Could a bidding war erode Brazil's pre-salt value?
Brazil's record oil auctions last year saw intense competition for some of the most prospective pre-salt offshore acreage. Could aggressive bidding risk destroying value and eroding the economics of potential future discoveries?
The competition for Brazil's pre-salt rounds is heating up
As operators prepare for this year’s pre-salt rounds, convergence of big oil companies on the same handful of deepwater plays is a growing concern.
Brazil's pre-salt is one of the most relevant of those deepwater plays and strong competition here could ultimately make some of the world's most coveted prospects uneconomic.
What happened last time?
In Concession Round 14 held in September 2017, the average winning bid for most offshore blocks was 2.6 times the minimum, while one of the pre-salt prone Campos basin blocks received a bid 90 times the minimum required. The competition seen in that round had a knock-on effect - pushing government profit-share bids in the Production Sharing Contract (PSC) Rounds 2 and 3 in October last year to record highs. While minimums were set between 10-20% by the government and bids were expected to stay under 50%, winning bids averaged 65% with some reaching 77%.
Will the pre-salt rounds see the same overpayment on blocks?
Heated pre-salt competition is expected again this year at Brazil's two bid rounds closing in late March (Concession Round 15) and early June (PSC Round 4). The two rounds put more than 40,000 square kilometres of prime offshore acreage on the auction block, including 22 pre-salt prone blocks. According to Brazil's regulatory agency, more than 35 billion barrels of oil equivalent (boe) of prospective in-place resources have been identified in the Campos and Santos acreage alone.
As with last year's bid rounds, the results of the concession round will likely influence bidding strategies in the following PSC round. With round rules placing no caps on profit-share bids, aggressive bidding for a few key blocks in Concession Round 15 could drive up PSC profit-share rates to new record highs, permanently impacting development economics and putting at risk future rates of return and value creation.
This could lead to blocks being relinquished or discoveries left undeveloped
Blocks at these profit share levels will require extremely optimistic assumptions to breakeven in full-cycle terms. This would erode profit margins and also set high government profit oil rates as the new norm for future pre-salt projects; something the Brazilian government will want to avoid along with undeveloped projects which would make the country miss out out on their long-term economic benefits. Read our reported results analysis on Petrobras.
So how will the government avoid those scenarios?
Brazil could adopt measures used in Mexico’s recent deepwater rounds to address the threat of overbidding. In Mexico's Round 2.4 a cap was set on royalty bids with a cash payment acting as a tie-breaker. This cap limited the likelihood of intense competition making contracts uneconomic. The tiebreaker cash payment ensured the government still captured the full value of a block from the keenest bidders in the form of an upfront payment that will later become a sunk cost for operators.
All eyes will be on Brazil this week going into Concession Round 15. However, with the long-term success of its coveted pre-salt play at stake, Brazil should be cautious of calling the round a success purely on a revenue-collection basis if the bidding concentrates once again around the pre-salt blocks only.