Operations in the Pre-Salt

Understanding the Pre-Salt

1. What is the pre-salt?

The expression "pre-salt" makes reference to an aggregation of rocks located offshore in a large portion of the Brazilian coast and with potential to generate and accumulate oil. It was called pre-salt because it forms a rock interval that ranges under an extensive layer of salt which, in certain areas of the coast, can be as much as 2,000 meters thick. The "pre" expression is used because, through time, these rocks were deposited before the salt layer. The total depth of these rocks, i.e., the distance between the surface of the sea and the oil reservoirs under the salt layer, can be as much as 7,000 meters.

Petrobras recently made the biggest oil discoveries in Brazil in the pre-salt layer located between the states of Santa Catarina and Espírito Santo, where major volumes of light oil were found. The oil that has already been found in the pre-salt layer in the Santos Basin, for example, has a specific gravity of 28.5o API, low acidity and low sulfur contents. These are the hallmarks of a high-quality oil with a higher market value.

2. What is the estimated volume of oil found in the pre-salt accumulations discovered thus far?

The first results indicate very large volumes. Just to have an idea, the Tupi accumulation alone, located in the Santos Basin, has recoverable volumes estimated at 5 to 8 billion barrels of oil equivalent (oil plus gas). Meanwhile, the Guará well, also in the Santos Basin, holds 1.1 to 2 billion barrels of light oil and natural gas, at a specific gravity of approximately 30o API.

3. Are the recent discoveries made in the pre-salt economically feasible?

Based on the results obtained from the wells that have been drilled and tested thus far, there is no doubt regarding the technical and economic feasibility of the commercial development of the accumulations that were found. The technical studies that have already been carried out for the development of the pre-salt, associated to the mobilization of specialized service and equipment resources and logistics, allow us to guarantee this venture will be successful. A few important stages in this process have already been overcome: in May 2009, Petrobras kicked-off the extended well test for the Tupi area, capable of processing some 30 barrels of oil per day. A month later, the Capuava Refinery (Recap), in São Paulo, processed the first volume of oil lifted from the Santos Basin's pre-salt layer. It is a historical milestone for the global oil industry.

4. How did this history of overcoming challenges begin?

In 2004, a few wells were drilled to look for oil in the Santos Basin. Drilling was done because known sandy rocks were found there, deposited in deep waters above the salt level. If oil were discovered, the idea was to drill deeper until reaching the pre-salt, where technicians believed major oil reservoirs would be found.

In 2006, when drilling had already reached a depth of 7,600 meters from the water line, a giant gas accumulation and reservoirs of oil condensate, a component of light oil, were found. That same year, in another drilling done in the Santos Basin, the Company and its partners made another discovery that would change the course of exploitation in Brazil for good. The great news came at a depth of a little more than 5,000 meters from the water line: signs of oil were found under the salt layer in the well currently known as Tupi. This success lead to the drilling of seven more wells, and oil was found in all of them. The investment paid off.

5. What changes for Petrobras with these results?

These discoveries will catapult the company, in the upcoming years, to a new oil reserve and production level, ranking it among the major operators. With the experience they have acquired developing fields nestled in deep Campos Basin waters, Petrobras' technicians are prepared to develop the accumulations discovered in the pre-salt. To this end, they are already adapting the technology and the logistics the company developed through the years.

6. Does the industry have installed capacity to meet these demands?

This is another major challenge: the good and service industry's installed capacity cannot meet the foreseen demands yet. On account of this, Petrobras will resort to a few competitive advantages that have already been identified to drive the development of the supply chain. Thanks to its leveraging capacity, due to the volume of purchases, the company can sign long-term agreements with its suppliers. This is quite a guarantee for a market that is currently in expansion. Additionally, it can anticipate agreements, provide support to strategic suppliers, raise funds, and attract new partners. All of this based on an aggressive tendering program designed to face the production challenges of the near future.

7. What are Petrobras' trumps to operate in the pre-salt area?

Firstly, the undeniable, world-renowned competence of its technical and managerial staff; the experience accumulated in the development of the reservoirs found in deep and ultra-deep waters in the other Brazilian basins; its logistics base installed in Brazil; its capability to articulate with good and service suppliers and with the academic area contributing with knowledge; and the great economic and technological interest this challenge arouses in the country's scientific and industrial community.

Understanding the Regulatory Framework

1. What is the new regulatory framework?

These are the new rules for oil and natural gas exploration and production in the Pre-Salt layer and in areas considered as strategic that the government submitted to the Legislative for analysis on August 31 2009 in the form of four draft bills.

The draft bills define the oil sharing system for exploration and production in the areas that have not yet been bid for in the Pre-Salt; the creation of a new state-owned company (Petro-Sal); the creation of a Social Fund; and the onerous transfer, to Petrobras, of the right to perform oil and natural gas exploration and production (E&P) activities in certain Pre-Salt areas, up to the limit of 5 billion barrels; in addition to a capitalization for the Company. If the government's proposal is approved, the Country will go on to have three systems for oil and natural gas E&P activities: concession, production sharing, and onerous transfer.

2. How do the different systems work around the world?

Each country adopts a different system or systems that have specific characteristics, according to each nation's peculiarities and needs. There are three systems that are used the most: concession, production sharing, and service provision.

The main characteristic of the concession system is that the activities are carried out at the concessionaire's expense and risk, with no interference by or greater government control over the exploration and production projects, in compliance with the existing regulation. If a discovery is made and developed, the oil and natural gas, once lifted, will belong to the concessionaires after they pay royalties and other government take.

