The challenge is to make natural gas more valuable as a market asset than as a catalyst for petroleum production

Arising from the production sharing regime, which was put in place upon the discovery of pre-salt petroleum, the Federal government is preparing to market petroleum and natural gas for the first time. Under this regime, the Government receives part of its share in surplus oil (petroleum and natural gas), raising the need to find mechanisms for marketing these assets. So far, there are contracts of this type only in Libra, which is the single pre-salt area that has been let in public bidding, where 1,548 km² are under contract under a production sharing regime. Another eight contracts of this type will be let by the end of the year, during the second and third rounds of public bidding for pre-salt, in October.

The legal pre-salt area is a 150-square-kilometer polygon, within which all of the new exploration and production contracts must be written as a sharing regime. But, as we are reminded by Olavo Bentes David, legal consultant of Pré-Sal Petróleo (company founded in 2013 to manage sharing contracts), not all of the operations that take place within this perimeter are necessarily working under a sharing regime. There are older contracts that cover post-salt objectives, under concession or onerous assignment. And there are post-salt accumulations that would perhaps be more attractive to investors and more lucrative to the Country if they were managed as concessions – since the sharing system is only indicated for high-production and low-risk regions.

In an exclusive interview to RCGI, David talked about the possibilities and the future of natural gas from pre-salt.

RCGI – How to you assess the use of shared natural gas in the context of the possibility of using natural gas as a potential instrument to increase the competitiveness of Brazilian industry?

David – The commercialization of the Government’s oil and gas is subject to the dictates of a marketing policy proposed by the National Energy Policy Council (CNPE) and approved by the President of the Republic. The current policy states that Pré-Sal Petróleo must pursue the best economic and financial returns, the best possible price, for the Government’s oil and gas. Is it possible to use natural gas as a tool for gaining industrial competitiveness? As I see it, yes. But that has to be established as a policy. At this time, that is not the case. It could be totally different, a few years from now, depending on the policy that is implemented. Things can change.

RCGI – You say that the sharing regime is more appropriate for situations of less geological risk (since the risks and costs are indirectly assumed by the host). Two questions: are geological and exploratory risks the same thing? How do the players deal with these risks?

David – Geological risk relates to investing, drilling, exploring, and finding nothing. Exploratory risk is the biggest geological risk, that is: most of the geological risks are exploratory. Worldwide, the exploratory success rate is 10% to 15%. But, with pre-salt, it is about 50%, which is an immense advantage. In the face of such high rates of failure, petroleum companies, after the second petroleum crisis, began to increasingly work with partnerships, consortia. That is for several reasons, but the basic rationale is: since the risk of success is low, it is better for the company to have a portfolio of a thousand assets held in partnerships with other companies than to have one portfolio with ten assets belonging solely to that company.

RCGI – In your own words, under the sharing regime the intervention of the State surpasses regulations, and affects the operational decisions of the one holding the exploration and production rights. With the lack of a robust natural gas market, as is the case in Brazil, is State intervention that goes beyond regulations good or bad for the natural gas sector? Why?

David – Sharing is only good when the geological risk is less than usual, which is the case of Pré-Sal. Under the concession regime, the Federal government does not run the risks: all of the risk rides on the oil company. Under the sharing regime, the Government has no risks or costs during the exploration phase. But, after declaring that the discovery is marketable, the Government assumes the costs. It is this that, together with fiscal flexibility, makes the production sharing regime more attractive, when the geological risk is low and productivity (profitability) is high.

RCGI – In your opinion, what would be the big challenge to the Federal government, in terms of marketing pre-salt natural gas?

There are many challenges. Let me point out a few. First: at this initial moment, the volumes of gas that the Federal government has at hand are very small, barely incipient. With such a small volume, it is hard to promote attractive public bids. Another issue: the gas from Libra has an extremely high concentration of CO2. That makes processing and the primary treatment of natural gas quite difficult, but it facilitates reinjection, thus improving the production of petroleum when the gas is reinjected. So the most economical way to explore Libra today is by reinjecting the gas. Pré-Sal Petróleo, together with the other members of the consortium, has been working hard to find ways to make natural gas production feasible. And I believe we will be successful.

RCGI – So, it is necessary to prove the economic feasibility of this gas.

David – Basically, we must show that this gas is the most profitable, when it is sold, rather than when it is reinjected. And we must demystify the expectation that there will be an enormous amount of natural gas in 2018, 2019…. Yes, we expect to have a lot of gas. I imagine that, in the mid-20s we will be a big player. But, until then, there are countless challenges to be overcome, reinjection being one of them. Natural gas has to have a bigger market value than it has as a catalyst for petroleum production.

RCGI – What is the big challenge for managing sharing contracts for Pré-Sal Petróleo?

David – First, the contracts are for 35 years, which cannot be extended, and that is not the usual practice of the industry: these contracts are usually extendable (because the company, knowing that it will have only 35 years, could naturally refrain from investing in production infrastructure in the latter years). We should remember that the fact the contracts cannot be extended does not mean that they can be suspended. The Libra contracts expire in 2048. The post-salt contracts of the Bacia de Campos, which are the oldest, would be ending in the mid-20s. A good share of them are already being extended. But the biggest challenge facing Pré-Sal Petróleo, as I see it, was the preparation and maintenance of a capable workforce, trained and supported by industry. The company was founded less than four years ago, in November 2013. On December 2, 2013, the first sharing contract was signed. That is: almost over night, the company had to dialogue, on an equal footing, with the big players on the international market. We didn’t have time to prepare and mature our personnel. So, the training of the technical corps – for both core and support activities – was an enormous challenge. But it has been worth all the effort. The company went through two governments with opposing ideological lines, while forming and maintaining a highly qualified work force that was recognized by the petroleum industry.

