Increasing Local Content Competetive Agenda For Offshore Oil and Gas Supply Chain in Brazil

Increasing Local Content C Competitive titi agenda d for f offshore ff h oil and g gas supply pp y chain in Brazil
Brazil Energy and Power

Houston A August t 30th, 2011
ONIP Organizao Nacional da Indstria do Petrleo
Institutional Framework
PETROBRAS monopoly system Constitutional Amendment end of monopoly
Petroleum Law
1953
1995
1997
1998
1999
..........
2010
National Petroleum Agency (ANP) regulator ONIP support s ppo t to local de development elopment
10 bidding rounds
Institutional Framework
ANP Study (1998);

OSO (UK) Norsok (Norway)
ONIP (1999)
ONIP National Organization of the Petroleum Industry

Governmental Agencies
Suppliers of Goods and Services
Oil &Gas Companies
Members Local Industry

National Associations (16) ABCE ABEMI ABINEE ASSESPRO ABDIB ABESPETRO ABITAM IBS ABEAM ABIMAQ ABRAPET SINAVAL FENASEG CIESP SEBRAE SOBENA
Industrial Federations (9) CNI FIEMG FIESP FIEB FIERGS FINDES FIRJAN FIESC FIEPE
Members - Operators (demand)

PETROBRAS ABPIP IBP
Agip A i Amerada Hess BP ChevronTexaco Devon ExxonMobil Ipiranga p g Kerr Mc-Gee
Maersk Ocean Phillips Repsol Shell Statoil TotalFinaElf Unocal Wintershall
Government
Federal MDIC ABDI ANP BNDES FINEP
Estate ES MG RJ RN SP BA
Mission
T cooperate To t t to maximize i i local l l content t t in i the th Brazilian B ili Oil & Gas G Sector: S t - based on increasing competitiveness and - assuring full and fair opportunities to the local industry.
Infrastructure and Industrial Investments 2011 2014 2011-2014

PaperandCellulose Harbors Railroads Automotive Steel Petrochemicals Eletronics Highways MiningandQuarrying Sanitation Telecommunications Electricity OilandGas
0 50 100 150 R$ $b billions ll 200 250 300 350 41 70 139 378 400 29 51 62 33 41 40 18 60 28
Total=R$990billion OilandGas=38%
Pre-Salt
Evolution of Crude Oil Reserves (million bbl)

30,000
25,000
Lula,Iaraand Guara (PreSalt)~12billion
20,000
15,000
10,000
5,000
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source:ANP
In that sense, Brazil(1) arises in a privileged position - many reserves are located in countries politically unstable or with conflicts
Situation of Major Reserves Countries
Reserves Distribution st but o

Others
5%
3%
6%
1%
China Kazakhstan Brazil(1) Russia OCDE Members
6%
7%
73%
OPEC Stable democracy Absence of external or internal armed conflicts Solid regulatory sector framework Foreign investment
Reserves
Conflict areas Political instability
1) Brazil's reserves include pre-salt estimate (80 billion barrels) Source: EIA, BP Statistical Review of World Energy June 2009, ANP, Petrobras business plan 2009-2013, Booz & Company Analysis
11
The discovery of Petroleum in the North Sea was a discontinuity for Norway and for the UK, but in a different context
Context At the time of discovery of Petroleum in the North Sea in the late 60s, Norway: Had good macroeconomic conditions
Norway
Faroe Islands
Norwegian Sea
N Norway
Stavanger
Aberdeen
Denmark
Had a low unemployment rate (1-2%) Had no operating company for oil and gas Bet on the fact that oil is a national asset and should be managed carefully so as not to unbalance the economy Already had strong research institutes Wanted to use oil as a mechanism for developing a new industry At the time of discovery of Petroleum in the North Sea in the late 60s, the United Kingdom: Presented deficit in the balance of payments and high unemployment rates It had two major global operators for Exploration and Production, BP and Shell Did not expect the O&G industry could represent a significant portion of its economy Discontinuity of state policies with alternating control between Labor and Conservative parties 12
North Sea
UK Netherlands Belgium
Germany
UK
France
Sources: BNDES; MIT - LIS; Booz & Company Analyses
Despite the differences, Norway and the UK have adopted mechanisms focusing on the internationalization of the chain, the increasing of local content, clustering and attracting global companies N Norway U it d Kingdom United Ki d
Attracting foreign companies with O&G know-how Both countries have struggled to ensure the presence of the major international players in their countries - eg. all major operators and integrators are present in both regions
Qualification of the local workforce
Foundation of Universities (ex. University of Stavanger) e Centers of Research
Already had important petroleum engineering courses due to the presence of BP and Shell
Formation of an industry cluster
Both countries formed an important cluster of O&G, which enabled the cooperation and collaboration in Norway, and the mobility of the workforce in the UK
Internationalization of the local chain
With the presence of foreign companies, local firms were forced to reach levels of global competitiveness - access to world markets through operators and service providers
Incentives to use the local content
Companies that had high local content were benefited by bid rounds for new fields
13
In Korea, government actions focused on basic industry development on a global scale

