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Oil and Natural Gas Sector

Oil is the world’s most important source of energy used in transportation. In 2006, oil represented 38% of global traded energy demand. Its nearest rivals, coal and natural gas, represented only 28% and 24% of global traded energy demand, respectively. Furthermore, in most regions oil’s lead is substantially higher than this – there are two major exceptions: Asia-Pacific where coal is the dominant fuel source, with a 44% share, and the former Soviet Union, where gas leads with a 54% share.

The oil and gas are produced in all continents except Antarctic. Recently, the fast growing consumption and decrease in spare capacity, estimated in 2009 in just 6% which is equivalent to 1 year of production depletion, have lead to price volatility, issues about the resources sustainability and growing discussions about possible alternatives. The global economy is critically dependent on oil, and the reduction of its usage is extremely challenging.

The Middle East dominates the world’s proven reserves of oil. Proven reserves include only those that have been discovered and are considered economic to produce at current prices, using current technology, and using current costs. Based on the BP Statistical Review, the Middle East contains almost two-thirds of the 1.15 trillion barrels of proven reserves globally.

There are three producing countries that are head and shoulders above the rest: Saudi Arabia, Russia, and the US. These three produce over one-third of the world’s crude oil, condensate and NGLs (natural gas liquids). The rest of the world’s production is widely dispersed among more than 60 countries, none of which accounts for more than 5.5% of the total.

Crude oil is a mixture of organic hydrocarbons, water, salts and minerals. The quantities of these components vary from one oil deposit to another as does the depth at which the crude was formed. In order to distinguish between the different types of crude oil, classifications are made according to sulphur content and the specific gravity (weight) of the crude:

  • Crude oil with a sulphur content of less than 0.5% is classified as “sweet” whilst a crude with a high sulphur content of more than 2.5% is known as sour'.
  • Light crude is more valuable than heavy crude as it contains hydrocarbons with lighter molecules which are easier to extract out of the crude mix and which can be sold for a higher value than the heavier constituents of crude.

The most common method to distinguish between light and heavy crude uses the API (American Petroleum Institute) Gravity index. Crude with an API greater than 34 is considered light whilst crude with an API less than 32 is heavy (light/heavy definitions vary between regions – oil with an API of 32 might be classified as heavy in the US but as light in the Middle East).

These variations between crudes occur at a regional scale and a number of regional ‘benchmarks’ have been established as a basis for comparison across crude types (Table 1). North Sea crude oil (Brent) for example is a light sweet oil where as crude from the Middle East (Dubai) is often heavier and sourer.

Typical yield from a barrel of crude

  Sulphur API
Brent 0.36% 38.5
WTI 0.24% 39.6
Dubai 0.20% 31.0

Fonte: Citigroup Investment Research

Some of the principal uses of oil are shown in Table 2. The most important products derived from crude oil are vehicle fuel and fuel for generating power. However, oil has a number of other uses in a range of industries.

Typical yield from a barrel of crude oil

Quantity Product Uses
46% Gasoline Vehicle fuel
27% Fuel oil Power generation
10% Jet Fuel Aircraft fuel
5% Coke Heavy industry
4% Liquefied gases Heating / cooking
3% Petrochemical feedstocks Chemical industry
3% Asphalt Road surfaces
1% Lubricants Industrial applications
1% Kerosene Heating / aircraft fuel

Fonte: API (American Petroleum Institute)

Oil volumes are measured in barrels (bbl) and one barrel is equal to 42 US gallons, which represents approximately 159 liters.

The products obtained from a barrel of crude and their uses are detailed below:

  • LPGs (10%): the lightest part of the barrel. They include butane and propane which are primarily used for heating, cooking and as feedstocks in the petrochemicals industry.
  • Light distillates (35%): include gasoline and naphtha which can be used as vehicle fuel and feedstocks in the petrochemical industry respectively.
  • Middle distillates (35%): Middle distillates are comprised of diesel, jet kerosene and gas oil. These products are used as transport and heating fuels.
  • Residual oil (20%): is the least valuable thick and heavy substance that remains after the distillation process. It includes bitumen which is used in road building and coke used as fuel in blast furnaces.

