Framework Paper i. Oil and Gas in Federal Countries: Brazil

Transcription

1 Framework Paper i Oil and Gas in Federal Countries: Brazil Sérgio Wulff Gobetti 1, Helder Queiroz Pinto Junior 2, Juliana de Carvalho Sardinha 3 1. Overview According to the BP Statistical Review, Brazil had 12.6 billion barrels of proven oil reserves in 2008, second-largest in South America after Venezuela. The offshore Campos and Santos Basins, located on the country s southeast coast, contain the vast majority of Brazil s proven reserves. In 2007, Brazil produced 1.8 million barrels of oil per day. The state of Rio de Janeiro alone represents 80% of oil production and reserves, which denotes a concentration and asymmetry in the distribution of oil resources throughout the Federation. Despite its sizeable reserves, in 2008 oil revenues accounted for 1.32% of GDP, against 0.57% in The recent oil discoveries in the geological stratum known as pre-salt and the changes proposed by the government in the oil-sector regulatory model have fired up a conflict among the 27 federal entities (and their 5,563 municipalities) over current and future oil revenues. The issue, as it seems, is that the new potential reserves spread over a continental platform that spans the coastline of just three states (São Paulo, Rio de Janeiro and Espírito Santo), which make up Brazil s most developed region: the Southeast. Indeed, unofficial estimates indicate that Brazil s oil reserves may quadruple over the next years well into the 70-billion-barrel mark, which would make the country the eighth largest oil producer in the world, at par with Russia, and twice as much as Canada or the United States. Such perspective unveils immense shortterm possibilities for Brazil, just as it brings upon the country a host of macroeconomic, fiscal and federal challenges yet to be fully grasped by economic and political experts. 2. Federal System and constitutional provisions From a historical point of view, Brazil s federal and democratic experience is fairly new and rather inconsistent. Between 1930 and 1945, for instance, Brazil went through what historians often call the Vargas Era. For 15 years, President Getúlio Vargas, a populist and nationalist politician, laid the foundations of industrialization and labor law in Brazil. He also took authoritarian and centralizing measures, politically appointing state governors and, after a new Constitution had been passed in 1937, suppressing the freedom of parties, undermining the independence among power and compromising federalism itself. With Vargas deposition in 1945 (although he would eventually be reinstated as President by popular vote, in 1951) and the new Constitution of 1946, the country was back on its way to democracy and a federal revival. In the fiscal arena, for example, the new constitution granted states and municipalities a vast array of powers, ranging from sales, exports and property taxes (states) to excise taxes on public entertainment, economic actions, crafts and trades and urban property (municipalities). In 1953, states and municipalities earned the right to receive compensation for oil extraction in their territory. 1 Macroeconomics Department, Institute of Applied Economic Research, Brazil. 2 Institute of Economics, Federal University of Rio de Janerio. 3 Energy Economics Group-Institute of Economics-Federal University of Rio de Janeiro, Brazil. March 3-4, 2010 Page 1

