This chapter aims to address the organization and functioning of the exploitation system of oil in Brazil, concerning the domain of the upstream petroleum industry. On this context, it will be demonstrated the evolution of the exploitation system of oil in Brazil with the flexibility of the monopoly afforded by the Constitutional Amendment 09/1995 and by the Oil Law (Federal Law No. 9.478/1997); the role of the Regulatory Agency that operates in the industry, the ANP and its relationship with the National Council for Energy Policy (CNPE) and with the Ministry of Mines and Energy (MME); the modal regulatory of the oil industry, showing how occurs the bidding of the exploration blocks, the operation of the concession contract, its characteristics and operating mode, as well as the other contractual forms in the petroleum industry; in this chapter, there are also highlights of the rents earned by Brazil due to the exploitation of oil, showing the signature bonus, the royalties, the special participation and the payment for the occupation or retention area, demonstrating the economic gains of the Brazilian state with those taxes.

3.1 Introduction

There is no doubt that contemporary civilization is heavily dependent on minerals,¹ especially oil, a hydrocarbon for which there is constant need, and the raw material for a number of products essential to our daily life, such as plastics and liquid or gas fuels. Oil is not a commodity like any other but rather a vital input for the security, development and economy of nations.²

The truth is that to date oil is still the primary component in the global energy matrix and plays a vital role in the geopolitical picture. This reality is no different in Brazil. Despite being a nonrenewable polluting fuel, oil meets modern needs and is present in a wide range of products.³

Not all countries have petroleum beneath their soil or continental shelves, and given the fact that it is a finite, nonrenewable resource for which there is universal dependency, oil provides countries with wealth, power and independence. In fact, the world has become small due to dependence on this hydrocarbon trapped in sedimentary rocks.

The oil and natural gas industry (ONGI) in Brazil, as defined by law, is the set of economic activities related to the exploration, development, production, refining, processing, transport, import and export of oil, natural gas and other fluid hydrocarbons and their derivatives.⁴

Brazil has achieved self-sufficiency in crude oil production, and for some time now its possible entry into the Organization of Petroleum Producing Countries (OPEC) has been debated,⁵ primarily owing to discoveries in the area popularly known as “Pre-Salt,” whose legal regime will be discussed in a separate chapter.

The growth in Brazilian oil exploration is a conjunctural issue, several factors having led to it. However, it is credited mainly to the flexibilization⁶ of oil and natural gas production instituted by Constitutional Amendment No. 09, of November 9, 1995, and consolidated by Oil Law, which, among other measures, inserted Petrobras into a competitive market.

Accordingly, the present chapter aims at discussing the organization and functioning of the oil exploration regime in Brazil, especially with respect to the upstream domain of the petroleum industry.⁷

We will describe the evolution of the oil exploration regime in Brazil with relaxation of the monopoly, the role of the Regulatory Agency that acts in the sector and the characteristics and function of concession contracts.

3.2 Regulatory Structure of the Oil and Gas Industry

As previously mentioned, Constitutional Amendment No. 9, of 09/1995, substantially altered the monopoly over oil exploration in Brazil. This amendment flexibilized the exploration of this hydrocarbon by allowing not only the Brazilian state but also private enterprise to engage in activities related to this industry. This measure was made possible by altering article 177 of the 1988 Brazilian Federal Constitution, which previously forbade any private enterprise involvement.⁸

This constitutional reform flexibilized the monopoly that the Brazilian state held in terms of research, exploration, export, import and transport of oil, allowing the Union to contract private companies.⁹

Subsequently, a complementary law was created to deal with the following issues: “I – guarantee the supply of oil derivatives throughout the country; II – contract terms; III – structure and responsibilities of the regulatory entity of the Union’s monopoly.”

