Following major discoveries of oil and gas in the pre-salt layer off the Brazilian coast in 2006, Brazil has been seeking to increase revenues and develop its offshore industry. This is being achieved in a number of ways, including increasing local content requirements, establishing Petrobras as the sole operator and main off-taker in the supply chain, and providing attractive financing for new building projects at Brazilian shipyards.
Managing partner
Wikborg Rein
Concession agreements used in the bidding process overseen by the National Agency of Petroleum, Natural Gas and Biofuels (ANP) typically include a provision requiring the purchase of Brazilian-produced products and services if such products and services are competitive in price, schedule and quality. Such agreements also prohibit procurement procedures that discriminate against local Brazilian industry.
Over the past decade, Chinese energy companies have wielded an advantage over international competitors in their ability to undercut price by using cheap, skilled Chinese labour, and equipment and parts produced in China. As Brazil flexes its muscles and turns an eye towards its own industry, China must work harder to remain competitive there.
Local content requirements
The ANP has traditionally viewed the percentage of Brazilian goods and services to be used by a bidder as an important factor when awarding concessions. Until 2003, bidders were free to propose their own local content thresholds. Subsequently, bidders were required to follow minimum local content thresholds established by the ANP. Further changes were subsequently made, and today, rather than overall thresholds, bidders must meet minimum local content thresholds for each individual item and sub-item specified in a standard ANP spreadsheet.
In July 2004, the Brazilian Oil and Gas Industry Mobilization Programme issued a “local content manual” which includes methodology for the calculation of the index of local content of goods, systems and services related to the oil and gas industry. This methodology is based on methods for calculating financing as applied by the Brazilian Bank of Economic and Social Development (BNDES).
In December 2010, the Brazilian government introduced a production sharing regime in pre-salt and strategic areas with the enactment of Law No. 12351/10. The Ministry of Mines and Energy was given the right to recommend to the National Energy Policy Council the applicable technical and economic parameters to be used in production sharing agreements, including local content requirements. Local content was defined as the ratio between the value of the goods and services produced in Brazil and the value of the goods and services provided from other countries.
The new law also placed Petrobras at the centre of the production chain as the sole operator of blocks in the pre-salt and strategic areas.
As a result of these changes, local content requirements filter through to agreements used for the provision of oilfield services, equipment purchases and supplies of materials. A typical local content clause in a Petrobras service agreement reads as follows:
The Contractor undertakes to contract services, from Brazilian suppliers, during the Unit operation phase, so that total amount paid by the Contractor, in relation to services contracted in Brazil, will be equal to or greater than XX% of the value invoiced in this Contract, at the end of each contractual year. Calculation of the value of the services contracted for the purposes of this clause shall include imposts, taxes and duties, the contracting of personnel, training, transport and other direct and indirect operating costs.
Positive impact on shipyards
In order to comply with high local content thresholds under the concession agreements, Petrobras customarily passes these requirements on to its suppliers. Because the hull of a floating production, storage and offloading vessel or floating storage and offloading vessel represents approximately 70% of the total value of the vessel, contractors feel obliged to build these hulls locally. This, coupled with special financing terms from the Merchant Navy Fund and BNDES, has resulted in a rebirth of the Brazilian shipbuilding industry.
Nonetheless, Brazilian goods and services are an estimated 30% more expensive than those provided by international competitors. This can be attributed to a variety of factors, including a lack of local technology, a dearth of large Brazilian suppliers, and tax disadvantages for Brazilian suppliers which can be traced back to a special tax regime enacted in the 1990s which significantly reduces the tax burden on foreign suppliers. This was originally intended to encourage international companies to participate in Brazilian industry, but now serves as a disadvantage to Brazilian manufacturers and service providers.
The Norwegian model
In developing an internationally competitive oil service industry, Brazil has been inspired by the regulatory model adopted in Norway, whose national suppliers were faced with similar challenges at the beginning of the exploration of the North Sea. In 1972, Norway established a regulatory system favouring Norwegian goods and services so long as they were competitive in terms of price, quality, schedule and service. The country also introduced a policy for knowledge transfer and research cooperation between Norwegian and international suppliers. Furthermore, Norway established a Goods and Services Office to monitor the contracting and procurement procedures of international oil companies operating in Norway. These protective measures were repealed when Norway joined the European Economic Area in 1994, but by then Norway had already succeeded in developing Statoil and several major globally competitive national oilfield service companies.
Local content requirements in certain regions of the world are nothing new, and international energy companies have learned to cope with them. Chinese companies must now do the same. Faced with these provisions in international production sharing contracts, farm-out agreements and oilfield services subcontracts, Chinese state-owned enterprises may soon be forced to integrate skilled Chinese labour and Chinese products with locally produced goods and Brazilian oilfield workers. This will undoubtedly affect their bottom line. If Chinese energy companies wish to remain competitive, they must play to their strengths. Economies of scale, financing by state-owned banks, cheap currency and hard choices regarding goods and personnel may just see them though.
Geir Sviggum is the managing partner of Wikborg Rein’s Shanghai office. His clients include national governments and Chinese and multinational corporations, including both private and state-owned companies in the energy industry. Sviggum is also chairman of the Norwegian Business Association in Shanghai. He may be contacted on +86 21 6339 0101 or by email at gsv@wrco.com.cnGeir
