This chapter aims to present the main points of the Brazilian oil, gas and biofuel industry regulation evolution. The first legislative provisions aimed at regulating the oil industry emerged in the period of imperial Brazil, reaching truly consecration in the legal system at the first part of the twentieth century. At that time, the oil production was an activity strictly monopolized by the state; however, this monopoly came to be more flexible, and that is how it is nowadays. Regarding the natural gas industry, the history is pretty much the same because its legislation emerged as appendices of the oil industry regulation system. At the beginning, the gas used was manufactured from coal, and its main application was to provide electricity for the city. In fact, the birth and development of the natural gas industry in Brazil are recent. With the oil crisis came the development of the biofuel legislative regulatory system, considering biofuels as a potential substitute for fossil fuels, but until these days, there has been no great expansion in their use, despite Brazil’s potential for renewable energy sources. Besides the Federal Constitution and the specific sector rules, oil, natural gas and biofuel industries are regulated by the Oil Law (Federal Law No. 9478/1997).

2.1 Introduction

The previous chapter described the institutional and economic environment within which the oil, gas and biofuel industries operate in Brazil. From the perspective of the relationship between law and development,¹ this description is important in understanding the creation of legal guidelines for the sector, starting from the following assumption: the stronger the economic sector of a country is, the larger the number of regulations is applied to it.

In this respect, the previous chapter made observations, albeit fleeting, regarding legislation in the sectors under analysis. However, this must be more thoroughly investigated in order to understand the origins of the process that enacted current legislation that regulates the oil, natural gas and biofuel sectors. Thus, the present chapter aims at providing a detailed description of regulatory evolution in the oil, natural gas and biofuel industries in Brazil. To this end, the main guidelines (constitutions, laws, decrees, resolutions, etc) applicable to the sector will be explained throughout the text, along with the respective transformations to the legal system in Brazil.

From the methodological viewpoint, the description will be presented in three parts: the first related to oil; the second, natural gas; and the third, biofuels. This description methodology was adopted because of the data themselves, which, as will be shown, does not allow us to describe the evolution of these sectors as a whole.

After this description, final considerations will analyze the regulatory evolution within the more general framework of public policies and development of the energy sector in Brazil.

2.2 Regulatory Evolution of the Oil Industry in Brazil

In Brazil, although there are almost no historical records on the beginning of oil use, the existence of a foul-smelling substance that came from the earth and was used to light fires was passed from generation to generation. Thus, it is said that oil was first discovered in Brazil through seeps on land and in rivers,² as occurred in North America. This gave rise to the use of oil in its main application at the time: as an energy source for lighting.

Initially, there was no specific legislation regarding oil; instead, it fell under the same regulations in place for minerals. As such, the early history of oil regulation is intermingled with that of mining. From an industrial and a legal perspective, the distinction made between soil and subsoil in the Federal Constitution of March 25, 1984, was a significant milestone in mining. With the enactment of the Constitution, the mines that once belonged to Portugal (before Brazilian independence on September 7, 1822) became part of the domain of the Brazilian government.³ However, the 1824 Federal Constitution contained no specific provision on national energy policy or economic activities related to the sector.⁴

In 1858, in the state of Bahia, the first concessions were granted for the extraction of bitumen (bitumen chalk) on the margins of the Maraú River and peat in the area surrounding the Araçaí River. The goal of these activities was to produce substances for lighting⁵ due to growth in the market as the result of new towns and the expansion of existing cities.

During this period, and by direct request, concession applicants themselves stipulated which substances would be extracted and over what period. Concessions were granted or denied in the form of Decrees issued by imperial authority, which transferred expropriation powers to individuals, as well as granting exemption from taxes on machinery and equipment used for mining.⁶ This type of concession was enforced throughout the subsequent decades until the end of the Empire in Brazil.

