Reforms to Brazilian Local Content Policy

Stringent local content rules were introduced into Brazil’s oil and gas industry in the 6th licensing round as a means of protecting and facilitating growth in the local industry, by requiring a minimum percentage, by value, of goods and services to be provided from Brazilian sources. In recent licensing rounds, oil and gas companies have been required to bid minimum local content percentages and, if they win the blocks, these become binding commitments, subject to fines for non-compliance (Local content in the Brazilian Oil & Gas Licensing process).

Although, these rules have undoubtedly benefitted local businesses and created jobs, in their current form they also represent a major obstacle to efficiency and growth in the sector. E&P companies, including Petrobras, and international service providers alike have struggled to achieve sufficient local content whilst delivering goods and services of the required quality, on time and within budget. That makes no sense at all. These difficulties have been exacerbated by recent revelations of widespread corruption within the Brazilian supply chain. Fines, arrests, contract cancellations and ongoing investigations have left many of the leading Brazilian suppliers unable to compete for new work. What is more, oil companies have been subject to very significant fines where they have been unable to meet their commitments, around BRL 455m last year alone.

In an effort to inject fresh impetus into the sector, however, it seems that these rules will soon be eased. On 18th January the Brazilian government changed its local content policy, through Decree No. 8.637/2016, which launched the ‘Incentive Programme for Supply Chain Competitiveness and the Development and Improvement of Suppliers to the Oil and Gas Sector’ (PEDEFOR). The aims of PEDEFOR, as stated in the Decree, include developing the Brazilian supply chain and its competitiveness, incentivising the national engineering sector, promoting innovation and increasing the level of local content. Whilst this might not immediately appear to represent a significant change of direction, the way in which these aims are to be implemented, does. The programme should lead to a change in local content rules which will contain a mixture of incentives and bonuses, making it easier for oil companies and their international suppliers to achieve local content targets.

Incentives and Bonuses

Although the exact make-up of the new rules has yet to be established, the Decree sets out the following framework for further discussion and implementation:

Incentives

: Increases are proposed to the valuation of the local content percentages obtained by suppliers for systems, goods and services of strategic importance. This includes systems, goods or services which develop local engineering; develop technological innovation within Brazil; have a high potential to generate skilled jobs; and / or promote exports.

Bonuses

: Local Content Units (“UCLs”) are proposed to be created, which would be granted to a company or consortium that promotes one or more of the following, in Brazil:

a) the entering into of contracts for the purchase of goods, services or systems which enable the creation of new suppliers in Brazil;

b) direct investment in the expansion of production capacity of Brazilian suppliers;

c) direct investment in the process of technology innovation of Brazilian suppliers;

d) the purchase of goods and systems in Brazil, with local content, for use outside Brazil; or

e) the acquisition of goods or systems of a pioneering nature, developed in Brazil.

These UCLs can then be applied against local content targets for a particular block to make up for any shortfall on that particular project. This should enable more flexible contracting, making it easier for oil companies to select the most suitable contractors for projects, with foreign contractors not necessarily being excluded for lack of local content.

Implementation

The programme will be coordinated and executed by various committees, which will include representatives from ANP (Brazilian petroleum and bio-fuels regulator), BNDES (Brazilian development bank), FINEP (Brazilian government agency for innovation and technology) and a number of key government ministries. Although the Decree sets out the framework for change, it also leaves much to be considered further. The Directive Committee has a period of 90 days within which to define the goods, industrial segments and technological areas to which the bonus and incentives will apply, as well as defining measurement criteria and agreeing the final detail to the rule changes in general.

According to the Minister of Mines and Energy, Eduardo Braga, the changes will reduce the number of problems with major contracts and relieve some of the pressure caused by the fines imposed on oil companies.

Talk of relaxation of the rules is often met with opposition, especially from the ranks of trade unions, concerned about the impact on jobs. This time is no different, as the sector struggles to cope with low oil prices and the fallout from the ‘Lava Jato’ corruption scandal, both factors causing Petrobras to suspend or cancel many projects. However, it is the crisis itself which is now the catalyst for change. It would seem that the Brazilian government has finally recognised that reforms are necessary to get the sector back on its feet and that local suppliers should be competitive and not able to hide behind local content rules. This is a positive move for the industry and should increase opportunities for foreign suppliers looking to enter this market.