Financial Regulatory Forum

Brazil’s Lula moves to boost state control over new oil wealth

By Reuters Staff
August 31, 2009

Brazilian President Luiz Inacio Lula da Silva attends a meeting with mayors in Sao Bernardo do Campo August 25, 2009. REUTERS/Paulo Whitaker (BRAZIL POLITICS)By Brian Ellsworth and Denise Luna
BRASILIA, Aug 31 (Reuters) – Brazilian President Luiz Inacio Lula da Silva proposed legislation on Monday to boost the role of the state in managing huge new oil finds that could drive the country’s development for decades to come.

The long-awaited proposal, which faces a tough battle for approval in Congress, boosts the government’s role by creating a new state holding company to manage new projects and a contract system that gives the government a share of the oil.

For Brazil, the stakes are high. The overhaul could usher in a new round of investment in Brazil’s oil sector if energy companies find the terms acceptable. But it could also leave billions of barrels of light crude trapped under the sea if the regulatory framework turns out to be too onerous.

Lula, a charismatic and hugely popular former union leader who has steered Brazil through an economic boom with a mix of market-friendly policies and social spending, hailed the unveiling of the oil legislation as a “new independence day” for South America’s largest nation.

“We don’t have the right to take the money we’re going get with this oil and waste it,” he said on Monday in his weekly radio address. “What we want … is to use this oil to make Brazil a wealthier country, to make it more developed.”

Under Lula’s plan, the government’s share of oil revenues would go into a development fund aimed at preventing the boom-and-bust cycles experienced by many other oil-rich countries in the developing world.

The fund would make regular transfers to the government’s budget to be invested in poverty reduction, science and technology, the environment and improving an education system that lags much of the world despite Brazil’s strong economic gains in recent years.

The plan would make state-run energy firm Petrobras the sole operator of new fields with a minimum 30 percent stake in all future projects in the so-called subsalt oil fields, the company announced.

It calls for a state capital infusion of about $50 billion in Petrobras to boost federal control over the firm, according to Romero Juca, the government’s leader in the Senate.

The firm said it would call a shareholders’ meeting to decide on the capitalization, which it said would be limited to the equivalent of 5 billion barrels of oil.

CONGRESSIONAL BATTLE LOOMS
Monday’s proposal, part of a worldwide trend toward the nationalization of key natural resources by governments, seeks to give the state greater control over the oil without shunting aside foreign capital.

But critics say the changes inject too much political influence into Brazil’s successful oil industry. The oil wealth is likely to be used as a major plank in Lula’s campaign to get his chief of staff Dilma Rousseff elected as his successor in October 2010 elections.

Petrobras shares were down 4 percent in afternoon trade at 31.25 reais after the plan’s details were unveiled. Investors have voiced concerns that its greater role in the development of the fields could overstretch its resources, while the capitalization could dilute shareholder value.

Some also say the government has played down the exploration risk of tapping the estimated 50 billion barrels of oil that lie below shifting sand and a thick layer of salt up to 5 miles (8 km) beneath the ocean surface.

The proposal gives an “absurd amount of power” to a cabinet level energy commission that could open the door to political interference in operational decisions, said Marilda Rosado, a Rio de Janeiro-based lawyer who specializes in energy.

Most noteworthy, Rosado said, were clauses letting the government assign fields directly to Petrobras without holding bids and to veto operational decisions of Petrobras’ joint ventures with private companies.

The prospect of prolonged wrangling in Congress over Lula’s proposal could also weigh on the company and on major foreign energy firms involved in exploration. The government leader in the lower house of Congress, Ideli Salvatti, said Lula had requested fast-track status for the bill, contradicting statements by Energy Minister Edison Lobao on Sunday.

“The government doesn’t want to improve the oil model, this is obviously only for electoral purposes,” said Luiz Paulo Vellozo Lucas, a deputy with the main opposition PSDB party.

“We will attack the proposal as a whole.”

Under the proposal, the government will have the right to declare any oil region as strategic and implement a sharing system, Petrobras said.

The proposed overhaul focuses on vast new oil reserves that were discovered off Brazil’s southern coast in 2007, giving the country the potential to become a major energy exporter. The Tupi oil find was one of the world’s biggest in a decade and has opened up a new frontier in global petroleum exploration.

Lula is proposing switching to a production-sharing system in which the government owns a part of the oil produced. That is a shift from the current system in which companies participate in competitive auctions to win the rights to explore for oil in blocks. [nN31435447]

The government also wanted to change the way oil royalties are distributed to ensure a steady revenue flow to poorer states. But Lula backed off that proposal late on Sunday after the governors of the top three oil-producing states of Rio de Janeiro, Sao Paulo and Espirito Santo protested.

For a graphic on Brazil’s deep-sea oil reserves, please click here.

For a Petrobras presentation on how oil production in the subsalt area works, please click here.

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