CAN THE OIL INDUSTRY BEAT BACK THE PRE-SALT LAW?

C O N F I D E N T I A L RIO DE JANEIRO 000369

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E.O. 12958: DECL: 2019/12/02
TAGS: EPET EIND EINV PREL PGOV BR CO
SUBJECT: CAN THE OIL INDUSTRY BEAT BACK THE PRE-SALT LAW?

REF: BRASILIA 1099; RIO DE JANEIRO 294; RIO DE JANEIRO 288

CLASSIFIED BY: Dennis W. Hearne, Principal Officer; REASON: 1.4(B),
(D)

SUMMARY




1. (C) Although major international and independent oil companies
continue to view the regulatory framework to develop Brazil's
offshore Pre-salt oil and gas reserves as potentially debilitating
to their future exploration and production (E&P) operations here,
the Rio de Janeiro-based industry group that represents these
companies has thus far been unsuccessful in efforts to enact
changes to the law in the House of Deputies. Industry continues to
argue that the most detrimental aspect of the framework on the
commercial viability of future Pre-salt operations, and even local
manufacturing, is Petrobras' designation as chief operator, part of
the bill addressing PSAs. Local manufacturers and suppliers also
will also be affected, but the largest Brazilian petroleum
suppliers group complained the political nature of the framework
was impeding their voice on the matter in Congress. With industry
resigned to the passage of the framework's four bills in the House
of Deputies (for the most part in current forms),its strategy
going forward is to enlist new partners to focus on the Senate,
with the goals of winning key amendments to the bills, as well as
pushing a vote back until after the October Presidential and
Congressional elections. End Summary.



ELECTION YEAR MAKING FOR A "HARD BATTLE" FOR INDUSTRY




2. (C) Although major international and independent oil companies
(IOCs) continue to view the regulatory framework to develop
Brazil's offshore Pre-salt oil and gas reserves as potentially
debilitating to their future exploration and production (E&P)
operations here, the Rio de Janeiro-based industry group that
represents these companies has thus far been unsuccessful in
efforts to enact changes to the law in the House of Deputies.
Patricia Pradal, head of government relations for Chevron told
Econoff on November 19 that since President Lula announced the
framework on August 31, industry had been fighting a "hard battle"
to enact changes to the legislation, but the House of Deputies has
not taken any industry concerns into consideration. (Note: Pradal
also heads the steering committee of the Brazilian Institute for
Petroleum (IBP),the industry umbrella group that represents all
major international and independent oil companies operating in
Brazil, including Petrobras. She spoke to Econoff in this
capacity. End Note). Pradal lamented the lack of support from
opposition parties in Congress, blaming Presidential and
Congressional elections next year and explaining, "The PSDB
[primary opposition party] simply has not shown up to this debate."
She expressed begrudging respect to President Lula's International
Relations Adviser Marco Aurelio Garcia and Press Secretary Franklin
Martins as the principal orchestrators of the Government's
strategy, stating, "They are the professionals, and we are the
amateurs."



PSDB'S SERRA REPORTEDLY OPPOSES FRAMEWORK, BUT NO SENSE OF URGENCY




3. (C) According to IBP's Pradal, likely PSDB 2010 Presidential
Candidate Jose Serra opposed the framework, but seemed to lack a
sense of urgency on the issue. She quoted him as telling industry
representatives, "Let those guys [Worker's Party] do what they
want. There will be no bid rounds, and then we will show everyone
that the old model worked...And we will change it back." As for
what would happen to foreign oil companies in the meantime, Serra
reportedly remarked, "You will come and go." Congressional
sources have also told Embassy officers that Serra has signaled
PSDB and other opposition sources that they should amend - but not
oppose the final Pre-Salt legislation, and urged opposition
legislators to avoid vocal opposition to the law.


CURRENT STATUS OF THE FRAMEWORK




4. (U) On August 31, President Lula announced the framework and
sent it to Congress for approval. On November 18, the House of
Deputies (Camara) passed the first of the four bills (reftel A)
that make up the framework, by a vote of 250 to 67, to create
Petrosal, a new government entity that will represent the Brazilian
government in the not-yet-approved production sharing regime.
Further reporting will be reported septel. (Note: The next bill
to likely go to vote in the House of Deputies will be the creation
of a social fund, followed by the 50 billion USD Petrobras
capitalization bill. We anticipate the bill instituting Production
Sharing Agreements (PSA) - and making Petrobras the chief operator
of all Pre-salt blocks - will be the last to go before a House of
Deputies vote. Once the House of Deputies passes a bill, it must
then go before the Senate for approval. If the Senate passes the
bill, it is final. If it amends the Qll, it will then go back to
the House of Deputies for discussion and revote. Post will report
further on legislative developments septel. End Note).



