Pre-Salt Bills Complete Passage Through Brazil's Chamber of Deputies, Attention Turns to Senate

Government Loses Vote on Royalty Distribution

The Brazilian government suffered a major defeat in the Chamber of Deputies on Wednesday (10 march) with the approval of an amendment leaving the federal government's share of production royalties the same, but proposing a more equitable distribution of revenue among Brazil's states and municipalities. The amendment, approved with 369 votes in favour, 72 against, and 2 abstentions, calls for the change in rules to apply to existing concessions as well as new contracts. Under the current rules the federal government is entitled to a 40% share of royalties and the so-called special participation tax levied on the country's most productive fields; 22.5% of revenues are allocated to producing states; 22.5% to municipalities where production is located; 7.5% to municipalities that handle the delivery of offshore oil production or its export; and 7.5% to the participation funds, which are then distributed to states and municipalities. Under this system the country's largest producing states—Rio de Janeiro, Espirito Santo, and São Paulo—have been the main beneficiaries of fiscal revenue generated by the oil industry. However, the amendment approved by deputies will see them lose a large chunk of their revenue. Under the proposed changes the federal government will retain 40% of royalties and 50% of the special participation fee, but the remaining 60% of royalties will be distributed between states and municipalities according to the existing rules for the transfer of participation funds, irrespective of whether or not they produce any oil.

The vote means that the Chamber of Deputies has now completed voting on the four pre-salt bills submitted by the government at end-August. The government's reform included a bill that creates a new state energy company, Petrosal; a bill establishing a production sharing contract (PSC) model for the award of new pre-salt blocks, rather than the concession model currently used (the state oil company Petrobras will have a minimum 30% share in the new PSC's); a bill to capitalise Petrobras; and another to create a social fund to hold revenues generated from future production from the pre-salt layer. In addition to the royalty distribution amendment, the Chamber of Deputies has made several other changes to the bills that will now have to be considered by the Senate. These include an amendment to the social fund bill calling for 5% of future pre-salt revenue held by the fund to be used for pension payments and an amendment allowing minority shareholders in Petrobras to use up to 30% of the balance of the FGTS employee severance fund to buy additional shares under a share sale planned under the capitalisation plan. The reform package will now be voted on by the Senate, with any further changes being resubmitted to the Chamber of Deputies before it can go to the president to be signed into law.

Outlook and Implications

Royalty distribution was not actually included in the package of pre-salt bills submitted by the government at end-August. Instead the changes were included in an amendment to the bill, creating a new contract model for pre-salt blocks not already under concession with disagreement between legislators on this issue delaying the passage of the reform through the lower house. The government had tried to broker an accord that would increase the share of revenues from future pre-salt production allocated to non-producing states, but would continue to allow producing states to receive a large share. However, this was rejected, with legislators approving an amendment that has upset both the country's largest producing state Rio de Janeiro and the government. According to reports by the local press the state government of Rio de Janeiro looks set to lose up to 4.8 billion reais (US$2.72 billion) in revenue next year alone from existing concessions if the change goes through, while municipal governments in the state could lose around 2.5 billion reais. Meanwhile, the federal government has expressed concern that the amendment is unconstitutional and would represent a breach of existing contracts. It has indicated that it hopes to overturn the amendment in the Senate, and if this doesn't work then a presidential veto would be used. The government has given previous assurances that the new regulatory framework will only apply to future contracts and that existing concessions will be honoured. The principle of non-retroactive application of the law is enshrined under Article 5 of the Brazilian Constitution of 1988. The authors of the amendment are also using the Constitution to defend the changes, arguing that the current system of royalty distribution is illegal because the Constitution asserts that the country's oil resources belong to the federal union, not individual states, and if the amendment makes it through the Senate as well, the issue may have to be referred to the Supreme Federal Court.

After their passage through the Chamber of Deputies the bills will have to be voted on in the Senate, where the country's main opposition parties are stronger and the process could take even longer than it has done in the Chamber of Deputies. The government wants to speed up voting and plans to mark all the bills "urgent", meaning that senators would have just 45 days to vote. The urgency comes from the need to get them approved before end of May or risk the voting process being held up by the electoral campaign and possibly not being completed until next year when a new government is in power. However, opposition senators have threatened to obstruct voting if all four bills are marked "urgent" and with electoral considerations already in their minds the debate on the pre-salt bills is likely to become increasingly politicized, making it even more difficult to build a consensus on controversial aspects of the legislation such as the royalty changes.