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Brazil Fights Over Oil Royalties as New Output Stays on Hold

Brazil President Dilma Rousseff is wrestling over whether to approve controversial legislation that distributes royalties from oil production, a politically charged issue that is holding up development of huge offshore oil reserves and may even influence the outcome of a re-election bid in 2014.

The president's decision will determine how federal, state and city governments across Brazil share the billions of dollars expected from oil production in coming years.

Near term, it is also blocking the development of some huge oil fields that have been found off the country's southeast coast, in deep waters and far below the Atlantic Ocean seabed. It has delayed new exploration, as no licenses have been sold since 2008, and oil companies have warned they are running out of areas to explore.

Congress caught the administration by surprise in approving legislation that redistributes money from existing oil production as well as from future output. The country's main oil-producing states, Rio de Janeiro, Espirito Santo, and Sao Paulo, may lose some six billion Brazilian reais ($2.9 billion) per year as a result, and are threatening to sue.

The president's predecessor and political mentor, Luiz Inacio Lula da Silva, vetoed similar legislation just before he left office in late 2010 for precisely this reason.

Ms. Rousseff now faces an awkward task of appeasing the governors in oil-producing states without upsetting many other states that stand to benefit significantly from the new legislation. The solution could ultimately even have influence on Ms. Rousseff's base of support for re-election in the 2014.

"In any case there will be legal challenges," said Adriano Pires, director of the Center for Brazilian Infrastructure. "If the government goes ahead with the auctions, there's the risk that there could be a series of court injunctions impeding them, so it looks like this soap opera is far from ending."

Ms. Rousseff has until Nov. 30 to sign the bill into law, veto some parts of it or reject it outright, according to Ideli Salvatti, the president's liaison with Congress.

"The president has until the end of the month to sign the law and will analyze it exhaustively, because this question of the division of royalities is strategic for the country, as are the auctions set for next year and the risk of legal challenges to this process," Ms. Salvatti said.

There may be too much at stake for the government to risk further delays by sending the latest royalty-distribution legislation back to Congress for changes.

"Ms. Rousseff will hesitate to pick a long and arduous fight with nonproducer states," said Eurasia Group political analyst Christopher Garman in a report to clients.

The government may instead seek an alternative way to compensate Rio de Janeiro, Sao Paulo and Espirito Santo for their losses. A broader overhaul of taxes and revenue distribution is being discussed with governors and congressmen, which could offer a way out.

But analysts said regardless of what is decided on the distribution of royalties, the latest legislation should be sufficient to guarantee new bid rounds can be held as the government hopes next year.

"What matters for new bid rounds is legal clarity over royalty rates for new acreage, not the distribution of royalty rates for existing concessions, where the political fight is concentrated," Mr. Garman noted.

Dow Jones Newswires - November 21, 2012

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