Equatorial Margin: Production Sharing or Concessions?

The more promising Brazil’s newest oil frontier looks, the harder it becomes to decide how much exploration risk still needs to be rewarded and how much of the upside should remain with the country.

Adolfo Sachsida has put an important question at the center of the oil policy debate surrounding a potential Flávio Bolsonaro administration. The former mines and energy minister, now one of the coordinators of the PL candidate’s government program, argues that Brazil’s production-sharing regime was a mistake, favors a return to concessions and wants to accelerate exploration along the Equatorial Margin. “We need to return to the concession model,” he told business leaders at an event hosted by Grupo VOTO. The issue goes beyond Brazil’s pre-salt fields. Brazilian law allows the government to apply production-sharing terms in other areas considered strategically important, particularly where geological risk is relatively low and production potential is high.

Much has changed since Brazil introduced production sharing in 2010. Guyana had yet to discover the giant offshore oil system that would transform its economy. ExxonMobil’s Liza discovery came only in 2015; today, the country produces more than 900,000 barrels a day. On the Brazilian side of the Equatorial Margin, Petrobras has also accumulated new geological evidence, finding oil at Pitu Oeste and Anhangá in the Potiguar Basin and hydrocarbons at the Morpho well offshore northern Brazil. None of these results proves that Brazil has found another Guyana. But geological knowledge has improved considerably, and the perceived risk is no longer what it was a decade ago.

That matters because concessions and production sharing divide risk and reward differently. Under a concession, the company bears the exploration risk and owns the oil it produces, while the government collects royalties, signing bonuses, taxes and an additional levy on highly profitable fields. Under production sharing, the investor first recovers eligible development and operating costs, and the remaining “profit oil” is divided with the federal government. The economic case for production sharing becomes stronger when geological risk is relatively low and potential returns are high: the less uncertainty the oil company has to bear, the weaker the case for giving it a larger share of the upside.

Sachsida nevertheless has a credible argument. Concessions are simpler, reduce the government’s role in administering projects and can speed up investment decisions. If a less complex system attracts more operators, more capital and faster development, Brazil could come out ahead even while capturing a smaller percentage of each field. The real question is how much incentive investors still need once an asset becomes better understood. The lower the risk, the stronger the bargaining position of the country that owns the resource.

Guyana, which Sachsida himself cites as an example of what Brazil risks leaving on the table by delaying exploration, makes the debate more complicated. Stabroek does not operate under a concession. It is governed by a production-sharing agreement. Yet the project moved from its first discovery to large-scale output in only a few years. After the Exxon-led consortium recovered roughly $55 billion of investment, Guyana’s share of production rose to close to 40%. The Guyanese experience strongly supports Sachsida’s argument for speed. It does not, however, show that abandoning production sharing is necessary to achieve it.

Others draw the opposite conclusion. Brazil’s oil workers’ federation, FUP, has argued that production sharing should be extended to the Equatorial Margin, on the grounds that a potentially strategic new frontier should preserve a larger share of petroleum rents for the country. The federation favors a stronger state role in the industry, but its argument raises a legitimate economic question: if success in Guyana and new geological evidence in Brazil are increasing the expected value of these areas, is this really the moment to lower the price investors must effectively pay for access to them?

There is another irony. Morpho, Pitu Oeste and Anhangá are all located in blocks that already operate under concessions. Changing the contractual regime would therefore do nothing to unlock those discoveries. The immediate challenge is different: confirming commercially recoverable volumes, securing the necessary permits and turning geological indications into producing assets. The concession-versus-sharing debate will matter most for future acreage offered by Brazil — and the answer may change as additional wells either reduce or increase uncertainty over the Equatorial Margin’s potential.

In the end, the right benchmark is financial rather than ideological: Brazil’s total economic return, including investment, speed of development and the government’s overall share of project economics through royalties, special levies, signing bonuses, taxes and any direct share of produced oil. Sachsida may be right that Brazil needs to move faster on its newest oil frontier. But the more geological evidence reduces the risk of the Equatorial Margin, the harder it becomes to justify giving investors a larger share of the upside. The paradox would be to discover that the region is worth a fortune just as Brazil decides to charge less for access to it.