Brazil's pre-salt value: what would a bidding war do?

Brazil's record oil auctions last year saw intense competition for some of the most prospective pre-salt offshore acreage. As operators prepare for this year’s pre-salt rounds, new research from Wood Mackenzie assesses whether aggressive bidding could risk destroying value and erode the economics of potential future discoveries.

Lead author, Horacio Cuenca, Research Director for Upstream Latin America at Wood Mackenzie, said: "As Brazil continues to push its aggressive exploration licensing schedule for 2018 and 2019, there is growing concern that the convergence of big oil companies’ strategies on the same handful of deepwater plays globally is heating up the competition.

“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."

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%.

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.

Mr Cuenca said: "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.”

He added: “Blocks at these profit share levels will require extremely optimistic assumptions to breakeven in full-cycle terms, leading to blocks potentially being relinquished or discoveries left undeveloped."

This would not only hit operators' bottom line but also the Brazilian government as it risks competition setting excessively high government profit oil rates as the new norm for future pre-salt projects. If projects are relinquished or discoveries left undeveloped, the country also risks missing out out on their long-term economic benefits.

Wood Mackenzie’s analysis adds that Brazil could adopt measures used in  Mexico’s recent deepwater rounds to address the threat of overbidding.

Mr Cuenca said: "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 and 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."

He added: "All eyes will be on Brazil next 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."