8 May 2013
As exploration and production (E&P) activities advance in the oil & gas industry, the host countries are challenged to create new, beneficial and efficient regulations that will ensure the development of a strong local industry. Also, the continuing demand for innovation and the increasing technological challenges faced by the sector make it clear that fostering national investments in research and development (R&D) is vital to building local industry. Establishing a legal obligation to invest in R&D has proven to be a crucial tool for encouraging a strong national development policy, which helps boost social and economic indicators.
Taking into account the numerous local content obligations imposed by developing countries in the oil & gas industry, the R&D investment obligation seems to be one of the cleverest and most efficient strategies in a long-term public policy. Investments in R&D can: (i) foment the development of a national technological industry; (ii) enable the increase of competitiveness of the country in the global market; (iii) indirectly or directly result in improved technical and upper-level education; and (iv) enable the creation of partnerships between government entities and private investors, especially in developing countries.
Current R&D Structure in the Concession Regime
In the Brazilian Concession Contract regime (Concession Regime), the R&D investment obligation derives from a combination of legal and contractual aspects. In actual terms, according to the Petroleum Law and Federal Decree 2,705, if production of oil or natural gas in a certain field reaches a specified volume of production, the concessionaire shall pay an additional financial compensation to the government—this is called Special Participation. In such cases, the Concession Contract also requires the concessionaires to invest an amount equal to 1 percent of the field’s gross production income in R&D projects. This obligation is also established by the National Agency of Petroleum, Natural Gas and Biofuels (ANP) in Resolution No. 33/2005 (ANP Resolution), which provides detailed guidance on the performance of the R&D expenditures, including models of standard reports to be used by the concessionaires when evidencing their R&D investments to ANP.
Up to one-half of that 1 percent R&D expenditure may be directed to development activities in the concessionaire’s own facilities or those of its affiliates, when located in Brazil, or may be contracted directly with national companies, regardless of whether those activities are involved with or are related to the operations under the Concession Contract. The remaining expenditure must be invested in institutions previously accredited by the ANP (Approved Institutions). The main purpose of this R&D investment requirement is to protect and channel the investments to institutions with high expertise, operational capability and technological standards.
In the current Brazilian E&P scenario, approximately 17 concessionaries operate big production/ revenue oil fields that exceed the specified production volume, resulting in their obligation to pay the Special Participation and invest in R&D projects. According to the ANP, the R&D obligation resulted in the contribution of around US$500 million to the country’s research and development sector last year. Additionally, since the R&D clause was introduced in the Concession Contract (in 1998), more than US$3.3 billion has been invested in R&D projects related to the oil and gas industry. The agency projects that for the next 10 years, more than US$10 billion will be injected to support the expansion of the industry in the country, reaching U$2 billion per year in 2017.
Given this success, the ANP has decided to revise the current R&D clause applicable to the Concession Regime. The new clause, which is to be included in the future Concession Contracts of the 11th bid round (expected to happen in May 2013), is estimated to provide the ANP with more decision-making power on investment allocation. The main purpose of the review is to respond to the agency’s development priorities by creating a committee that will be responsible for generating an annual list of investment priorities.
One expectation for the new clause is that up to 20 percent of the R&D amount may be designated to fund research initiatives other than technological R&D projects. This would significantly expand the range of investment opportunities to include other areas relevant to the oil & gas industry, including Business Management and Economics.
The Future of R&D and the Pre-Salt Discoveries
Because of the recent oil discoveries in the pre-salt layer in the Campos, Santos and Espírito Santo offshore basins, the Brazilian government has decided to adopt a new regime to govern the E&P activities in Brazil, together with the current Concession Regime. The production-sharing regime, created by the Pre-Salt Law in 2010, will apply exclusively for the E&P activities to be developed in the pre-salt and strategic areas (PSA Regime), while the Concession Regime (governed by the Petroleum Law) will continue to be applicable for all the other areas (onshore and offshore), which represent 98 percent of the Brazilian sedimentary basin, according to ANP.
Unlike the Concession Contract, the PSA Regime does not expressly determine any percentage for investments in R&D. In the PSA Regime, as determined by the Pre-Salt Law, the financial compensations due by the concessionaries will be (i) the signature bonus and (ii) the royalties.
The Pre-Salt Law also created the so-called Social Fund, which will benefit from the following resources: (i) a portion of the signature bonus, (ii) the royalties due to the government, (iii) the revenues deriving from the sale of the government’s share of oil profit, (iv) the royalties and special participation revenues due to the government regarding pre-salt areas that have already been granted under the Concession Regime, (v) the fund’s financial earnings and (vi) other resources allocated to the fund in accordance with the Pre-Salt Law. Moreover, the Social Fund will serve as a reserve of resources for the government’s oil revenues arising out of the production-sharing contracts, and is also supposed to work as a strategic fund, meaning that the government will allocate its resources for the development of social and regional programs related to areas such as education, culture, sports, public health, science and technology, environment and climate change.
The main criticism, however, of this new legal framework adopted by the PSA Regime vis-à-vis the investments in R&D is that the oil money will be allocated directly by the government through the Social Fund. That means that science and technology will now compete with other initiatives, such as public health and education. Moreover, because the allocation of funds is discretionary, there is a concern about whether the government will allocate to the R&D projects the amount of investments that are necessary to meet the sector demands and standards.
Although there is no Special Participation in the PSA Regime, continuing technological development requires that the PSA contract that is currently being drafted by the government also establishes a mechanism through which the concessionaires are obliged to invest in R&D. The adoption of a model similar to that already in force under the Concession Regime could lead to more investments in R&D projects, with a focus on new technologies for the pre-salt areas, or to research linked to the development of alternative energy technologies, for example. It is known that the major oil companies are already investing in the development of technologies related to biofuels, and that they will play a leadership role in the clean energy market in the future.
Furthermore, the application of mandatory R&D investments to the concessionaires in the PSA Regime would enable the creation of more opportunities for partnerships between public R&D institutions and private entities. An example of this is the technological park of the Federal University of Rio de Janeiro (UFRJ), where Petrobras and other E&P companies and oilfield service providers work together with the researchers of the UFRJ to develop new technologies related to the oil & gas industry.
Considering the current technological challenges for the E&P activities in ultra-deep waters and the huge estimates for the oil production in the pre-salt layer, there is a lot to be expected from R&D in Brazil for the next decade. The country has already started to experience the benefits from the development of the petroleum industry, but it is necessary that new E&P bid rounds are effectively launched in the upcoming years. If that happens, the companies already operating in the country will be able to increase their portfolios, new players will finally have the opportunity to enter the market and, consequently, more R&D projects will develop.