UNIVERSITA’ DEGLI STUDI DI PADOVA

DIPARTIMENTO DI SCIENZE ECONOMICHE E AZIENDALI

“MARCO FANNO”

CORSO DI LAUREA MAGISTRALE IN

ECONOMIA E FINANZA

TESI DI LAUREA

“GROWTH STRATEGY AND RISK MANAGEMENT: THE CASE OF

OSX IN THE BRAZILIAN OIL MARKET”

RELATORE:

CH.MO PROF. FABIO BUTTIGNON

CORRELATORE:

C.MO PROF. ALBERTO LANZAVECCHIA

LAUREANDA: CLAUDIA BUONO

MATRICOLA N. 623033

ANNO ACCADEMICO 2012– 2013

Ai miei genitori,
Vittorio e Giulia
ABSTRACT

INTRODUCTION

Chapter I - Brazil: the giant economy or the economy of a giant?

1.1 Becoming an emerging market: the challenge 1
1.1.1 First industrialization: the teoria nacional-desenvolvimentista 3
1.1.2 Liberalization and deregulation: the revenge of Brazil 4
1.1.3 The XXI century: the confirmation on macro data 5
1.2 Oil market in Brazil 7
1.2.1 The energy sector: a new regulatory framework 7
1.2.2.1 The Rights Concessions Agreements regime 8
1.2.2.2 The Production Sharing Agreements regime 10
1.2.3 The pre-salt oil field revolution 15
1.2.4 PLANSAL: the Master Plan for Santos Basin’s Pre-Salt Cluster 20
development
1.2.5 Internationalism and Local Content restrictions 23

Chapter II - OGX: the golden opportunity in the black gold market

2.1 Petròleo e Gàs Participações S.A. 27
2.1.1 EBX: the 360° Vision by the German-Brasilian visionary 28
2.1.2 OGX: company overview 32
2.1.2.1 Inside excellence 32
2.1.2.2 Outside excellence 36
2.1.3 OGX investment for development and production phase 37
2.1.3.1 Waimea first oil production and shipment 43
2.1.3.2 Waikiki first oil production 46
2.2 The escalation towards success 47
2.2.1 The 9th Bidding round 47
2.2.2 OGX and competitors at a glance 51

Chapter III - OSX: the “truffle-sniffing labrador” has found the X-factor in
his EBX Empire
3.1 OSX Brasil SA 61
3.2 Project finance for OSX start-up 63
3.2.1 Risks assessment and agency costs in emerging market 63
3.2.2 International awards for the triad signed OSX 73
3.2.2.1 OSX Construçao Naval S.A. (OSX Shipbuilding Unit) 73
3.2.2.2 Chalki Participações S.A. 78
3.2.2.3 OSX Serviços Operacionais Ltda. (OSX Services) 78
3.2.2.4 OSX Leasing division 79
3.2.2.5 OSX 1 Leasing B.V. (“OSX-1”) 80
3.2.2.6 OSX 2 Leasing B.V. (“OSX 2”) 86
3.2.2.7 OSX 3 Leasing B.V. (“OSX 3”) 87
3.3 OSX key success factors 90
3.3.1 Brazilian Naval industry recovery 91
3.3.2 OGX strong potential demand 92
3.3.3 The local content barrier: cost or opportunity? 95

Chapter IV - A Crystal Ball application for OSX evaluation model

4.1 “OSX L&S”: the replicable project 100
4.1.1 OSX standard Leasing contract for OGX: the basic assumptions 100
4.1.2 OSX standard Services contract for OGX 105
4.1.3 OSX L&S fiscal treatment 106
4.2 OSX static evaluation model 108
4.2.1 Modeling a reliable business plan: the static assumptions 108
 4.2.2 The cost of capital puzzle: incorporating the Country risk premium 113
4.2.2.1 The Global/local CAPM 114
4.2.2.2 The Godfrey-Espinosa model 116
4.2.2.3 Estrada’s Model 117
4.2.3 Damodaran model: the total equity risk premium 117
4.2.4 OSX L&S project: the value with static models 121
4.2.4.1 FCFF deterministic method 122
4.2.4.2 FCFE deterministic method 123
4.3 OSX dynamic evaluation model 125
4.3.1 Crystal Ball modeling 126
4.3.1.1 Monte Carlo simulations 126
4.3.1.2 Goodness-of-fit statistics 127
4.3.1.3 Goodness-of-fit plots 128
4.3.1.4 Fitting the best distribution 129
4.3.2 OSX L&S risk assessment 131
4.3.3 Pre-completion risks 134
4.3.4 Post-completion risks 135
4.3.4.1 “Operating efficiency” assumption 135
4.3.4.2 “Learning-by-doing” assumption 136
4.3.5 Supply or input risks 138
4.3.6 Market risk 139
4.3.7 Environmental risk 143
4.3.8 Default risk 149
4.3.9 Financial risks 150
4.3.10 OSX L&S dynamic risk evaluation results 151
4.3.10.1OSX L&S project Sensitivity analysis 159

CONCLUSIONS

REFERENCES
 ABSTRACT
La tesi si propone di analizzare un caso aziendale, calato nella realtà dell’industria petrolifera, in un
mercato emergente.
La società analizzata è “OSX Brasil S.A.”, una start-up brasiliana focalizzata sulla fornitura di servizi di
assistenza e operatività in ambito estrattivo offshore: la società propone una gamma di soluzioni
integrate, dalla cantieristica navale, presso il proprio porto in costruzione ad Açu, alla fornitura di
vascelli di produzione e prima raffinazione del petrolio greggio in leasing.
Dopo una ampia anamnesi di tutto il sostrato economico-politico brasiliano, e delle recenti scoperte
di ingenti giacimenti di petrolio nello strato di pre-salt al largo dello stato di Campos e Santos Basins,
il lavoro si concentra sulla realtà del Gruppo EBX, di proprietà del magnate dell’industria energetica e
dell’infrastrutture brasiliano, Mr. Eike Batista.
La sua visione a tutto tondo, “360° Vision” permea la policy di sviluppo e di ricerca di sinergie
dell’intero gruppo societario.
Proprio lo stretta collaborazione strategica firmata tra OGX, società petrolifera del gruppo, e OSX,
società di servizi petroliferi del gruppo, costituisce materia di interesse e di studio della tesi.
La società viene analizzata in riferimento ai suoi fattori strategici di successo e nelle sue alternative
tecniche di finanziamento che si basano sulla logica del project finance.
L’obiettivo della tesi è quello di ricercare i le figure trainanti del valore dell’azienda: l’analisi è
condotta tramite il focus su un singolo progetto replicabile di “Leasing and Services”, fornito dalla
società OSX alla sorella OGX.
L’analisi parte dalla costruzione di un business plan del progetto, in cui tutte le condizioni di
finanziamento e contrattuali sono state costruite in base alla documentazione ufficiale fornita dalla
società.
Il modello statico fa, quindi, da supporto alla valutazione dinamica, in cui vengono introdotte le
figure di rischio evinte da una attenta analisi delle caratteristiche del progetto.
L’analisi quantitativa del rischio, per mezzo del programma Crystal Ball, consente di attribuire una
distribuzione di probabilità alle singole assunzioni che muovono i flussi di cassa del progetto.
Tramite il lancio della simulazione Monte Carlo vengono proiettati 10000 scenari in cui le varie
assunzioni di rischio impattano sui modelli di valutazione, costruendo una distribuzione probabilistica
del valore ricercato, il Net Present Value e il suo Internal Rate of Return.
I risultati delle prove hanno fornito una conferma dei valori statici, ma con una connotazione in più
sulle potenzialità del progetto: l’upside risk si annida nell’efficienza operativa, il down side risk nelle
zone d’ombra, o, “Cigni neri”, rappresentati da rari eventi disastrosi inseriti nei modelli dinamici di
vautazione.
 INTRODUCTION
The role of managers is to take decisions that will impact on the whole company value.
Their task is crucial in the development strategy of the company business: the final choice among
alternative projects is the result of an accurate analysis of all the complex interconnections between
the financial and economical matters.
The success of a company, however, is not measured by its business dimension, its geographical
extension, but by the capability to create value.
Many discussions on “value” definition have been made: whether it could depend on the method of
evaluation, on the best expectations on future cash flows, if it is lowered by debt pressure.
There are many interpretation of value.