This law, established by the Brazilian Constitution, aims at regulating the relaxation of the Union’s monopoly, which would result in the implementation of a new regime for the oil and gas sector in Brazil, in order to reduce oil exploration costs and productive efficiency.¹⁰ Although the ownership of underground resources with this law remained in the hands of the Federal Union, it opened the doors to private companies, allowing concession contracts to engage in upstream activities or, through specific authorization, to perform downstream activities. This constitutional reform was followed by the Oil Law, regulating the new judicial regime prescribed by the Brazilian Constitution.

Thus, in the terms of article 176 of the Brazilian Federal Constitution of 1988, in conjunction with articles 3, 21 and 26 of the Oil Law, the concessionaire retains the right to ownership of these resources after their extraction, supported, however, by government participation prescribed by law.¹¹ This transfer of ownership only becomes concrete after measurements at the wellhead for payment due to government participation and any other taxes incident to this activity.¹²

To oversee and apply the terms of the new regulatory framework, Constitutional Amendment No. 09/1995 and the Oil Law instituted the National Council for Energy Policy (CNPE) and the National Oil, Natural Gas and Biofuels Agency (ANP),¹³ in addition to altering the institutional framework of the Ministry of Mines and Energy (MME).

Although the Federal Constitution prescribed the creation of a regulatory agency, which became the ANP, it has not become an isolated and totally independent entity but rather is part of a larger context, that is the MME and the CNPE, requiring it to dialogue and deal with both in their regulatory decisions. However, it is important to underscore that technical regulatory decisions are the exclusive purview of the agency and must not suffer interference from the aforementioned Council and Ministry.

The MME deems it essential to conduct studies and sector planning in the energy field, including the petroleum industry. In Federal Law No. 10.683/2003, article 27, item XVI defines the areas of responsibility of this ministry as being geology, mineral and energy resources; hydraulic energy; mining and metallurgy; oil, fuels and electric energy, including nuclear energy. Thus, the alterations to the Oil Law strengthened the role of the MME as a formulator of policy, guaranteeing adequate planning for the sector, a role that is even more evident with the Gas Law.¹⁴

Thus, this entity is in charge of National Energy Planning, with access to data and information on Brazilian sedimentary basins, whose collection, maintenance and management is the purview of the ANP.¹⁵

The MME is also responsible for overseeing the ANP, ensuring that the latter fulfills its institutional role, especially the objectives proposed by the Oil Law, as follows: preserving national interests; promoting free enterprise, development, increasing the labor market, energy conservation and exploiting energy resources; protecting the environment and consumer interests such as price, quality and supply of hydrocarbon and biofuel-derived products; guaranteeing the supply of oil derivatives to the entire country; increasing the use of natural gas; augmenting the participation of biofuels in the national energy matrix in economic, social and environmental spheres; attracting investments in energy production.

The function of the National Council for Energy Policy (CNPE), under the presidency of the Ministry of Mines and Energy, is to propose measures to the President regarding the country’s energy resources and their rational use; define concession and production sharing blocks, economic and technological development policies for the oil and natural gas industry and other fluid hydrocarbons and biofuels, as well as their supply chain; establish import and export guidelines that meet the internal consumption demands for oil and its derivatives, biofuels, natural gas and condensed gas and ensure the adequate functioning of the National System of Fuel Stocks and fulfillment of the Annual Plan for Strategic Fuel Stocks; establish guidelines for the use of natural gas as raw material in industrial productive processes, with regulation of conditions and specific criteria, aimed at their efficient use, compatible with internal and external markets; define strategies and policies for economic and technological development of the oil and natural gas industry, other fluid hydrocarbons and biofuels, as well as their supply chain.¹⁶

The ANP, in turn, was implemented in the form of a special self-sufficient regime linked to the Ministry of Mines and Energy, with legal status of public law; patrimonial, administrative and financial autonomy; and indeterminate duration as a regulatory entity of the oil, natural gas and biofuel industry, authorizing, regulating and overseeing¹⁷ while limited by the basic rights of the respective economic agents and guaranteed by the Federal Constitution and national policies concerning the rational use of energy sources, as prescribed by the Oil Law.

