When the Going Gets Tough the Tough get Going: Brazil Oil & Gas Thrives Despite the Pandemic
In a speech on 24 November 1992, marking her Ruby Jubilee on the throne, Queen Elizabeth II said, “1992 is not a year on which I shall look back with undiluted pleasure. In the words of one of my more sympathetic correspondents, it has turned out to be an annus horribilis.”
Annus horribilis. This is a moniker that oil and gas insiders might well apply to 2020 given the disastrous effects on the industry from Covid-19 pandemic (“Pandemic”) and its accompanying recession which brought a precipitous fall in demand and price. Indeed, in May the price of crude oil briefly went negative for the first time in history. This was followed by massive layoffs across the board and sharply curbed investments in planned and ongoing projects. Several major oil companies announced profound changes in their long-range focus from hydrocarbons to greener energy.
Brazil’s oil and gas industry was by no means immune from Covid-19´s fallout. In a June 29 communique, the Brazilian Petroleum Institute (“IBP”) predicted that the negative effects of the pandemic would last through the end of 2021. In addition, the pandemic returned Brazil to recession after three years of modest recovery. Despite this adversity, the Brazilian oil and gas sector, led by a proactive National Petroleum Agency (“ANP”), managed to largely maintain focus on long-term industry goals, benefiting from certain short-term regulatory relief discussed below.
The long-term robustness of the Brazilian oil and gas sector, despite short-term obstacles, manifested itself in many ways in 2020. Below we discuss five positive factors in particular.
- Petrobras Divestment Program.
In March 2015, Petrobras launched an aggressive divestment program (“Divestment Program) aimed at shedding the Company’s non-core assets and using the resulting income to bankroll its ambitious goals in its key focus area – the prolific Pre-Salt basins. Despite the Pandemic, the Divestment Program made healthy strides in achieving its objectives. Petrobras has 49 divestment operations in play, including 7 projects in the initial phase of the divestment process, 32 projects in the binding phase and 10 contracts awaiting closing. Since January the Company has sold (i) Petrobras Oil & Gas B.V., (ii) the Macau cluster, (iii) its remaining 10% share in TAG, (iv) the Pampo and Enchova clusters, (v) the Ponta do Mel and Redonda cluster, and (vi) the Lagoa Parda cluster. Petrobras has also entered into contracts for the sale of (i) the Tucano Sul cluster, (ii) the Pescada cluster, (iii) the Cricaré cluster, (iv) the Rio Ventura and Fazenda Belém clusters, and (v) PUDSA assets in Uruguay. As of the end of October, Divestment Program revenues totaled US$1,036 billion. [1]
The Brazilian supreme court (STF) recently rejected two constitutional challenges to (i) Petrobras Divestment Program regarding the sale of several refineries and (ii) the Decree that regulates the Company special assignment procedure (see discussion in Item 5 below).
- Covid Mitigation Measures
When the Pandemic first emerged, the ANP took quick action to allow good faith players to avoid default on their contractual obligations. In particular, the ANP published Resolution No. 812/2020[2], which established the procedures to be followed by regulated entities during the emergency public health situation caused by the Pandemic. Next, Resolution No. 815/2020 extended certain deadlines related to exploration and production contracts, while Resolution No. 816/2020[3] mandated procedures to be followed by petroleum and petroleum services companies during. The result has been an orderly transition to a Pandemic mode and the avoidance of costly and disruptive force majeure declarations that might have ensued absent the ANP’s decisive actions and policies.
- Bid Offerings
Beginning in April 2017, the National Energy Policy Council (CNPE) approved ambitious bid round calendars for both the concession and production-sharing regimes through 2022 (“Bid Rounds”). At the time industry insiders were skeptical, given the Governments dismal bid-round track record during the preceding decade.[4] However, the ANP was admirably on schedule with the 2017-2019 Bid Rounds and 2020 also looked positive. And then the Pandemic hit, with the expected negative consequences. Fortunately, 2020 was not a lost year. Indeed, on 4 December, the ANP organized the so called the “2nd Cycle of the Permanent Offer” – (see our legal update) for relinquished and previously non-bidded blocks, resulting in the award of 18 blocks.