Decree No. 1.067 of July 28, 1860, created a new government department called the “State Department of Agriculture, Trade and Public Works,” responsible for addressing issues related to mining. In conjunction with the National Industrial Aid Association (whose members included the most prominent figures of the time in different fields of knowledge), the State Department began a systematic survey of the country’s mineral resources, encouraging the discovery of new wealth. This included detailed instructions for data collection on mineral production and the possibilities of each municipality, parish or district.⁷

In 1889, the oil industry was already somewhat developed in countries such as the United States and Russia, where the combustion engine was in use and oil distillation had begun to power machinery. Meanwhile, failure rates in the sector were high in Brazil; inadequate machinery and manpower meant there was no precise knowledge on areas with oil potential and mining was based on so-called surface geology (semiprofessional). As a result, most concessions were returned well before the established deadline.⁸

The oil industry saw substantial development in the last 20 years of the nineteenth century, when oil moved away from exclusive application in lighting and more generalized development began, largely due the use of new converters that allowed the energy source to be more efficiently exploited.⁹

Item 29 of article 34 of the 1891 Federal Constitution gave the National Congress exclusive authority to “legislate Government land and mines.”¹⁰ In regulating the right to property, the aforementioned Constitution did not distinguish between soil and subsoil and expressly stipulated that mines belonged to the landowners, formulating absolute right to property¹¹ and changing the system in place under the 1824 Federal Constitution.

In 1907, the Brazilian Geological and Mineralogical Service (SGMB) was created under the Ministry of Agriculture to promote geological surveys. However, exploration could only be conducted on federal land, particularly in remote areas that were difficult to access. Misgivings regarding major international oil companies and an increase in nationalism due to the approaching centennial celebrations of 1922 led the Federal Government to exclude foreign companies.¹²

Lack of capital, trained personnel and regulatory incentives meant that the search for oil in Brazil in the late nineteenth and early twentieth centuries did not produce truly significant results. From 1864 to 1918, private initiatives drilled only about a dozen wells in search of oil.¹³

In the late 1920s, there was already a notable presence of foreign companies in Brazil, dividing the national market as follows: Jersey—49 %, Shell—18 % (through the Anglo Mexican), Texas-Co.—17 %, Atlantic Refining—12 % and other companies—4 %. Over time, these companies began diversifying the distribution of gasoline. It was during this period that commercial and military aviation began to develop in the country.¹⁴

On December 16, 1931, then President Getúlio Vargas issued Decree No. 20.799 (altering Decree No. 20.223 of July 17, 1931), which established standards for government authorization of research activities and mining of mineral deposits across the national territory. This was followed by Decree No. 23.016 of July 28, 1933, acknowledging the importance of mineral resources as a production source by creating the General Board of Mineral Production under the Ministry of Agriculture, which took over the administration of subsoil resources.

The 1934 Federal Constitution separated mining properties and other soil and subsoil riches for exploration or industrial use (article 118).¹⁵ As a result, the absolute right to property enshrined in the 1891 Federal Constitution was no longer valid and landowners lost the rights over the subsoil.

In the same period, Decree No. 23.979 of March 8, 1934, created the General Board of Scientific Research and the National Department of Mineral Production (DNPM).¹⁶

Decree No 24.642 of July 10, 1934, created the Mining Code in light of the need to unify the laws and regulations issued over time to regulate the mining industry and facilitate the rational use of subsoil resources through measures that facilitate, encourage and support private initiatives in the research and mining of these riches. Following its enactment, oil and natural gas were classified as Class X deposits.

Amid debate at the time surrounding the nationalization of subsoil resources, the 1937 Federal Constitution reiterated the separation of ownership of soil and subsoil stipulated in article 111 of the 1934 Federal Constitution (article 143, caput) ¹⁶ and limited authorization for the use of these riches to Brazilians or companies made up of Brazilian shareholders (article 143, paragraph 1).¹⁷ As a result, foreign companies could not participate in mineral extraction activities in Brazil.

Shortly after the enactment of the 1937 Federal Constitution, Decree No. 366 of April 11, 1938, was issued incorporating a new regulation into the Mining Code (Decree No. 24.642 of July 10, 1934) governing the exploration and exploitation of oil and natural gas, including noble gases. However, in practice, the regulation was not effective since it was repealed by the new Mining Code (Legal Decree No. 1.985 of March 29, 1940).

The National Oil Council (CNP) was created by Legal Decree No. 395 on April 29, 1938, and declared national oil supply (understood as the production, import, transportation, distribution and sale of crude oil and its derivatives and the refining of imported or nationally produced oil regardless of its source) a public utility activity (article 1, caput). The CNP had the power to fix the price of oil derivatives and authorize refining installations, as well as direct control over research work in national territory, among other less relevant functions.¹⁸

One of the pioneering wells in the discovery of oil in Brazil was well DNPM-163, drilled in Lobato in the state of Bahia under the supervision of the National Oil Council (CNP). Despite the efforts made, the well quickly lost its oil flow. After drilling 17 wells and finding oil in only 3, the field was defined as noncommercial. Though not economically viable, the discovery of the well on January 1939 drew attention to the country by confirming the existence of oil and shifting investments to the Recôncavo Basin.¹⁹

A short time later, Legal Decree No. 1.985 of March 29, 1940, which created the new Mining Code, defined rights over mines and deposits, established a regime governing their use and regulated state intervention in the mining industry, as well as overseeing companies that use mineral raw materials.