PETROSAL: ALL THE CONTROL, NONE OF THE LIABILITY?




5. (C) While not opposed per se to the existence of Petrosal,
industry is concerned this group of political appointees, who will
administer the Pre-salt blocks on behalf of the Brazilian
government, will also wield disproportionate power over the
operations of any Production Sharing consortium into which an oil
company enters. Under the law as proposed, Petrosal controls 50
percent of the seats - with veto power - in a PSA consortia's
operating committee. According to IBP's Pradal, this will
therefore give Petrosal significant power over key E&P decisions,
such as budget, environmental, and safety matters, in the Pre-salt
blocks. "They will have all the control, and none of the
liability," she said.



PETROBRAS AS CHIEF OPERATOR UNIVERSALLY CRITICIZED




6. (C) Industry continues to argue the most detrimental aspect of
the framework on the commercial viability of future Pre-salt
operations is Petrobras' designation as chief operator, part of the
bill addressing PSAs. Emphasizing a point she made to the Charge
d'Affaires on September 1 (reftel B),Exxon's Lacerda said having
Petrobras run all Pre-salt blocks will effectively relegate oil
companies to mere financing bodies. Robert Abib of Anadarko said
on November 19 that Petrobras' role as chief operator could shut
out the smaller independent oil companies if the parastatal focuses
on the Pre-salt's largest fields, rather than smaller ones where
independents normally specialize and focus their operations.
Exxon's Lacerda complained the PSA bill failed to sufficiently
define the fiscal terms assigned to the contracts, and said under
the proposed regime, such terms would only become clear immediately
prior to a bid round, making it nearly impossible for a company to
effectively prepare. Both IBP's Pradal and Lacerda said ongoing
debate on the distribution of royalties to oil producing and
non-producing states, municipalities, and the federal government,
which is also part of the PSA bill, was preventing any real
discussion on the framework's transparency and ability to attract
investment.




7. (C) Should Petrobras' chief operator designation remain, IBP's
Pradal said it would be impossible to compete in bid rounds against
National Oil Companies (NOC),such as China's Sinopec and Russia's
Gazprom. According to Pradal, it will come down to who gives the
government the most profit. "The Chinese can outbid everybody,"

she explained. "They can break-even and it will still be attractive
to them. They just want the oil." Pradal said Chevron would not
even bid under such circumstances. (Note: Foreshadowing greater
NOC involvement in Brazil, Colombia's 90 percent state-owned oil
company Ecopetrol opened an office in Rio de Janeiro on November

18. Furthermore, Petrobras CFO Barbassa said on November 23 that
the parastatal would be sending top executives to China in early
2010, in an effort to attract Chinese petroleum equipment suppliers
to Brazil. Post will report on both issues septel. End Note).



WHAT ABOUT THE LOCAL MANUFACTURERS?




8. (C) Brazilian manufacturers and suppliers also stand to lose
from Petrobras' role as chief operator, but Brazil's largest
petroleum suppliers group complained the political nature of the
framework was impeding their voice on the matter in Congress.
Exxon's Lacerda said local manufacturers and suppliers would stand
to lose by having only one principal client, suggesting the
National Organization for the Petroleum Industry (ONIP),a
nonprofit forum that brings together Brazil's largest petroleum
service providers and suppliers, could be a powerful ally in this
fight. She complained, however, that ONIP had thus far been
"quiet" on the issue. ONIP Director Alfredo Renault told Econoff
on November 23 that while ONIP does not engage on public policy or
lobbying, it was concerned about Petrobras' designation of chief
operator in the framework, and expressed these worries to Congress.
Unfortunately, he explained, the Special Committee in the House of
Deputies where Renault made his presentation was driven by
"politics rather than logic," and appeared indifferent to his
concerns. According to Renault, having only one client would not
benefit Brazilian manufacturers' competitiveness nor provide them
with the opportunity to establish the buyer-supplier relationships
with major international and independent oil companies, crucial to
doing business overseas. Renault stated some industry associations
within ONIP favored the framework, but said these groups tended to
include companies that already have extensive commercial
relationships with Petrobras.