2 This democratic phase was interrupted by a military coup d état in 1964, which ushered in a long dictatorship with five military presidents taking turns in office. In the social and economic domain, the military regime was characterized by increased of State intervention, and limited authority was granted to the states. The constitutional reform of 1967 further increased centralization of powers, and taxing authority. At the same time, it increased the system of intergovernmental transfers, thereby creating a series of revenuesharing mechanisms as well as funds for states (FPE) and municipalities (FPM) linked to income tax (IR) collection and that of the federal tax known as IPI. When Petrobrás made its first off-shore oil discovery offshore Sergipe state in 1968, the military government determined that 5% of future oil income would stay with the Union, and would not be transferred to states and municipalities as mandated by the 1953 law on onshore production. It is no coincidence that one of the first bills passed during the civilian administration of President José Sarney, in 1985, acknowledged states and municipalities rights to offshore royalties. In addition to oilproducing states and the so-called bordering states, Law 7453/85 also created a Special Oil Fund (FEP) to ensure that part of oil royalties would be shared by whole federation. This mechanism is still in force, although it has become less relevant over time. The 1988 Constitution fostered an ample process of tax decentralization. Not only it recognized the right of states and municipalities to financial compensation for production in their territories, but it also widened the autonomy and tax base of states and municipalities, as well as the rates of taxes earmarked to FPM and FPE. At the same time, the Constitution reaffirmed the State monopoly in the oil sector (later reversed with the 5 th constitutional amendment that opened oil exploration and production to private investors), as well as a whole set of rights and social benefits which would later be the subject of a public sector reform initiative. The 1995 Constitutional Amendment, of the marks the end of the nationalistic era, and the Fiscal Adjustment Program of 1999 resumed tax centralization by way of federal levies not shared by states and municipalities. 3. Ownership and jurisdiction According to the Brazilian Constitution oil reserves found onshore and offshore belong to the Union, but an infra-constitutional piece of legislation grants states and municipalities about 60% of the income derived from royalties. 4. Petroleum revenue arrangements in context of the federal fiscal regime Oil and gas revenues The fiscal regime for oil and gas includes royalties, a special entitlement ring-fenced at field level, landowner participation, and corporate income tax. In addition, the signature bonus is among the parameters for competitive allocation of oil and gas exploration and production rights. Retention fees also apply. These tax are levied by the Union and are described below: The royalty is paid monthly on oil and natural gas production. The current rate is 10%, but may be reduced by ANP depending on technical and financial consideration. The Special entitlement is calculated over net income according a sliding scale that can reach a maximum 40%, according de level of production and other parameters of each field. The landowner participation varies from 0.5 to 1.0% of oil and gas production according to criteria defined by ANP. Corporate taxes and social contribution apply in accordance with relevant legislation. March 3-4, 2010 Page 2

3 The signature bonus consists of a single payment made by the bid winning company on signing the concession contract. ANP (the regulator) is the only beneficiary of its levying and its minimum value is established by the same in the bid notice. The occupation or retention fee is an inhibiting factor, to foster active exploration by successful bidders. ANP is the sole beneficiary of these payments. Centre-State fiscal transfers For the purpose of inter-governmental sharing, oil and gas revenues can be divided in two categories: 1) Special imposts specifically related to oil, including royalties over gross production revenues, special entitlement, signature bonuses, occupation or concession fees. 2) Direct taxes on oil companies profits, as in any other sectors, including the corporate income tax (IRPJ) and the social contribution on net profits (CSLL). The former is shared by states and municipalities while the latter is strictly linked to the federal government s social security system. About 61% of the royalties and special entitlements are redistributed to subnational governments, while 48% of income tax (IRPJ) revenues are channeled to entitlement funds and regional funds and the remaining resources are appropriated exclusively by the Union. Considering the total revenue, approximately 45% belongs to states and municipalities. While taxation on oil companies profits is shared with all states and municipalities through entitlement funds, according to quotas directly proportional to their populations (municipalities) and inversely proportional to their per capita income (states), the royalties and special entitlements are distributed according to very complex rules that have been and continue to be amended over time. Revenue from these on-shore royalties started to be shared exclusively among states and municipalities at an 80/20 ratio, respectively. In 1969, with the discovery of oil off the coast of Sergipe state, the government extended the collection of royalties to off-shore production, only this time keeping the all indemnity payments. With the approval of Law 7453/1985, states and municipalities became entitled to receive 80% of royalties from offshore production in the following proportion: 20% to all states and municipalities, 30% to bordering states, and 30% to bordering and states encompassed in their geo-economic areas. The concepts of bordering or coastal proximity was determined in 1986 with reference to oil fields lying within the area formed from the projection of orthogonal lines extending towards the continental platform from the territorial borders of states and municipalities (in the case of municipalities parallel lines were also considered). According to Serra (2005), there is no economic justification for the sharing of royalties among municipalities, especially not on the basis of a geometric criterion such as coastal proximity, which shows no direct correlation with the economic impact of oil-related activities on a local level. Yet, this concept somehow made its way into the 1988 Constitution and later gained key weight in further legislation dealing with royalty distribution. The legislation extended the benefit of royalties not just to the bordering municipalities, but to all those having industrial processing and treatment plants for oil and natural gas (primary production area), as well as those cut through by pipelines (secondary area) and the municipalities bordering those in the primary area. Each of these groups would get a percentage of the municipal quota, which would then pro-rated among the municipalities according to their populations. Law 7990/1990 increased the list of municipalities partaking in these royalties. The new act required that March 3-4, 2010 Page 3