Therefore, the ANP is a federal autarchy, linked to the Ministry of Mines and Energy,¹⁸ responsible for executing national policies for the oil, natural gas and biofuel sector, in accordance with the Oil Law.¹⁹

Thus, the ANP acts in a strategic and sensitive economic sector and holds the policing power to guarantee that economic agents, despite the individualism inherent in commerce, conduct their activity in accordance with the precepts of social justice and the constitutional principles of the economic order.²⁰

The regimental structure of the autarchy under study reveals its institutional purposes,²¹ listed in article 2,²² which are to promote the regulation, contracting and monitoring of economic activities in the petroleum industry.

The ANP’s functions are listed in the Oil Law, as well as in arts. 3 and 4 of Decree No. 2.455/1998,²³ and include those considered most relevant to the present study, namely, implement national oil and natural gas policies; promote studies aimed at delimiting blocks, for the concession of exploration, development and production; regulate the execution of geology and geophysics services applied to oil prospection, aimed at obtaining technical data, destined to commercialization in nonexclusive bases; compile bid data sheets and promote bid applications for the exploration, development and production and oversee the execution of any resulting contracts; oversee petroleum industry activities, either directly or through agreements with State or Federal District authorities, as well as applying administrative and monetary sanctions established by law, regulation or contract; organize and maintain information and technical data related to petroleum industry activities.

The regulatory agency is directly responsible for delimiting the areas to be auctioned off and proposing their auction to the National Council for Energy Policy (CNPE), as well as studying these areas, organizing the auction and overseeing the execution of the concession contract once signed.

Moreover, the Ordinances and Resolutions issued by the ANP are subject to constitutionality, legality and regulations since they are not purely discretionary acts²⁴ but rather subject to market regulation, albeit in accordance with legal precepts, such as article 177 of our Political Charter and the Oil Law. Thus, the regulatory power of the ANP does not involve the freedom to decide the criterion but, as an instrument for implementing national oil policy, is determined by the respective normative acts.²⁵

The essence of regulatory power, therefore, is in the function of normative power—and not discretionary administrative power. Thus, the most important aspect of this power results from a function attributed to the Executive branch through the law formulated by the Legislative branch.²⁶

Monitoring by the ANP can be exercised directly, indirectly or via a public administration entity or autarchy of the Union, the States, the Federal District or Municipalities, through agreements defining the conditions for performing this role, with the delegation of powers to verify infractions, instruction and assessment of performance, as well as applying the corresponding penalties.

3.3 Petroleum Industry Regulatory Model: Concession, Auctions and Authorization

The oil and natural gas exploration model instituted after the aforementioned legislative reforms, and within this institutional framework, allowed individuals to enter into contracts with the Brazilian State to explore and produce oil, as an incentive to competition. This was achieved by auctioning oil exploration and production blocks²⁷ through concession contracts for areas believed to contain oil deposits and selected by the ANP through the public test law (auction), held periodically.²⁸

Article 23 of the Oil Law states that “exploration, development and production of oil and natural gas will be exercised based on concession contracts, following auctions.” Specific blocks are put up for auction and determined according to the tender. The blocks to be auctioned off and demarcations will be defined in prior studies conducted by the ANP.²⁹

3.3.1 Concession Contracts in the Brazilian Petroleum Industry

This type of contract has always been present in Brazilian legal order, but only with the Constitution of 1988 was it included in the regime of economic activities and public services under the purview of the State, though executed by private agents.

The concession regime for oil exploration and its derivatives is the oldest model in the world, currently being used by 44 % of oil-producing countries,³⁰ this being the legal instrument that from the beginning regulated most of the relationships between states with oil reserves and foreign companies. ³¹

The concession contract, in Brazil, is an administrative contract by which the administration grants a private entity the remunerated execution of a public service or public works, or use of a public asset, at its own cost and risk, at prescribed deadlines and conditions³² or temporarily awards the concession to a private entity that executes a determinate service, at its own cost and risk, but seeking general interest, consubstantiated in the signed contract.³³

Thus, the concession holder has exclusive rights on the concession area during the period stipulated in the contract. It is the responsibility of the holder to recover costs and obtain profits, as well as pay the States any monetary obligations (government participation, signing bonus) and taxes on the oil extracted.³⁴ In this respect, oil concession contracts in Brazil are different from the most common type of contract (public service contracts) since there is no stipulation as to tariffs or any other form of payment to the concession holder.

