NEW REGULATORY FRAMEWORK FOR THE GAS SECTOR IN BRAZIL

Superintendência de Infraestrutura e Movimentação - SIM

24 de julho de 2018

Summary

• Overview of Brazil’s Natural Gas Industry

• Gas to Grow Initiative

• New Market Design

• Main drivers and obstacles to the development of the gas market

80 Million

NationalProduction

77%

ImportedfromBolívia

21%

ImportedLNG

2%

m³/d

February, 2018

*

* Until February/2018

Average 2018

0

20

40

60

80

100

120

2012 2013 2014 2015 2016 2017 Avg 2018 feb/2018

Mill

ion

sm

3/d

ia

Título do Eixo

Supply – national and imported

Imported GNL Imported Bolívia National Prod.

Natural Gas Supply

ThermalPower

32%

Transport

8%

Cogeneration

4%

Industry

53%

Natural Gas Demand

80 Million m³/d

Others

3%

Consumptionbysector (Feb/18)

Source: Boletim Mensal de Acompanhamento da Indústria de Gás Natural (feb/2018)

February, 2018

0

20

40

60

80

100

120

2012 2013 2014 2015 2016 2017 Avg.2018

feb/2018

Mill

ion

sm

3 /d

Título do Eixo

Consumption by sector

Industrial Transport.-Auto Electric Gen.

Cogeneration Other Total Demand

Natural Gas Production

109 Million

Pre-Salt

51%

Offshore Conventional

30%

Onshore

19%

56

33

20

Associated gas

89 Million m³/d

m³/d

February, 2018

0

50

100

150

20

08

/01

20

08

/06

20

08

/11

20

09

/04

20

09

/09

20

10

/02

20

10

/07

20

10

/12

20

11

/05

20

11

/10

20

12

/03

20

12

/08

20

13

/01

20

13

/06

20

13

/11

20

14

/04

20

14

/09

20

15

/02

20

15

/07

20

15

/12

20

16

/05

20

16

/10

20

17

/03

20

17

/08

Mill

ion

sm

³/d

Natural Gas Production

Brasil

Nonassociated

21 Million m³/d

Offshore (Pre-Salt) Offshore (Conv.)

Onshore

Natural Gas Production

109 Million m³/d

February, 2018

AM: 13%

MA: 5%

RNCE: 1%

BA: 6%

SEAL: 3%

ES: 8%

SP: 18%RJ: 50%78%

22%

Petrobras

81%

19%

Gas Production by State

Offshore Onshore

+85% Net Marketed

Production

Production(Feb/18)

Reinjection

30%

Platform Consumption

12%

VentedandFlared

3%

MarketedProduction

55%32

12

3

60

Marketed Production

60 Million m³/d

Between 2017 and 2010:

0

20

40

60

80

100

120

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Mill

ion

s m

³

Production x Marketed Production

February, 2018

Platform consumption

Reinjection

Vented and Flared

Marketed Production

Natural Gas Industry Reforms

201819971953

Union

Monopoly,

carried out by

Petrobras

(NOC, Union

controled

company)

End of Petrobras

Monopoly(Oil Law)

Petrobras retains it´s

dominant position

Creation of

New Reform needed:

leading to a liquid and

competitive gas

market

This is due to

Petrobras divestment

of assets

2001

Fuel Prices

Liberalisation

2009

Gas Law(first reform to

specifically target

the natural gas

Market, with

emphasis in

transportation)

