An oil-rich region was set aside for development by the Brazilian government and named the Transfer-of-Rights (TOR) area. The TOR area is estimated to hold oil reserves nearly as large as those of Norway and Mexico combined. The Brazilian state oil company, Petrobras, paid that nation’s government the equivalent of 42.5 billion US dollars in 2010 for the rights to extract 5 billion barrels of oil in the TOR area. At the time, other oil companies could only look on with envy.
The Technical Challenges
Although the TOR area has incredible potential, realizing that potential was always going to require an enormous amount of technical skill and financial investment. The oil in the TOR area is underneath a layer of salt in addition to being under sediment and ocean water. The TOR area is actually only part of a much larger region known as the Brazilian pre-salt area. The pre-salt area takes its name from the layer of salt that covers it. The total pre-salt area holds somewhere between 50 and 100 billion barrels of oil.
We believe that full-cycle costs in the pre-salt area are likely to be higher than expected. While Petrobras has substantial experience in deep-water drilling, the pre-salt area presents new technical challenges. Other firms may face even more difficulties. At lower oil prices, the development of the area may not be cost-effective.
Falling Prices and Fading Interest
Oil prices fell precipitously during parts of the last decade, which has dampened interest in the TOR area. When the price of oil briefly went below 30 US dollars a barrel in 2016, the TOR area looked highly unprofitable. However, Brazil continued to develop the area during a deep recession. With prices up to around 60 US dollars per barrel in 2019, the situation seemed to have improved. After resolving some disputes with Petrobras, the Brazilian government decided that it was time to auction more oil drilling rights.
The auctions were intended to show Brazil’s commitment to markets, and several international oil firms initially showed interest. Fourteen companies registered, including Exxon Mobil, Royal Dutch Shell, and Chevron. The auctions were only partially successful. The government raised the equivalent of 17.5 billion US dollars, just 66% of the target. Petrobras won 90% of the Búzios field, with the Chinese oil firms CNODC and CNOOC taking 5% each. Petrobras also won 100% of the Itapu field, and there were no bids at all for the Atapu and Sepia fields.
The Need for New Auctions
The relatively poor results indicate that Brazil must hold more competitive auctions in the future. The high minimum bids, profit-sharing with the government, and Brazil’s reputation for excessive bureaucracy may have deterred international bidders. The winning bidders must give over 23.24% of profits from Búzios and 18.15% of profits from Itapu to the Brazilian government.
The memory of low oil prices and relatively recent losses made most oil companies too cautious to bid. Only Petrobras can expect the Brazilian government to share in losses if prices fall again. The World Economic Forum (WEF) ranked Brazil last out of 141 nations for the burden of government regulation. On the positive side, reducing that burden is a priority for the government. Furthermore, the WEF reported that Brazil’s regulatory red tape did diminish this year.
The Promise of the Future
Despite a slow start, the TOR area and greater pre-salt region still have enormous potential for the future. Brazil’s total oil production is projected to rise from 3.2 million barrels a day in 2020 to 5.5 million by 2029. Most of that growth comes from the development of the pre-salt area. With improved governance, technical advances, and perhaps higher oil prices, more firms will become interested in developing Brazil’s oil resources.
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