This thesis aims to focus on what are the main drivers of value in running a business.
I have analyzed the case of “OSX Brazil S.A.”, an oil and gas services company for offshore exploration
and production activities.
This company has many interesting aspects to be studied: its core business belongs to energy
industry, which is a pillar of each economy and is determinant on all the other sector development; it
is a start-up, hence more volatile and exposed to the market dynamics; it is located in Brazil, a
powerful emerging country with strong performance, in term of GDP growth rate.
Evaluating a company is something more than merely knowing its main numbers; it involves different
dimensions that are interrelated, and, therefore, must be studied and understood.
Only in this way it is possible to have the “360° Vision” of the matter.

Each company tells a different story and investors or managers have to learn its moral before taking
decision on it.
The story of OSX is, at first, that of Brazil, a developing country, which has overcome many heavy
problems: the military regimes, the hyper-inflation, the energy dependence on oil imports.
These issues, and their recent progress, are the main contents treated in First Chapter.
In Second Chapter is analyzed the Group EBX, which has the major stake in OSX: the synergies
created in the Group is one of the distinguish characteristics of this company. Its establishment and
development is the natural outcome of the growth of the sister oil company, OGX S.A.
Third Chapter focuses on OSX company in every aspects of its corporate governance: its main
projects, that want to meet the increasing demand from Brazilian shipbuilding market, the business
tripartite division, that allows to focus on each financial needs and strategic planning.
In particular there is a wide treatment on the project finance system, which is deeply used by OSX in
order to take the maximum profit from the single special purpose vehicles established.
I
The Fourth Chapter is the personal contribution to the value creation ability of OSX: basing on all the
previous close examination, I have realized two models of evaluation of “OSX Leasing and Services”
standard project.
The two methods used, Free Cash Flow to Firm and Free Cash Flow to Equity, allow the comparison
between equity holders and common investor perspective.
Through these analysis these models wants to give a clear definition of the “value” of OSX main
project: this evaluation is possible by making one more step towards the complex dynamics of
reality.
The static evaluation is completed by a dynamic model that wants to replicate, where possible, the
specific characteristic of the project, from a multi-dimension perspective.
The dynamic model has been enforced through Crystal Ball program, which, based on probabilistic
assumptions, launches Monte Carlo simulations in order to give, in output, a distribution of
probability of the value measures, Net Present Value and Internal Rate of Return of the project.

II
 FIRST CHAPTER
Brazil: the giant economy or the economy of a giant?

“The last will be the first”

- Matthew 20, 1-16 -

1.1 Becoming an emerging market: the challenge

The definition itself of “emerging markets” suggests an image of something that surges, that takes
off: it refers to realities that are on the economic frontier, hence they usually offer opportunities of
making huge profits or losses for the investors.
But what are the main features that determine the “emerging” category for a country?
Does exist a map or a common path that all these countries had travelled to gain this qualification?
The term “emerging markets”, coined 30 years ago by Antoine van Agtmael, then at the World Bank,
defines an economy as emerging if:

 its level of wealth creation, measured as gross national product (GNP) per capita, is below
that of developed economies;
 it’s characterized by the absence of a sovereign debt rating of “A” or better;
 its CAGR, the Compounded Annual Growth Rate (in terms of GDP, Gross Domestic Product),
is considerable high, at the extent to be a multiple of the developed ones, in order to cover,
in the future, the role of leading economy in the global economy.

That had been the case of USA and Japan during the XX century, when they rapidly became the
leading superpower economies, and this is the time for BRIC1 area: in 2003, Goldman Sachs
notoriously declared Brazil as one of the BRICS, the emerging countries destined to become the
economic superpowers by the middle of the XXI century.
Brazil is the giant country par excellence: it’s the most populous country among the ones in the south
of America, it’s the fifth country in the world for extension -after China, US, Canada and Russia- and
the seventh for its GDP, as highlighted in Chart 1.1; it’s considered the “Earth lung” (the Forest of
Amazon enlarges upon Brazil by 65% of its whole dimension) and also the “Earth granary”.

1
BRICS is an acronym that refers to the economies of Brazil, Russia, India, and China, which are seen as major
developing economies in the world: the BRIC countries include more than 40% of the world's population and
occupy over a quarter of the world's land area.
1
 Chart 1.1 – Brazil GDP vs major economies worldwide - 2010

Source: “The Economist” (March 2011)

Although the Brazilians themselves fear that Brazil could remain the “ever country of the future” due
to the unacceptable wealth inequalities, level of poor through the population and corruption, Brazil’s
economic future is attracting interest from investors, scholars and policymakers: the country size, its
impressive resources, the consolidated corporations and the strict macroeconomic management,
contribute to let this “giant” play a strategic role in the world economy, in particular in the global
agricultural, mining, industrial sector and, as better explained in the following paragraphs, in the
energy field (THE BROOKING INSTITUTION, 2009).

Chart 1.2 – Brazilian export diversification by item

Source: Banco Central do Brazil (2012)

In the previous Chart 1.2, in fact, it’s easy to see that quite the half of the total exports are
constituted by primary products (iron ore, coffee, meat, soy, raw oil, ecc..) equivalent to about 124
billion US$, and manufactured products (especially fuel oil and automobiles) while on Chart 1.3 it’s
notable that the main importers are the emerging markets of BRIC area: since 2006 they have been
substituting the developed traditional counterparties in cross border trades; US percentage in total

2
exports has reduced by about 8%, meanwhile China has more than doubled its trades with Brazil,
increasing them by an exorbitant 11%.

Chart 1.3 – Brazil Export diversification by destination

US$ 258.3 billion

Source: Banco Central do Brazil (2012)

Despite its evident potentialities, Brazil has achieved its actual economical and industrial successes,
through an awkward and slow process of openness to industrialization, to the capitalistic liberalistic
economic system, to the technology improvement and changes in production methodology.
It’s useful to highlight each of these important steps that interested Brazil, from the post- colonialism
to the last democratic election, that have built its “emerging” process.

1.1.1 First industrialization: the teoria nacional-desenvolvimentista

The modern exporting model of Brazil was established in 1930 by the new elected president, Getùlio
Vargas, whose first purpose was to dismantle the one-crop economy based on coffee production,
especially after the “Big crack” happened in Wall Street Exchange in 1929, that heavily depressed the
price of the commodities.
He gave renewed power to the central government that received 20 million US$ by Washington
(MADDISON et al., 1992) in order to build great state-controlled enterprises that drove Brazil at the
top of international industrial market: Companhia Siderùrgica Nacional in Rio de Janeiro, that
immediately became the greatest iron park in Latin America, Petrobras2 and Companhia Vale do Rio

2
Petrobras is a semi-public Brazilian multinational energy corporation headquartered in Rio de Janeiro, it’s the
largest company in the Southern Hemisphere by market capitalization and the largest in Latin America
measured by 2011 revenues, PB is a world leader in development of advanced technology from deep-water
and ultra-deep water oil production.
3
Doce3, with whom for the first time Brazil could diversify its exports towards US and Germany, are
the main examples.
In this way Vargas achieved its goal to transfer the accumulated financial resources from coffee
industry to the heavy industries and other manufactured products.
To strengthen the Brazilian industrial system during this “substitution of imports” economic
phase(IANNI, 1974), Kubitschek4 pursued the getulian theory of industrialization by increasing the
pace of production: he promoted the flood of external capital by US, Europe and Japan, but led to a
phenomenon of hyper-inflation. To compensate the accumulated external debt, in fact, and payback
the interests, he was obliged to devaluate the currency, fictitiously increasing exports volume: so It
did happen that during the global rise in crude oil prices, due to the oil shock in the 70’s, Brazil
recorded an inflation rate by 239% per year.

1.1.2 Liberalization and deregulation : the revenge of Brazil

To face the inflation and the unemployment nightmare, first signals of recovery came after 1989
when president Collor del Mello started to privatize economy and deregulate the cross border
trading rule with an unfixed exchange rate: the following Nineteen’s witnessed a series of structural
reforms that allowed the public accounts balance and a massive reduction in inflation rate to a great
result of 4,5% in 1995.
The whole economy benefited and Brazil knew another wave of external capital inflows thanks to the
so-called “Washington consensus”: the most important American financial institutions (World Bank,
International Monetary Fund) declared their approval on Brazilian policy and economy, so that the
country focused on private sector development, prices stabilization and international commerce.
In 1991 “Mercosur”5 increased the Brazil international trading share and in the following years
another step towards the Brazilian economic redeem was achieved: the boom in stock market in São
Paulo and Rio de Janeiro, the financial emancipation that characterizes each growing economy.

