Brazil: Exploration And Production In Brazil: A Rewarding Business

Last Updated: 2 November 2004

Article by Ivan Tauil and Roberta Caneca

The Brazilian oil and gas monopoly started to became more flexible in 1995, after the enactment of Constitutional Amendment No. 09 by the National Congress. The amendment removed constitutional barriers to the participation of the private sector in oil and gas activities in Brazil.

The flexibility of the monopoly has allowed the inflow of private investment in the Brazilian oil and gas industry. Previously, legislation granted the national oil exploration and production company – Petrobras - the exclusive right to operate the monopoly. The enactment of Law No. 9.478 (the "Petroleum Law") in 1997, made possible competition and investment from foreign oil companies, thus starting a new period in the country’s petroleum history and turning Brazil into one of the most attractive markets in the world.

According to the law, the investors own 100% of the oil and gas production (subject to the payment of government royalties and taxes) and are allowed to operate all aspects of the petroleum chain from exploration and production to refining and distribution, under the supervision of an independent regulatory agency. After the opening up process, six bid rounds have been held since 1999.

As with all commodities, oil is a "risky business." It carries not only the usual risks attached to the geological uncertainties of the exploration, but also market and political risks. Nonetheless, economists say that Brazil offers a safe and strong environment for E&P investors. According to current studies, the regulatory environment in Brazil is less burdensome than in West Africa and about the equivalent of the Gulf of Mexico.

When making an investment decision, a foreign company generally takes many aspects into consideration. Overall crude potential is the main consideration, followed by political, economic, and legal aspects. The stability of taxation rules and contract terms and the size of the local market will also affect the company’s decision. We can distinguish three different main aspects of the legal framework, related to (a) independent and stable regulatory agencies, (b) taxation, including government takes and the corporate tax regime, and (c) import/export rules for equipment and supplies.

Independent and Stable Regulatory Agencies

The National Petroleum Agency (ANP) was created by the Petroleum Law with the purpose of implementing the national oil and gas sector policy. The ANP is a special government entity linked to the Ministry of Mines and Energy enjoying a large degree of legal, administrative, and financial independence.

According to the Petroleum Law, the exclusive duties of the ANP include the delimitation of the blocks that are offered to bid, the promotion of exploration concessions, and the production of hydrocarbons in the granted areas.

ANP also has the duty to create a favorable environment for investments in the energy sector, promoting free competition by increasing the competitiveness of the country, whether in the international or domestic markets. The agency stimulates investments respecting the transparency principle, as ANP must abide by the principles of publicity of the acts of the public adminnistration.

Additionally, because of the environmental impact of the petroleum industry, ANP has a duty to maximize efficiency of the energy resources of the country. ANP has to lead and regulate the activities in order to preserve the environment as well.

Along with the Brazilian Institute for the Environment and Renewable Natural Resources (IBAMA), ANP has taken positive actions aiming at simplifying and shortening the time required for E&P licensing. The result of this partnership was the issuance of a guide that provides investors with hints on the procedures for getting enviromental approval, thus helping to reduce the waiting time from one year to six months. This improvement was welcomed by the upstream sector just weeks before the 6th Bid Concession Round.

Favorable Tax Structure

Tax issues are also very important for an investment evaluation. Government take in Brazil (bonuses, royalties, rents, and special participation) is relatively attractive by comparison with other areas of the world (countries such as Angola and Nigeria present higher tax rates), and the Government is reevaluating the royalties and tax burden for heavy oil discoveries in deep waters. The Petroleum Law provides for royalties rates at 10%, reducible to 5% taking into account geological risks, reserve estimates, and other factors, such as production in remote areas, non-associated gas, heavy oil, etc.

It is important to remark that, as of 2004, the services rendered by foreign companies to Brazilian companies, which have already been a taxable event for the Income Tax (at a tax rate that can vary from 15% to 25%) and CIDE (at a tax rate of 10%) are currently subject to the following taxes charged on the gross invoiced amount:

  1. City Service Tax ("ISS"), at a maximum tax rate of 5%;
  2. Social Integration Contribution ("PIS"), at a tax rate of 1.65%, and Social Security Contribution ("COFINS"), at a tax rate of 7.6% (both recoverable).

Import of Goods and Equipment

As to the import of goods and equipment destined for the oil and gas sector, the Brazilian Federal government implemented a tax benefit system called REPETRO (originally set to expire in 2007) designed to reduce the operational E&P costs during the initial exploration phase. REPETRO allows the suspension of federal taxes on the importation of goods and equipment, such as Import Duty ("II"), Excise Tax ("IPI"), PIS, and COFINS, for the term of any concession contract as long as the equipment is returned to its country of origin upon termination of the concession contract.

Legal Stability

Just weeks before the 6th Bid Concession Round, the Federal Government issued Decree No. 5138 extending REPETRO until 2020. The thirteen-year extension is an evident signal of legal stability and demonstrates the Government’s intention to support investments and to maintain its commitment to keep the oil and gas sector open and attractive for international investment.

Other possible hurdles to E&P are currently not in effect. The State of Rio de Janeiro ("RJ"), where the majority of E&P projects and investments is concentrated, has passed but has been unable to implement two laws that would negatively affect international investment:

  1. RJ Law No. 4117/2003 (Lei Noel), which declares that the production of oil is a taxable event for state VAT ("ICMS"), has not been implemented, and
  2. RJ Law No. 3851/2002 (Lei Valentim), which imposes ICMS, at the rate of 19%, on every imported good entering or destined to the State of Rio de Janeiro under REPETRO. This law has already been subjected to an injunction issued by a RJ State Court.

These unfavorable RJ state laws may have no immediate practical effect on E&P investment as they have been challenged before the Supreme Federal Court ("STF"), pending a decision as to the constitutional support of the law. The STF’s intervention shows that investors can trust Brazil’s democratic institutions to protect the E&P investors, whether national or foreign.

The precedents issued by the Brazilian Courts are a positive signal to the investors and express the country’s intention to preserve the democracy, protecting legal rights as well as the contractual stability from any politically biased acts.

Brazil is a huge market for petroleum by-products with a considerable growth potential. Most of the country’s sedimentary basins are still unexplored. Generally speaking, the country has a favorable political and macroeconomic environment and a stable tax and regulatory framework. The National Congress is legislating towards a more attractive system trying to make up for the times when the oil and gas business was out of reach of the private sector. There is also a history of contractual stability and reputation of honoring the contracts. The success of the opening up process is expressed by 33 exploration concessionaires currently in the country holding 51% of the net exploration acreage.

Ivan Tauil Rodrigues is a partner with Thompson & Knight LLP in Rio de Janeiro. He is the Chairman of the Science Board of the Brazilian Academy of Tax Law.

Roberta Perez Caneca is an attorney with Tauil, Chequer, & Mello, Associated with Thompson & Knight LLP, in Rio de Janeiro. She has a Master’s in Tax Management from Candido Mendes University.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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