Major Government Action
Behavioral changes Increased development focus
Promoted cultural change with emphasis on meritocracy, meritocracy efficiency, efficiency education and discipline within government agencies (eg.: currently, Korea is one of countries that invests most in education in the world, ~15% of public spending Change of focus from light industries (consumer goods) to heavy industries and chemicals Focus on the development of large national groups (Chaebols) to gain production scale and worldwide competitiveness Incentives for JV formation between Chaebols and international companies (eg.: Japanese Nippon Steel) obliging know-how transfer Investments in universities and research center having strong ties to industry (eg.: Korea Institute of Science and Technology, Pohang University of Science and ec o ogy) Technology) Public financing at low interest rates, special depreciation on tax deductable terms Limit the number of competitors in certain segments through licensing Government and country demands aimed at local companies Setting up a large national steelyards (POSCO) to ensure supply to other industries Use of diplomacy (mainly with the US and Japan) for commercial agreements Exchange rate devaluation
Focus on Development
Heavy and Chemical Industries Steel Mill Naval Chemical Machines Electrical equipment Electronics
Capability development
Financing facilities Competitive b benefits fit Supply assurance Export facilities
14
In Brazil, Offshore production growth will be high - even considering only the fields already granted
Oil Production P d ti
(Million Barrels/Day) 5,6 5,1 4,4 3,5 2,9 2,4
18 1,8 19 1,9
0 1 0,1 0,1 1,0 0,6 0,8 1,1 0,4 0,1 0,4 1,8 1,5
Oil Production P d ti Pre-Salt P S lt Fields Fi ld (1)

(Million Barrels/Day)
1,8 1,5 1,0 03 0,3 0,5 0,6
0,3
2,2
2,5
2,7
2,8
2,8
2,7
0,1
0,1 0,1 2012
0,4 0,1 0,3 2014
1,0 0,7
1,2
2006
2008
2010
2012
2014
2016
2018
2020
2010
2016
2018
2020
Tendered Pre-salt Post-salt and onshore - Other Players Post-salt and onshore- Petrobras
1) Tendered pres-salt fields Source: Petrobras business plan 2009-2013 (2009); Booz & Company Analysis
Other Players Petrobras
15
Projected Investments 2011 2015
Total investment to reach : US$ 260 billion

(Petrobras + other concessionaries)
ONIP Organizao Nacional da Indstria do Petrleo ONIP Organizao Nacional da Indstria do Petrleo
Purchase of new equipment
Equipment and materials requested 2010 - 2014
This list does not exhaust all equipment and materials demand
Source: PETROBRAS
The demand for goods and services will be around $ 400 billion by 2020 - sufficient scale to develop a robust local supply chain of goods and services
Expenditures p and Investments in the E&P Sector
(US$ bn 2009)
312 231 155 86 30 129 71 191 255 400 (Investment and
Total Expenditure Operating expenses)
Cumulative 324 Investment
Sectors Consolidated Investments
25
25,1 1,0 6,0

