Magic realism: is it the time to carry Petrobras on the onerous assignment regime?

In an oil price scenario in the range of USD 50-60, perhaps the time has come for the Brazilian Government to seek alternatives that would make affordable financial support for Petrobras in exploration areas which require high “CAPEX” investments.

One of the alternatives to be examined would be the amendment of Law No. 12,276, of June 30, 2010, which authorizes the federal government without a bidding procedure to “onerously assign” to Petrobras the performance of exploration and production activities in certain areas located in the Pre-salt ("Onerous Assignment Law").   

According to the Onerous Assignment Law, Petrobras must in return pay the federal government in securities of federal public debt, which would be received by the former as a capital increase subscribed by the latter.

That is to say, the premise was always that no cash would be involved in the Assignment and nothing would come from Petrobras' resources, since the payment for the Assignment would be made with securities received from the controlling shareholder, the federal government.

The effectiveness of the Onerous Assignment is not permanent and is limited to 5 billion/boe. The hydrocarbons volumes and their respective values ​​will be determined according to technical reports prepared by experts in reserves certification, in accordance with the Best Practices of the Petroleum Industry. It will be up to the Petroleum Agency (the “ANP”) to secure a technical report which will assist the federal government in negotiations with Petrobras concerning the amounts and volumes involved in the Onerous Assignment.

For future production in these areas, royalties will be levied at a rate of 10%. In addition, the Assignee must contract activities and services with domestic universities or technological research institutions, and for these purposes, must spend a minimum of 0.5% of the annual gross production revenue.

In summary, the Onerous Assignment Agreement provides for: (i) the identification and geographical boundaries of the areas; (ii) the respective volumes, subject to the limit of 5 billion/boe; (iii) minimum amounts ​​and progressive targets of local content in exploration and production activities throughout the life of the agreement; (iv) terms and conditions of payment; and (v) terms for the revision of the agreement. The Onerous Assignment Agreement and any amendments are to be approved by the National Energy Policy Council (CNPE).

Background

In the Message sent to the Presidency by the then Minister of Mines and Energy, Minister of Finance and others, the enactment of the Onerous Assignment Law was justified "by the interest of the federal government as controlling shareholder of Petrobras in strengthening the company with resources derived from areas of low exploratory risk and considerable potential for profitability." The promulgation of the Onerous Assignment Law took place at the time the Brent crude oil price revolved at around USD 74.00/barrel, with an upward bias, which was confirmed in the following months when the price exceeded USD 120.00/barrel in March 2012. At that time, the general mood was still euphoric, or at least optimistic, within the petroleum industry, and particularly within Petrobras, as can be seen from the excerpt from the above Message: "Moreover, since the federal government does not have the necessary structure for exploratory activities for such petroleum potential, assigning the exercise of these activities to Petrobras in exchange for adequate compensation also contributes to the growth and strengthening of a NOC, of which the federal government is a controlling shareholder."

Petrobras’ Primary Public Offer of 2010

Just after the Onerous Assignment Law had come into effect, Petrobras held, in September 2010, the largest public offering of shares in history, which resulted in the capitalization of approximately R$ 120.25 billion (USD 67 billion), of which R$ 74.8 billion was meant to pay for the Onerous Assignment at a price of R$ 29.65 per common share (USD 17.29) and R$ 26.30 per preferred share (USD 15.33). With the capitalization, the federal government increased its interest in Petrobras, whose capital was then structured as follows:
 

Source: http://www.investidorPetrobrasPetrobras.com.br/pt/governancacorporativa/capital-social 

Under the Onerous Assignment Agreement, the federal government assigned to Petrobras the exploration rights in the blocks of Florim, Sul de Guará, Entorno de Iara, Sul de Tupi, Nordeste de Tupi, and Peroba, in the Santos Basin, with a limit of 5 billion barrels of oil equivalent. Petrobras disbursed approximately R$ 75 billion, at a weighted average price of R$ 14.96/boe. The terms of the Onerous Assignment Agreement were approved by CNPE Resolution No. 2, dated of September 1^st, 2010. The agreement between Petrobras and the federal government was signed on September 3^rd, 2010.