Since the 1970s there has been a clear shift in oil demand away from the heavier end of the barrel (fuel oil) towards transport fuels (gasoline, diesel and jet kerosene). However, demand patterns have varied from region to region.

Most oil trading takes place on the New York Mercantile Exchange (NYMEX) and in London at the International Petroleum Exchange (IPE). These exchanges offer spot (physical) contracts for immediate delivery as well as futures for delivery at a later date.

The two most common price benchmarks for crude oil are Brent and West Texas Intermediate (WTI) and they are always priced in US$/bbl. Brent is mainly used as a reference outside the US whilst WTI is the US reference for crude. Both are light sweet crude oils and Brent has historically traded at a $1.49¹ discount to WTI as a result of quality and market issues.

There are different types of oil and gas companies:

  • Exploration and Production (E&P): Discovery and extraction of hydrocarbons.
  • Integrated: Global companies active in each part of the oil and gas business - exploration, production, refining and marketing.
  • Refining & Marketing (R&M): Refineries convert crude oil into marketable energy products such as gasoline and diesel. Marketing is the retailing of the refined products.
  • Oil Services and Equipment: Specialist companies active across the whole oil and gas chain including rig leasing co.s, drilling co.s and project management (EPC).

The oil and gas value chain is divided in Upstream, Midstream and Downstream.

Upstream

The Upstream relates to the finding, development and production of oil and gas. This process begins once a government body has offered exploration acreage in return for a fee and some form of performance or work obligation such as drilling as well. In today’s high oil price environment however, even the process of bidding for exploration acreage is highly competitive. In many cases this bidding requires upfront payments of sizeable signature bonuses.

  • Exploration: involves a study of all the available geological and geographical information of a proposed location. This process involves independent oilfield service companies as well as the large integrateds and it is split into 2 phases – surveying and preliminary drilling to confirm de discoveries made in the surveying phase (3 out of 4 exploratory Wells dos not have enough volume of hydrocarbon to make production feasible).
  • Development: The development of oil wells refers to the installation of the required infrastructure to permit full scale production. It is the phase which Lupatech starts to have exposure to the segment, supplying equipments for the construction of the production infrastructure.
  • Production: relates to the continual extraction of hydrocarbons and their preparation for transportation. Despite being very capital intensive, this part of the industry generates the highest returns over the cycle, as it for the only cash generator phase. Lupatech also has exposure to the production phase, supplying services and equipment for replacement.

Midstream

The midstream relates to the transportation of crude from where it was extracted to the oil refinery where it is processed into usable products. Crude oil can be transported across the globe via pipeline, trucks and ship tankers to refineries.

Downstream

The downstream part of the oil sector comprises the refining and marketing of oil. Refining refers to the processing of crude oil whilst marketing entails the distribution and sale of the refined product.

Oil in Brazil

The history of oil in Brazil is mixed with Petrobras’ history, created on October 3, 1953 by the president Getulio Vargas. “Constituted with capital, technique and workforce exclusively Brazilian, Petrobras is a result of a national policy in the economic field. “It is with satisfaction and patriotic pride that today I have sanctioned the law approved by the Senate and Low House, which constitute a new landmark in our economic independence”, said Vargas, during speech of the sanctioning of Law 2004 that created Petroleo Brasileiro S.A. - Petrobras².

At the beginning the company received from the National Oil Council (CNP) some oil fields and had a 22 ships fleet. The oil production was 2,700 barrels per day. The refine base served a small fraction of the national consumption of derivates, which was around 137 thousand barrels per day, mostly imported. The initial options were the construction of new refineries, seeking the reduction of the cost of derivates imports, and the creation of a supply infrastructure, with the improvement in the transportation network and the installation of terminals in strategic regions of the country. By the end of the decade, the oil production had increased to 65 thousand barrels per day, the reserves amounted to 617 million barrels, while the works in place in the industrial sector were promising for the next decade, the self-sufficiency of the refining base in the production of basic derivates.

Petrobras has reached the self-sufficiency in the production of main derivates in 1961 with the initiating of the Duque de Caxias Refinery (Reduc), in Rio de Janeiro. During the decade, other units were initiated as well. The installed base expansion has changed the imports structure radically. By the beginning of its creation, the purchase of derivates corresponded to 98% of external purchases and only 2% oil crude oil. In 1967, the profile of imports was 8% of derivates and 92% crude oil.