5,3 3,8
14,5
22,3 22 3 1,0 2,7 6,8

4,2
30,3 0,5 87 8,7

9,5 4,7
33,6 0,6
10,9 10,1 5,3
30,1 0,5 76 7,6

9,4 5,7
33,8 0,5
9,8 10,2 6,0
7,5 7 5 1,5 2008 2010

Production Development
6,0 6 0 1,7 2012
5,0 0 1,9 2014
4,7 4 7 2,1 2016

Construction of Productive units Exploration and Evaluation
4,7 4 7 2,3 2018

Seismic
5,0 5 0 2,4 2020
Construction of Petroleum Vessels and Supporting Boats
Driller construction
Note: Includes drillers and production units already rented Source: Petrobras business plan 2009-2013 (2009); PROMINP; Clippings; Booz & Company Analysis
19
The offshore supply chain is quite comprehensive, encompassing a large number of players ...
Plastics
Mechanical Equipment Modules / Systems
Field Operator p Logistic Support
Chains drivers
Other Related Sectors

(1) Includes all materials and equipment for which the offshore chain has low representativeness, staying then out off the main supply chain
Direct suppliers Related sectors
20
The P-ZZ(1) vendor list confirms it and indicates the national chain growth potential about 40% of the equipment groups have not been considered as local suppliers
Supply of equipment and Systems
Companies in Vendor List P-ZZ
Number of Companies
Number of Groups 112
Suppliers
% Estimated Value
Type of Groups
286
38%
Only Foreign Companies
42-46%
Turbo generators; Centrifugal Compressors; Flare; Sulfate Removal Unit; Gas Motors; Gas Reciprocal Compressors
111
37%
Predominance of Foreign Companies
48-52%
Centrifugal Air Compressors; Control Valves; Diesel Motors; Flow Instruments; Positioning Systems (POS); Synchronized Motors and Generators Automation and Control systems; Centrifugal Pumps; VAC equipment Heat Exchangers; Screw Type Air Compressors; p ; Rotary y Pumps p
18% 7%
Brazil
1) Source:
Predominance of National Companies Only National Companies
3-5% 1-2%
Other countries
Recent platform Booz & Company Analysis
21
According to suppliers, structural factors are the main impediments to the sector competitiveness - operators also point to other high impact issues
Key Challenges for Brazilian Companies
(% of O&G Suppliers) High Taxation Qualified Labor High Capital Cost Business Bureaucracy Technology Access / Leading Equipment Credit/Assurance Access Raw Materials Local Cost 40% 55% 76%
Additional Factors from Direct Customers Supply pp y uncertainties Risk excessive pricing Margin addition on non-value non value added steps
35%
Culture of "negotiation pricing

29% 28% 26%
Size - raw materials purchase through distributors and lack of scale
Source: Quantitative and Qualitative Research, Booz & Company Analysis
22
The local interest rate is still among the world's highest ones and the difference to the final borrower (spread) is big
SIMULATION
Reference Interest Rate

(% a a.a.) a) 5,31% 3,25% 0 10% 0,10% Japan 0 25% 0,25% USA 0,50% UK 1,00% EU 2,00%
12.5 % 8,75% ,
Estimative of Interest Impact on Price Difference Impact on Interest

(% Final Price) 4,8% 3,4%
Highest difference
South Korea
India
China
Brazil 0,9% Large g Industry y 1,5% Mid-size Industry y

