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Cablegate: Brazil Considers Changing Energy Sector Rules

VZCZCXRO2343
RR RUEHRG
DE RUEHRI #0138/01 1571659
ZNR UUUUU ZZH
R 051659Z JUN 08
FM AMCONSUL RIO DE JANEIRO
TO RUEHC/SECSTATE WASHDC 4491
INFO RUEHBR/AMEMBASSY BRASILIA 0832
RUEHSO/AMCONSUL SAO PAULO 5153
RUEHRG/AMCONSUL RECIFE 3425
RUCPDOC/USDOC WASHDC
RHEBAAA/USDOE WASHDC

UNCLAS SECTION 01 OF 02 RIO DE JANEIRO 000138

SIPDIS
SENSITIVE

STATE FOR WHA/BSC, WHA/EPSC, EB/ESC
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOE FOR CAROLYN GAY AND RHEA DAVIS

E.O. 12958: N/A
TAGS: ENRG EPET EIND EINV BR
SUBJECT: Brazil Considers Changing Energy Sector Rules

REF: A) RIO DE JANEIRO 91 B) RIO DE JANEIRO 35 C) 07 SAO PAULO 0953

Sensitive But Unclassified - Please Protect Accordingly

SUMMARY
-------

1. (SBU) Brazil is considering changes to its oil sector for the
purpose of capturing more revenue from the country's significant
newfound "pre-salt" oil reserves. Brazil's National Energy Policy
Council will meet later this year to decide how to proceed.
Meanwhile, further leasing of offshore exploration blocks has been
suspended. There are two competing proposals being considered --
maintain the current concession model and increase royalties, or
nationalize petroleum reserves and use production sharing agreements
to partner with oil companies to develop them. Both options would
yield similar revenue levels for the government, but political
factors will be the driving force behind the decision on a way
forward. The issue has become highly politically charged in recent
months, with some government officials making public nationalistic
comments. On the ground, energy officials and Petrobras
representatives are noticeably hesitant to discuss the issue with
outsiders. End Summary.

2. (U) Brazil is likely to change its rules for the oil sector
later this year, with the goal of raising the amount of revenue the
government receives from the oil industry. In the current
concession system, foreign companies have rights to the oil in the
ground and compensate the government for taking the resources via
royalties. Because Brazil has recently discovered significant
pre-salt offshore reserves (Refs A and C), there is consensus among
government officials that Brazil needs to raise its take from
industry. What is unresolved is how to accomplish this.

3. (U) Brazil currently charges a lower tax and royalty rate than
many other oil producers. This is a legacy from the late 1990s when
the country was a net oil importer and wanted to attract companies
to explore and find new deposits. After the recent discoveries,
industry says that Brazil has every right to raise its take given
that it is one of the few promising frontiers in global oil
exploration. However, industry representatives hope the government
does not go too far, wait too long, or apply new rules to existing
contracts.

THE SIMPLE SOLUTION? INCREASE ROYALTIES.
----------------------------------------

4. (U) Currently, companies that produce oil and gas in Brazil pay
a 10 percent fixed royalty rate. On top of that, they pay an
additional "special participation rate" for large fields ranging
between 10-40 percent of revenue depending on the volume, location,
depth and age of the field. State governments levy even more taxes
(rates vary by state). In total, Brazil collects between a maximum
of 57-62 percent in oil royalties for large fields. In comparison,
Russia and Kazakhstan take around 70 percent. Some governments take
as high as 80 percent.

5. (SBU) Brazil's National Petroleum Agency (ANP), the country's
oil regulatory agency, is working on a proposal which it plans to
present to the government's National Energy Policy Council at the
end of June. It will likely propose a hike in the special
participation rate to somewhere between 40-60 percent. The
Brazilian Petroleum Institute (IBP), Brazil's main oil industry
group, supports ANP's proposal and actually contracted an
independent study to demonstrate that the government could capture
as much revenue by raising the special participation rate as it
could by changing to a production sharing model (the competing
proposal). The benefit of this approach, argues IBP, is that the
rate increase could be handled relatively simply by a Presidential
decree. Industry representatives at a May 13 luncheon with visiting
Director of the Minerals Management Service, Randall Luthi, also
privately confirmed their support for the ANP proposal.

RETHINKING PRIVATIZATION: PRODUCTION SHARING AGREEMENTS
--------------------------------------------- ----------

6. (U) Petrobras, however, which currently produces more than 95
percent of Brazil's oil, would be the hardest hit by such a hike in
the special participation rate. If the rate were to rise to 60
percent of revenue and applied to existing contracts, for example,
the company would have to pay an additional US$4.1 billion -- more
than double what it pays in special participation now. For this
reason, some in Petrobras are pushing for a new regime altogether.
Guillherme Estrella, Petrobras' Director for Exploration and
Production, has been the chief proponent for a production sharing
regime.

7. (SBU) Under a production sharing regime, Brazil would have to
nationalize the country's petroleum resources by an act of Congress.
The Brazilian government would legally own all of the country's
petroleum resources, and then partner with oil companies who would
assume the costs of exploration and production in exchange for a
share of the revenue. Production-sharing basically shifts the
ownership of oil from companies to the government, and inverts the
flow of payments between the government and companies. Exxon
executives visited Embassy Brasilia in April specifically to express
their concerns about this model and a few others that were rumored
to be under consideration. It was their view that the production
sharing regime would be a disincentive to private industry.

8. (U) Such a regime change would be very complicated, which is why
many see this as an unlikely outcome. First, Brazil takes great
pride in the openness of its petroleum industry. Nationalization
would be considered a very serious political statement. Second, in
today's political climate, there is little confidence in the
Brazilian Congress and any such legislation that it might pass.
Third, production sharing requires that Brazil have a 100 percent
state-owned company to manage the petroleum resources.

9. (U) While Petrobras used to be a wholly state-owned company, 63
percent of the company's shares are now publicly traded. It would
be impossible for the company to revert. One idea under
consideration is to use the Energy Research Corporation (Empresa de
Pesquisa Energetica -EPE), the Rio-based strategic planning arm of
the Ministry of Mines and Energy. In fact, EPE President Mauricio
Tolmasquim is said to be currently participating in many
petroleum-related meetings not historically in EPE's portfolio.

TIMING OF OUTCOME IMPORTANT
---------------------------

9. (U) Regardless of outcome, international industry sees oil
exploration in Brazil as a lucrative venture and is eager to get
into the pre-salt game. However, it fears that it may have to wait
two or three years before getting the opportunity to bid on new
exploration opportunities since offshore oil lease auctions have
been suspended since the pre-salt discoveries were confirmed in
November 2007.

10. (SBU) Some industry representatives think that Petrobras is
pushing production sharing with the primary objective of stalling
the National Energy Policy Council's deliberations. This would give
Petrobras more time to pull together resources to bid competitively
on more pre-salt blocks. By many accounts, Petrobras is not
currently well positioned to win prime blocks in an open auction
against international oil companies such as Exxon and domestic
newcomer OGX.

11. (U) For its part, ANP wants to resume oil lease auctions as
soon as possible. It realizes that its very existence is dependent
on an open and competitive sector. ANP hopes to offer its next bid
round sometime in 2009, possibly as early as the first quarter if
the National Energy Policy Council accepts the ANP royalty increase
proposal.

12. (U) ConGen Rio de Janeiro will continue to follow this issue
closely and report on further developments. This cable has been
coordinated with and cleared by Embassy Brasilia.

MARTINEZ

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