RCGI – All of the infrastructure existing in Brazil for transporting and processing natural gas was built by Petrobras. And private companies do not have free access to a good part of that structure. Why isn’t the construction of such structures as gas pipelines, for example, still good business and what is needed for it to truly become good business?

David – Regarding free access to the infrastructure built by Petrobras, that is a sensitive issue. Yes, Petrobras built it all: the access gas pipelines, the transporting pipelines, and the processing and treatment plants. With all of this structure, other companies only have free access to the transportation gas pipelines. The transport and transfer pipelines, as well as the Natural Gas Processing Plant (UPGN), are for the exclusive use of Petrobras. The fact that gas pipelines are not yet “good business” can be explained in a number of ways: we do not have a robust natural gas market; we do not have a culture of gas utilization; and a real monopoly has been built over many decades that, in my opinion, cannot be seen simply as a negative thing. Because, as I have already said, no company, besides Petrobras, has built even one kilometer of gas pipeline in Brazil, over all these years. And gas is not a commodity: it is impossible to store. It needs to be produced, flow, be transported, and consumed immediately.

RCGI – Has the Gas Law facilitated or inhibited addressing these issues?

David – It is not a legal problem. The Gas Law brought advances, but it doesn’t resolve everything. It is a planning problem, which is hard to solve, because it involves a whole range of sectors and their interests, and they must be involved. The fact is that all of these structuring factors need Government planning. The U.S., which now has an extensive capillary network of gas pipelines, made ample use of State interventionism in the formation of the network of pipelines. Therefore, I think that such initiatives as Gás para Crescer (Gas for Growth) are important: because they systematically address these issues, among the various players.

RCGI – Technologically speaking, we know, through the research done by RCGI, that there are options for making this gas viable. In your opinion, what are the most promising ones?

David – Yes, technologies are under study that could help make pre-salt gas viable. Starting with the obvious, we have the gas pipelines. They have several factors in their favor, including a large flow capacity and little need for maintenance. Not to mention that it is a long-term infrastructure. But its viability depends on the topography of the ocean bed and they have very little flexibility, that is to say: they have a limited capacity for expansion. The second technology that I would highlight are the Floating Liquefied Natural Gas (FLNG) plants, that are capable of producing, liquefying, and storing natural gas out at sea, and of transferring liquefied natural gas (LNG) to the continent. They do not need heavy investments and are economic alternatives to large reservoirs and long distances from the consumer market. But there are still no FLGNs functioning anywhere in the world. And, technologically, they offer a big technical challenge to overcome, which is to liquefy gas on a ship that is in motion. In the case of Libra, where the gas has a high concentration of CO2, the challenge is even greater. We also have (Floating Gas-to-Wire (FGTW) thermal electric plants. In this case, the Capex is very high and there is a need to develop underwater transmission cable at a depth of 3,000 meters below the surface of the water. This is still unusual in deep water. Since it is a very recent technology, there exists a certain amount of uncertainty regarding the maintenance of the stations. It is the type of enterprise that demands market development and exposure to business risk. There is also uncertainty about the stability of the supply. That is: it is a highly complex model, with technology that has not yet been proven, and a high level of uncertainty.

RCGI – You call attention to the fact that we have had no public bid auctions in the Bacia de Campos since 2005. In your opinion, when did this happen and how does this decision impact the policy laid out for the coming years for the oil and gas sector?

David – The fact is that the pre-salt polygon takes in both the geological pre-salt and the geological post-salt. The Bacia de Campos is almost entirely within the pre-salt polygon, but it is, for the most part, post-salt. Due to political indecision, not public bidding was held for many years regarding what was inside the pre-salt polygon. But, besides the pre-salt area, it had the best we have to offer: the Bacia de Campos was always our most prolific basin, from the beginning, in the 1980s to the discovery of the pre-salt oil. However, in the legal pre-salt area, by law, contracts could only be let on a sharing basis. It is well-known that the production sharing tax regime is not adequate for the post-salt area of the Bacia de Campos. Here, we are talking about a confused zone, between the legal pre-salt and the geological pre-salt. That will have to be resolved, somehow. I believe it is urgent to make a legal change that drops the concept of the pre-salt area – specifically the 150,000 km² – and uses a concept that already exists, which is that of “strategic areas”. They can be created or extinguished by CNPE directives. Thus, an area that has excellent potential could be established under a production sharing regime, and an area of greater geological risk could be bid upon under a concession regime.

As for the impacts, I would say that, if we wanted investments, local content, in short, enjoy the benefits of this immense wealth in the best possible manner, we would not have done what we did: we didn’t offer any section in 2008 (during the tenth round), in 2013 (during the eleventh and twelfth rounds), not even in 2015 (the thirteenth). The first sharing offer finally came in 2013, but only one section was offered: Libra. That is: besides Libra, the last section auctioned off within the legal pre-salt area was in 2005, nearly 11 years ago, during the seventh round of public bids. That discourages investors and the market. Now, the bidding rounds are being resumed. By 2019, nine auctions are scheduled, under both sharing and concession regimes.