BRAZIL: NEW OIL REGIME ALMOST READY FOR PRIME TIME; ENERGY

UNCLAS SECTION 01 OF 03 BRASILIA 000765 SENSITIVE SIPDIS NSC FOR DNSA MICHAEL FROMAN ENERGY DEPARTMENT FOR DEPSEC DANIEL PONEMAN, CAROLYN GAY, RHIA DAVIS AND GARY WARD COMMERCE DEPARTMENT FOR SECRETARY LOCKE DEPT FOR EEB WHA/EPSC WHA/BSC E.O. 12958: N/A TAGS: ENRG EINV PREL BR SUBJECT: BRAZIL: NEW OIL REGIME ALMOST READY FOR PRIME TIME; ENERGY MINISTER OFFERS PREVIEW REFS: A) 07 Sao Paulo 899, B) Rio de Janeiro 91, C) Rio de Janeiro 35, D) Rio de Janeiro 138, E) Rio de Janeiro 135, F) Rio de Janeiro 159, G) Brasilia 910, H) Brasilia 1122, I) Rio de Janeiro 237, J) Rio de Janeiro 235, K) Rio de Janeiro 237, L) Rio de Janeiro 245, M)Rio 0014 ¶1. (SBU) SUMMARY: Brazil is poised to finally unveil its long-awaited proposal for a new oil regime to administer its ultra deepwater (also known as "pre-salt")oil reserves. According to the Minister of Energy, the new proposed structure will include a small state-owned company under the auspices of the Ministry of Mines and Energy, to manage the auctions for pre-salt blocks in the Santos and Campos Basins. The proposed legislation will contain safeguards to maintain Petrobras' market position but will remain open to international oil companies. Ministry sources indicated that the proposal may be unveiled June 18 but there are still details to be resolved which could further delay the proposal. News reports indicate that there will be a "bonus" payment required to the government to win the rights to a certain block and that bonus will be paid in oil, the proceeds from which will go into a social responsibility fund. Lobao told the Ambassador that he is eager to visit the United States and Energy Secretary Chu and wants to see continue improved bilateral relations. He also noted that Brazil is continuing to work towards making a deal with the Paraguayans over the contested contract terms of the binational Itaipu dam. END SUMMARY ¶2. (SBU)In a meeting with Ambassador Sobel on June 8, echoing Petrobras predictions, Lobao told the Ambassador that Brazil expects to more than double its daily production of oil when the pre-salt oil reserves in the Santos and Campos Basins come on line. The current production is just under 2 million barrels per day and within 10 years it is expected to total to 6 million per day. ¶3. (SBU)To manage these reserves, Lobao confirmed that the executive branch will propose a new state company, established along the lines of the model in Norway. The completely government owned company will have approximately 100 employees and be attached to the Ministry of Mines and Energy. It will be responsible for managing all of the pre-salt reserves, except for those already auctioned under the old system (whose existing contracts will continue to be managed by national oil regulator ANP). He confirmed that Brazil will maintain its current two year exploration period for any concessions, after which period, if the block is not declared commercial, it will revert back to the government. ¶4. (SBU) The proposed law will permit the GOB to assign blocks to a particular company when desired, a provision ostensibly open to any company but designed to apply to Petrobras. The provision will not require that Petrobras be involved in every block. Lobao said the idea is to allow Petrobras to maintain its current position in the market. "We don't want it to get smaller, we don't want it to get bigger." Petrobras had advocated publically to develop a company to hold the pre-salt assets under Petrobras' umbrella, further strengthening Petrobras. Press reports speculate that as a means of appeasing Petrobras, which lost the battle on the model, the current law will provide a provision to ensure Petrobras will not be weakened vis vis the new company. ¶5. (SBU) In a later conversation, Jose Lima Neto, Undersecretary for Petroleum, Natural Gas and Renewable Energy at the Ministry of Mines and Energy, confirmed to Econoff that there will likely be a provision for the GOB to designate certain blocks for Petrobras, similar to what is done by many countries in the region, while other blocks are put out for bid via service contracts. Lima Neto, who has been tasked with leading the effort to build the new model, indicated that any concerns that this provision would lead to a monopoly power for Petrobras would be misplaced. "It would be impossible" for Petrobras to try to control the entire area since the resources needs are too great to permit one company to dominate. ¶6. (SBU) Lima Neto has portrayed the government's relationship with Petrobras as a somewhat wary one. While recognizing the tremendous economic contribution Petrobras makes to Brazil, many, including apparently President Lula, are concerned about having any one entity in Brazil gain too much power. GOB contacts say Lula has quipped that he's the third most powerful person in Brazil after Petrobras' BRASILIA 00000765 002 OF 003 CEO Sergio Gabrielli and Luciano Coutinho, head of national development bank BNDES. A recent report by the Brazilian newspaper Valor highlights the fact that the majority of the proceeds from Petrobras' gains go to private investors, many of them foreign; which only serves to increase the government's determination not to over benefit Petrobras through the pre-salt reserves. ¶7. (SBU)Lima Neto stressed that the new structure would remain open to international companies and that all prior contracts would still be honored. He said, "we're talking about the future, not the past," indicating that Brazil is remaining careful not to violate any of its existing contractual obligations. He did not discuss how the government planned to handle unitization of blocks which border blocks previously concessioned under the old system. According to Lima Neto, Brazil's primary reason for developing a new state-owned company to manage the reserves is to allow Brazil a greater hand in controlling the pace of exploration and production, especially in the face of fluctuating oil prices. ¶8. (SBU) Lima Neto confirmed that the government is working to announce the new structure for the pre-salt oil reserves on June 18. However, he said, there is no guarantee they will achieve agreement on the final model by that time. The issue of how to structure