In 1941, the first economically viable oil field, the Candeia Field,²⁰ was discovered in Brazil. As a result, the Recôncavo region in Bahia state became known as Brazil’s first “oil school” due to the substantial amount of research conducted by the National Oil Council and the arrival of foreign technicians, which led to the first generation of qualified Brazilian specialists.²¹

With the first significant discoveries in Brazil, the importance of oil in the country began to grow. This growth drew media attention and culminated in a campaign entitled “The Oil is Ours” (O petróleo é nosso in the original Portuguese), whose main themes were preserving national interests, the debate over sovereignty and the role of oil reserve ownership in achieving these goals. Protest was directed primarily at the lack of government policies for the creation of national oil exploration companies. One of the campaign’s best known activists was the writer Monteiro Lobato, who politicized his writing with books such as Mrs. Benta’s Geography, The Oil Scandal and The Viscount’s Well in an attempt to convince the younger generation to join the campaign’s cause.

In the late 1940s, Brazil was the focus of intense political and ideological dispute surrounding a set of proposals aimed at establishing forms and limits for participation by the government, foreign capital and private corporations in oil industry activities. Since the 1920s, as the National Congress considered the first federal laws proposed on the issue, competition had arisen between nationalist groups defending the exclusive participation of government companies and private domestic corporations in oil exploration and corporate, political and social groups who were in favor of foreign companies in the sector, or simply against direct interference by the state in the oil supply chain.²²

In 1948, the Military Club, represented by General Horta Barbosa, formed the Center for the Study and Protection of Oil with the primary goal of centralizing the “Oil is Ours” campaign in order to prevent President Getúlio Vargas and the lawmakers from creating a state-owned oil company. This resulted in Bill 1.516/51, which, after 22 years under consideration, became Federal Law No. 2004/53 and created Petróleo Brasileiro S.A.–Petrobras, making the oil industry an issue of national security.²³

The National Petroleum Program was proposed in conjunction with the project that led to the creation of Petrobras and was set to be implemented within a period of 5 years (1952–1956). At the time, it was predicted that the consumption of oil derivatives would increase from 100 to 200,000 barrels/day by 1955 and that national production would be unable to meet even half the demand. As such, in order to meet the growing demand for oil and thereby reduce national dependence, the National Petroleum Program estimated an investment of around eight million cruzeiros (the national currency at the time), of which 62 % would be allocated to research and production, 25 % to refining and the remainder to equipment and transport.²⁴

In addition to the creation of Petrobras, Federal Law No. 2.004 of October 3, 1953, sanctioned by Getúlio Vargas established a state monopoly in the oil and gas sectors. According to article 1 of the same law, the government monopoly encompassed the prospecting and exploitation of oil deposits, other fluid hydrocarbons and noble gases (I); refining of national or foreign oil (II); sea transportation of domestic crude oil and its derivatives, as well as pipeline transport of crude oil, its derivatives and noble gases of any origin (III). The government monopoly was exercised by the National Oil Council (advisory and supervisory authority) in conjunction with Petrobras and its subsidiaries (enforcement authority).

In its first year of operation, Petrobras invested approximately US$84 million. During this period, oil production exceeded a little more than 2,600 barrels/day, the equivalent of less than 2 % of the country’s internal consumption (160,000 barrels/day). Refining capacity reached close to 40,000 barrels/day, accounting for 25 % of internal consumption of derivatives.²⁵

At first, Petrobras had neither the proper physical infrastructure nor the specialized and experienced technical personnel needed to execute its required activities. As such, foreign manpower was hired to fulfill this role and train a team of national technicians. To that end, the first president of Petrobras hired American geologist Walter Link, retired from Standard Oil, as the Head of Exploration. In light of the minimal hydrocarbon discoveries and considering the status of technological development in the national industry at the time, Link issued Petrobras’ Board of Directors with a report known as the Relatório-Link (Link Report), advising against large-scale investment in oil and gas exploration in Brazil. After a radical shift from the optimistic view with which he began his work in Brazil, Link’s report briefly mentioned the maritime potential of coastal basins and concluded with the suggestion that if Petrobras was serious about finding oil, the agency should look for it in other countries.²⁶

In the 1960s, Decree No. 53.337 of December 23, 1963, expanded the government monopoly established by Federal Law No. 2.004/1953 for the import of oil and its derivatives, determining that the activity be undertaken solely by Petrobras subject to authorization by the National Oil Council.