In 1962 was in place the monopoly of oil and derivates imports to reduce the cost of imports. After reaching the mark of 100 thousand barrels a day of production, in 1968 there was the first discovery of oil in the sea, a landmark to the country. The Guaricema field, in Sergipe, represented an important step for the company to go deep in the offshore activity.

The derivates of oil consumption duplicated in the beginning of the 70’s due to the GDP growth. With that, Petrobras was forced to review its investment strategy to supply the internal demand for derivates. Some refineries were build, other revamped, and parallel to that there was a growth in efforts to increase the national oil participation in the Brazilian consumption. Because of that, the continental platform started to have special attention.

After the discovery in 1968, there were more than 20 discoveries of small and medium sizes in the coastline of several states. With that, it was started a success path in Campos Basin, which rapidly transformed itself in the most important oil production region in the country.

The 70’s and 80’ decades brought crisis and high volatility to international oil prices. With that, market became disturbed and sealed with uncertainties not only about the prices but also the guarantee of supply. To surpass the exchange rate difficulties, the government adopted economic measures, some of those directly connected to Petrobras’ activities, as the reduction of derivates consumption and the increase in the internal offer of oil. Other initiatives as the encouragement of the use of ethanol as vehicle fuel, with the creation of the National Ethanol Program (Pro-Alcool) were put in practice. The exploration and production investments became priority, resulting in an increase in the national oil production, which occupied a larger contribution in the refineries.

In the late 80’s, Petrobras was facing the challenge of producing oil in water below 500 meters, challenge never achieved before by any company in the world at that time. The oil company then decided to develop in Brazil the technology needed to produce oil in water up to a thousand meters. Less than a decade later, Petrobras has proven technology for deepwater oil production.

In August 1997, a new scenario of competition in the Brazilian oil sector was established by the Law No 9,478, which regulated the constitutional amendment opening the activities of the Brazilian oil sector to private investment. The Oil Law established a new regulatory environment, allowing competition in all segments of the oil and gas sector in Brazil. As a result of the constitutional amendment and the subsequent implementation of planned changes in the Oil Law and related rules, Petrobras has been operating in an environment of gradual deregulation and increasing competition.

The Petroleum Law also created a independent regulatory agency (ANP). ANP is in charge of regulating the oil and natural gas sector in Brazil. One of the ANP main guidelines is to create a competitive environment for the activities of oil and natural gas sector in Brazil, in order to provide lower prices and better services to end consumers. ANP is also responsible for regulating conditions related to exploration and development of oil and natural gas and granting new exploration concessions.

The Petroleum Law granted Petrobras the right to exclusively explore oil reserves in all fields in which it had already started production, according to the concession contract signed with the ANP on August 6, 1998. For each area of concession, the concession period is 27 years from the date which the field is declared commercially viable. The Petroleum Law also established procedures enabling Petrobras to explore and, in the case of successful drilling, develop exclusively for up to three years those areas in which Petrobras provides evidence that it performed prospecting prior to the passage of the Petroleum Law.

Between 1997 and 2003, Petrobras has doubled its production and has surpassed 1.8 million barrels of oil and natural gas per day. In March 2009 surpassed 2.0 million barrels of oil and natural gas per day.

Exploration and Development

During the period that Petrobras exercised its monopoly over oil and gas operations, it held the right to explore all production, exploration and development areas in Brazil. When the monopoly ended, the Brazilian government was authorized to hire any public or private companies to execute activities related to exploration, production, transportation, refining and distribution of oil and natural gas. Before establishing the bidding process for the granting of concessions, the government granted to Petrobras the exclusive right to explore oil reserves where operations had already started. In 1998, ANP stared the bidding process for the granting of concessions for production, exploration and development reserves, forcing Petrobras to enter the competition process to acquire concessions.

