The Brazilian Local-Content Policy in the Oil and Gas Production

Local Content Requirements in the Oil and Gas SectorAluisio de Lima-CamposChairman, ABCI Institute; Adjunct Professor, American University Washington College of LawVienna, September 30, 2013

ContentGeneral aspects of LCRs

The Norwegian and Brazilian Models

Relevant WTO disputes and provisions

Lessons learned and final remarks

National LCR policies in effect for the oil and gas sector CountryLegislation/Policy Year enacted FocusBrazilLocal Content Legislation2003 Oil concession Trinidad & Tobago Local Content & Local Participation Framework 2004In-country fabrication Kazakhstan Law of the Republic of Kazakhstan; 223-IV 2009 Procurement & services Indonesia Local Content Rules2009Procurement of domestic inputs NigeriaLocal Content Act2010 Indigenous participation and domiciliation of oil and gas activities Source: ADO, Rabiu. Local content policy and the wto rules of traderelated investment measures (trims): the pros and Cons. International Journal of Business and Management Studies. Aberdeen: Vol.2(1), 2013, p.137-146.Desired Goals and arguments in favor of LCRsmacroeconomic and short-term: strengthening demand directed to the domestic market and employment expansion;more specific focus and long-term perspective:(i) diversification of the industrial sector; (ii) development of technology-intensive sectors and high growth potential; (iii) build relevant segments to enhance national securityArguments against LCRs The policy inhibits benefited sectors from becoming more competitive vis a vis foreign suppliers;The consequent trend is then reduction of investment in R&D and innovation;Costs associated with the acquisition of inputs increase; andResulting disincentive to further investments by foreign investors in the country.

The Norwegian ModelNorwegian Model (oil & gas)Focused in the production chain not in the sector;The Norwegian government could add local companies in the operators list of suppliers;The more the operators contracted with Norwegian suppliers the greater their chances in subsequent biddings.

The Brazilian Model Focused in the O&G sector; LCR set by Government (ANP) in concession bidding notice;LCR based on percentage of local inputs;Requirement of certification of LC and audit of reports;No sunset provisions

Brazils Regulatory FrameworkLaw/RegulationWhat does it establish?Law No. 9.478 of 6 August 1997Minimum local content requirements are established in licensing round for the award of oil and gas exploration and production rights, and change over time and for different type of acreage (based on relative maturity and location) Specific commitments are set out in petroleum contracts.Law No. 12.276 of 30 June 2010Authorizes the federal government to cede at a cost to Petrleo Brasileiro SA - PETROBRAS the exercise of research and production of oil, natural gas and other fluid hydrocarbons in the areas of Pre-SaltLaw No. 12.304 of 2 August 2010Authorizes the Executive to create the company Empresa Brasileira de Administrao de Petrleo e Gs Natural S.A. - Pr-Sal Petrleo S.A. (PPSA)Law No. 12.351 of 23 December 2010The text provides for the exploration and production of oil, natural gas and other fluid hydrocarbons, under the regime of production sharing in areas of pre-salt and strategic areasANP Regulation No. 6/2007 ResolutionNo.36/2007Specify the criteria and procedures for the calculation and certification of local contentANP Regulation No. 8/2007 andResolution No. 38/2007Specify the procedure for audit of local content certificationANP Regulation No. 9/2007 andResolution No. 39/2007Specify the reporting procedure and formatThe Brazilian Local Content Requirement (LCR) policy evolution for Oil and GasBidding12345678910Year1999200020012002200320042005200620072008Nature (requirements)No requirements of LC in bidding notice. LC commitments are offered by interested parties in their respective bids.Global LC minimum percentages are set in bidding notice. Commitment with additional % for certain activities may be offered by bidding parties.Global LC minimum and maximum percentages are set in the bidding notice for the phases of exploration and development, as well as minimum percentages for items defined by the bidding party.DefinitionSupplier locationDomestically manufactured goods (LC of more than 60% in 2000; more than 40% thereafter) and, by 2001, for Services Provided in the Country (more than 80%)Calculation methodology to quantify LC by Supplier of Goods and ServicesEvidenceNo proof of LC requiredRequirement to report quarterly spending on national and foreign goods and servicesRequired Declaration of Origin by supplierRequirement of certificates of domestic content by accredited bodiesSource: GUIMARES, Eduardo Augusto. Confederao Nacional da Indstria. Poltica de contedo local na cadeia do petrleo e gs: uma viso sobre a evoluo do instrumento e a percepo das empresas investidoras e produtoras de bens / Confederao Nacional da Indstria Braslia : CNI, 2012.

The Pre-Salt first BiddingLibra Oilfield Santos Basin (11 companies bidding) May compete consortia composed of up to five companies with a R$ 610 million minimum investment;The winner will be established based on the best return for the Brazilian government, with a price established at between US$100-120 p/barrel;Petrobras is the operator, with a minimum share of 30%, and can also participate in a bidding consortium;A signing bonus of R$15 billion must be paid to the Brazilian government.

The Pre-Salt first BiddingFor the exploration phase, the minimum LC is 37%.For the development phase, the corresponding figure is 55% for the first oil produced until 2021 and 59% thereafter.