3
Vale is a Brazilian multinational diversified metals and mining corporation and one of the largest logistics
operators in Brazil: in addition to being the second-largest mining company in the world, Vale is also the largest
producer of iron ore, pellets, and second largest of nickel.
4
Juscelino Kubitschek de Oliveira was President of Brazil from 1956 to 1961: after the dictatorship of Vargas his
presidency experienced a time of political optimism, by continuing the teoria nacional de desenvolvimento.
5
Mercado Comum do Sul is an economic and political agreement among Argentina, Brazil, Paraguay and
Uruguay that aims to promote free trade and the fluid movement of goods, people, and currency.
4
 1.1.3 The XXI century: the confirmation on macro data

Brazil had just been promoted by Standard and Poors: the government debt had finally been rated at
investment grade, in contrast to the situation in some developed countries in Europe that, even with
an equal and higher rating, have a negative prevision if looking forward.
The XXI century has displayed Brazil as a dynamic emerging country that has quickly overwhelmed
the global financial crisis: president Lula da Silva had shown unprecedented self-assurance when he
said “The times in which emerging countries depended on the IMF are over”.
In Chart 1.4 data have been collected on Brazil’s foreign reserves: they are now $205 billion, four
times higher than in 2004; as in China, the strategic key to Brazil’s success depends on the domestic
market: a growing middle class, large infrastructure projects, rise in private consumption and
domestic investment are the major sources of growth, as highlighted in Chart 1.5.

Chart 1.4 - Brazil International reserve in US$ Chart 1.5 - Contribution of E/D to Brazil GDP

Source: Banco Central do Brazil (March 2012) Source: Banco Central do Brazil (March 2012)

What is important to say is that this growth isn’t based on high levels of foreign indebtedness as it
had been in the ‘70s: the Debt/GDP ratio has been in constant fall since the beginning of the century,
passing from 62,9% at the end of 2002 to 37,2% in 2010 mainly thanks to Lula’s policy on fiscal
discipline, and is expected to further decline in the next years.
On Table 1.1 economical data have been collected and financial indexes have been computed in
order to confirm the level of economical development achieved by Brazil during the last decade.

5
 Table 1.1 - Brazil 2001/2011: Main Economic data

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

GDP 509,7 459,3 506,7 540,2 N/A 1088 1366 1652 1594 2028 2354

Trade Balance 2,7 13,1 24,8 33,7 N/A 46,5 40,0 24,8 25,3 20,3 28,7

FDI 21,04 18,78 12,9 18,17 N/A -9,38 27,52 24,6 36,0 36,96 69,1

LIT* 0,5% 2,8% 4,8% 6,24% N/A 4,27% 2,93% 1,5% 1,59% 1% 0,6%

LFDI* 4,13% 4,09% 2,55% 3,36% N/A -0,9% 2,01% 1,49% 2,26% 1,82% 2,93%

Source: Economist Intelligence Unit Banco Central do Brasil, OCSE (2012)

Indexes (*) computed by the author

The Level of International trade (LIT), defined as the absolute value of the sum of imports and exports
as a share of gross domestic product (GDP) is a ratio typically used to measure the degree of
openness of an economy: Brazil shows a boom since 2002, passing from 0,5% to an average of 3%.
The Level of Foreign direct investment (LFDI), defined as the absolute value of the sum of capital
cross-border inflows and outflows, again as a share of GDP, is the thermometer for the external
interest on Brazil economy by the rest of the economic world: it confirms the previous affirmations.

6
1.2 Oil market in Brazil

Energy is one of the most politicized sectors of Brazil economy: the achievement of energy self-
sufficiency has been the main target of policies adopted since the 1970s, especially during the two oil
shocks period.
The state-owned energy companies (Petrobrás, Eletrobrás, and Nuclebrás) were primarily
established in order to be sources of revenue for the country and to improve the balance of
payments: they consolidated the Brazilian state monopolies over oil and gas exploration and
production, refinery, import, export and transportation activities.
In order to secure the country economic growth from the global crisis that cyclically hurts oil prices,
they started to convert the industrial use of oil into biomass energy6 supply for transportation and
industries, rearranging the traditional Brazilian energy matrix. Throughout the last thirty years, Brazil
had intensified the renewable energy sources consumption, representing in 2011 the 44.1% of total
national energy consumption(sugar cane biomass by 15,7%, hydraulic and electricity by 14,7%, coal
by 9,7%, wind and other alternative sources by 4,1%), otherwise OECD matrix confirm oil and
derivatives as the main energy sources (OECD biomass use is about a tenth of Brazil ethanol fuel
consumption)( Empresa de Pesquisa Energetica, 2012).

The oil substitution with ethanol biofuel for domestic demand has reduced the imports of energy
sources, while the strong external demand coming from emerging economies, such as China, has
fostered oil exports: the consequence today is that Brazil has become a net exporter of oil and their
derivatives, which is a relevant result considering its past history. The gross domestic offer of oil in
2007 has been by 89 thousand tep( tons of equivalent petroleum), equivalent at about 38% of total
gross domestic offer of Brazil energy and the 32% of its total exports.

1.2.1 The energy sector: a new regulatory framework

Regulatory reforms during the 90s were much more market oriented: in 1995, a constitutional
amendment liberalized the country’s oil and natural gas regime, allowing the participation of
national and international capital in this industry: Petrobras was partly privatized and the system for
allocating oil concessions was liberalized. This market openness have attracted external influx of
capital which has increased the possibilities to finance and develop projects but could also lead to a
sort of “colonization” by international oil companies on Brazilian energy sources. That’s why

6
The ethanol biofuel had been promoted by the governmental program launched in 1970s named Pro-Alcohol:
it developed sugarcane-based ethanol with the purpose of substituting on a large scale oil derivatives
consumption. This reduced the Brazil dependence on foreign currencies and permitted energy self-sufficiency
during the oil shocks crisis.
7
presidents Lula and Rousseff have enforced a series of laws that have rewritten the legislative frame
of Brazilian oil market: they have declared all the oil fields a federal propriety, whose right to explore
could be onerously assigned to Petrobras, the only accepted operator, which could organize in Joint
ventures with interested international companies.
Actually there exist two different regimes that regulate the Brazilian oil market, the Concession and
the Production Sharing Agreement regime, which co-exist since the old concessionaries still hold
their rights following the previous legislation, while the recent bidding winners submit the PSA rules.
Both the concession regime and the PSA regime allow for the acquisition of exploration and
production rights by any company that meets certain requirements as established by Brazil’s
National Agency of Petroleum, Natural Gas and Biofuels.
However there’s uncertainty on the legal regime which will govern unitized areas of production that
involve PSA and concession blocks; not irrelevant consideration can be done on the two different
legal frameworks, better specified in the next paragraphs.

1.2.2.1 The Rights Concessions Agreements regime

In 1997, the Oil Law was enacted, creating Agência Nacional do Petróleo, Gás Natural e
Biocombustíveis7, ANP, and regulating private participation in the oil and gas industry: the
concessions for exploration and development of oil accumulation were to be sold at auctions, in
which any company, Brazilian or foreign, could bid equally for the assignment of the block8.
This model of concession agreement was initially designed for a system where exploration risks were
considerably high: in fact the companies took under their own account the involved risks during the
exploring and production activities, and paid the Federal Union a subscription bonus, the royalties
(10%) and special participation fees, while maintaining ownership of all hydrocarbons produced.
Considering the Concession Law, NR.9.478/1997, some articles are relevant:

 Art. 7: it establishes ANP as administrative and regulatory agency, under the supervision of
Ministry of Mines & Energy.
 Art. 23: it empowers ANP to issue concession contracts in blocks .
 Art. 24: it require for each concession contract the analysis and development of a priory
exploration phase (that includes appraisal and the determination of commerciality of oil
fields) and a consequent production phase, that means the development of the drilling
operations and first refining.

