BRAZIL: Oil Production Threatened by New Royalties Law

Bottom Line: Massive plans to tap into Brazil’s subsalt fields and an upcoming auction of new oil and gas blocks in May could be delayed as we expect a high-profile legal battle pitting key oil-producing states against the federal government over a controversial new law aimed at adjusting oil and gas royalty distribution. In the meantime, protests against the measure in the two top oil-producing states have the power to severely disrupt production.

Analysis: Brazilian President Dilma Rousseff attempted to veto a controversial oil and gas royalty redistribution bill, but on 7 March, Congress overturned the veto, paving the way for the law’s enactment. Essentially, the law seeks to redistribute the oil wealth more equally among the country’s 27 states.

Rio de Janeiro and Espirito Santo—two of the biggest oil-producing states—will fight the enactment of this new law through legal means that could delay existing and new projects. More than 80% of oil and gas extraction takes place in these two states and both would see royalties dwindle from 40% to 20% by 2019 under the new law. Rio de Janeiro stands to lose around $1.58 billion in royalties in 2013 alone. This loss of state revenue would have a significant impact on the state’s ability to host the World Cup in 2014 and the Olympics in 2016. Espirito Santo state could lose around $5.1 billion over the next 7 years. Both states, along with Sao Paulo, plan to file a petition with the Supreme Court arguing that as a unilateral modification of a contract between the federal government and the states, the new law is unconstitutional. Rio de Janeiro has also threatened to suspend all oil and gas payments to the federal government (an estimated $241 million for March 2013 alone) in protest until the Supreme Court rules on the legality of the new bill.

Thirty-four congressmen have called on the governor of Rio de Janeiro to suspend state environmental licenses for oil production, which would effectively halt oil production. Protests over the law also threaten production by preventing oil workers from accessing offshore rigs—and this threat should not be underestimated.

We are particularly concerned about the pre-salt prospects and what this will mean for Brazil, which stands to be one of the next big subsea production venues. The legal battle could cause major delays in planned projects in this sector.

Recommendation: Keep a close eye on the maneuvering of Rio de Janeiro and Espirito Santo ahead of the planned 14 May auction of new oil and gas blocks, if the auction indeed goes ahead in this atmosphere. Also keep an eye on subsea equipment manufacturer Cameron International Corp. (CAM), which just won a contract from Brazil’s state-run Petrobras to provide subsea equipment for the development of pre-salt and post-salt areas offshore Brazil. This is a massive deal for Cameron, but may get caught up in red tape.