- Progress on Natural Gas Law
For decades, Brazil has been long on potential natural gas discoveries throughout its massive territory but short on viable gas policies and regulations. In September the House of Representatives approved the text of an ambitious and industry friendly new natural gas law (“Gas Law”) and sent it to the Senate (see our article on this matter). Dashing widespread hopes for quick approval, Senate returned it to the House of Representatives with amendments. Eventual passage of the Gas Law should incentivize significant new investment throughout the natural gas value chain.
- Judicial and Administrative Decisions
Brazil is a model among oil producing nations in terms of providing an even playing field by judicial and administrative authorities who normally reach logical and pragmatic conclusions. Three 2020 cases stand out in this regard.
JOA Default
The recent Dommo[5] case, in which our firm represented a successful party, demonstrates the Brazilian “freedom of contract” principle in action. Dommo, a non-Operator party to an E&P joint operating agreement (“JOA”), persistently defaulted on cash calls. The non-defaulting parties placed Dommo in default and applied the JOA’s forfeiture of interest provision. Many Brazilian industry observers questioned whether the provision would be enforced by regulators and the courts both as a matter both of law and public policy. In granting the requested remedy, the ANP stressed (i) the clear public interest in enforcing industry standard risk allocation provisions, and (ii) the need to promote efficient self-enforcement mechanisms. To this date, the courts involved in Dommo have taken similar approaches.
Petrobras Divestment
In October, the Supreme Federal Tribunal (STF) issued two decisions confirming the constitutionality of the Divestment Program by ruling against challenges from the Senate leadership and the Brazilian Labor Party (PT). In the judgment of Claim 42576, which was intended to suspend the divestment processes of the refineries and its respective logistical assets[6], the STF held that Petrobras had adhered to procedures agreed with the Federal Audit Court (TFC) and did not need congressional approval of refinery sales. Such procedures largely thwarted the nuisance lawsuits traditionally filed with chilling effect by labor unions in similar circumstances. In the same month, the STF dismissed the Direct Unconstitutionality Action 5942 (ADI 5942)[7], which contested Decree 9355/2018, maintaining the regulation that allows Petrobras to sell E&P assets. These favorable decisions allow Petrobras to confidently proceed with the Divestment Program which is vital for achieving its long-term financial and technical objectives.
Annus horribilis? To a certain extent, yes. However, through quick action and effective follow-through by a wide range of industry players the worst predicted outcomes were avoided, and positive momentum maintained. Hopefully, the perseverance and grit displayed in 2020 will lead to an annus marabilis for the Brazilian oil and gas sector in 2021 and beyond.
* * * * *
As this article was going to print, Petrobras announced record production numbers for 2020 despite the Pandemic – 2.28 million bpd.[8] When the going gets tough, the tough get going.
[1] Source: Petrobras Financial Performance – 3Q20.
[2] ANP publishes special measures due to COVID-19
[3] Brazil’s ANP Allows Extensions of Contractual Deadlines and Establishes E&P Procedures (COVID-19)
[4] https://www.offshore-mag.com/business-briefs/article/16755931/brazil-looks-to-reform-its-oil-and-gas-sector
[5] Dommo Energia vs. Queiroz Galvão Exploração e Produção S.A. and Barra Energia do Brasil Petróleo e Gás Ltda.
[6] https://www.agenciapetrobras.com.br/Materia/ExibirMateria?p_materia=983095
[7] https://www.agenciapetrobras.com.br/Materia/ExibirMateria?p_materia=983098
[8] Josh Lewis, “Petrobras posts record output despite Covid-19 pandemic”, Upstream Magazine, 8 January 2021 6:43 GMT