7
National Agency of Oil, Natural Gas and Biofuels.
8
Blocks are parts of a sedimentary basin, whose boundaries are defined by the regulatory authority, in which
oil and natural gas exploration and production activities are performed.
8
  Art. 26: it states that the concessionaire are obliged to explore at its own expense and risk
and, if successful, is obliged to develop and produce oil in the area under concession.

Concessionaire submits development plans for ANP approval: they are considered approved 180 days
after submission if ANP does not respond. The company or consortium has the obligation to realize a
Minimum Exploratory Programs , PEM, on the block obtained: the program states all the activities
necessary to the completion of the project. In particular it must define the operations to enforce for
the First exploratory phase, which usually takes no more than 7 years to collect all the seismic data
and the first drilling of exploratory well; only after the conclusion of the PEM the company can pass
to the Second phase of production. In the event of a discovery the concessionaire, hence, has to
proceed with the evaluation of commerciality and submits a Development Plan for ANP approval; the
production period established by ANP is for a maximum term of 27 years.

 Art. 29: it declares that concessions may be transferred to party who meets technical,
financial and legal requirements to obtain ANP approval, which, in addition, may require
further guarantee.

The Oil Law issued, otherwise, that the Government should reduce its participation in the state-
owned firm to 50% plus one additional share: however it has always held a majority of voting shares
in Petrobras, the major and effectively monopolistic oil company since 1953, when it was formerly
established.

Oil and energy market is a strategic economic field in any country, and especially in Brazil its
regulation is the key factor for improvement and social development: the royalties paid from local
and foreign oil company to obtain the allotment of blocks for exploration, are crucial sources of
revenues to redistribute through the different states and for creating a new middle class of
consumers, saved from the poverty status. Nevertheless the royalties social function could give origin
to fiscal obstacles to the normal management of these business: if production activities would result
too expensive, also considering the governmental rules and fees, there’s the risk that the investors
could abandon the projects, causing inefficiencies and delays. The Chart 1.7 displays the production
revenues after taxes and royalties paid to Government: from the gross production income are to be
subtracted the government royalty (10%), the taxes9 (34%) for international oil companies (PIS and

9
General taxes ussually include:
- Corporate Income Tax
- Social Contributions
- Import Duties
- Value Added Tax (IPI/ICMS)
- Service Tax (ISS)
9
COFINS10) and the Special Participation (maximum 40% of net revenue), that is extraordinary
financial compensation for great volume of production or great earnings.

Chart 1.7 – Net production revenues for International Oil Companies

Gross
Production

Government
Royalty

Production
Net of Royalty
IOC's
Taxes
Perhaps Special
Participation IOC’s Production
Net of Gov't Take

Source: O.L. ANDERSON (2011)

Until 1998 have been issued 397 concession contracts to Petrobras.

From 2000 yearly rounds of bids for exploration acreage took place for 10 years: this competition for
oil exploration licenses attracted international companies, especially in the second and third rounds,
to gain the assignment of the unexplored Santos Basin area, after known as the “Santos Basin pre-
salt clusters”.

1.2.2.2 The Production Sharing Agreements regime

Under the former concession regime, the extracted oil belonged to the company that had the license
for exploring a certain area; the company then sold the oil and paid the federal government through
taxes and royalties, that consequently would be redistributed among the States.
Since 2007 the whole oil market, the entire conception of E&P on offshore has changed: the huge
volume of oil trapped in the shale of Cretaceous rocks, the high quality and commercial value of the
oil extracted and the considerably low risk of failure in drilling had have motivated the Government
to rethink the Brazilian oil regime.
As a result the Government, through the Ministry of Mines and Energy, commenced an evaluation of
possible changes to the legislation in place that conducted to the Law No. 12.351/2010: this

10
The PIS, Programa de Integração Social, is an employers’ profit participation program. The contribution value
is summed over each production step, and this sum is then a credit to the final production step; the 1.65% tax
rate is applied to the base amount in Materials Management (MM). The COFINS, Contribuição para
Financiamento da Seguridade Social, is a social security contribution. Its tax rate is 7.6% and it is based on the
acquisition and production costs (APC).

10
substituted the concession regime with the Production Sharing Agreements one, for all the
operations in the entire supply chain from upstream11 to downstream12 referring to the Pre-Salt
areas13. Under the production sharing system all oil belongs to the federal government and
companies receive a fixed share of revenues or of barrels of oil: in case of commercial findings, the
party would be reimbursed from costs incurred during the explorations getting a portion of
production, the so called cost oil.
The sense is exactly that of sharing the production rights because the exceeding oil and gas produced
(defined profit oil) would be divided between the Federal Union and the contracted party; the
companies assume all the risks of the exploration, evaluation, development and production activities
and its right to receive the recovery of the costs in oil can be exercised only in the event of a
commercial discovery; the term is 35 years maximum.
Luiz Inácio Lula da Silva, Brazil’s president at the time, justified these 2010 changes declaring that “…
you offer risk-sharing contracts when there is risk. In the case of the pré-sal, we are sure…” since in
Santos Basin Petrobras has had 100% success rate in finding oil with drilled wells, so the expected
low risks are charged only on the national and international oil companies (respectively NOC and
IOC), while the Federal Union most benefits from the overall supply chain by its Host Government
Instruments: these are all the forms of guarantees that the Government takes to assure its revenues;
their composition and different voices of costs and profit for contractors and HG are better explained
in the next Table 1.4. and Chart 1.8.

Table 1.4 – Host Government Instruments vs IOC revenues

Investors Take Government Takes

- Cost Recovery - Signature Bonus (at the PSA start)
- Investor Profit Oil Split - Royalty (10% of gross production)
- Net of Royalty - Government Profit Oil
- Net of taxes - Investor’s Taxes

Source: the author elaboration

The boxes in red represent the costs sustained by the IOC, while those in blue are the components of revenues,
the last in green is the net profit for the contractors.

11
Upstream operations concern the exploration, development and production activities, including the
research, appraisal, transport of oil and gas from the producing well to a delivery point that can be a tanker
close to the producing rigs or a pipeline to a downstream terminal.
12
Downstream operations and activities refers to the refining of crude oil, the selling and distribution of natural
gas and products derived from crude oil, including liquefied petroleum gas (LPG), gasoline or petrol, jet fuel,
diesel oil, other fuel oils, asphalt and petroleum coke. The downstream sector includes oil refineries,
petrochemical plants, petroleum products distribution, retail outlets and natural gas distribution companies.
13
The following paragraph 1.2.2 is focused on pre-salt geological definition and importance in Brazil oil market.
11
The second milestone was put through the Law 12.304/2010 which created Petrosal or Pré-Sal
Petróleo SA), PPSA, a national entity established to govern the Federal Union sharing contracts, their
marketing and the administration of new pre-salt oil production system: it owns all pré-salt deposits
and all the other areas considered “strategic” for the nation interest. ( ENERGY INFORMATION
ADMINISTRATION, 2012

Chart 1.8 – Net Contractor profit under PSA

Gross
Production
Governmen
t Royality

Profit (& contractors'

Deemed Profit) Cost Recovery
Petroleum Petroleum

Contracotrs' PPSA's Share

Share Profit Profit
Petroleum* Petroleum

Contractor's
taxes**
Contractor's Profit
Net of Gov't Take*

Source: O.L. ANDERSON (2011)

The main roles of PPSA are to manage and supervise production sharing agreements and to
represent the government in project operating committees, whose chairman and half of the
members PSA has the right to nominate. The awarding of PSA may be concluded only after the
consensus of Ministry of Mines & Energy upon advise of ANP: the first one, also, proposes to ANP
blocks to be offered at PSC bid rounds, certain technical and fiscal terms for PSC, such as Amount of
signature bonus, Host Government (HG) minimum profit-oil share, maximum annual cost-oil
allocation, minimum local content percentage.
The result is an increased state control on oil market that could fear IOC and make their entering
more awkward.

PSA may be may be executed either directly (without a bidding procedure) if the NOC is Petrobras, or
through a public bidding procedure, under the modality of auction for international oil companies;
the different awarding of the bidding blocks are defined by National Council for Energy Policy, CNPE.

12
ANP defines bid terms, conducts bid process, and determine PSA: bid terms include to define blocks,
key terms, to specify local content, to set signing bonus, to specify bidding qualifications, minimum
investments, and set bid guarantees. The criterion applied for awarding an agreement to a bidder is
the highest offer of profit oil to the Federal Union; foreign companies that take part to public
biddings could also be required to incorporate a local company.

