Challenges with Production Sharing Contracts in Brazil: What the International Experience and Literature Review Can Tell Us?

Abstract

Following the discovery of the giant Pre-salt play in Brazil in 2006, the Government implemented a new fiscal regime in 2010, namely the Production Sharing Contract (PSC), for the exploration and production of oil and gas in this area. The introduction of the PSC regime brought about challenges and uncertainties on the day-to-day activities for all stakeholders involved. In this context, the objective of this article is to highlight the main challenges faced by the industry participants in Brazil, based on international experiences and literature review. Concurrently, the paper adds more clarity on areas where, in practice, we expect the majority of these risks to materialize, such as the design, implementation and operation of PSCs, with a view to investigate the main challenges related to the implementation of PSCs. Most notably, the article addresses the resource and competency requirements that regulators and oil companies alike require to enable an accurate and compliant recovery of eligible costs. We focus our international experience analysis on Indonesia, a jurisdiction with a mature oil industry, which pioneered the cost recovery PSC model, and draw learnings from the premises and results of recent changes in the Indonesian fiscal regime, as documented in industry publications. Moreover, the article attempts to quantify the financial impact on oil companies for not recognizing all recoverable costs and the magnitude of government revenue losses arising from poor cost discipline or gold plating behaviors by offshore contractors. Conclusions are drawn on key improvements since the first pre-salt licensing round, when the terms of the PSC were considered relatively onerous and risky for investors. We also draw attention to the key factors which have enabled a more transparent and competitive bidding environment in the Pre-Salt in recent years, while allowing the Brazilian Government to maintain a significant share of revenues and control over the assets.