Lowest difference
Industry Funding Cost Working Capital

(% a.a.) 16,0% 11,5% 8,8% 7,6% SELIC Large Industry Working Capital 11,5%
Premises
Variable
% Financed product value Production time
Scenario Minimum
60% 6 months
Scenario Maximum
80% 9 months
Mid-size Industry Working Capital
Income tax and CSSL Funding cost of foreign companies 4% a.a.
34% 3% a.a.
1) Average Working Capital, November 2009 in Brazil Note: Interest Rates, January 2010 Source: Global Economics Research - Trading Economics; Balance Sheet Analysis; Booz & Company Analysis
23
Brazilian R&D investment is also below its main competitors, causing technological deficiencies - greater cooperation between universities and industry is a key action
R&D Investment
(% PIB - 2005) Relative Difference 2,68% 2,64% 1,89% 1,75% 1,44% 1,17% 1,14% 0 98% 0,98% 2.7x 2.7x 1.9x 1.8x 1.5x 1.2x 1.2x
3,8 3,4 41 4,1 4,9 4,6 4,6 5,4
R&D Cooperation between Universities and Market

(Scale: 1-7)
USA South Korea UK Norway China Russia Italy Brazil

Source:
5,9
World Bank, World Economic Forum, Booz & Company Analysis
24
high tax burden

Tax Burden in the Main Power Commodities(1)
(%) 45%
Comments
43%
Brazil has high tax burden on the main power commodities In some cases, taxes account for almost half of the raw material total cost The high taxes of these commodities directly impact the chain competitiveness, increasing both production and logistic costs
24% 20%
Power
Natural Gas
Diesel
Gasoline
1) SP Basis Source: ANP, ANEEL; Acende Brasil Study
25
The comparison with developed countries shows in China an advantage in feedstock/raw material and labor costs
Butterfly Valve 4(1) Composition of Cost Difference
Brazil vs vs. China 358
18 42
5 10 13 13 13 Taxes Capital Cost Business Expenses Labor Inputs & Components Imported vs vs. National
N/A -76% -67% -71% -52%
39 51
9
124
179
Raw Material
-68%
100
3 21 4 9 55 8 China Price
1) 2) Note: Source:
46
54 Margin Raw Material Inputs & Components Labor Business Capital Cost Expenses(2) Taxes
Non Recoverable
Margin
-86%
Brazil Price
Butterfly valve, iron-nodular body, cf8m steel plate, epdm seal Selling, general and administrative expenses, including logistics cost and depreciation Exchange @ R$1,80 per dollar Field Research, ABIMAQ, Interviews, Booz & Company Analysis
26
The comparison with developed countries shows in Norway, a big difference in scale/technological capacity and in capital cost/ taxes
Sea Water Lift Pump Composition of Cost Difference
Brazil vs. Norway 118 100
8
1 4 4 -7 4 5 5 6 5 12 Taxes Capital Cost Business Expenses Imported vs. National
N/A -83% -31%
30
Labor
+30%
37
28 24
23 19 11 Norway Price
1) Note: Source:
Inputs & Components
-26%
Raw Material Margin
-25%
14 Margin Raw Material Inputs & Components Labor Business Capital Cost Expenses(1) Taxes
Non Recoverable
-20%
Brazil Price
Selling, general and administrative expenses, including logistics cost and depreciation Exchange @ R$1,80 per dollar Field Research, ABIMAQ, Interviews, Booz & Company Analysis
27
As a result, the segments were categorized into three groups
Targeting Matrix for Development of Offshore Segment

High Gains on the Developm ment of the Segment
Segments that individually have a cost-benefit balance a Individual segments that offer high benefits with a low / medium cost Shipyards Drilling Services Automation, Measurement and Control Services and Completion equipment Electrical Systems EPC/Integrators Generators Tubes and Pipes Turbo Generators Systems Rig Operation Segments that Individually have high costs for limited benefits Seismic Drills Compressors Pumps Heat Exchanger g Valves Subsea Equipment Logistic Support Basic Engineering
Low High Effort Required for Developing the Segment Low