The 1967 Federal Constitution was the first to elevate the oil monopoly to a constitutional level by stipulating that “prospecting and exploitation of oil on national territory constitute a monopoly of the State under the law” (article 162).²⁷ Shortly thereafter, Constitutional Amendment No. 1 of October 17, 1969, which modified the 1967 Federal Constitution, maintained the same wording with regard to the oil industry monopoly (article 169).

Given the limited production capacity of onshore basins, where even imports failed to meet the internal demand for fuel, Petrobras ventured into offshore exploration with the construction of the Petrobras I drilling platform, capable of drilling at depths of 30 m. This experience led to the drilling of the first well in Espírito Santo in 1968 and countless subsequent discoveries, the most noteworthy of which include the fields in Guaricema, Robalo, Dourado, Caioba and Camorim in Sergipe (1970), Ubarana in Rio Grande do Norte (1973) and Garoupa in Rio de Janeiro (1974), among other areas.²⁸ The 1980s and 1990s were much the same: Petrobras continued to announce the discovery of new fields, including deepwater and ultra-deepwater drilling.

In the 1970s, the organization and jurisdiction of the National Oil Council (CNP) were established by Decree No. 70.750 of June 23, 1972. According to article 1, the CNP was directly subordinate to the Ministry of Mines and Energy, which controlled national oil and coal policy,²⁹ acting in conjunction with the advisory authority on issues related to oil and its derivatives, coal and by-products.

In reality, the CNP was set to become a major decision-making authority; however, this was to affect its entire organization and ultimately caused it to compartmentalize, primarily because the agency was not adequately equipped to handle the tasks attributed to it, so much so that both the Board and its president were so absorbed by general oil policy that agency divisions (particularly the technical and administrative sectors) suffered from the lack of firm and comprehensive guidance.³⁰

Despite the absence of regulation and with the aim of satisfying different interests, Petrobras began to negotiate contracts for the provision of technical, operational and financial services with international oil companies and private Brazilian corporations, which were paid for these services according to a set of predetermined conditions. These agreements were referred to as Risk Contracts.³¹

Nevertheless, this type of contract was virtually defunct with the enactment of the 1988 Federal Constitution, which classified both mineral and subsoil resources (article 20, clause 9) and consolidated the following activities under government monopoly through article 177: prospecting and exploitation of oil, natural gas and other hydrocarbon fluids (I); refining of national or foreign oil (II); import and export of products and basic derivatives resulting from activities stipulated in previous clauses (III); sea transport of national crude oil or the basic derivatives of oil produced in the country, as well as pipeline transport of crude oil, its derivatives and natural gas of any origin (IV); and exploration, mining, enrichment, reprocessing, industrialization and trade of minerals and uranium ore and their derivatives (V). This led to prohibition of the sale or concessions of any type of participation by foreign companies in these activities.

Article 177, paragraph 1 of the 1988 Federal Constitution expressly forbids the sale or concession by the government of any form of participation in oil or natural gas exploration, except under the terms of article 20, paragraph 1, pursuant to the participation or financial compensation for states, the Federal District, municipalities and direct government authorities based on the results of exploration on national territory, the continental shelf, territorial waters or an exclusive economic zone. However, despite the amendment to the legislative provision that consolidated the government monopoly, contracts already in force were maintained.³²

Throughout the 1990s, a movement began to emerge to allow oil exploration by private national and international corporations, known as a relaxation of the monopoly. The relaxation of the monopoly governing oil industry activities in Brazil was one of the consequences of the so-called neoliberal state, where government influence in society declined, particularly with regard to economic activities.³³

As a result of the significant changes at the time concerning the government’s role in the economy, Federal Law No. 8.031 was passed on April 12, 1990, creating the National Privatization Program (PND), whose main objective was to “revise the government’s strategic position in the economy, transferring activities unduly exploited by the public sector to the private sector” (article 1, clause I).³⁴

As part of the restructuring process in Brazil’s downstream segment, the National Oil Council (CNP) was disbanded in 1990 and replaced by the National Fuel Department (DNC), controlled by the Ministry of Mines and Energy. During this period, the price fixing, control of distribution margins and resale of fuel that were carried out by the CNP were replaced and gradually eliminated by setting price caps.³⁵ This was a means of stimulating competitiveness and opening the distribution sector to new companies, largely due to the abolition of minimum order volumes by distributors and the end of mandatory sale of the products supplied by gas station brand distributors. However, the result was an increase in the number of distributors, fuel adulteration and tax evasion.³⁶

In 1995, the enactment of Constitutional Amendments No. 6 and No. 9 relaxed the government monopoly, making it possible for private or state-owned enterprises to once again participate in the exploration and production of oil and natural gas in Brazil.

