencia Nacional de Petroleo (ANP) to regulate the industry and to let contracts and concessions to outside companies. (See "The Sleeping Giant Stirs," in Oil and Gas Investor, June 1998.) Petrobras, although stripped of its privileged position as a state monopoly, was nevertheless ensured dominance in the new order. The company was allowed to select concessions not exceeding 12% of the total Brazilian sedimentary area. Petrobras could apply for concessions in areas where it had established production; in areas where it had undeveloped fields that were capable of production; and in areas where it had made significant investments. Significantly, the ANP allowed Petrobras to maintain control of slightly over half the offshore Campos Basin, the source of about 70% of Brazil's current production. The ANP gave Petrobras three years to begin commercial production on its preferred concessions; the agency later extended 31 blocks for two additional years, and two blocks for six additional years. The remaining blocks received no extension. If Petrobras does not begin production by that time, the concessions revert to the ANP, which then can reassign them to other companies via a bidding process. After the passage of the oil legislation, the first step for many companies was to join with Petrobras in partnership deals. Petrobras offered 32 areas to outside companies, concessions on which the clock was ticking. These deals marked the beginning of private investment in Brazil. The first such arrangement Petrobras made was in October 1998, when it and Coastal Corp., along with two other partners, finalized a deal in the offshore Camamu Basin. Companies that have entered into partnership contracts with Petrobras include ExxonMobil, Texaco, Kerr-McGee, Amerada Hess, Shell, Odebrecht, Japex, Marubeni, Santa Fe Snyder, TotalFinaElf and Enterprise Oil. For the most part, the partnerships have involved exploration acreage. Only in a few cases has Petrobras invited companies to participate in development opportunities. Companies competitively negotiate with Petrobras for the partnerships; Petrobras receives offers from various companies and amalgamates the offers into groups for each block. Generally, Petrobras has retained an interest in the partnerships similar to that of the operator. In the first flush of partnership agreements, it generally did not choose to operate. However, in two recent agreements with Chevron, on Block BC-20 in the Campos Basin and Block BCUM-100 in the Cumuruxatiba Basin, Petrobras will hold a 50% interest and operate. Shell Brasil S.A. is one company that quickly capitalized on the opportunities offered by the partnerships. Shell's exploration and production activities in Brazil mainly focus on deepwater acreage, says Phil Hanson, Rio-based vice president, E&P; the company has a long history in the country. "This is our second E&P incarnation in Brazil. Our first was Pecten, the international arm of Shell Oil. Pecten operated in the risk contract period in the 1970s, discovering Merluza Field, a gas accumulation in the Santos Basin that is still producing. The current E&P division of Shell Brasil, set up in March 1998, was the start of its renewed activities. "Our interest started with partnerships with Petrobras, in three areas," says Hanson. Deepwater Block BC-10, a prime concession that lies quite close to Petrobras' 2.8-billion-barrel Roncador Field, stands at the top of Shell's list. Water depths over the Campos Basin block range from 1,300 to 2,300 meters. "We operate and have 35% of BC-10, ExxonMobil has 30%, and Petrobras retained 35%," he says. Shell has succeeded in securing a semisubmersible rig, now on location offshore Congo, says Hanson. The company plans to begin drilling in the middle of this year on the BC-10 Block; drilling on BS-4, a second block in the Santos Basin, will follow in late 2000 or the early part of 2001. "We're going to have a very hectic year." Brazilian firm Queiroz Galvao, the leading domestic independent involved in exploration, has also taken on partnerships with Petrobras. "Up until now, our most important unit has been construction. We build roads, dams and electric power stations," says Jose Augusto Fernandes, Rio-based E&P director. "When the law changed for the oil business in Brazil, we decided to move into E&P. We already had an oilfield service subsidiary that owned drilling rigs." Queiroz Galvao has two semisubmersible rigs operating under contract for Petrobras in the Campos Basin and four land rigs, two of which are heli-transportable. Queiroz Galvao's initial partnership is a shallow offshore exploration project in the Camamu Basin, in the state of Bahia. Petrobras continues to operate this block with a 35% interest. Queiroz Galvao has 55%, and another Brazilian firm holds the remaining 10%. "Our minimal obligation is to drill a well; we will invest about $4 million. If we are successful, we could be seeing investments of between $50- to $100 million," says Fernandes. The company expects to drill its first 1,800-meter well shortly. Its other contract is on Block BC-7 in the shallow-water portion of the Campos Basin. "Most of the block is from 50 to 400 meters water depth. The minimum work program involves shooting 250 square kilometers of 3-D seismic and drilling one well," he says. Total depth of the test will be between 3,500 and 5,800 meters. Queiroz Galvao operates this block and holds a 30% working interest; Petrobras holds the remainder. "The investment is predicted at around $20 million for the block; $1.9 million for seismic and the rest for drilling," says Fernandes. The company plans to use one of its own drilling rigs for the test, if possible. "We intend to drill this well after we acquire seismic over the project." The company is also negotiating other contracts in several different basins. "We are still negotiating with Petrobras for onshore projects in the Amazon, the Sergipe/Alagoas, and the Renconcavo basins." An offshore project in the Santos Basin is in the works as well, a development of a field discovery made by Petrobras some years ago, he says. The