Bidding Rounds and Local Content

Since 1999 until today, the National Agency of Petroleum, Natural Gas and Biofuels (ANP) has carried out nine bidding rounds of blocks for the exploration and production of oil and gas in the country. The eighth bidding round, scheduled to occur in November 2006, was only partially completed. The ANP decided to cancel this bidding round due to a series of lawsuits. The ninth bidding round, which was carried out on September 27, 2007, was also subject of controversies. The tender for bid originally included 312 blocks available for bidding but, upon resolution of the National Council of Energy Policy (Conselho Nacional de Política Energética), or CNPE, 41 of theses blocks were removed from the bidding process. These areas, located in the so-called pre-salt layer in the Espírito Santo, Campos and Santos basins, were withdrawn because they are said to be critical to the country. In the beginning of November 2007, Petrobras announced that there was evidence of a large volume of oil and gas reserves in the pre-salt layer, which runs for 800 kilometers between the coast of Espírito Santo and Santa Catarina Estates. Market analysts estimate that reserves in Brazil could exceed 70 billion BOE, almost five times the current level of reserves, based on the volume that could be produced in this region.

The ninth bidding round offered 271 blocks in nine sedimentary basins (Campos, Espírito Santo, Pará-Maranhão, Parnaíba, Pernambuco-Paraíba, Potiguar, BA, Rio do Peixe and Santos), totaling 73,079 square Kilometers. Of these total, 117 blocks were acquired by bidders. Despite the withdrawal of 41 blocks around the Tupi field, this bidding round resulted in record proceeds in the amount of R$ 2.1 billion, higher than the R$ 1.08 billion recorded in the seventh bidding round. However, these proceeds were below the R$ 3 billion to R$ 4 billion estimated by the ANP before the commencement of the ninth round. The agency licensed 67 of the 72 companies (record number) that have expressed interest in participating in the new bidding round. Large companies in the industry such as Shell, Exxon and Chevron did not participate in the bidding process.

The tenth bidding round was carried out on December 18, 2008, in Rio de Janeiro. Offering 130 blocks, all located in onshore basins, this bidding round has attained its goal of attracting small and medium sized companies, alongside with major oil companies. Seventeen companies were granted - 11 national and 6 foreigners. The concessions were granted for 54 blocks, comprising a total area of 48,000 square kilometers, an onshore area. The tenth bidding round has raised about R$ 700 million, of which R$ 89.9 million was offered as Signature Bonus for the Union and R$ 611 million as minimum investments expected for the exploration phase. The figures have surpassed the expectations for a round without the inclusion of offshore blocks.

The winning Companies (in individual or in consortia)

Companies Bids Purchases Bonus Amount
OGX 25 21 R$ 1,567,873,282
Petrobras 56 27 R$ 296,523,906
Cia Vale do Rio Doce 16 9 R$ 88,426,900

Source: ANP (National Petroleum Agency)

Since the first bidding round for exploration, development and production areas for activities of oil and natural gas in 1999, the ANP established the commitment of local goods and services acquirement, which were defined and undertaken by bidders, from its own analysis of the viability of national supply, and were taken in consideration to define the best proposals.

Local content is the term which defines, in the concession agreements entered into by the ANP with the winners of the bidding rounds, the minimum percentage of participation required of Brazilian companies that are suppliers of goods, systems and services for economic activities related to the activities set forth in the concession agreement. This percentage is established in the invitations to bid disclosed prior to the bidding rounds. The concession agreements require that companies should hire Brazilian suppliers whenever their offers' price, time and quality conditions are equivalent to other suppliers’ offers.

The first to the fourth bidding rounds, carried out between 1999 and 2002, did not require the use of minimum amount of local content, but it did require a minimum amount of 70% of products and services from the local market. The companies offered a percentage for the exploration phase and another for the development phase.

From 2003, the Brazilian government started to support and fostered the strengthening of the domestic market of suppliers of goods and services, in particular with respect to projects related to the oil and gas industry.

Since July 2003, the CNPE issued a Resolution No. 8, of July 21, 2003, which established that the ANP must  determine a minimum percentage of national content for the supply of goods and services to be used in exploration and production of oil and natural gas and adjust these percentages in accordance with the growth of Brazilian inndustrial production capacity and technological developments. By the fifth bidding round, carried out in 2003, a minimum percentage set in relation to blocks located onshore, in shallow water and in deep water established by the ANP. The weight of the use of local products and services in offshore blocks score grew from 15% (in the first to the fourth bidding rounds) to 40%.