Local decision Foreign Subsidiary
Source: Corporate balance sheets, interviews, Booz & Company analysis
28
The competitiveness agenda is composed of policies and instruments for chain development
Vectors
Knowledge and Productivity
Competitiveness Agenda
Policies for the Development of the Offshore Goods and Services Chain
1
Generating and disseminating knowledge and innovation throughout the chain
Increase productivity and improve processes for local production Stimulate the formation of technological excellence centers within the production clusters
7
Productive and Technological Arrangements Strengthening L Local l Business
Strengthen industrial activities in 3-5 productive clusters

5 6
Simplify and increase transparenc regarding the transparency local content policies
Encourage cou age local oca dec decision so and global focus
9 10
Attract technology and in estments from investments international companies
Competitive Isonomy
Ensure tax isonomy between local and foreign competitors
Establish funding conditions and g guarantees internationally competitive
Access raw materials and infrastructure in competitive conditions
Actions - "What are the pillars that make policies tangible?" - What To Do Mechanisms - "Which are the tools to implement those policies?" - How To Do Governance - "Who is responsible for defining and driving these policies?" - Who Should Do It 29
The offshore chain as a whole engages in Brazil (2009) ~ 75,000 direct jobs and over 350,000 related sectors and income effect
Current Scenario Offshore Sector Supply
Ch i Drivers Chain Di Di Direct t Suppliers S li R l t d Sectors Related S t
Supply Chain
I Income-Effect Eff t
Drivers Almost its total revenue is intented to the O&G offshore sector Strong foreign presence in of wells and seismic services
General equipment, pipes, integrators, etc. Relevant share of its re en e is allocated to revenue offshore segment High import level
Indirect sectors: primary (e.g., steel, forging, foundry, components) or pp ( (e.g., g , telecom, , support hotel) Delivery to multiple sectors, including offshore
Income effect: expenditures from the income generated g the chain throughout
Employment E (000)
EPC: 25 thousand Others: 15 thousand Total: 40 thousand
equipment and pipes 20-25 mil Others: 10 thousand Total: 30-35 thousand
Total: 32-36 thousand
Total: 310-330 thousand Chain Total 410420 thousand
Source:
ABIMAQ, ABINEE, Petrobras, PROMINP, ABRASEG, Sinaval, ABIFA, SINDIFORJA, IBS, Sector players, Field research, IBGE, BNDES, Booz & Company Analysis
30
In the desired view is expected to add between 1,7 and 2.1 million jobs in Brazil
Number of Employment in the Chain in 2020
(Th. Jobs)
140 - 170
2.110 - 2.500
Organic increase in Demand with Constant Participation 940 - 1.150
The Chain Increases its Exports with the Greater Companies Competitiveness
1.700 - 2.080
620 - 760
National Industry increases its Participation in the captured Value
410 - 420
Current
Increasing Local Demand
Change in the supply Participation
Increase in Exports
Desired Vision
Source: Petrobras Investment Plan, Chain Companies Website, studies and sector reports, Booz & Company Analysis
31
Local Content Policies
Objective To increase local employment and income
Offi i l Policies Official P li i 1. ANP rules for the bidding rounds; 2. PETROBRAS requirements; 3. BNDES criterion
Local Content Policies - PETROBRAS requirements