the "government take" of the revenues is still very much at issue. According to Lima Neto, some of the top options still in play are a royalty structure or a possible federal tax, or a combination of both. ¶9. (U) While government sources are guarded in discussing some of the details of the new structure, pending finalization of the proposal and approval by President Lula, news reports continue to speculate. Recent reports from news daily Valor suggest the proposal will be sent to Congress in August by the Lula administration via three separate bills. The first will create the new state company to manage the pre-salt reserves and the second will establish a "social responsibility fund" to use the pre-salt revenues to invest in areas such as education, health, and housing. The third bill will alter the previous 1997 Petroleum Law to allow for a mixed system with a new service contract model for the uncontracted pre-salt reserves, in which the competition will be determined largely by which bidder offers the government the largest share of revenue in the form of a bonus, starting from a fixed minimum bid, and maintaining the old system for areas currently under contract and those unexplored areas deemed to have less potential than the pre-salt blocks. ¶10. (U)Valor reports that payments to the national treasury from the concessions will be paid in oil. It also reports that despite requests from Finance Minister Guido Mantega for a higher bonus payment to be directed towards current accounts in the Federal operating Budget, Minister Lobao won out with a bonus payment that will be "minimal and fixed." The bonus amount will reportedly be fixed in a decree rather than as part of the law, in order to allow the government to adapt it if needed, depending on any new discoveries as well as the difficulty and pace of exploration. RUMINATING ON THE RELATIONSHIP ¶11. (SBU) In his conversation with the Ambassador, Lobao referenced comments by Minister of Strategic Planning Mangabera Unger that there are no two countries more alike that the U.S. and Brazil - but the governments don't know it yet. Lobao agreed. He said we need to put the two countries side by side for the long haul, for the good of our countries and the good of humanity. He said it's a shame that President Lula can't continue doing the work has he has undertaken to move down this path,(Note: President Lula's mandate is limited to two consecutive terms, the second of which will end in 2010) but Lobao expressed his hope that Lula's Chief of Staff and possible preferred successor, Dilma Rouseff would be able to continue that struggle, possibly holding the line until Lula could return in 2014. (Note: Lobao did not indicate any knowledge of plans to this effect but expressed his hope that it could happen). Lobao opined that renewable energy was one avenue to pursue the continued development of the bilateral relationship. ¶12. (SBU) In that vein, Lobao said he had been impressed by Energy Secretary Chu at the G8 Energy Ministers' meeting in Rome and would BRASILIA 00000765 003 OF 003 like to visit him soon, with Ambassador Sobel accompanying him. They discussed the possibility of the week of July 20th on the margins of the CEO forum in Washington. Ambassador Sobel suggested that Deputy Secretary Marcio Zimmermann consider traveling in advance of a Lobao trip to help set up technical discussions. (NOTE: Zimmermann has since confirmed his intention to travel to the United States the week of July 6 - 10.) ¶13. (SBU)While cautioning Lobao not to forget the possibilities for cooperation in the area of fossil fuels, the Ambassador also conveyed DOE suggestions for some areas in which the GOB could take a leadership role in the hemisphere: renewable energies, diversifying the energy matrix, rural electrification, and cooperating with Peru's proposed center of energy efficiency. ITAIPU ¶14. (SBU) When asked about ongoing negotiations with Paraguay over disputed contract terms on the binational dam, Itaipu, Lobao, exhibiting some irritaion, noted that although Paraguay wasn't entitled to it, Brazil was looking to find a solution to help Paraguay. (NOTE: Paraguayn President Lago has made renegotiating the below-market contract prices Brazil pays for energy from the dam a central goal of his adminstration, wile Brazil has firmly insisted on the sancity of contract terms though it is willing to explore other options to mitigate the situation.) Because Paraguay currently does not use all of the energy it is entitled to from the Itaipu dam, Brazil has proposed that Paraguay increase its usage of Itaipu energy, allowing it to decrease the use of energy from two of its national dams. Paraguay would then be permitted to sell the energy from the other two dams on the free market in Brazil. This would enable them to use the Itaipu energy at a rate of $21 per Megawatt and sell their excess energy at a rate of $50/MW. Brazil is also offering US$500 million to finance the transmission lines necessary for Paraguay to put this scheme in place, along with other unspecified energy assistance in the range of $1 - 2 billion. ¶15. (SBU) COMMENT: While some details remain to be decided in the proposed new regulatory structure governing the promising pre-salt oil reserves, the government has again made clear that it will honor all existing contracts and the new system will be open to international oil companies as well as national ones. The time Brazil has taken in developing thse regulations demonstrates the GOB's determination to develop a regime that can pass Congress and will stand the test of time. Much of the delay in putting forward a new model has been attributed to the fact that every time a new proposal is developed, it has to be thoroughly vetted by lawyers. Based on the actions and statements of Brazilian officials, it seems certain that Brazil will continue to welcome and encourage the participation of outside firms in the development of this potentially enourmous and resource-intensive national asset. Similarly, the Ministry of Mines and Energy is very favorably inclined to working with the U.S. in multiple areas of the energy sector; the upcoming trips by Lobao and Zimmermann to the U.S. offer excellent oportunities to capitalize on those desires. END COMMENT SOBEL