IBP advocates enhancements to local content policy
At an event in Rio de Janeiro, the Brazilian Institute for Oil, Gas and Biofuels (IBP) presented proposals to improve Brazil’s local content policy for the oil and gas industry.
One proposal is to simplify local content commitments by prioritizing supply chain segments with greater development potential in terms of job creation and technology content.
To inform its proposal, IBP commissioned a study from consultants Bain&CO which mapped seven priority segments based on an analysis of social and economic value for Brazil and the global relevance of Brazil’s demand. The seven segments are: module and topsides design, fabrication and installation; subsea equipment; subsea installation services; high-tech well drilling and completion; high-tech machinery and equipment; medium-technology machinery and equipment; and construction of offshore support vessels.
Strategic segments will also be prioritized on the basis of their ability to compete in the global market, as there is a risk that local businesses reliant on the oil industry will disappear as domestic offshore demand declines.
In practical terms, the proposed policy is not to create a market reserve, but to support Brazilian-based companies in establishing the capabilities to offer goods and services on the West Coast of Africa and the Gulf of Mexico, for example, which are currently dominated by Korean, Chinese, American and European companies, so they are able to grow and establish themselves as relevant players on the global market.
Evolving Local Content Policy
“IBP believes local content policy should be maintained as it plays an important role, but that to capture its potential value it must continue to evolve with the economy and the industry, with a focus on those value-added sectors in which we excel, ensuring that we leave a legacy of world-class, globally competitive and sustainable capabilities that can be integrated into the global supply chain,” says IBP Chairman Jorge Camargo. “It has never been a discussion about whether we should have a local content policy at all, but about how best to use it to create value for society.”
In 2005, annual investments in the oil industry were around US$ 6 billion. Today, projected investments are in the order of more than US$ 30 billion annually, after topping US$ 40 billion in 2013.
“When the current policy was implemented the challenge was utilizing idle manufacturing capacity. Now there is a requirement to invest in new capabilities to meet demand on a competitive basis and ensure the future sustainability of our suppliers. The pre-salt discoveries have also brought new technological challenges, which further changes the situation,” says IBP’s Executive Secretary for Exploration and Production, Antonio Guimarães.
These challenges, according to the policy document presented by IBP, include:
- Creating an attractive environment in Brazil for expanding supply chain investments;
- Expanding industrial capabilities and capacity on a competitive basis;
- Addressing short-term obstacles to new investment decisions in oil and gas exploration and production due to existing weaknesses in local supply capabilities;
- Aligning local content policy requirements with the business models of operators;
- Leaving a competitive and sustainable industry legacy.
IBP believes that developing a competitive and sustainable industry will require the following conditions to be met: local suppliers meshed into the global value chain; the potential for job creation, especially for high value-added jobs; expansion of production capabilities; and high-level investment in research, development and innovation.
Other proposed approaches to stimulating investment include the introduction of incentive and compensation mechanisms to recognize companies’ efforts and investments in production and innovation, and regulating the exemption clauses in concession, assignment-of-rights and production-sharing agreements to recognize situations where local content is unavailable or impracticable.
“Operators have made huge efforts to develop the local supply chain. But due to a number of factors that are beyond their control, at times they are unable to achieve the contractually required percentages. Adopting an incentive approach and compensation mechanism will create an appropriate environment for attracting and stimulating investments and expanding local supply chain capabilities,” says Camargo.
IBP recommends implementing mechanisms that encourage and reward investment. For example, rather than applying penalties directly, companies could be allowed to implement compensation initiatives such as developing suppliers in strategic segments within the government’s interest, with the positive effect of stimulating the development of local industrial capabilities. These compensation instruments would recognize initiatives such as investing in new production capabilities and exports, and would be more effective in promoting the development of the supply chain than just penalties, which often have the undesirable effect of delaying or inhibiting investment, with negative impacts on oil production and the benefits provided to society in the form of royalties and taxes – two important sources of funding for education, health and other public services.
Another issue needing to be addressed is the weighting given to each item and sub-item in contractual local content schedules, which often vary significantly from the procurement stage to final execution several years later. This variance is normal in the industry and is due to fluctuations in product and service prices, foreign exchange variance affecting the proportions of local and imported goods, and the introduction of new technologies resulting in project design changes. IBP is therefore advocating a simple mechanism in which local content computations recognize the actual amount invested in each item and sub-item.
Another factor creating significant uncertainty, in addition to market changes as described above, is that the oil and gas industry is also affected by economic cycles and especially uncertainty in terms of what actual project requirements will look like based on the findings from the exploration phase. During an auction, there is a high degree of uncertainty as to the actual characteristics of an oilfield development 7 to 10 years into the future – if any discoveries are made at all. With so much uncertainty, it is unreasonable to expect companies to be able to bid on local content – and especially for the regulator to accurately assess the quality of bids and select the successful bidder – at the time of the auction.
In this regard, IBP proposes adopting the local content approach used in the production-sharing system, which recognizes the value of local content policies and has already evolved to where it now recognizes the uncertainty when local content percentage guidance is pre-established in the contract with the successful bidder.