second entry point for companies wishing to work in Brazil was through bid rounds for exploration acreage. The ANP held the first round of bidding for blocks not retained by Petrobras in June 1999. The ANP sold exploration rights to 12 of the 27 blocks being tendered, for a total of $180 million. The offshore blocks are gigantic: their average size is the equivalent of 225 blocks in the Gulf of Mexico. Among the winners were some of the world's elite multinationals. Petrobras won five of the 12 blocks, and Italian firm Agip won four. Repsol-YPF, Texaco, BP Amoco, ExxonMobil and Shell each offered winning bids, as did smaller international explorers Unocal, Amerada Hess, Kerr-McGee and British Borneo. Several teamed up in ventures with each other or with Petrobras. The successful bidders have between four and nine years to begin production on their concessions. "The first round was a big success, especially because it was held when oil prices were at very low levels," says Ivan de Araujo Simoes Filho, the ANP's general manager of licensing rounds. "We awarded 12 blocks to 11 different companies. Of course, Petrobras already operated in Brazil, but the others were new operators. The bid round was the actual opening of the E&P sector in Brazil." Now, the ANP is preparing for Round 2, announced last September. The agency is offering 13 offshore and 10 onshore concessions; bidding is scheduled for June, 2000. Round 2 differs somewhat from Round 1, notes Simoes Filho, because it offers several opportunities for smaller companies. "We have eight blocks in major onshore basins where we have a long history of exploration activity. These blocks are smaller than the deepwater blocks or the exploration blocks in the Amazon or the Parana regions; they are the type of opportunity that we expect will attract smaller companies." The decision to target smaller firms was in response to the results of Round 1-the onshore blocks failed to generate any bids. "We reshaped some blocks. Parts of certain Round 1 blocks are now part of Round 2 blocks. Three of the blocks have acreage from Round 1, but all the rest are new offerings," he notes. Some enhancements: for eight blocks aimed at smaller companies, the ANP lowered the requirements from $10 million to $3 million for the amount of shareholders equity a company needs to qualify for bidding. "We are even allowing companies with shareholder equity of as little as $1 million to participate, provided they are in a consortium where the total shareholders equity is greater than $3 million. Also, companies will have one year to present a letter of credit to guarantee the minimum work obligations," says Simoes Filho. "Rental fees and royalties are also lower for these blocks than for the offshore blocks. We also have a special deal on the cost of data packages for these blocks." Also, in Round 1, the ANP allowed 3-D speculative seismic data to count towards the minimum work obligation. In Round 2, 2-D as well as 3-D data will count toward work commitments on onshore blocks. "We think these incentives will attract companies into the onshore areas." That expectation seems to be borne out by the interest the ANP received during its Round 2 road shows in Rio, Houston, Calgary, Tokyo, and in cities in Australia. "In those presentations, the level of interest from smaller companies was much higher than in Round 1," says Simoes Filho. "We are seeing lots of smaller companies participating now that didn't participate in Round 1." For its part, Queiroz Galvao plans to take part in Round 2, although it skipped Round 1. "We considered participating in the first round," says Fernandes. "Members of our group were not interested in the deepwater blocks, so we decided to make no bids. For the new round, however, we have already made a lot of contacts and we are sure that we will participate. We are still refining our strategy, but presently we are most interested in onshore and shallow-water offshore opportunities. The deepwater is a possibility too." Naturally, Round 2 also features the large, high-potential offshore blocks that will certainly attract the international majors. Petrobras recently discovered a light-oil accumulation thought to contain as much as 700 million barrels of oil in its BS-500 Block, the first giant oilfield found in the Santos Basin. This find dramatically redefined the Santos Basin's reputation as a poor cousin to the Campos Basin. BM-S-4, the block immediately west of BS-500, garnered the high bid of Round 1. Of four Santos Basin blocks up for bid, two are adjacent to BS-500. The basin, thought by some to be more gas- than oil-prone, is more sparsely explored than the prolific Campos Basin and also lies close to the huge industrial markets of Sao Paulo. Four Campos Basin blocks are also being offered. Terms have eased for these blocks as well. For certain Round 1 blocks, the ANP required the winning bidders to drill a well in the first exploration period; other blocks required only a seismic option during the first period. "This time, all the blocks have a seismic option, and there is no mandatory drilling in the first exploration period, which lasts three years," says Simoes Filho. The ANP has high hopes for Round 2, notes Simoes Filho. "Companies now know what Brazil is all about. Last year was the first bidding round, and no one had experience with the procedures. Now they have seen the transparency and the fairness of the bidding process." Three components were used to calculate the winning bids in Round 1. The amount of the signature bonus was 85% of the bid; the remaining 15% reflected the commitment of the companies to procure goods and services from Brazilian suppliers. One part was commitment in the exploration phase, the other in the development stage. "We are still defining the rankings for Round 2, but we will announce those at least 45 days in advance of the bids," he says. "Everybody knows precisely how the points are computed, how many decimal places we use and how we round up. Everything is clear, and there is no doubt why a company wins." Texaco Brasil S.A. has fared very