Comments to our Libra model release

Following our publication of the financial model and narrative report on Brazil’s $90 billion Libra project, we share with you a first set of comments as they were provided to us by our reader Ahmed Mousa Jiyad, Independent Oil & Energy Development Consultant.

Please find below his unedited comments, as well as our direct responses in line (red):

Dear Johnny and colleagues at OpenOil,

Thank you Johnny and your colleagues for sharing this impressive work: highly appreciated.

It was really enjoying skimming through both parts (the narrative report and Excel spreadsheet) of this comprehensive assessment of Libra project. Surely, the report deserves thorough reading, which I hopefully do in the near future. We very much appreciate these thoughtful comments, and welcome more as you read further.

For the time being the following matters had attracted my attention.

The $6.5 billion signature bonus-SB is staggering and probably the highest SB paid so far. In a comparative sense, Iraq received one third of this SB through four bid rounds involving some 16 oil and gas fields with almost ten-folds that of Libra’ production plateau and proven reserves of onshore and low-cost fields.

This SB is 7.2% of the assumed Capex of $91billion, which becomes $97.5 billion if SB is added to it. This raises the issue of possible recuperating of SB through the known practice of “factoring in” throughout the duration of the PSC.  Adding this SB to the Capex or recovering it has implication on the calculations of the Model. Has the authors (Alessandro and Alistair) considered these two possibilities, and if not what will be the impact of such inclusion on the Model results.

Indeed, the signature bonus is also the biggest we have heard of, far exceeding the ~$1bn bonuses that Angola got for a few of its blocks in its 2006 licensing round (which we expect some of those paying now regret).

The PSC explicitly states that the bonus is not cost recoverable under the production sharing, but is silent on whether the IOCs can deduct it against income tax. We have assumed (see INPUTS F249) that it is deductible, so you can switch this off and see what happens. It would basically increase income tax by 34% x 6.5bn or around $2bn, worsening contractor post-tax economics. You are right to point out that fiscal treatment of the bonus is important.

There seems to be an “excessive” production capacity of one million barrel per day (mbd), which represents 80% over the 1.3mbd of the assumed plateau production-PP. This is much too much and exceeds any “spare capacity” considerations. A 1.3mbd plateau production requires 8 FPSOs, with extra capacity of 140kbd or 10.8% of the PP. Reducing the number of FPSOs  from 13 to 8 would reduce  Capex (development cost) by $7.5 billion. Whether constructed or leased such reduction has significant implications on the total cost and thus on the Models’ conclusions.

We got the 13 FPSO number from a couple of sources (see source note XII). You are right that 13 x 180 MBOPD = 2.34MMBOPD, which exceeds our assumed plateau of 1.3MMBOPD. The latter is sourced from TOTAL (source note VI). So you may be right that either the plateau production could potentially be higher, or the number of FPSOs required smaller than 13. However, we need to keep in mind the geography of this huge field, which likely means the FPSOs have to be distributed around it.

You can readily run your own alternative scenarios in the model by varying the production parameters on DASHBOARD, and the number of FPSOs and their scheduled deployment in row 200 in INPUTS. The entire capex is linked to the FPOS’s so changing their number will scale total capex up and down accordingly. That is a bit artificial, so we look forward to refining that with better data.

Price differentials of 7.9%/barrel between the Libra 27API and Dated Brent might need some “sensitivity analysis” by considering the impact of other factors such as Sulphur and other particulars contents  and fright/insurance cost among others which determines the “realized export price” or the “net-back” value as the case may be seen by the marketing authority.

Agreed. We sourced the -7.9% from a Gaffney Cline study (source note X). Again, you can readily change this on the DASHBOARD and see what happens to results.

Matters related to “Associated Gas” are missing. Gas-oil ratio; gas production and utilization; and with the increasing environmental considerations this issue has significant cost & revenue implications.

There is some associated gas but we assumed that it is either used as fuel on the FPSOs, or is reinjected for pressure maintenance – in other words none is sold. Note that production happens hundreds of kilometers from the coast and as far as we know there is no pipeline planned to pipe gas to shore, and no floating LNG liquefaction facilities.

The assumed inflation rate of 2% p.a is much lower than the 8.48% p.a in Brazil as per CPI September 2016. The two very different rates will surely have imp acts on the calculations and the results of the model.

The model is in US$, so we assume an inflation rate consistent with that currency (which has just taken a hit from the Trump election victory this morning!). You are right that project costs denominated in Brazilian Real will inflate by a higher rate than 2%, but we implicitly assume that the Real will then depreciate by the difference between Real and US$ inflation, thus maintaining what is called “Purchasing Power Parity” between the two currencies. So the Real costs inflating at 8% will convert to US costs inflated at 2%.

More technically we (implicitly) assume that future Real/US rate = current Real/US rate * (1 + Real Inflation) / ( 1 + US$ inflation)

From national development and political economy perspectives Petrobras net cash-flows should either be included to government share (national share) or be presented as a separate analytical. By adding this it provides the Model with invaluable merit.

This is a fair point. We considered doing that, but decided in this initial version of the model to analyse the sharing of project benefits between the contractor group as a whole and the government. The Brazilian government owns 64% of Petrobras, so I suppose we could include 64% of Petrobras’ 40% share of the contractor net cashflows after tax as also accruing to Government. We can readily add that to the model. However,  conventional quotation of government fiscal shares (by the IMF and others) usually excludes government equity participation if it is on a non-concessional basis – i.e. if the government participant shares the same risks and rewards as the other IOCs, which Petrobras does/will in Libra. As another example, Norway’s fiscal share is usually quoted as 78%, which excludes the governments State Direct Financial Interest in Norwegian projects held through Petoro. However, this is a debatable point so we will consider adding that statistic.

Having said that, we think the key question is how Petrobras will finance its 40% share of the ~$90Bn capex…

Finally, the results of any model depend largely on the how realistic are the assumptions, the accuracy and completeness of data and the methodology. But, a project such as Libra is subject to high degree of uncertainty in a very changeable environment. Probably, Petrobras review of this Model and related report could be helpful.

The above remarks do not and should not be construed to undermine this very impressive work.

Currently I am focusing my attention on pressing petroleum issues in Iraq and thus I regret for not earmarking enough time to make comprehensive review of your report.

Many thanks again and keep the good work going.

It is exactly this kind of constructive criticism that we had hoped for in publishing the models, so we are looking forward to receive further comments to our past and upcoming releases.

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