In addition Law no. 1.276/2010 has been claimed to becomes a third regime that authorizes the
“Onerous assignment” of exploration rights from the Federal Union to Petrobras: this regulation
functions exclusively for Petrobras that has recently signed a contract with the Federal Union to
explore up to 5 billion boep in the pre‐salt areas; in addition, under PSA regime, Petrobras
participates in all the consortiums as the designated operator, in particular in Joint Ventures with
PPSA and IOC has assured a minimum stake of 30% for each project.
Empresa de Pesquisa Energética, EPE, is an advisory institution, which has the liability to elaborate
technical studies for MM&E and CNPE, which is in the second level; at the third level ANP regulates
Petrobras, at the forth level. CNPE, ANP, PPSA and Petrobras are directly linked to MM&E: their roles
and functions are interdependent and complementary14.
The following Chart 1.9 displays the hierarchical relationship between the public institutions.

Chart 1.9 – PSA regime institutions

Brazil
Presidency

CNPE
EPE
MM&E

ANP

PPSA

Petrobras

Source: O.L. ANDERSON (2011)

To coordinate the two legislations in oil market CNPE Resolution n.° 6/2007, Article 3° establishes
that the new petroleum regulatory framework must respect existing concession agreements: since
2010 has been applied a mixed regulatory regime; the existing concessions obtained by private

14
The PSA Law also created a social fund for investment in education, culture, sports, public health, science,
technology, and environment using the revenues of the pre‐salt production, including part of signing bonus,
royalties, crude oil sales and other revenues.

13
companies continue to be regulated by the 1997 Oil Law, while new laws are in force for previously
unlicensed pre-salt areas and all the other areas considered strategic by the Government.

The doubts about this regulatory change are mostly bound to the monopolistic power played by
Petrobras, as what did happen before the privatization of upstream oil market: the absence or heavy
reduction in competition could be harmful for the economical development of Brazil and,
specifically, for the E&P business. Otherwise Petrobras is reaching top quality in deep and ultra-deep
technology and its obvious minor dimension, if compared to Exxon Mobile, would mean to not win
auctions.

Another question is the strong central control held by the Government on the market: they are the
only ownership of pre-salt blocks, and, for this reason, can decide on management, on policy and
technical terms of operations. To not limit the possibility to have more revenues the Government has
declared its proprietary rights also to all the areas considered “strategic”: the definition depends on
“large volumes of petroleum produced”, that is generic because what is large for one company might
not be large for another one. However the target of this policy is the social improvement and
education: the PSA Law created a social fund for investments in schooling, culture, sports, public
health, science, technology, and environment using the revenues of the pre‐salt production,
including part of signing bonus, royalties, crude oil sales and other revenues.

The PSA regime has shacked the E&P sector, highlighting the fiscal risk and expropriation and/or
relinquishment risks ( due to the environmental licenses system and the strict requirements), but it’s
a common practice in the African and Asian oil regulation, as showed in the following Figure 1.1 in
red areas, while concession regime in green areas is the most widespread.

Figure 1.1 – Oil exploration and production regimes worldwide

Source: BAKER & Mc KENZIE (2011)

14
1.2.3 The pre-salt oil field revolution

“God is Brazilian!”
With these words president Dilma Rousseff 15has celebrated the Brazil bonanza in natural resources:
during the last years, in fact, Petrobras has been becoming one of the greatest oil company in the
world, even overwhelming Exxon Mobil within a decade (THE ECONOMIST, 2011), according to the
more optimistic engineers.

The first oil discovery in Brazil was made in 1939, it was the onshore16 oil fields17 located in
Reconcavo Basin, in the state of Bahia (Swiss Business Hub Brazil, 2011). First discoveries had no so
much value added on oil market, in fact historically Brazil was an exporter of heavy oil, that is
petroleum characterized by high viscosities and high densities, greater carbon, sulfur, and heavy
metal ratios, but importer of the light oil: in addition it mainly had refineries of heavy oil. During the
sixties Petrobras begun its offshore activities18, off the coast of the state of Sergipe, and in 1974, was
discovered the Campos Basin, the largest deposit till then. Campos Basin gave origin to the steadily
increasing role played by offshore oil fields in E&P market: following Figure 1.2 points out Brazilian oil
reserves per state in percentage of the total, whose 81% in Rio de Janeiro is wholly drilled in offshore
fields, quite the same is for Espirito Santo fields; in 2012 have been planned 66 offshore exploratory
wells, with particular focus on Espirito Santos (11 wells), Campos (16 wells) and Santos (18 wells).

Figure 1.2 – Oil reserves and offshore wells distribution per state

Source: ANP, Petrobras (2010)

15
New Brazilian President Dilma Rousseff comes to power with an extensive background in energy, having
been Secretary of Energy of the State of Rio Grande do Sul (1993-1994, 1999-2002), Minister of Mines and
Energy of Brazil (2003-2005), and President of the Board of Directors of Petrobras (2003-2010).
16
Onshore activities refers to oil and gas operations in the continent, inland.
17
An oil field is an area in a sedimentary basin where the existence of reservoirs containing volumes of
commercially producible petroleum has been demonstrated by exploration activities (seismic acquisition and
interpretation, exploration and appraisal wells, etc). A field is a commercial accumulation of oil and/or gas,
consisting of a reservoir or group of reservoirs in subsurface.
18
Offshore activities refers to oil and gas operations in the oceans.
15
Six fields in the Campos Basin, Marlim, Marlim Sul, Marlim Leste, Roncador, Jubarte, and Barracuda,
as showed in Figure 1.3, accounts for more than half of Brazil's crude oil production: the operator is
Petrobras, each one produces between 100,000 and 350,000 bbl/d of heavy oil19.
The geology of the oil shale accumulation in Campos is characterized by the Albian carbonate that is
a post-salt oil system: the rock stratus is located above the salt layer, so its biggest depth touches
4000 meters under the ocean level.
The post-salt exploratory process in the central area of the Campos Basin counted 42 discoveries and
needed 27 years to reach daily production target of 1 million bbl/d.
The big change did happened in 2006 with the discovery of Tupi oil field by the exploratory well 1-
BRSA-369A-RJS (JIMENEZ K., 2011), lead by a consortium composed by Petrobras, BG Group, and
Petrogal, which is located between 5,000 and 7,000 meters in deepwater, under an irregular and
thick layer of salt.

Figure 1.3 - Map of the Campos Basin reservoirs, oil blocks and details on first six fields

Source: Petrobras, Petroleum Geo- Service (2010)

It has been considered the Western Hemisphere's largest oil discovery of the last 30 years, so that
the former president of Brazil, Luiz Inácio Lula da Silva, called the Tupi field “the second
independence for Brazil” because it revolutionized oil exploration method in Brazil, which could
change from self-sufficient state, in 2007, to global player on international oil markets during the
next decades: the field was located in the Santos Basin (Figure 1.4), 250 km off the coast of Rio de
Janeiro, in a pre-salt, Aptian carbonate, layer below 2 km of ocean, 1 km of post-salt soil and 3 km of
salt, with an estimate of 5 to 9 billion barrels of light oil, the higher quality of oil that means a specific

19
The American Petroleum Institute gravity, or API gravity, is a measure of how heavy or light a petroleum
liquid is compared to water, so if one petroleum liquid floats on another it is less dense and it has a greater API
gravity, so its quality is better.
16
gravity of 28,5° API20, low acidity, low sulfur contents and greater value added. The stratigraphy of
the pre-salt reserves are better described by the following Figure 1.5.
In 2008 Petrobras proudly announced the discovery of other super-giant oil fields in Santos Basin:
followed Tupi (BM-S 11), then renamed Lula field in honor of former President who gave great
impulse to the operations, in a timing order Parati (BM-S 10), Carioca Sugar Loaf (discovered about
50 mi west of Tupi) and Guará (BM-S 9), Bem-Te-Vi (BM-S 8), Iara (BM-S 11), Caramba (BM-S 21),
Jupiter (BM-S 24), Azulão (BM-S 22), Iracema, as showed in the following Figure 1.4.
Before the declaration of commerciality of an oil field, the block21 to which belongs is defined as
“contingent”, under exploration appraisal, since it’s not sure if the technology will suit its particular
geology: once the seismic data collection have confirmed the possibility to enforce the production of
oil in gross scale then the block becomes “definitive”.
Consequently these blocks are classified, in the Mandatory Exploration Program, with no more risk of
losses.