4 10% of royalties from on-shore or off-shore production be destine to municipalities featuring installations for the loading and unloading of oil and natural gas. This adjustment in the distribution of royalties was made in parallel to a reduction in the share reserved for states (onshore production) and for the special funds (offshore production). With the Petroleum Act 1997, royalties started to be shared according to four distinct rules, depending primarily on the location of the field (onshore or offshore). In addition, the 10% royalty rate was split in two: the basic 5% rate and the supplemental rate. Royalties corresponding to the basic rate continued to be shared in accordance with Law 7990/89, while the additional royalty introduced by the Act was to be shared with bordering municipalities in a manner proportional to the yield of oil fields contained in their respective territory (and no longer in proportional demographic terms). The same rule would apply to special entitlements. Only the coastal municipalities lucky enough to have their orthogonal and parallel projections intersect with oil fields should benefit from those revenues. As a result of these sharing arrangements Rio de Janeiro holds 75% of the decentralized resources. It is even more remarkable that 50% of shared royalties and special entitlements are concentrated in only 10 cities in the state. In addition to being unfair, the current rules have proven unable to significantly improve the social and economic indicators in municipalities favored by those royalties. In some cases, there is evidence that the abundance of resources has created tax laziness and waste, which in turn translates in low levels of autonomous taxation and high public spending. These problems derive in part from the weakness of institutions and provisions, including the legislation stipulating the rules of financial compensation. While funds available to the Union have several strings attached, those geared to states and municipalities are practically unencumbered. Such distortions in the distribution and application of royalties, as well as the competition among states for the new pre-salt wealth, has brought about a series of draft bills aimed at replacing the orthogonal line criterion with proportional mechanisms, parallel lines or with a system to broaden the pool of royalties shared by all states and municipalities. The debate of sharing criteria gained momentum after the government sent to Congress in 2009 a draft bill establishing a production-sharing arrangement for pre-salt oil fields. The major change in the proposed new regime is the elimination of the special entitlement and the creation of a new concept of State s share on profit oil. While the special entitlement in practice represents the government s share over the surplus, and now accounts for 20% of the profit oil, with 50% of its revenues transferred to states and municipalities, in the sharing regime, such entitlement will be contractually established at no less than 50% of profit oil, and be exclusively retained by the Union. This change which would increase the federal entitlement on financial compensations from 40% to 75% -- is not favored by the governors of Rio de Janeiro, Espírito Santo and São Paulo, who would be the major beneficiaries should the special entitlement system be extended to the pre-salt. The governors of northeastern states, in turn, opposed the proposal that pre-salt royalties (seen as a national treasure) could continue to flow massively to bordering states. 5. Macroeconomic challenges Brazil currently faces serious exchange rate issues from its larger-than-average appreciation vis-à-vis the dollar. This is as much a reflection of massive inflow of foreign direct investments as it is the result of large domestic and external interest rate spread. To tackle this problem in the context pre-salt, the government sent to Congress a draft bill to create a fund that will hold all future oil revenues. As stated in its article 2, the idea is to build public, long-term savings, offer a source of income for social and regional development and amortize the effects of income and price fluctuation in the national economy. March 3-4, 2010 Page 4

