8 May 2013
The phrase “local content” has begun to appear more frequently in the laws, internal policies and tender protocols of governments and companies around the world, particularly with regard to the oil & gas industry. The main argument to justify the local content rules is the enhancement of the local industry. But is it working?
Before analyzing the efficacy of the local content rules, it is important to understand the different approaches being adopted by different countries. Certain countries consider a local content rule to be fully observed when a service or good is provided by a company that is owned or controlled domestically; other countries have more complex methods to calculate the percentage of good and services available in the country, by local providers.
The first model seems to fail to reach the main purpose of the rule—the growth of the local industry—as it does not incentivize the manufacture, or even the assembly, of goods in the country or the provision of services, locally. Rather, the model simply creates opportunities for a few individuals who will own more than 51 percent of the joint ventures to be formed with foreign entities.
The second model seems to be more realistic, and closer to reaching the main purpose of the local content rule. However, the success of its implementation is not guaranteed, as the rule itself is not enough to ensure the development of the local industry, to develop sufficient manpower or to secure competitive prices. In this article, we will focus on the Brazilian model.
The Brazilian Model
Article 171 of the Brazilian National Constitution of 1988 used to classify companies as “Brazilian companies” or “Brazilian companies of national capital,” creating a clear distinction between companies incorporated in Brazil but controlled by non-Brazilians, and companies incorporated in Brazil and controlled by Brazilians. Under this constitutional provision, any local content rule in Brazil would probably follow what we are calling “first model,” according to which the definition of local content is conditioned to the nationality of the controlling shareholder of an entity.
However, with Constitutional Amendment no. 6/1995, Article 171 was revoked and companies incorporated in Brazil were considered “Brazilian companies” for all legal purposes, no matter the origin of the capital or the nationality of the shareholders (a few exceptions still exist, but it will not be considered in this article). Therefore, since 1995, unless expressly authorized under the constitution, any rule that creates any protection to Brazilian companies controlled by nationals in detriment to companies controlled by foreigners is considered unconstitutional and is null or voidable.
Constitutional Amendment no. 6/1995 was also the amendment that opened the Brazilian oil & gas sector to private companies. This was followed by the creation of the National Petroleum Agency (ANP) and the promotion of bid rounds, where the local content policy was adopted in the country for the very first time.
In 1999, during the first bid round for oil & gas concessions, the development of the local industry was already a point of concern. An initial local content rule was included in ANP’s Tender Protocol and the Concession Agreements. At that time, the Concessionaire agreed to “provide Brazilian Suppliers with the opportunity to present proposals for the supply of services in connection with Operations herein contemplated, with the objective of maximizing the Brazilian contents of such services in the Country subject to similar availability and condition in price, period and quality.”
In addition to that general principle, each bidder had the opportunity to present, as part of its offer, a minimum percentage of local investment that would be dedicated to the purchase of goods and services from Brazilian Suppliers. This model was used by ANP until the 4th bid round (2002).
In 2003, in order to expedite the development of the local industry, the Brazilian regulator decided to require a minimum percentage for the acquisition of goods and services in Brazil for all concessions for exploration and production of oil & gas, whether or not the blocks are considered onshore, shallow water or deep water. Thus, during the 5th and 6th bid rounds, the local content percentage suggested by each bidder continued to represent a relevant portion of its offer, but there was a minimum percentage that had to be observed by all bidders.
Due to the slow development of the local industry at that time, many concessionaires were unable to reach either the minimum local content requirement or the incremental percentages offered during the bid rounds. This influenced the final result, as the local content commitment was part of the offer, which ended up as just a number, unenforceable for several reasons. In order to avoid distortions in the offers, ANP decided in 2005 (7th bid round) to establish a range of percentages (minimum and maximum) that should be considered by bidders during the preparation of their proposals.
Therefore, the minimum percentage of local content required under the tender rounds (and the maximum that each bidder was allowed to offer) was being constantly revised and improved by ANP, until the last bid round occurred in 2008 (10th bid round), as follows:
Brazilian Local Content Certification System
Since their beginning, the Brazilian concession agreements for oil & gas exploration and production included different provisions regarding local content and minimum percentages to be observed by the concessionaires. However, enforcing these provisions was a rather complex task, either because of the lack of qualified suppliers and service providers in the country (the main justification presented by the concessionaires) or because of the difficulty to confirm whether a specific good or service acquired in Brazil would satisfy the local content rules.
The model was improved in 2007 with ANP’s enactment of the Local Content Certification rules. These rules established a methodology to calculate the percentage of local content in goods and services acquired in Brazil and provided clear rules and procedures for the accreditation of independent companies to certify such percentage.
Under this revised system, a certifying entity (accredited by ANP) is responsible for measuring the local content found in goods and services acquired/contracted by concessionaires in connection with their oil & gas exploration and production activities in the country. Using an independent certifying entity is important to ensure the transparency of the entire process; it also protects the seller/contracted parties from disclosing information that would put them at a competitive disadvantage.
Possession of a certificate issued by an independent entity enables the concessionaire to prove local content compliance for each specific good or service acquired in Brazil. Attaching the certificate to the respective invoice assists ANP with auditing the concessionaire’s fulfillment of its commitment regarding the minimum or the exact percentage of local content.
Even if the concessionaire is not able to achieve the percentage of local content agreed under the concession agreement, the independent certification is important, as the contractual penalties are calculated based on the difference between the agreed and the actual percentage of local content achieved by the concessionaire.
Perspectives and Challenges
It seems clear that local content rules such as those in force in Brazil will be more efficient in developing local industry than rules where the nationality of the controlling shareholder is the sole criteria for determining whether certain equipment, materials and services have incorporated actual and effective domestic contribution. However, the legislation itself does not ensure the development of the local content. Recent research from a reputable Brazilian university indicates that the Brazilian local industry is only able to provide 5 of the 24 categories of equipment considered critical to exploration and production activities. In the other 19 categories, the national market prices exceed those of foreign competitors, and the products are subject to untimely delivery or falling short of the quality standards required by the oil & gas industry.
The development of a local industry, especially the segment dedicated to the oil & gas industry, takes time, and the reliability of the local suppliers is a paramount issue to be considered by the concessionaires. At the same time, if ANP simply waives compliance with the required minimum percentages of local content defined in the concession agreements due to lack of qualified suppliers in the country, the local content policy will have failed.
In recent announcements made by ANP, it seems that the local content regulation is becoming more mature. There is a clearer understanding about the kind of goods and services that can be provided in Brazil, and what still needs to be acquired abroad.
The development of the local industry is critical for the generation of jobs and maximization of the advantages that the oil industry can offer to the country. However, the pertinent policies must be implemented cautiously, without creating requirements that cannot be fulfilled or that might somehow jeopardize the safety of the operations.