The sharing system is usually used by countries that have abundant reserves and low exploratory risks. In these agreements, the company or the consortium that undertakes the activities takes-on the exploratory risks. If successful, it has its investments and costs reimbursed in oil (the so-called cost oil). Profit is made from this activity by deducing the investments and production costs from the total revenues. Converted into oil, this amount is called profit oil, which is then shared between the company (or consortium) and the government, at variable percentages.

In the service provision system, a company is hired to carry out the exploration and production activities and has its services paid for based on predefined contractual methodologies. Under this model, the entire production usually belongs to the State.

Approximately 80% of the global reserves are in countries that adopt the shared production model or mixed systems that blend characteristics of more than one model, but with greater control of the State over the exploration and production activities.

3. How will the sharing system work?

The production sharing system will be in effect for areas that have not yet been bid for in the Pre-Salt and for those that may be defined as strategic by the National Energy Policy Council (CNPE).

Under production sharing, the contractors take-on the activity risks and they will only be reimbursed if they make commercial discoveries. This payment is made with the cost in oil (the so-called cost oil), at an amount that suffices to reimburse the contracted company's expenses. The rest of the production (excess oil, the so-called profit oil) is divided between the Union and the contractor(s).

Under this draft bill, the Union can sign two types of agreements: solely with Petrobras (100%) or based on tenders in which companies can participate freely. In such cases, Petrobras will both be the operator and hold minimum equity stakes of 30% in all consortia.

The agreements, until specific legislation is enacted, will have to pay royalties, as per Act 9478/97, and a fixed subscription bonus, defined contract by contract, which will not be a bidding criterion. The draft bill also foresees that, until a specific regulation goes into effect, special participation will be owed, under Act 9478/97, to be paid out of the revenue earned from selling the production that belongs to the Union.

4. How will the onerous right transfer system work?

The onerous right transfer system foresees the Union may grant Petrobras the right to undertake E&P activities at its own expense and risk, in given pre-salt areas, without a tender and at a limit of up to 5 billion barrels of oil and natural gas. The company will bear all costs and take-on all production risks. The value of this onerous transfer will be assessed pursuant to the best practices in the oil industry, and Petrobras will pay the Union that amount. According to the draft bill, Petrobras' will pay the government using federal public debt securities, the price of which will be based on their market value. So far as the criteria to be used to set the values of the onerous transfer production rights are concerned, such amounts will be set via negotiations between the Union and Petrobras, which, in turn, will be based on technical reports prepared by international certification entities and in accordance with the best practices in the oil industry. The ANP and Petrobras will be in charge of hiring the mentioned technical reports.

5. Como funciona o sistema de cessão onerosa de direitos?

Under the terms provided for by the draft bill, the Social Fund will be a financial fund composed of resources generated by production sharing and used for the following priority actions: fighting poverty, education, culture, science and technology, and environmental sustainability.

The Social Fund's revenues will come from the sales of the excess oil of the Union coming from the sharing agreements, from the subscription bonus, and from the royalties earmarked to the Union.

6. Will pre-salt areas that have already been bid for also be governed by the new system?

No. For areas that have already been granted, even if they include the Pre-Salt, previously signed agreements will be respected and they will remain in the concession agreement system.

The Pre-Salt province ranges 149,000 square kilometers. Of these, 41,772 square kilometers (28% of the total) have already been granted. The new legislation will be in effect, therefore, for the 107,228 square kilometers (72%) that have not been bid for yet, except for the areas that may be the object of onerous transfer to Petrobras.

7. What does an operator do? Why does the draft bill propose Petrobras be the sole operator of the blocks put up for bidding in the pre-salt?

The operator carries out the oil and gas exploration and production activities based on the decisions made by the Operating Committee. As one of the members of this Committee, and complying with its decisions, the operator arranges for the human resources and materials needed to carry the activities out. It must, for example, make the usage of new technologies feasible and implement the hirings that are required to execute the operations, whether directly or through its affiliates.

Under the Federal Government's proposal, Petrobras will be assigned to operate all of the blocks under the new system because, with 56 years of accumulated experience, it was responsible for the discovery of the oil in Brazil's Pre-Salt layer. It is the biggest deep water operator in the world and has the largest floating production system fleet. Additionally, Petrobras has fundamental knowledge about researching and mining the Brazilian sedimentary basins, a fruit of the investments it has made in Brazil in upwards of five decades. As the sole operator, Petrobras will be able to apply all of this experience in exploring and producing oil and gas in the Brazilian Pre-Salt.

The Federal Government proposes Petrobras as the sole operator because it is a semi-public corporation, with both private and public capital, and it can be used as an instrument for the implementation of the national energy policy, always preserving the minority shareholders' rights. As such, Petrobras will have the role of defending and putting into practice, together with the other members of the Operating Committee, the guidelines for the preferential contracting of goods and services on the domestic market. As a result, this segment's supplier chain will grow and be strengthened, and there will be a ripple effect for the entire Brazilian industry, which may gain relevant space in the international good and service market for the oil and gas industry.

8. Can other companies partner with Petrobras to explore in the pre-salt?

Yes. The draft bill foresees Petrobras will hold equity stakes of no less than 30% in the investor consortia.

Other companies, including Petrobras, may compete for the remaining percentage in each case. The winner will be the company that offers the biggest part of the excess oil to the Union, and Petrobras will be required to forward to the government the same percentage of the winning bid.