Round zero
T Topside id CL min = 60%
Hull Normally CL = 0% to 60%
Compression Module CL min = 75% Power Generation Module CL min = 75% Turbo T b generators t CL = 0%
Gas Compressors LC = 0%
Measuring Local Content
R l of Rule fO Origin i i - BNDES The 60% criterion;
Methodology established by ONIP Contract with Petrobras on : P-51, P-52, P-53, P-54 e PRA1; Refining projects Value added concept. 1 - imported = % of local content (excludes taxes) contract total
Opportunities for Cooperation
Strategic Alliances Technology; Increase in local installed capacity; Joint agreements for packages.
In conclusion
Brazil offers a very attractive investment portfolio, with no parallel in the world considering the same timeframe Local content policies are expected to play an increasingly important role Pre-salt represents an unique opportunity for the consolidation of an entire supply chain However, Brazil is in a challenging position higher costs than other emerging countries and lower productivity than developed countries due to limited scale and technological gap If implemented successfully, successfully the policy recommendations will have high impact and can generate over 2 million jobs by 2020 If there is no significant improvements in the levels of competitiveness, only a part of this potential will be achieved Do your market research and consider greenfield projects and local partnership as a way of g the Brazilian market accessing
36
Thank You
Bruno Musso bmusso@onip.org.br (21) 2563-4615

Increasing Local Content Competetive Agenda For Offshore Oil and Gas Supply Chain in Brazil

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Increasing Local Content C Competitive titi agenda d for f offshore ff h oil and g gas supply pp y chain in Brazil

Brazil Energy and Power

ONIP Organizao Nacional da Indstria do Petrleo

ANP Study (1998);

ONIP Organizao Nacional da Indstria do Petrleo

ONIP National Organization of the Petroleum Industry

Suppliers of Goods and Services

Oil &Gas Companies

ONIP Organizao Nacional da Indstria do Petrleo

Members Local Industry

ONIP Organizao Nacional da Indstria do Petrleo

Members - Operators (demand)

Maersk Ocean Phillips Repsol Shell Statoil TotalFinaElf Unocal Wintershall

Federal MDIC ABDI ANP BNDES FINEP

ONIP Organizao Nacional da Indstria do Petrleo

ONIP Organizao Nacional da Indstria do Petrleo

Infrastructure and Industrial Investments 2011 2014 2011-2014

ONIP Organizao Nacional da Indstria do Petrleo

ONIP Organizao Nacional da Indstria do Petrleo

Evolution of Crude Oil Reserves (million bbl)

Lula,Iaraand Guara (PreSalt)~12billion

ONIP Organizao Nacional da Indstria do Petrleo

Reserves Distribution st but o

China Kazakhstan Brazil(1) Russia OCDE Members

Conflict areas Political instability

ONIP Organizao Nacional da Indstria do Petrleo

Sources: BNDES; MIT - LIS; Booz & Company Analyses

ONIP Organizao Nacional da Indstria do Petrleo

Qualification of the local workforce

Foundation of Universities (ex. University of Stavanger) e Centers of Research

Formation of an industry cluster

Internationalization of the local chain

Incentives to use the local content

ONIP Organizao Nacional da Indstria do Petrleo

In Korea, government actions focused on basic industry development on a global scale

Financing facilities Competitive b benefits fit Supply assurance Export facilities

ONIP Organizao Nacional da Indstria do Petrleo

Oil Production P d ti Pre-Salt P S lt Fields Fi ld (1)

1,8 1,5 1,0 03 0,3 0,5 0,6

0,1 0,1 2012

0,4 0,1 0,3 2014

Other Players Petrobras

ONIP Organizao Nacional da Indstria do Petrleo

ONIP Organizao Nacional da Indstria do Petrleo

Projected Investments 2011 2015

Total investment to reach : US$ 260 billion

Purchase of new equipment

Equipment and materials requested 2010 - 2014

ONIP Organizao Nacional da Indstria do Petrleo

Cumulative 324 Investment

Sectors Consolidated Investments

25,1 1,0 6,0

22,3 22 3 1,0 2,7 6,8

30,3 0,5 87 8,7

30,1 0,5 76 7,6

7,5 7 5 1,5 2008 2010

6,0 6 0 1,7 2012

5,0 0 1,9 2014

4,7 4 7 2,1 2016

4,7 4 7 2,3 2018

5,0 5 0 2,4 2020

Construction of Petroleum Vessels and Supporting Boats

ONIP Organizao Nacional da Indstria do Petrleo