The oil concession contract in Brazil fulfills a social function and is therefore not only a private instrument for appropriating profits or a mere government instrument. This social function occurs through societal benefits, with the counterparts received by the Brazilian government by means of oil exploration and its financial applications.³⁵

Under this regime, the ownership of oil extracted in a certain area (the concession block), and for a certain time period (as a rule, 20–30 years), is exclusive to the concession holder. This is guaranteed by article 1988 of the Brazilian Federal Constitution of 1988, which states that “the ownership of exploration oil is guaranteed to the concession holder.”³⁶

In fact, the contract grants the concession holder a series of exclusive rights over certain concession areas (respecting the right of third parties), which allow the research, extraction and sale of any amount of oil, in exchange for the financial compensation obtained through the sale of oil and its derivatives on the market.³⁷

The different phases into which upstream activity is divided are currently standardized in different oil laws worldwide: obtaining rights, prospection, assessment, development, production and field abandonment. Passing from one phase to another depends on combining a set of natural, economic, financial and legal factors; encouraging private investment; and equitable remuneration by the host State.³⁸

Although the specific content of concession contracts varies in different auctions, in Brazil these generally always include two distinct phases.

The first phase is exploration and assessment. This is the phase in which the concession holder conducts studies to determine the commercial value of the concession area, carrying out geological studies, drilling wells and fulfilling the minimum exploratory plan offered at auction³⁹ with respect to the seismic study.

The second phase is production. It occurs only if the company understands that there are, indeed, commercially viable oil reserves and informs this fact to the regulatory agency. If the area does not enter the second phase, its management reverts to the ANP.⁴⁰ Deadlines are established in the concession contract. As a rule, the exploration phase has a deadline of 3 years, starting from the contract signing date, and can be extended if the request is justified and meets the contractual requirements. The production phase, on average, has a maximum period of 27 years, which can be extended as long as the contractual, regulatory and public interest stipulations are met, as determined by the ANP.⁴¹

The exploration phase involves the possible discovery of oil or gas to determine its commerciality. Thus, after discovery by the concession holder, it decides, by its exclusive criteria, to declare or not its commerciality. If there is no declaration, the concession holder must return the respective development area to the ANP.

Thus, if the first phase is not met, that is, there is no discovery of oil reserves or declaration of commerciality, the contract and all its conditions are cancelled.

However, if a declaration of commerciality is made before the production phase, there is an intermediate phase between exploration and production, which is the development phase, also stipulated in the concession contract. The development phase refers to the measures required to prepare the area for oil and gas production.

To put this into practice, the concession holder must provide a development plan. This plan, which will depend on the proposal presented in the bid, must be approved by the ANP, which may request modifications and explanations. This plan must be completely carried out by the concession holder, with alterations only possible when approved by the regulatory agency.⁴²

The concession contract must faithfully reflect the conditions of the bid data sheet and the winning bid and contain the following essential clauses (article 43 of the Oil Law): I – definition of the concession block; II – the duration of the exploration phase and the conditions for its extension; III – the work program and the amount of investment foreseen; IV – concession holder obligations in terms of government participation (to be explained); V – guarantees to be provided by the concession holder in relation to fulfilling the contract, including in terms of making adjusted investments for each phase; VI – specification of rules regarding the return and vacating of the areas, including the removal of equipment, installations and assets; VII – procedures for monitoring and overseeing exploration, development and production activities, as well as contract auditing; VIII – the obligation of the concession holder to provide the ANP with reports, data and information concerning the activities carried out; IX – procedures related to contract transfer; X – rules regarding the solution of disagreements related to the contract and its execution, including conciliation and international arbitration; XI – cases of contract annulment or termination; XII – penalties applicable if the contract holder does not comply with contractual obligations.