In the seventh and eighth bidding rounds, carried out in 2005 and 2006, changes were introduced to the local content rules. In addition to the requirement of overall minimum percentage, the offers were limited to a pre-established maximum price. These bidding rounds took into consideration the location of the blocks according to 4 criteria: onshore, shallow water with depth of up to 100 meters, shallow water with depth between 100 and 400 meters and deep water with depth above 400 meters. A list comprising areas and sub areas, both for exploration and development of the blocks, establishes a minimum percentage of local product use utilized in connection with each of these areas and sub areas. The overall local content score, both for the exploration and development of the blocks,  was calculated by multiplying the local content percentage offers related to items and sub items by the respective scores. Another new procedure in the bidding rounds was the adoption of the local content manual as a tool to measur contractual local content. The local content score in connection with these bidding rounds was weighted at 20%.

The ANP bidding rounds have been characterized by increased percentages of minimum commitments of local content.

The consolidated results indicate an average domestic content of 65%, resulting in an annual average of US$ 12.6 billion invested in the local supplier market in Brazil.

Busisses Areas Domestic Investments 2010-2014
(US$ billlion)
Amount Spent on Services and Productcs
 in the Domestic Market 2010-2014
(US$ billion)
Local Content
(%)
E&P 108.2 57.8 53%
Downstream 78.6 62.8 80%
G&E 17.6 14.4 82%
Distribution 2.3 2.3 100%
Petrobras Biofuel 2.3 2.3 100%
Corporate 3.3 2.6 80%
Total 212.3 142.2 67%

Source: Petrobras

The average amount spent on services and products in the local market of the previous Plan was approximately US$ 10 billion.

Also in 2003, the Brazilian government, through Decree No. 4925 of December 19, 2003, created the PROMINP - Mobilization Program of the National Oil and Gas Industry, in order to increase the participation of the domestic industry of goods and services, in a competitive and sustainable base, in projects of oil and gas in Brazil and abroad. The PROMINP is under the supervision of the Ministry of Mines and Energy (Ministéio de Minas e Energia), or MME and Petrobras and comprises all the entities that represent the sector in an effort to identify the demand for goods and services, the domestic productive capacity and to promote the overcoming of barriers to full development of the domestic supply.

The requirement for local content in the process of granting concessions of exploratory and production blocks of oil and natural gas helped to boost the development of the domestic industry. The ANP has created the System of Local Content Certification, with regulations published on November 16, 2007, after completing the public enquiry process. This System provides the methodology for certification and the rules for the certification of entities under ANP. The authorized entities will be responsible for measuring and reporting to ANP the content of local goods and services hired by the oil companies to be used in exploration and development of oil and natural gas.

Recently the certification of local content has become more restrictive, requiring that all components of products certified as local content were also produced (and certificated) in Brazil. From now on, the commitment to local content begins to become a reality, with the issuance of the first certificates of origin for goods and services hired by operators. Until then, the entire content measurement was based on declaratory acts of the contractors. This will benefit domestic manufacturers that have their entire supply chain based in Brazil.

Petrobras Business Plan

Petrobras' strategic goals and planning are supervised by the MME. Its activities are also subject to regulations issued by MME, among other agencies.

Petrobras business plan for the years of 2011 to 2015 (“Business Plan”) estimated investment amounting US$224.7 billion in the period, being 87% of the investments dedicated to E&P. The investments are divided into business areas, as follows:

  Investments (US$ billion)
Business Areas 2010 - 2014 2011 - 2015 Change
E&P 118.8 127.5 7.32%
Downstream (RTC) 73.6 70.6 -4.08%
Gas & Energy 11.8 13.2 -25.84%
Petrochemicals 5.1 3.8 -25.49%
Distribution 2.5 3.1 29.17%
Biofuels 3.5 4.1 17.14%
Corporate 2.8 2.4 -17.24%
Total 224.0 224.7 0.31%

Source: Petrobras Business Plan Presentation, Petrobras

The total long-term target (2020) also increased substantially, from 5,382,000 to 6,418,000 boed (4,910,000 boed from oil production in Brazil), mainly due to the expected increase in the share of the pre-salt discoveries and the start-up of production in the Transfer of Rights areas.