State and Federal Regulation

Upstream

Midstream

Downstream

E&P

Processing

Storage

Transport

Local natural gasdistribution

city-gates

Source: Adapted from Northwest Gas Association

Transport Pipelines

Natural Monopoly

• Regulation

• Tariff Setting

• Return on Investment

• Fair rate of Return

Third-PartyAccess

• Open and non-discriminatory access to the networks

• Avoid Barriers to Entry

EfficientAllocation of

Resources

• Underinvestment – not to takeadvantage of economies of scale

• Overinvestiment – strand assets andAverch–Johnson effect

Stages of development of gas-to-gas competition

Non-competitive marketDeregulated/Developing

marketCompetitive market

MonopolyWholesale market

competitionFull retail

competition

- Monopoly rights ongas transmission anddistribution

- Supply obligation- Regulation of gas

prices

- Third-party access- Unbundling of transport and

marketing functions- Competition in gas supply to

large end users and local distributors

- No price controls on gas sales- Regulation of access including

use-of-system charge

- Third-party access- Full unbundling- Competition in gas

supply to all end users- No price controls on

gas sales- Regulation of access

including use-of-system charge

Increasing competition

Source: Adapted from OECD/IEA, "Gas Pricing and Regulation - China’s Challenges and IEA Experience", 2012

Gas to Grow Pillars

Third-partyAccess

Transparency

CompetitiveMarket

InvestmentAttraction

Requires a New Market Design

Market adaptation in the transition period needs:

• Separation of transport x competitive activities

• Models of independence (OU, ISO, ITO)

• Entry Exit capacity booking

• Transportation tariffs approved by ANP

• Coordination of transporters on Transportation System

• Network Codes

• Transparency of the offering and contracting of services

• Gas Release Programs

• Capacity Release

Natural Gas Market Transition

Market Design(depends on new legislation and regulations)

Energy/Competition Policy

Entry-Exit – changes for Shippers

• Capacity reservation for all pipeline segments referring to the gas flow from the receiving point to delivery

• Normally, the trading is done bilaterally for delivery to the buyers in the city-gates

• Consequences:

single shipper as the supplier

emphasis on long term contracts (GSA and GTA)

limited choice and low market liquidity

Point to Point in Brazil

• Capacity Reservation related to the injection or withdrawal points in the transportation system

• Buyers and sellers act as shippers

• The shipper that has booked an entry may have as counterpart in the commercialization any other shipper in the system, and vice versa

• Emphasis in short-term contracts

• Increased choice of suppliers and more liquidity

Entry-Exit

Emergence of a liquid and competitive market

It depends on creation of market mechanisms that give transparency to the formation of prices, allow consistent price signals and have liquidity in the short term.

Entry and Exit zones with virtual trading points

Shippers can flexibly book and use transportationcapacity of entry and exit points

Natural gas trading based on virtual trading points

Liquid NG Hubs with efficient use of infrastructure

Goals

Transporters have to promote open-season every year

Offer transport contracts of up to 1 (one) year term, in advance to a maximum of 5 (five) years for existing infrastructure (pipelines)

Each year, the process could signal demand for capacity expansion with a horizon of 5 (five) years

Transportation Capacity Booking

Market Transition: first step

Market Reform: Next steps

Union Monopoly

Put into effect the separation model “full ownership unbundled” between transporters and agents engaged in potentially competitive activities in the natural gas industry: transporters must be completely separate and independent from vertically integrated companies

Organizing the transportation of natural gas by means of Network Codes with Entry and Exit System

Adoption of Essential Facilities Doctrine

Offering of homogeneous contracts (transportation capacity; standard hub GSA wording)

States Monopoly

Put into effect functional unbundling of natural gas distribution companies to avoid self-dealing

Separation of natural gas commercialization and distribution activities

Elaboration of a regulatory framework on the operation and maintenance tariffs applicable to the distribution of natural gas.

Market Reform: Next steps

Main drivers and obstacles to development of the gas market

Lack of competitive forces More suppliers and free consumers needed

Lack of comprehensive legislation New draft bill sets “market design”

Lack of market driven gas price mechanisms Trade hubs and exchanges

Contractual congestion managementLack of third party access Essential Facilities Doctrine

Shorter term transportation contracts

Lack of transportation authorization of new pipelinesinfrastructure Ten year network develop. plan

Thank you!

Superintendência de Infraestrutura e Movimentação – SIM