Since the discovery of the huge pre-salt reserves in 2006, Brazil has been experiencing an energy boom which, in the words of one analyst, will make Brazil an oil power by the end of the decade with production in line with that of Iran. In what is fast becoming one of the largest offshore markets in the world, international companies are queuing-up to get a slice of the action. Overseas service companies and suppliers, particularly in the offshore and subsea sectors, are looking to capitalise on growth in demand for their products. Additionally, as a sign that things are continuing to heat-up in the sector, Petrobras, which in 2010 was ranked as the second most profitable company in the Americas, recently bucked the international trend for slashing budgets by announcing the largest investment plan in its history, US$224.7 billion planned for the period between 2011 and 2015.

However, an essential factor for operators and suppliers to consider when entering this promising market is “local content”. This refers to the requirement for operators to procure a minimum proportion of goods and services for exploration and production from local sources. These rules affect operating companies when bidding for licences and suppliers selling into the Brazilian market.

The Brazilian Petroleum Agency (ANP), which regulates the oil and gas industry and runs the licensing rounds for oil and gas concessions states that its objective is “to maximize the content from the national goods and services industry, on a competitive and sustainable basis, in the implementation of oil and gas projects in Brazil and abroad.”

1. LEGAL FRAMEWORK

Since the first competitive licensing round for oil and gas in Brazil in 1999, the concession agreements have included a clause requiring concessionaires to ensure preference to Brazilian suppliers if their proposed price, delivery schedule and quality conditions are at least as good as competing suppliers.  This requirement is found in many concessions and production sharing agreements around the world, and particularly in developing countries.  The concessionaire is also required to keep track of appropriate Brazilian suppliers and ensure they are invited to tender on equivalent terms to their non-Brazilian competitors.

In addition, concessionaires undertake in their concession agreements to procure a specified minimum percentage, by value, of goods and services from local sources.  Competing bids for oil and gas concessions are evaluated on a points system, with points awarded according to the level of bidders’ proposed signing bonus, minimum exploration programme and local content undertaking.  The bidder for a particular block that receives the most points will be awarded the concession agreement for that area.  Since the seventh licensing round, 40 points have been awarded for the signing bonus, 40 points for the minimum exploration programme and 20 points for local content.

In the first five licensing rounds, the bidding rules did not specify a minimum level for local content.  Bidders could propose any local content percentage they wished, but higher bids would accrue more points and a consequent advantage.

The 6th licensing round introduced a prescribed minimum local content percentage, which varied depending on whether the block was on land, in shallow water or deep water.  The 7th licensing round also introduced a maximum percentage, so that bids will not accrue more points for specifying a local content percentage above the maximum level.

Bidders are required to specify a separate local content percentage for the exploration phase and the development stage.  The range of acceptable bids is higher during the development stage and this element attracts more points for the purpose of evaluating bids (Exploration - 5 points / Development – 15 points).

In addition to specifying an aggregate local content percentage, the current licensing regime requires each operator to specify a separate local content percentage for particular categories of goods and services (items and sub-items).  The tender protocol for each bidding round sets out separate minimum local content percentages for each of these items and sub-items.  By way of example, some of the minimum local content percentages in the most recent (10th) licensing round were 40% for seismic interpretation and processing, 90% for drilling rig chartering, 95% for engineering of process plant and 100% for well lining.

Concessionaires may request a waiver or amendment of their local content undertakings in relation to the procurement of specific items or sub-items in certain limited circumstances (e.g. where bids for the supply of local goods and services are excessively high or could result in delay to the development schedule, or where new technology that was not available at the time of the licensing round is only available from non-local suppliers).  However, no such waiver or amendment will affect the aggregate local content percentage.  The concessionaire will have to make up the shortfall of local content in a particular item or sub-item by exceeding its local content obligation in relation to other items or sub-items.

If, at the conclusion of the exploration phase or any development stage, a concessionaire has not satisfied its local content obligations, it will be liable to pay a fine of between 60% and 100% of the non-realized local content percentage.

3.  CERTIFICATION REGIME

The detailed rules for calculating local content are set out in a rulebook published by the ANP (Cartilha de Conteúdo Local – ANP Resolution No.36 dated 11.13.2007, Annex III 

To qualify as local content, products must not only be acquired locally, they must be manufactured locally.  The value of imported and domestic inputs for each product or service are calculated to arrive at a percentage.  The rules also deal with applicable exchange rates and how taxes and freight charges are taken into account.

In order to prove compliance with the local content rules, the concessionaire must obtain local content certificates from each of its suppliers at the time of purchase.  Certificates are awarded by ANP-accredited certification agencies and follow a prescribed format and state the local content percentage of the product or service being supplied.

Concessionaires must request their suppliers to provide the required certification, but suppliers may obtain prior certification of their goods on their own initiative.  For products that are standardized and produced in series, suppliers may reuse a certificate on subsequent sales of the same product.  In order to do so, there must be no change of specification, composition or means of production and the certified local content value must not have changed by more than 10%.  Upon the supply of such goods, the supplier must attach to the local content certificate a statement of integrity confirming that the goods conform to the original certification.

To allow the ANP to monitor this process, concessionaires must submit quarterly investment reports to the ANP setting out, in a spreadsheet, the local content percentages of items and sub-items procured (and certified) in that quarter, as well as the cumulative local content percentages.  Certification agencies, likewise, are subject to periodic audits.

4.  IMPLICATIONS FOR OPERATORS AND SERVICE COMPANIES

For the purpose of bidding in Brazilian licensing rounds, oil companies should have a clear idea of what their exploration and potential development requirements might be and their ability to procure the necessary goods and services from Brazilian sources.  This is increasingly important in the current environment, where Petrobras’ huge requirements for its sub-salt developments are widely expected to lead to a supply crunch in various sectors of the offshore supply market.

Failure to meet local content undertakings may result in serious fines being imposed, whereas failure to specify a high enough local content percentage may be prejudicial to a bid for a concession.  On the other hand, if operators are able to line up local suppliers in advance for the high value components of their exploration and development budgets, they may feel confident to bid a higher local content percentage and gain a consequent advantage in the bidding process.

From a potential supplier’s perspective, it is important to consider the advantages, in terms of competitiveness, that may result from supplying products with a high local content.  In particular, every supplier to the Brazilian market should be aware of the minimum local content percentages for their particular products under the various licensing rounds. 

In some cases, these local content requirements may make continued importation of raw materials, components or products into Brazil unsustainable.  On the other hand, Brazil’s rapidly growing offshore oil and gas industry may justify some suppliers moving production to Brazil or reconsidering their own supply options.

Updated October 2011