Concession contracts are terminated for a number of reasons.⁴³ The “natural” manner of terminating any contract is its completion, in terms of time, with both parties entirely fulfilling their obligations by the end of the contractually established deadline. This includes any extensions over the course of the concession.

The second manner of ending a contract can only occur by mutual agreement between the ANP and the concession holder, at any phase of the contract (exploration, development and production). The administrative act that authorizes the amicable termination must originate in the duly informed administrative process, in which the nonexistence of noncompliance and violation of the public interest can be proven in the termination of the concession contract.

Contract termination can also occur for reasons expressly stipulated in the contracts, which, as a rule, are noncompliance of the concession contract itself for a period of more than 90 days, or in cases of bankruptcy, insolvency or judicial recovery requirement on the part of any concession holder.⁴⁴

Contract termination by the ANP for reasons of default on the part of the concession holder is an extraordinary manner of ending a contract. It is an administrative sanction for noncompliance of contractual obligations to which the concession holder is bound from the contract signing, requiring the opening of an administrative process with ample defense guaranteed to the defendant.⁴⁵

A further reason for termination is when, at the end of the exploration phase, there has been no commercial discovery, as mentioned above. There will be no justification for the concession holder’s legal right to maintain this contract.

Finally, the last reason to terminate the concession contract can occur when, during the exploration phase, the concession holder desists and returns the area, in which at its criteria there are no reasons to justify investments.

Once the areas are returned or the contract is terminated, the legislation stipulates that that this will incur no financial burden on the Brazilian state or the ANP and will grant no right to any compensation for research, services, wells, real estate and/or activities carried out. The area becomes the property of the Union and under ANP management, and it will be the responsibility of the concession holder to repair or compensate for any damages resulting from its activities, as well as complying with any environmental recovery actions determined.

However, exploration, development and production of a determinate area may, at the discretion of the company, not be commercially viable but attractive to another (smaller, for example). Thus, a concession contract may be awarded, that is, a change in contract holder. This change cannot occur freely since it is a regulated sector, preceded by a bidding process and the need to establish whether the new title holder meets all the technical, legal and financial requirements stipulated, in order to avoid fraud.

The change in block ownership can only occur with the express permission of the ANP, which will have 90 days to manifest itself after the request with all the necessary documentation. It is noteworthy that only part of the block may be awarded, that is, exploration of a determinate concession block is fractioned.

The block concession holder must always act and adopt in its operations the best practices of the international petroleum industry and comply with the guidelines and pertinent technical and scientific procedures, including appropriate recovery techniques, aimed at streamlining production and controlling the decline in reserves.

3.3.2 The Selection of Concession Holders: Call for Bids

The law could not allow the administrator and regulatory agencies sole discretion in the selection of individuals to be contracted because this could lead to improper selections that would not be in the public interest.⁴⁶

Considering these problems, the bidding process was established in Brazilian law. This procedure precedes the contract itself and allows several persons to make their bids and, as a consequence, results in the best selection.⁴⁷

The bidding process in Brazil can be defined as an administrative procedure linked to the regulations of the call for tenders, by which Public Administration entities and those they control select the best proposal among those presented by the interested parties, with two objectives: execution of the contract according to conditions contained in the call for tenders or obtaining the best technical, artistic or scientific work.⁴⁸ In other words, the call for tenders is an administrative procedure with a selective purpose,⁴⁹ based on administrative morality and equal opportunity for those who wish to be contracted by public administration.⁵⁰

Only companies that meet the technical, economic and legal requirements established by the ANP and stipulated in the call for tenders, that is, those deemed qualified to take part in the public tender, will be able to obtain a concession to explore and produce oil and natural gas.⁵¹

The call for tenders for the granting of concession contracts must comply with the precepts of the Oil Law, ANP regulations and the rules stipulated in the call for tenders.

