Brazil’s government, seeking to extend its control over rapidly expanding offshore oil reserves, has walked into a political and constitutional quagmire.
A law that was close to receiving presidential approval as we went to press will mandate that oil royalties and taxes on windfall profit, previously directed to producing states, be divided among all of Brazil’s 27 states and 5,500 municipalities. It means big money for a country expected to produce about seven million barrels of oil per day by 2020—more than triple today’s production. Under the proposed law, which has already received approval by the Brazilian Congress and Senate, once the cost of producing a barrel of oil is taken out, 71 percent of what’s left goes to the government in the form of royalties and taxes, and only 29 percent goes to the company that produced it.
If the law is enacted, many cities and states will be in line to get tens of millions of dollars a year in new revenue. The funds will be divided equally among recipients based on current federal transfer arrangements. But the State of Rio de Janeiro and dozens of its municipalities—which are home to 85 percent of Brazil’s oil and gas output—will lose more than 95 percent of the 8.71 billion reais ($5 billion) a year it receives directly from two types of oil royalty.
Without a way to make up for the shortfall, Rio de Janeiro’s plans to host the 2016 Summer Olympics and 2014 World Cup are in jeopardy, according to Governor Sérgio Cabral. State finance officials have warned that the immediate loss of more than 15 percent of state revenue may cause Rio to default on its debts with the federal government and, according to Cabral and former State Treasury Secretary Joaquim Levy, plans to cut crime and poverty may be shelved.
Rio de Janeiro further argues that the country’s 10 percent basic royalty on oil is compensation for the disruptions caused by development and insurance against environmental risks.
Brazil’s 1988 Constitution appears to back the state’s claim with a clause prohibiting legislation that would revoke “acquired rights.” As a result, many lawyers say the new royalty rules will be overturned on constitutional grounds in cases of payments on existing oil concessions. Royalties on new fields are another matter.
Meanwhile, the rest of Brazil is anticipating the potential boost in revenue if the royalty law stands.
In 2009, basic oil royalty payments in Brazil reached 7.98 billion reais ($4.56 billion), the second highest on record. In 2008, when oil hit a record high of almost $150 a barrel, royalty payments reached 10.9 billion reais.
That amount does not include a windfall profits tax, known in Brazil as “special participations,’’ which is really a kind of extra royalty. Brazil’s oil regulator, the Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (ANP), keeps a running total of monthly oil production and assesses basic royalties of 10 percent per barrel produced based on either a basket of world oil prices or a minimum monthly price set by the ANP, whichever is higher. If a field has “substantial” volumes, an additional payment is due every three months.
When these windfall profits payments are included, the 2009 total doubles to 16.4 billion reais ($9.4 billion), more than half of which went to Rio de Janeiro State and its municipalities.
If oil prices remain at about $82 a barrel, this year’s royalty and windfall profits payments may beat the record year of 2008.
As of late May, the latest month for which 2010 figures are available from the ANP, royalties of $5.84 billion were paid to producing states and municipalities, as well as Brazil’s navy, finance ministry and science and technology ministry. The addition of windfall profits would more than double that.
Of the royalties paid so far this year, 67 percent or 2.56 billion reais went to the State of Rio de Janeiro and 62 municipalities in the state, not including extra windfall royalties. Overall 30 percent of each real paid in royalties goes to the state governments, 34 percent to municipalities, 16 percent to the navy, 8 percent to the finance ministry’s special fund and 12 percent to the science and technology ministry.
Still, in a country where the phrase “The Oil Is Ours” rings in national mythology, the idea of one state getting more from a resource owned by all Brazilians rankles many. Politicians also like access to these funds because royalty money comes without strings attached.
Under the new oil bill—to which the royalty amendments were added—the overall government share per barrel will probably rise. This means more money for states and municipalities. Right now the government auctions concessions to the highest bidder, with the concession owner getting the right to sell the oil in exchange for tax and royalty payments.
Under the new rules, all new rights will be sold to the company or companies willing to give the Brazilian government the biggest share of oil produced after recouping costs, in addition to taxes and royalties.
Rio’s state government has said it might be willing to give up its fight to keep oil royalties if a tax rule exception made two decades ago is resolved in the state’s favor. According to Brazil’s Constitution, the country’s ICMS tax—similar to a value-added levy—is collected at the state level on all products and services produced in the state.
There is one exception: petroleum. In the case of oil and gas, the ICMS is collected and spent in the state where it is consumed, an exception made to spread the country’s oil wealth.
Rio, the main petroleum producer, loses about 8 billion reais a year because of the rule, according to Rio de Janeiro’s state finance secretariat. At the same time São Paulo, the biggest consumer of petroleum products, collects 55 percent of the ICMS taxes related to petroleum.
Rio de Janeiro has not lost yet. The bill containing the royalty changes still requires a lower-house vote to reconcile differences with the Senate-passed version.
In November, when it is taken up during the lame-duck session before the new president and Congress take office on January 1, the bitter battle over royalties will likely get worse. This means the next administration may have a short honeymoon before dealing with this contentious issue over distribution of powers and profit.