well in both the partnership arrangements offered by Petrobras and in the first bid round. The company also boasts a history in Brazil, having participated in the risk venture era in an onshore project in the Marajo Basin in northern Brazil. "Brazil is not new to us," says Antonio C. Pinho, Rio-based vice president of exploration and production. "We have acquired three blocks so far in partnership with Petrobras. Two are exploration blocks and one is development. We operate the BC-4 Block and the Frade development project, both in the Campos Basin," he says. Texaco operates and has a 42.5% interest in both BC-4 and in Frade; Petrobras also has 42.5%; Nissho-Iwai holds 12.75%; and Odebrecht, 2.25%. Frade, located northeast of the giant Roncador Field in approximately 1,200 meters of water, should eventually produce around 100,000 barrels per day. Texaco completed the seismic for BC-4 and Frade last December. "It was a speculative 3-D survey. We are analyzing this data, and our plan is to start drilling in July 2000. We will drill three wells in these two blocks, probably two in Frade and one in BC-4 for this particular campaign." The first well, planned for Frade, is projected to a depth of approximately 3,000 meters. "In the Santos Basin, we have a 20% interest in the Shell-operated BS-4 partnership with Petrobras," Pinho adds. Texaco was a big winner in Round 1, acquiring three blocks. Bidding solo, the company took 100% interests in blocks BM-S-2 in the Santos Basin and BM-C-5 in the Campos Basin. Texaco also participated with Unocal and Repsol-YPF on the successful bid for Block BM-ES-2 in the Espirito Santo Basin. The company holds a 32% interest in that Unocal-operated block. "We are negotiating for seismic on BM-S-2. We already have seismic on BM-C-5 and Unocal already has seismic on BM-ES-2," he says. "These are exploration blocks, and I do not expect to drill before next year because we have to look at the seismic carefully." The blocks have an initial exploration period of three years, and during the first three years Texaco is obliged to run the seismic. "We plan to drill before the three years expire, however," he says. "We have to look really carefully at the data, because when we enter the second two-year period we have to relinquish 50% of the acreage." Texaco certainly sees world-class potential in Brazil, according to senior geologist Neil Allen. "Geologically, present-day Brazil and Angola were connected before the African and South American continents split apart. We already know that there are two or three billion-barrel fields offshore Brazil, concentrated in a small area, and a huge area remains that is very sparsely drilled." Allen says it's entirely possible that Brazil will eventually yield more deepwater discoveries than Angola. "And, in our personal opinion, Brazil could have more discoveries than Nigeria. Like the other majors, we are concentrating on the Campos, Santos and Espirito Santo basins, but will not discard other opportunities." "Texaco has a good portfolio, with a good diversity of projects," says Pinho. "We have blocks of several types in three basins, and we plan to participate in the ANP's second bid round as well. We see potential, and that's why we're here." Several issues continue to trouble foreign companies operating in Brazil. Indirect taxes, specifically import taxes and excise taxes, have been a factious problem. "Business in Brazil has some structural problems the oil industry is keen to sort out," says Hanson. Presently, any piece of oilfield equipment would be subject to import and excise taxes. "These taxes could increase our capital expenditures by as much as 20%," Pinho says. "The industry is working with the government on these problems, explaining how it is handled in other parts of the world." The companies now have a temporary exemption for equipment that extends to December 2005. "It's not the ideal solution, and we hope that it can be resolved on a permanent basis." Currency exchange is another concern. Under Brazilian law, a crude oil exporter has 180 days to bring the receipts of the export into the country. "Companies need to retain this money outside of the country and to freely utilize it. Now we have a compromise solution-a dollar account in Brazil. Again, we are working for a better solution." While the issues are not yet resolved to the full satisfaction of the industry, a degree of comfort has been attained that enables companies to move forward, says Pinho. "The Brazilian government has been very flexible, so we are confident that we can continue to work with them." "Tax issues and currency exchange mechanisms are gradually being resolved," agrees Hanson. The time crunch the foreign firms feel is also extreme. "About 30 partnerships have been announced to date. All of these blocks, and blocks that Petrobras retained, have exactly the same time limitations. Everybody wants a rig for the second half of 2000 and the first quarter of 2001. Everything is peaking at the same time," says Hanson. "Permitting in Brazil requires a learning curve for the new operators. Environmental permits in particular are quite rigorous with a processing time of about four months, but we still have to establish a track record. Rigs are also very difficult to line up at the moment," he notes. Another problem is infrastructure. Activity will be unprecedented this year, and operators will have to share facilities. "We expect a 20% increase in wells drilled this year," says Jeff Gorski, the Rio-based commercial director, Schlumberger Latin America South. "Petrobras has been very active, and everyone in the partnerships is under the same time constraint. The infrastructure does not exist today outside of Petrobras, and it's a slow process to develop that." Indeed, the world is still waiting for the first international company to drill a well. "The operators have no recent history of working in Brazil, and there are many contractual, legal, financial and logistical problems that have to be addressed," Gorski says. "The companies that have come to Brazil first are real trailblazers."