Figure 1.4 - Map of the Santos Basin reservoirs and cluster of pre-salt

Source: Petrobras, ANP (2012)

In 2010 the Onerous Transfer of Rights Agreement between Petrobras and the Brazilian Union took
place: under payment of royalties it authorized the company to make research activities both in the
blocks classified as definitive and in the block classified as contingent.

20
A way of expressing the relative density of an oil or oil product is the API scale (API Gravity of the American
Petroleum Institute (ºAPI), measured in degrees, varies in inverse proportion to the relative density, so that the
API degree is higher when the petroleum is lighter. Oils with an API degree higher than 30 are considered light;
API degrees between 22 and 30 are medium; and below 22 degrees, heavy; an API degree equal to or less than
10 indicates extra-heavy oils. The higher the API degree, the greater the value of the oil in the market.
21
Block is a part of a sedimentary basin, whose boundaries are defined by the regulatory authority, in which oil
and natural gas exploration and production activities are performed.
17
 Table 1.5 - Blocks/consortia in pre-salt
Block Companies Shares Discovery/year
Petrobas* 66%
BM-S-8 Shell 20% Bern-te-vi/2008
Petrogal 14%
Petrobas* 45%
Carioca/2007
BM-S-9 BG 30%
Guarà/2008
Repsol 25%
Petrobas* 65%
BM-S-10 BG 25% Parati/2006
Partex 10%
Petrobas* 65%
Tupi/2006
BM-S-11 BG 25%
Iara/2008
Petrogal 10%
Petrobas* 80%
BM-S-21 Caramba/2008
Petrogal 20%
Petrobas* 80%
BM-S-24 Jupiter/2008
Petrogal 20%
Source: JIMENEZ K. (2011)

According to the ongoing ANP regulation, Petrobras has obtained the major stake on each block of
exploration and production, being also the sole operator for the six clusters: Table 1.5 indicates all
the partnership for the six fields and the respective percentage of stake in the project while Table 1.6
identifies all the technical terms of the Agreement signed to have the assignment of exploration
rights.
The initial contract value was 42,5 thousand of US$, that Petrobras has paid to the Union in
government bonds or federal securities denominated in Brazilian Reais, its term is 40 years from the
date of signature: for each field are indicated the volume of rights in terms of thousand of boe ceded
to Petrobras, the per barrel price, whose range is 5,82$ (Iara)/ 9,04$ (Franco), and, obviously, the
quantification of the total estimated value per block. Most of them are definitive type of blocks
because, as explained before, the success rate of discovery had been by 100%.

Table 1.6 - Onerous transfer of rights agreement terms

Volume of Onerous Volume of Total valuation of the
Field Name Block Type Transfer of Rights the Barrel Onerous Transfer of
(Thousand of boe) (U.S. $/boe) Rights (U.S. $ thousand)
South Tupi Definitive 128,051 7,85 1,005,197
Florim Definitive 456,968 9,01 4,207,380
Tupi NE Definitive 427,784 8,54 3,653,275
Peroba Contingent - 8,53
South Guara Definitive 319,107 7,94 2,533,711
Franco Definitive 3,056,000 9,04 27,644,320
Surrounding of Iara Definitive 599,560 5,82 3,489,437
TOTAL 4,999,468 42,533,320
Source: JIMENEZ K. (2011)

In addition to the heavy costs of exploration, pre-salt development presents numerous technical and
operational challenges due to the huge depth and pressure that the deepwater drilling rigs find

18
through the perforation of the Cretaceous rocks: the Figure 1.5 puts in comparison the post-salt
reservoirs of the previous oil fields, in Campos Basin, and the field of Tupi at 7000 m depth.

These types of wells penetrate the reserves by drilling also up to 2000 m of salt: the impact of the
carbon dioxide (CO2) on production apparatus, above and below the water level, depends in its
different densities (usually it can vary from a minimum of 8% to a maximum of 55%) (BECKAM J.,
2011) and make the exploration and development work riskier and more complex.

The development activities started once the exploratory wells has given the expected positive results
in 2009. The first oil drilled in the pre-salt layers needed about one year and cost 240 million US$ to
Petrobras:, on May 1st of the same year Petrobras started the first oil production of Tupi in small
scale, by the mean of the Extended Well Test, EWT, with the staff of the Floating Production Storage
and Offloading FPSO22, the converted Cidade de São Vicente vessel.
These special vessel have become fundamental in the E&P chain because they make an amalgam of
marine and petroleum functions, receiving crude oil from deepwater wells and storing it in their hull
tanks until the crude can be pumped into shuttle tankers (moving oiler that cover the distance
between the coast and the drilling rig) for transport to shore. Its relevance and technological
challenges have driven a specified business, in the shipyard sector, that will be widely discussed in
the following chapters.

Figure 1.5 – Pre-salt layer composition and extraction depth

23
Source: Petrobras, COPPE UFRJ (2011)

22
The following paragraph 1.2.3 will better explain the function of FPSO.
23
COPPE-UFRJ Instituto Alberto Luiz Coimbra de Pós-Graduação e Pesquisa de engenharia: The Alberto Luiz
Coimbra Institute for Graduate Studies and Research in Engineering , helped renew Brazilian universities;
thereby contributing to the country’s overall development. Founded in 1963 by the engineer Alberto Luiz
Coimbra, the institution made it possible to create graduate courses in Brazil. Over the course of the last four
decades it has become the most important center for engineering research and education in Latin America.
19
Brazil currently produces 2,1 million barrels/day of oil from its deepwater fields, and by 2020 the
company plans to be pumping 4.9 million b/d (Chart 1.10), whose 40% from the pré-salt reservoirs,
and exporting 1.5m b/d.
Today Brazil is the 11th largest oil producer in the world, and, if the expectations of Petrobras are
correct , by 2020 it should be in the top five greatest producers: in particular the following Chart 1.10
highlights the previsions made by Petrobras and OGX, another strategic Brazilian oil company that is
run by Mr. Eike Batista: the least expects to be pumping 1,4 million of barrel of equivalent oil in 2020
vis-à-vis 6 million for the state-owned company.

Chart 1.10 - Oil and gas production

Source: Petrobras and OGX (2012)

1.2.4 PLANSAL: the Master Plan for Santos Basin’s Pre-Salt Cluster
Development

The overall area of pre-salt fields spread from the south of the Santos Basin to the north of the
Campos Basin and, according to the majority of technicians, the total recoverable pré-salt oil now
come at 50 billion barrels, with a success rate of 85%, which is a notable percentage if compared to
the industry average of 30%: a little less than all the oil in the North Sea concentrated in the waters
of one country. That’s why Mr Gabrielli, the president of Petrobras, has recently emphasized the
distinction between “exploration risk”, which seems low for the pré-salt, and “development risk”
(THE ECONOMIST, 2011), which is high for the challenges implied by the huge depth.
The disaster of the last year in the Gulf of Mexico has revealed how risky and awkward are these
ultra-deep drilling projects. The salt shifts during drilling, making the oil too hot when is coming out

20
of the reservoirs: that’s why new seismic techniques24 are needed to overwhelm the geological limits
of such these fields.
The Master Plan for Santos Basin’s Pre-Salt Cluster Development or PLANSAL, contains the strategies
that guide the E&P projects for these unconventional oil reserves. The first version of this plan was
developed in 2008: it was divided into what is called “Phase 0” and “Phase 1”.

During the Phase 0 they collected all the geological data and simulations results in order to improve
the definitive production systems to be implemented in the pre-salt blocks. It is expected to last in
the period 2008/2018.

It consists in a series of extended well tests (EWTs)25 installed through:

 two relatively small duplicate floating production, storage, and offloading facilities, FPSO,
vessels;
 13 exploratory wells;
 a production Pilot in the Tupi started in the last quarter of 2010 using the multiple FPSO
Cidade de Angra dos Reis, come into operation since 28th October of 2010.