Lupatech believes that Petrobras investments and other companies which also explore and produce oil in Brazil, should increase the demand for goods and services, including the purchase of industrial valves, ropes for anchoring platforms, equipment for exploration and production of oil and gas, services, sensors, compressors, etc…

The Company also believes it is well positioned to benefit from growing opportunities in this sector, given the quality of its product portfolio as well as the strength of its brands in this market.

Success in this sector depends largely on the ability of suppliers to meet the strict quality and technology standards imposed by the sector players, particularly Petrobras and its contractors in the contracts of EPC (Engineering, Procurement and Contracting). Lupatech believes to be one of the few Brazilian suppliers of valves ranked under the highest quality level among suppliers of Petrobras ("Level A"). Its products and production processes also have international certifications and incorporate the latest technology.

In addition of being leadership, Lupatech benefits from the credibility and close relationship with clients due to the significant number of products that are current installed in platforms, pipelines and industrial units. Also provides technical assistance and has one of the most well structured and technically skilled technical and sales teams. The Company believes that the current policy of the Federal Government to prioritize the purchase of products manufactured in Brazil, associated with the small number of Brazilian competitors that are able to make the investments needed to meet the high demands of industry players, particularly Petrobras, additionally contribute to its prospects of strong growth in this sector.

How Lupatech will benefit from the investments of this business plan

  • Technological Innovation: its products have a high degree of engineering and technological innovation, positioning the company in a specific market for equipment and services suppliers to the oil and gas sector. It owns a research and development center (CPDL) that works constantly in order to search for innovations in products and processes, enabling the company to anticipate trends and market demands.
  • Track Record: from a long and intense relationship with Petrobras, the world's largest deepwater exploration Company, it was able to develop a history of delivering products and services of excellent quality and exceptional performance, which naturally has positioned the company as one of major suppliers, which is one of its main competitive advantages today.
  • Physical Proximity: currently the exploration and producing oil and gas companies are demanding high amounts of equipment and services with short delivery time, as demand grows faster than the new reserves discoveries and the current producing wells suffer from an annual depletion between 10% to 15%. Since investments in increased production are happening at an accelerating rate, the suppliers’ physical proximity from the oil exploration and production companies is also a great competitive advantage. Lupatech, being close to the main deepwater market with units in Nova Odessa (SP) and Macaé (RJ), is well positioned to provide equipment and services with greater efficiency in delivery time and execution.
  • Clones Projects and Refineries Expansion: the fact that new projects are clones of old projects, in order to reduce the development time of new projects, makes companies, that have already provided to these older projects, better prepared to deliver again same equipment with the same technical specifications. It is also important to mention the process of capacity expansion of refineries in Brazil, which also use the same equipment supplied. Lupatech is well positioned to meet these two demands as it was a major supplier of construction equipment on the latest platforms (P-51 and P-54) to be used as design base for new platforms "clones" (P - 56, P-55, P-57 and P-62). Moreover, it provides large quantities of valves used in the construction of refineries that are being expanded, as REVAP and REPLAN. Even some of the facilities from BNDES will be used in acquiring a valve company with great exposure to these markets, providing complementary line of valves.
  • Local Content (domestic): Local Content is one positive factor of Lupatech, because is one of the fewest brazilian companies with technology and installed capacity to supply equipments and services for national industry. Besides that, is has a close relationship  with Petrobras that allows the company to build partnerships to develop new technologies and antecipate market needs. 
  • Market Share: Currently, based on its market knowledge, Lupatech estimates that with its current offering of products and services, is able to supply equipment and services to Petrobras, which accounts for about 10% of Petrobras total Capex. From a survey conducted by its units with the market and customers, the Company currently has an estimated market share between 0.75% and 1.1% of Petrobras total Capex, which indicates a room for a growing percentage of its market share, without considering that may increase its offer of products and services through new acquisitions.
  • New Players: in partnership with Petrobras, new international players such as Repsol, BG, Galp, Petrogal, Shell, Exxon and OGX are entering the Brazilian exploration and production market of oil and gas. Thus, it is estimated a greater exposure to a new range of customers who may become potential customers of Lupatech.

¹Source: Introduction to the Oil & Gas Industry – Citibank – March 2007
²Petróleo no Brasil – Investimentos, Desafios e Oportunidades – January 2008
³Source: Petrobrás

Last Update: February 8, 2012

 

 
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