Policy Objectives can be UnderminedLack of incentives to and lack of firm commitment by local industry to become competitive Open-ended protection of local industry;No planned gradual reduction of LCRs overtime;No clear goals;High administrative costs.WTO disputes on LCRDS412 - Canada Certain Measures Affecting the Renewable Energy Generation Sector Japan alleged that Canadas use of LCR was not in accordance with GATT and TRIMS agreements.Canada argued that its program was consistent with Art III:8(a) of GATT because the LCRs have environmental objectives and were not for profit.The WTO AB agreed with Japan (May 6, 2013).

WTO Disputes on LCRDS456 - India Certain Measures Relating to Solar Cells and Solar Modules (Complainant: United States)The U.S. (Feb. 6, 2013) started a DS case against India related to LCR under the Jawaharial Nehru National Solar Mission (NSM) for solar cells and solar modules claiming that the program is inconsistent with GATT and TRIMS agreements;No decisions issued yet.

WTO Provisions that may apply to LCRsArt III:4 GATT: National Treatment Principle The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favorable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use. The provisions of this paragraph shall not prevent the application of differential internal transportation charges which are based exclusively on the economic operation of the means of transport and not on the nationality of the product.

WTO Provisions that may apply to LCRsArt III:5 GATT: No contracting party shall establish or maintain any internal quantitative regulation relating to the mixture, processing or use of products in specified amounts or proportions which requires, directly or indirectly, that any specified amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources. Moreover, no contracting party shall otherwise apply internal quantitative regulations in a manner contrary to the principles set forth in paragraph 1.

WTO Provisions that may apply to LCRsArt. III:8 GATT

(a)The provisions of this Article shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of products purchased for governmental purposes and not with a view to commercial resale or with a view to use in the production of goods for commercial sale.

(b)The provisions of this Article shall not prevent the payment of subsidies exclusively to domestic producers, including payments to domestic producers derived from the proceeds of internal taxes or charges applied consistently with the provisions of this Article and subsidies effected through governmental purchases of domestic products.

WTO Provisions that may apply to LCRsSCM Agreement, Art.1.1:1.1 For the purpose of this Agreement, a subsidy shall be deemed to exist if:(a)(1)there is a financial contribution by a government or any public body within the territory of a Member (referred to in this Agreement as government), i.e. where:(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);(ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits);(iii) a government provides goods or services other than general infrastructure, or purchases goods;(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments;

WTO Provisions that may apply to LCRsSCM Agreement 3.1(b):

3.1 Except as provided in the Agreement on Agriculture, the following subsidies, within the meaning of Article1, shall be prohibited:(b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods.

WTO Provisions that may apply to LCRsArticles 2.1 and 2.2 TRIMs Agreement;

1.Without prejudice to other rights and obligations under GATT 1994, no Member shall apply any TRIM that is inconsistent with the provisions of Article III or Article XI of GATT 1994.

2.An illustrative list of TRIMs that are inconsistent with the obligation of national treatment provided for in paragraph 4 of ArticleIII of GATT 1994 and the obligation of general elimination of quantitative restrictions provided for in paragraph 1 of ArticleXI of GATT 1994 is contained in the Annex to this Agreement.

GPA ProvisionsThe Art.III: 3(b) of Government Procurement Agreement establishes that:With respect to all laws, regulations, procedures and practices regarding government procurement covered by this Agreement, each Party shall ensure:that its entities shall not discriminate against locally-established suppliers on the basis of the country of production of the good or service being supplied, provided that the country of production is a Party to the Agreement in accordance with the provisions of ArticleIV.The Brazilian CaseArt. 177 of Brazils Constitution According to this article, the Union has the monopoly of research, exploration and refinement of oil, natural gas and other fluid hydrocarbons. Therefore, the government is directly responsible for purchasing goods and contracting services for those activities, through government procurement;In accordance with the Art. 177 1 of the Brazilian Constitution: The Union may contract with state or private companies through tendering for services of research, development and exploration in accordance with specific law.

The Brazilian CaseThe specific Law (Law No. 9.478 of 6 August 1997) in its Art. 5, allows the Brazilian Government to offer through tendering concessions in the sector of Oil and Gas. This is done by the Brazilian Governments National Petroleum Agency. In other words, it is a government transaction involving government property and acquisition of services to explore and develop that property.GPA provisions would not apply, because Brazil is not a signatory.

Some lessons learnedLCRs are desirable when the social benefits associated with it are greater than the resulting losses from cost of production increases (focus on maximizing competitiveness, welfare, not LC);Works better in countries that have a stable macroeconomic environment;Not a sure cure against Dutch Disease, unless other policies are applied to deal with persistent distortions (currency overvaluation, relative interest rates);It should stimulate the production chain through incentives and not hinder it through market reserve policies (policy should include clear goals and a system of rewards and penalties for those goals);LCRs should be temporary and contain a phase-out mechanism, with set deadlines.

Productive Development Policies have been used for a long time with various degrees of success. Existing literature suggests that countries that (1) focused on exports and productivity; (2) had a stable macroeconomic environment; (3) were more concerned about activities as opposed to sectors; and (4) clearly, explicitly, and publicly disclosed the governments objectives, were more likely to develop sizeable and complex productive sectors. Countries that lacked these characteristics tended to develop noncompetitive productive sectors that overtime generated sizeable economic costs.

24Final RemarksLCR policies in the O&G sector can achieve economic and social objectives if adequately designed and implemented.Policy design should give due attention to and avoid international trade law violations.In the absence of DSB precedents, more WTO disputes on LCR policies are possible. Coverage of all instances of LCR, however, may require a specific multilateral understanding for the O&G sector.