One of the major changes brought about by Constitutional Amendment No. 6 was the modified wording of paragraph 1 of article 176 of the Federal Constitution, which allowed the prospecting and mining of mineral resources and the exploitation of hydroelectric power by companies incorporated under Brazilian law with headquarters in the country, as opposed to restricting activities to national capital companies as stipulated under the previous wording.

Constitutional Amendment No. 9/1995 modified paragraph 1 of article 177 of the Federal Constitution, which prohibited the government from selling or granting concessions for any form of participation in oil or natural gas exploration, and allowed the state to contract private or state-owned companies to carry out the activities stipulated in clauses I–IV of article 177,³⁷ subject to conditions established under the law.

This was followed by the enactment of Federal Law No. 9.478 on August 6, 1997, known as the Oil Law, which, in addition to regulating activities pertaining to the oil monopoly, established the National Oil Policy; created the National Oil, Natural Gas and Biofuels Agency (ANP)³⁸ and the National Council for Energy Policy (CNPE); and established the so-called bidding rounds, where interested companies competed for access to potential oil-producing areas under a free competition regime, according to a set of predefined rules.

The Oil Law was at least partially inspired by the Norwegian model, particularly with regard to the dual presence of the government, represented by a regulatory authority (the ANP had similar functions to those of the Olje- og Energidepartamentet—OED) and a state-owned company (Petrobras performs a similar role to StatoilHydro).³⁹ There are also similarities in the concession model adopted, where bidding companies participate directly (without government interference) and attain ownership of the oil produced. Given the limited resources of Petrobras at the time, the Oil Law was, to some extent, responsible for attracting funds to finance exploration and production activities in Brazil, which contributed significantly to the country’s energy self-sufficiency achieved in 2006.⁴⁰

As per article 7 of Federal Law No. 9.478 issued on August 6, 1997 (the Oil Law), the National Oil, Natural Gas and Biofuels Agency is an Indirect Federal Administration authority under the Ministry of Mines and Energy, charged with regulating the oil, natural gas and biofuel industries. Articles 8 and 9 of this same law contain a list of duties to be performed by the ANP in implementing National Oil Policy contained in the National Energy Policy.⁴¹

Decree No. 2.455 of January 14, 1998, created the ANP and established it as an authority under a special regime of public law, with administrative and financial autonomy. Article 2 of Annex I in this decree stipulates the ANP’s purpose of “promoting the regulation, contracting and monitoring of economic activities in the oil industry”⁴² in line with legislation, under the guidelines of the National Council for Energy Policy (CNPE) and in the interests of the country.

The regulation drafted by the ANP basically consists of establishing regulatory provisions (e.g., resolutions, instructions) aimed at operations and trade in the oil, natural gas and biofuel industries. With respect to contracting, the ANP grants permits for regulated industrial activities, promotes public procurements and signs contracts on behalf of the government with concession companies for exploration, development and production activities. The agency also acts to ensure compliance with industry regulations, either directly or through agreements with other public authorities (e.g., universities).

The year 1999 marked the first auction held by the National Oil, Natural Gas and Biofuels Agency (ANP) that enabled the entry of foreign companies into the Brazilian oil exploration and production industry.⁴³

The ANP is also a reference center for data and information on the oil, natural gas and biofuel sectors and performs a number of roles, including maintaining the Exploration and Production Database (BDEP), promoting research on petroleum potential and development in the sector, receiving and publishing reports of discoveries, publishing official statistics on reserves and production in Brazil, conducting periodic studies on the quality of fuels and lubricants, as well as the prices of these products.⁴⁴

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The Evolution of Brazilian Oil, Gas and Biofuel Industry Regulations

2. The Evolution of Brazilian Oil, Gas and Biofuel Industry Regulations

2.1 Introduction

2.2 Regulatory Evolution of the Oil Industry in Brazil