From 2001 to 2004 Petrobras has realized the largest 3D seismic acquisition and interpretation in the
world of complex intra-salt deformation: the company is still working on the ideal geometry for
deviating wells through the deep salt layer, especially with bilateral, radial and horizontal
multifractured drilling, that can perfectly suit to the movements of layers of salt.
The Cidade de São Vicente FPSO is directly connected to two well producers RJS-646 and RJS-660,
which submit technical testing in order to achieve the Declaration of Commerciality for the field.
After installing 13 exploratory well drilled by Petrobras with 100% success rate in Santos Basin, on
May 1st 2009 Tupi EWT produces the first commercial oil.

24
Among other exploration technologies the seismic method is by far the main and most utilized one: it
consists basically in an energy source and receivers. 1)Signals are transmitted from the source down into the
rock layers; 2) some of the energy is reflected in the interfaces between different rock layers; 3) reflected
signals are collected by receivers and 4) transformed by computers in images reflecting the distribution and
other properties of the rock layers in subsurface. Composition, fluid content, extent and geometry are some of
the rock attributes that can be extracted from the seismic data.
25
These are tests of longer duration than conventional tests, performed during the Exploration Phase, for the
exclusive purpose of obtaining data and information to find out about the behavior of the reservoir and fluids
during production.
21
 Figure 1.6 – 3D seismic simulation, map of the Tupi Northeast prospect (base salt depth)

Source: Petrobras (2012)

The first EWT on Lula during 2009/2010, revealed good well productivity, but also a complex oil
composition with a high gas-oil ratio and high levels of CO2: these results led Petrobras to revise its
well perforation strategy, successively overcome, as mentioned, with the first horizontal well.
In 2012 will start the production of Guarà Pilot with FPSO Cidade de São Paulo.

Phase 1 is dedicated to definitive production systems installation and is subdivided into two sub-
phases:

 Phase 1a aims to exceed production of 1 million bopd operated by Petrobras during the
period 2013/2017, using consolidated technologies from the Campos Basin tests adapted to
Santos Basin conditions and taking advantage of possible synergies and scale to permit cost
reduction;
 Phase 1b will start since 2017 and will strengthen the technology innovation and overcome
all the risks and problems linked to the peculiarity of rocks drilled, as the formation of
unwanted by-products during pre-salt production.

The pre-salt has potential to achieve the same level gained in the North Sea through 11 years and in
Gulf of Mexico in 24 years, in 12 years: daily production of one million bbl.

Chart 1.11 - Petrobras Business Plan 2010/14 vs 2011/15

BP 2010-14 US$ 224 billions

BP 2011-15US$ 224,7 billions

Source: Petrobras (2012)

22
Petrobras business plan for 2011/2015 plans to invest $224,7 billion, most of the spending will be
focused on exploration and oil production, which will receive 57% of the total capital, and US$ 22,8
billion for exploration only (Chart1.11): the company is shifting its investments from downstream
activities to focus on the domestic upstream sector.

1.2.5 Internationalism and Local Content restrictions

International companies also play a fundamental role in Brazilian oil market: the prime minister
Dilma Rousseff had declared that "..there is a unique opportunity available right now for private and
state-owned participation..," referring to the discoveries of large reserves made in the last decades in
the country's deep waters: these words mean that Brazil is open to international companies, private
or state-owned, that are willing to invest in the pre-salt fields (Chart 1.9). Many international oil
companies came to Brazil in 2000 and 2001 to take advantage of opportunities in the 2nd and 3th bid
rounds: Royal Dutch Shell was the first foreign crude oil producer in the country, followed by
Chevron, Repsol, BP, Anadarko, El Paso, Galp Energia, Repsol, Statoil, BG Group, Sinopec, ONGC and
TNK-BO. This relevant influx of capital cause the so called “Dutch Disease”26: it is the risk to hurt the
industrial sector of a national economy that happens when the huge discovery of a natural resource
raises the value of the national currency: imports increase and exports decrease because
manufactured goods are less competitive on international trade, they are too much expensive.

Table 1.7 – International players in Brazilian oil market on May 2011

Exploration activity
Offshore production Onshore production
Company (number of drilling
(boe/d) (boe/d)
rigs in operation)
Petrobas 68 1.736.454 174.916
Shell 1 46.960
Chevron 2 36.870
BG 14.369
Statoil 2 14.131
Frade Japao 13.051
Devon 7616
ONGC 1 8954
SK 5078
Repsol YPF 4794
Petrogal 3 4243 98
OGX 8 -
HRT O&G 3
Imetame 2
Total 98 1.894.352 177.333

Source: ONIP (2011)

26
The term originated in the Netherlands after the discovery of North Sea gas in 1959

23
Petrobras is by far the biggest player in Brazil oil and gas industry, but multinational companies are
active and private Brazilian companies are emerging, like OGX (of Eike Batista’s EBX group) and HRT
O&G, both heavily investing in exploration staff.
The previous Table 1.7 gives an idea of the relative importance of the different players according to
the Brazilian Institute for Oil, Gas and Biofuels, IBP till May 2011.
The only two Local companies are OGX and Petrobras, the first is a private company while the second
is a mixed capital company whose major stockholder is the Brazilian government: even if at a
previous stage, OGX counts the major number of drilling rigs, after Petrobras, while Shell is the most
productive IOC.
This E&P market is characterized by high level of capital absorption to achieve the technological
requirements: the largest oil companies, Petrobras and Statoil, have the best conditions to work in
this business scenario, but other important players who can contribute to total investments planned
for Brazil upstream segment are:

 BG group, whose 2010 gross capital expenditure commitment has been of 13 billion US$ and
plans to invest more than 30 billion US$ by 2020;
 The Anglo-Dutch company Shell, the first to produce in the country after the end of
Petrobras monopoly, has already invested over 3 billion US$ and plans to invest more,
drilling up to ten exploration wells in the next years;
 Norwegian Statoil has in the Peregrino field, in the Campos basin, its largest international
project: with a production of 40.000 boe/day and planning on reaching 100.000 boe/day by
2012, the company estimates the total capacity of the oil field in approximately 600 million
boe, recoverable over 30 years of production;
 China Petrochemical Corp’s (Sinopec) that purchased 40% of the Brazilian branch of Spanish
Repsol, creating Repsol Sinopec Brasil, its investment in Brazilian oil and gas reaches US$ 7,1
billion;
 HRT , that announced investments about 3,1 billion US$ until 2014;
 OGX, that has already invested US$ 3.2 billion since 2007 and is to invest US$ 4.5 billion more
by 2013 in the search for oil and gas, it plans to produce 730.000 boe/day by 2015, reaching
1.38 million boe/day in 2019.

All these companies active in the oil and gas industries are members of the IBP, the Brazilian Institute
for Oil, Gas and Biofuels, a private organization that counts 194 associated companies, and of the
ONIP, the National Organisation of the Oil Industry, that include companies from the upstream,
midstream and down-stream segments.

24
This wave of discoveries is making Brazil one of the leaders of oil reach countries on the international
arena: nevertheless its main problem, poverty and social inequalities, can constrain and re-dimension
this impressive economical boom in Brazil. Perhaps the biggest challenge is led by the strict local-
content requirements that the government has imposed on all the pré-salt projects.
It consist in making compulsory a percentage of contractual commitment of purchasing local goods
and services in a competitive basis: the finality is clear and important, to enrich Brazil GDP, its
population and human resources, creating thousands of job, elevating both the unlearned and
graduated masses of workers, redistributing incomes and constituting the middle class that will
foster domestic demand for goods and consumption.
Local content was required in all bid rounds, but, from the first to the least one, the rule have been
progressively changing: free local content offering have been substituted by a minimum and
maximum threshold of offering granted by certification, released by a third party.

In particular local content must represents 20% of the final score:

 5% to exploratory phase: for what concerns deepwater blocks ( depth > 400 m) this phase
requires from 37% to 55% of LC;
 15% to development phase: for what concerns deepwater blocks this phase requires from
55% to 65% of LC;
 ANP monitoring and auditing the contractual local content requirements enforcement.
 Value added concept:

If implemented successfully, the local content policy will have high impact and can generate over 2
million jobs by 2020: the job creation gives impulse to the formation of the middle class that is
responsible for the internal demand development, the only real driver for Brazil economy.
However this compulsory domestic production of goods and services could also turn out an
economic trap: according to Booz & Company, a consultancy agency, Brazilian suppliers for the oil
and gas industry charge from 10% to 40% more than world prices, pushing up costs and causing
costly delays in the timeline of production and projects accomplishment.
The other problem is the scarcity of staff, Brazil labor market is so tight that employers define it a
“labor blackout”: when Aker Solutions, a Norwegian oil-services company, explained weak results in
August, it explained the diseconomies in Brazil by accusing “too many inexperienced people” (THE
ECONOMIST, 2011).