5 Although the fund was dubbed social, in an effort to add to its political legitimacy, the government s priority is clear: to prevent inflow of dollars that may cause further exchange rate appreciation. However, two issues need to be resolved to avoid compromising this strategy: The first relates to the high cost of Brazilian public debt, and the poor coordination between monetary and fiscal policies. With an actual yearly real interest rate of 6%, there would seem to be little point in accumulating financial assets abroad when they could be used to repay the government debt. Yet, if it were to do so, the government would increase liquidity in the economy, thereby forcing the central bank to reduce the interest rates or else issue new bonds. This dilemma is already a reality. Indeed while the Treasury borrows, a significant primary surplus accumulates with the Central Bank. The cost of accumulating dollar-denominated assets and of issuing bonds at an actual rate of 6% per annum accounts for 1.5% of the GDP every year, on average, according to Central Bank s own statistics. The second relates to issue when establishing a sovereign fund is that given the degree of the decentralization of oil revenues and the lack of spending control on states and municipalities. If more revenue were to be shared, the federal government ability to mitigate revenue volatility may be severely affected. In fact, the current fiscal and monetary framework and the federal structure both get in the way of solving the macroeconomic challenges that lie ahead for Brazil. And without solving these problems, the country will find itself in dire straits when it comes to the other structural challenges outlined in the foregoing requiring massive federal infrastructural, social and economic investment. 6. Environmental and social issues IBAMA (Brazilian Institute of Environment and Renewable Natural Resources), a Brazilian Federal regulator, has the power and authority to issue regulations and standards related to environmental protection and preservation, and to monitor and enforce their application. IBAMA produces environmental licensing guides with an updated classification of areas according to environmental sensitivity. The guides provide general guidelines to investors and the ANP with respect to areas that may be offered in licensing rounds. 7. Conclusions Brazil finds itself in an extremely privileged position in relation to the supply of oil and natural gas. The recent discoveries in the subsalt areas could transform the country into a major player on the international market. However, in spite of the promising news, the announcement of new oil discoveries requires caution due to the technological barriers to be overcome as well as the sources of uncertainty in the geological and the institutional-regulatory plans. On the other hand, should the potential of new reserves be confirmed then macroeconomic policy will be confronted with a host of challenges, which will call for careful coordination of monetary, exchange and fiscal objectives. The resulting tension will be relatively smaller in economic terms if interest rates keep declining, but that will require adapting the current fiscal rules based on primary surplus goals to the peculiarities of the oil industry. The discussion is still in its early phases in Brazil, although the dispute over ownership of oil revenues is intense. Unfortunately, over the last 25 years, royalty distribution rules have been based more on political bargains and on federalism traits that are unique to Brazil than on any oil sector-specific logic, as documented by Serra in its historic account of events (2005). In its attempt to once again dodge a discussion on the merits of federalism from the belief that this would facilitate the approval of a new regulatory model the federal government eventually brought the very issue afloat in an unorderly and opportunistic way. This, in turn, reveals poor understanding of the impact that the current federal arrangements may have March 3-4, 2010 Page 5

6 on the country s macroeconomic foundations should Brazil become a major oil producer. i This Framework Paper was prepared for the Conference on Oil and Gas in Federal Systems, and summarizes the findings of a more detailed paper on Oil and Gas in Federal Countries: Brazil. The Framework Paper is not for citation without authors permission. The full version of the paper is available on the Conference s webpage at The findings, interpretations, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the International Bank for Reconstruction and Development or the World Bank or of the Forum of Federations and their affiliated organizations, or those of the executive directors of the World Bank or the governments they represent. The World Bank and the Forum of Federations do not guarantee the accuracy of the data included in this work. March 3-4, 2010 Page 6

7 Brazil Courtesy of the Forum of Federations Political and Economic Indicators INDICATOR DATA GDP $ trillion PPP (2008) GDP per capita $ 10,300 PPP (2008) Number, type and % of Sao Paulo 21.8%, Minas Gerais 10.5%, Rio de Janeiro 8.5%, Bahia population of constituent units 7.7%, Rio Grande do Sul 6.0%, Paraná 5.6%, Pernambuco 4.7%, Ceará 4.4%, Pará 3.6%, Maranhao 3.3%, Santa Catarina 3.1%, Goiás 3.0%, Paraíba 2.0%, Espírito Santo 1.8%, Alagoas 1.7%, Amazonas 1.7%, Piauí 1.7%, Rio Grande do Norte 1.6%, Mato Grosso 1.5%, Federal District (Brasilia) 1.2%, Mato Grosso do Sul 1.2%, Sergipe 1.0%, Rondônia 0.8%, Tocantins 0.7%, Acre 0.3%, Amapá 0.3%, Roraima 0.2% Total population ~192 million Area km 2 Currency and Exchange rate Brazilian Real 0.53c - US $1, floating rate Political system Federal Federal Republic Political Party Regime Competitive, largely four party regime Distribution of powers/ According to the Brazilian Constitution oil reserves found on- or Ownership of petroleum off-shore belong to the Union, but an infra-constitutional piece of resources legislation grants states and municipalities about 60% of the income royalties Source: CIA 2009 Fact Book; Helder Queiroz Pinto Jr. and el al, Oil and Gas: Brazil, from the Conference on Oil and Gas in Federal Systems, March 3-4, 2010, Washington, DC. Conference on Oil and Gas in Federal Systems World Bank Headquarters, Washington, DC - Black Auditorium - March 3 rd 4 th, 2010