RISKY PETROBRAS CAPITALIZATION




9. (C) Oil company representatives see legal problems with the bill
concerning the capitalization of Petrobras through a guarantee of 5
billion barrels of Pre-salt oil, and question the constitutionality
of the transaction. IBP's Pradal explained the proposed
capitalization, which will infuse Petrobras with promised reserves
in exchange for increased government shares in the company, has
precedent in other countries; she said, however, such precedent
involved proven reserves, rather than unproven ones, as they are in
this case (Note: Pradal was unable to name the country where this
occurred, but stated Chevron's legal team was researching the
precedent. End Note). Anadarko's Abib emphasized the risk of
diluting Petrobras' shareholder value, and said the company was
risking a breach of its fiduciary responsibilities. Claiming it
was impossible to accurately value the Pre-Salt oil, he claimed
Petrobras shareholders could sue the company, if it turns out the
reserves were over-valued. According to Pradal, accounting firms
and investment banks held serious concerns over the transaction,
but only one group of minority shareholders was vocally expressing
these worries. She expressed consternation that the CVM had not
even opened an investigation into the transaction. (Note: CVM is
the Brazilian equivalent of the SEC. End Note). Pradal added,
"As a matter of fact, we do not believe Petrobras is doing things
by the books," claiming Petrobras willfully overestimated the 5-8
billion barrels of oil deposits in the Tupi offshore area. (Note:
Petrobras is currently under Congressional investigation for
fraudulent practices - tax evasion, overpaying for goods, and
favorable donations to Lula supporters - but is widely expected to
be cleared of charges by a Senate committee controlled by the
governing coalition. End Note).


INTERNAL CONFLICT IN PETROBRAS?


10. (C) Petroleum industry players in Rio claim there is a division
of opinion within Petrobras over the framework, and how it will end
up affecting both Petrobras and the Pre-salt's overall development.
Industry insiders claim some key Petrobras personnel oppose the
shift to PSAs and the chief operator role, Qile Petrobras' upper
management mostly favor the framework, viewing the Pre-salt
reserves in zero-sum, nationalistic terms. For example, at a
November 23 conference in Rio de Janeiro, Petrobras CFO Almir
Barbassa expressed concern over whether Petrobras had the capacity
to meet even its current commitments. "The pace of growth of new
projects continues to increase, and I always wonder how much longer
we will be able to grow at this pace," he said. "Projects abound,
but we are constrained by a lack of available personnel, material,
and equipment." Fernando Jose Cunha, General Director for
Petrobras for Africa, Asia, and Euroasia told Econoff in August
that the chief operator provision, along with the 30 percent
mandatory share in every block, would "chase investors away"
(reftel C). On the other hand, Exxon's Lacerda said Petrobras E&P
Director Guilherme Estrella was largely responsible for the PSA
bill's terms that prejudice international oil companies. (Note:
Estrella has publicly compared Petrobras to a national space
program, in terms of nationalist ambition, and is considered close
to President Lula. End Note).



INDUSTRY STRATEGY: WHAT NOW?




11. (C) With industry resigned to the passage of the framework's
four bills in the House of Deputies (for the most part in current
forms),its strategy going forward is to focus on the Senate, which
has a greater number of opposition legislators than the House of
Deputies. Pradal said IBP would seek to enlist new partners to
focus efforts, such as Brazilian independent E&P company OGX, the
Federation of Industries of Sao Paulo State (FIESP),the
Confederation of National Industries (CNI),and various Chambers of
Commerce, in order to win Senate amendments concerning the
Petrobras chief operator role and Petrosal terms. She also said
it would be ideal to prevent a Senate vote before May, which could
then push a vote back until after the October Presidential and
Congressional elections. According to Pradal, the "real fight"
would take place in February, after Congress returns from Recess.
Exxon's Lacerda also stated industry planned to make a "full court
press" in the Senate, but, not leaving anything to chance, Exxon
would now also branch out on its own to conduct lobbying efforts.
Pradal emphasized both IBP and Chevron's hopes that
Ambassador-designate Shannon could make a significant impact in
this debate, and asked Econoff on multiple occasions when
Congressional confirmation was expected.



COMMENT




12. (C) As they increase their efforts within this highly
nationalistic debate, the IOCs will have to tread cautiously.
Numerous Congressional contacts have shared their assessments with
Post that, by becoming more vocal on the subject, the IOCs risk
galvanizing nationalistic sentiment around the issue and damaging,
rather than helping, their cause. At the same time, the IOCs are
not optimistic over their ability to force key amendments to the
current framework. Furthermore, even if the IOCs succeed in at
least forcing a delay of a Senate vote until after a possible - but
uncertain - victory of an opposition President, there is a sense
that the wait to bid on commercially attractive opportunities in
the Pre-salt will be long. Such outlooks, as well as the limited
attractiveness of onshore blocks and the uncertainty of
non-Pre-salt offshore frontier acreage, impede the IOCs' ability to
effectively map out their local operations, and threaten their
overall interest in Brazil. End Comment.


13. (U) This cable has been coordinated with Embassy Brasilia.
HEARNE