Four years later, CNPE Resolution No. 1, dated of July 24, 2014, approved the direct contracting of Petrobras, in a sharing regime, for production that exceeds the limit established by the Onerous Assignment Law, in the fields of Búzios, Entorno de Iara, Florim and Nordeste de Tupi, according to the following parameters, amongst others: (i) US$ 105.00/barrel; (ii) average production of 11,000 barrels/day per active well; (iii) monthly appropriation of the “cost oil”, respecting the threshold  of 50% of the gross amount of production in the first two years and 30% in the following years; and (iv) signature bonus of R$ 2 billion. It is worth noting that the areas delimited in this new sharing agreement are non-transferable.

Issues concerning asset evaluation

The issues surrounding the asset evaluation for the purpose of reviewing the Onerous Assignment Agreement began in 2014, when the ANP and Petrobras contracted Gaffney, Cline and Associates and DeGolyer and MacNaughton, respectively, to prepare the technical reports, in accordance with the Best Practices of the Oil Industry. The revision procedure is set forth in Clause Eight and will begin "immediately after the Declaration of Commerciality of each Field" and "may result in the renegotiation of the following items: (i) the contract value; (ii) maximum volumes; (iii) term; and (iv) minimum local content percentages".

Annex V of the Agreement also establishes the guidelines that should be observed for the review of assets using the discounted cash flow methodology to calculate the net present value (NPV) of the boe, according to the technical and economic assumptions established therein, and among these are the discount rate (8.83% per year) and the hydrocarbons reference price.

Note that if the revised contract value exceeds the initial amount established in the agreement (approximately R$ 75 billion), Petrobras  will either (i) pay the difference in cash or in securities of federal public debt, or (ii) compensate the surplus amount by reducing the maximum volume to be produced in each field. On the other hand, if the revised contract value is less than the amount of R$ 75 billion, Petrobras will be a creditor of the federal government.  This may happen due to the drop in oil prices in the international market.

Such revision procedure was analyzed by the Decision No. 353/2016 from the Federal Audit Courts (Tribunal de Contas da União), which summarized the main differences between Petrobras’s and ANP’s positions regarding the geological and petrophysical models to estimate and evaluate the volumes in place and to simulate the field recovery curve, among other issues.

Prohibition of the farm-out of the areas subject to the Onerous Assignment

The Onerous Assignment Law states that the assignment of rights is non-transferable. Thus, Petrobras is unable to assign, even partially, the areas of Florim, Sul do Guará, Entorno de Iara, Sul de Tupi, Nordeste de Tupi, and Peroba in the Santos Basin. Clause 30 of the Assignment Agreement also provides for its non-transferability to third parties. Likewise, the definitions of the Agreement set forth that the operator of the blocks will be Petrobras.

In the same way, the sole paragraph of Article 31 of Law No. 12,351, of December 22, 2010, which introduced the production sharing regime, authorizes Petrobras to transfer its participation only in production sharing contracts that the company has entered by means of a bidding regime. This restriction is also reproduced in Article 4 of CNPE Resolution No. 1/2014. Currently, therefore, it is not possible to transfer to third parties the contracts that resulted from the direct contracting of Petrobras with the federal government.

In other words: there are many restrictions, perhaps due to a prevailing view at the time that Petrobras would be permanently assured of the exclusive right to carry out exploration and production activities in areas considered as strategic under the Onerous Assignment, since the company would have sufficient cash to pay for these operations over time.

In practice, such restrictions prevent Petrobras from entering into even partial farm-outs of the areas received under the Onerous Assignment and of the surplus in the production sharing regime under CNPE Resolution No. 1/2014.

In a time in which capital costs are more expensive, even though Petrobras was successful at the beginning of the year with raising funds through the issuance of securities in the international market, there is no doubt that this prohibition restricts the company's ability to seek partners that may provide it with “carries” for the development of these areas.

A concrete aspect of the application of the "Magic Realism" of Gabriel Garcia Marques, notably by the crystallization in legal rules of current situations as if they were going to be permanent.