Article 37 of the Oil Law states that concession contracts signed in Brazil must contain a series of clauses whose content remains constant over time.

The first mandatory clause is the description of the concession block since it is impossible to conceive of a call for tenders and a contract without precise delimitation of the block.

Another essential requirement is that the duration of the contract be stipulated in the mandatory clauses, as well as the time limits for each phase and execution of the minimum exploratory plan.

Moreover, the call for tenders must exhibit the legal, technical and financial requirements, as well as the prequalification criteria of the competitors.

The call for tenders will also clearly stipulate government participation owed and its percentages, such that the bidding company has an idea of the economic and transaction costs involved. For the same reason, there is also a clause that requires the express indication regarding the amount the concession holder must pay in compensation in the case of expropriations or obligations necessary to execute the contract.

The call for tenders must also list the documents required to take part in the public bidding process and the criteria to follow to prove the technical qualifications, financial solvency and good standing of the interested parties, as well as technical and economic-financial assessment of the proposal.

There is also the estimated deadline, place and time in which data, studies and other elements and information regarding the blocks to be auctioned needed to prepare the proposals.

To define the winning field, in addition to criteria expressly stipulated in the call for tenders, the following will be considered: the general work program, proposals for exploration activities, deadlines, minimum investment amounts and the physical-financial chronograms.

The call for tenders defines how the winner of the bidding process will be selected. The last two calls for tenders determine the signing bonus and minimum exploratory plan, respectively, with a weight of 40 % to assign a final score, for a total of 80 %, and the other 20 % is represented by Local Content.⁵²

3.3.3 Authorization

As previously mentioned, the ANP is the regulatory entity of the entire production chain of the petroleum industry; however, it also has the function of overseeing these guidelines. This entity also controls petroleum industry activities through regulatory guidelines in order to obtain data on the economic activities of the sector and guarantee enforcement of established regulatory guidelines. Moreover, some petroleum industry activities have a relevant social structure, attracting greater care and attention from the Brazilian State.

For some petroleum industry activities, ANP authorization is required, demonstrating the still strong interventionary aspect of the Brazilian State.

This authorization in its classic version constitutes a unilateral administrative act, discretionary and precarious, through which the Administration authorizes a private enterprise to use public assets, perform material activity or engage in an act that, without this consent, would be legally prohibited.⁵³ If granted for a certain time period, the act has a certain degree of stability, giving a private entity the right to be compensated if the Administration revokes it before its termination.

Although they are not public services or administrative activities, many require large investments, incompatible with the classic conception of authorization as a unilateral, discretionary and precarious act. For this reason, the doctrine constructed what is conventionally called “linked authorization,” in other words, a stable authorization provided it meets certain legal requirements. Thus, the right to exercise the activity until its conclusion is one of the subjective rights of the authorized entity.

Furthermore, authorization is not, in this case, discretionary but rather linked, that is, the private entity meeting the requirements stipulated in regulatory guidelines and laws will have the right to be granted authorization to perform the activity.

It is important to underscore, however, that “linked authority” is the exception and not the rule. The rule is that granting authorization is still a unilateral act, and the Administration decides, in a discretionary manner, whether it will authorize or not or revoke the act at any time.

However, what actually matters is that petroleum industry authorization is linked, creating stability in economic relationships and legal and economic security for entrepreneurs and investors, and ratified if legal requirements are met, preventing the arbitrariness of the regulatory agent from being revoked.

Among the activities that need authorization are “Oil, Derivatives and Natural Gas Transport,” as prescribed in article 56 of the Oil Law. This article mandates the creation of an independent legal person, whose social object has the exclusive purpose of providing transport services. The construction of transport facilities also requires this administrative representative.

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Regulation of the Oil Industry According to the Brazilian Oil Law

3. Regulation of the Oil Industry According to the Brazilian Oil Law