25
26
 SECOND CHAPTER
OGX: the golden opportunity in the black gold market

“ … virtute duce, comite fortuna ...”

(with the virtue as the guide and the fortune as companion)

- Marco Tullio Cicerone, Epist. ad Fam., X, 3 -

2.1 Petròleo e Gàs Participações S.A.

In the flourish megalopolis of Rio de Janeiro is headquartered Petròleo e Gàs Participações S.A. or
OGX company, the largest private company1 in Brazil oil and gas market, one of the 15 largest pure
exploration and production companies worldwide, as defined by Bloomberg.
The acronym OGX stands for Oil and Gas limited company, while the final X is a multiplying sign that
symbolizes the power of profit making and production increasing at a geometrical pace, which is
present in each of the companies name of EBX Group.
Since it was founded in 2007, OGX has already invested more than 9 billion $ in its activities in Brazil,
which makes the company the main private investor in the oil and gas sector in the country, but it’s
not the only goal the company wants to achieve: OGX aims to become the largest private producer of
oil and gas in Brazil and, in order to do this, it is developing projects which consolidate the value of its
assets and create strong operating revenues for next decades.
Its pillars and principles are the same that interest all the EBX group, so it’s useful, to better
understand what’s the managerial conception of OGX, to take a look on the holding principles and
structure.

1
S.A. stands for "Sociedade Anônima" until 1991, and "Sociedade por Ações" for Brazilian private company.

27
2.1.1 EBX: the 360° Vision by the German-Brasilian visionary

Thirty years about has been the time needed to build his empire, EBX Group, or, better, Eike Batista
Group, an infrastructure and energy focused holding that covers all the most strategic areas for Brazil
economical development: probably taken by its founder initials name (E.B.), EBX is a conglomerate
company that has made its success thanks to the great resources that have blessed Brazil country,
but, above all, thanks to the dynamic, intuitive, rational entrepreneurship signed “Batista”.
The group stakes spread, in fact, from iron-ore miner MMX Mineracao e Metalicos SA (MMXM3.BR),
to power generator MPX Energia SA (MPXE3.BR, MPXEY), logistics LLX Logistica SA (LLXL3.BR), coal
(recent spin-off from MPX) CCX SA (CCXC3), oil OGX (OGXP3) and offshore industry OSX Brasil SAN
(OSXRY, OSXB3.BR) companies.

The five companies (except for CCX) are publicly traded and listed on the BM&BOVESPA Novo
Mercado, a segment of the Brazilian exchange market that presents the highest level of corporate
governance requirements to be listed and traded: the best practice required translates into equal
rights for shareholders, that is one share/one vote policy, open dialogue with all the stakeholders,
Board of Directors whose 30% composition, on average, is made up of independent members,
frequent meetings with the investors, availability of a reporting channel for employees, financial
statements written in accordance with international accounting standards available both in
Portuguese and in English version.
Still EBX is a giant economical reality that require some specific concepts in doing business, which are
sharing knowledge, the first milestone of the winning formula for its success, respecting financial
discipline and social responsibility, making only transparence communications both inside and
outside the company, believing in the good ideas for the progress and the wealth of the whole
country.

This industrial colossus is the creature of a smart mind, that of Eike Batista: with his German
perfectionism received from mother, and his devotion to Brazilian economical projects received from
father, Eliezer Batista, Brazilian mining industry legend who once ran iron ore giant Vale,
businessman Batista has been crowned in 2011 by Forbes, the U.S. magazine dedicated to
economics, finance and business, the richest Brazilian in the world, beyond occupying the 8th
position in the global classification, thanks to his estimated US$ 30 billion of wealth.
However there’s much more than a huge fortune: he’s the man under the Group who, first, theorized
what he likes to call the “360° Vision” for carrying out a business. His strong engineering background
permeates all his activities and ways of managing, making the precise analysis and interconnections
among the different company’s areas his usual “habitus vivendi et laborandi”.

28
It’s possible to say that he has rearranged the Jigoro Kano’s philosophy, lit. “The mind before the
muscles”2, where, for muscles, is intended the financial and natural resources that are “conditio sine
qua non”, necessary conditions but not sufficient to create and hold enterprise value long lasting,
and the mind is the capability to organize and coordinate all the areas and fields of production.
Batista’s vision at 360°, in fact, considers all the nine managing functions, financial, legal, fiscal,
political, logistical, environmental and social communication, human resources, health and safety, as
different engineering sciences that, directly bound to the engineer science strictu sensu, collaborate
at the same level, opening the horizons and not limiting each others, but making also the details,
belonging to each segment, relevant for the common target achievement.
The EBX logo, which is the first contact between the company and the public, is characterized by a
simple layout that highlight this innovative vision of integration and collaboration: the sun gives
immediately the idea of strength, light, clearness, leadership and passion, all attributes that the
different companies want to embody through their management; the -X, as said before, is the
capacity for accomplishments, transformation and multiplication of wealth, talents and values for
each company of the group; the three parallel horizontal lines, that seem to support the brand
elements, refer to the Chinese ideology of the perfect equilibrium between the Earth, humanity and
the sky, precisely symbolized by the three continuous lines, as to constantly remember that the pillar
of each company stands in the harmonious balance among its functions.
The choice to build a conglomerate group of such dimension assume, hence, a greater value added,
in the 360° vision: effectively, the different companies separately operates in each field, but
frequently share long term investments to realize common projects, benefiting from economies of
scale and scope.
The vertically integrated structure in the oil industry has had some success, especially in the “super
majors” cases, as British Petroleum, Chevron Texaco, Exxon Mobil, Total and Petrobras itself:
upstream, midstream and downstream oil industry is operated in the same company and evidence
generally shows positive correlation between size and performance.
However there are several doubts about this operation enlargement: the skills needed to run
different businesses are so diverse and specific for sector (i.e. the exploration operations vis à vis the
refining step) that a central team of managers will not likely be able to operate as efficiently as a
focused one, and there is always the dilemma trade-off between reinvesting in growth and
maintaining high returns on capital.
An important characteristic of these vertically integrated companies that, partly, gives some answers,
is that what we see in the oil industry today is not vertically integrated operations, but, rather,

2
J. Kano is the founder of Judo Kodokan martial art at Tokio in 1882: his theory is based on his point of view of
judo and life, stating that the first is not only a physical activity but, priory, it’s an attitude to live using all our
energies, rationality and capabilities in order to be the most efficient possible, also being socially useful.
29
vertically integrated ownership, or what might be described as “financial vertical integration” (ANTILL
N. et al., 2004): EBX is the example that embodies the main and many advantages of such this
category.

In Figure 2.1 is represented the Group structure and its controlling participations hold by EBX in the
different companies: this structure reflects the formula of ownership integration that take the
positive aspects from both the types of oil company ( that of “super majors” and that of “niche”
focused companies).
Each single company of the Group is highly specified, in fact they are led by seasoned professionals
for their sector, so best practice of governance applied considers as prime financial goal, that to
maximize the net present value (NPV) of expected future cash flows for each project, rather than
using return on capital criteria (ROIC): the Corporate policy governance of OGX, in an official
document defines “the Best Practices of Corporate Governance (is that) designed to increase the
company’s value, facilitate its access to capital and contribute to its continued success”.

Figure 2.1 – EBX Group structure

Source: EBX

Under the direction of a central corporate staff of EBX, as major oil companies do, the cash flow
generated in excess by one company can be redistribute for new business opportunities or to
another with a capital need. EBX, indeed, benefits from the fact to be a solid, big Group that can
count on the cash generated by the single company, so it’s easier to rise funds to further direct to a
specific project: on March 2012 EBX sold a 5.6% stake to Mubadala Development Corporation, the
Abu Dhabi government sovereign-wealth fund, for 2 billion US$, which means having evaluated the
Group about 35 billion US$.
Surely the cash injection has been using to boost exploration investment of OGX, especially after
having obtained optimistic results by appraisals wells in Campos Basin: most companies are in the
early or start-up stages, i.e. OSX and shipbuilding project, so they need a massive influx of capital to
become cash-flow positive.
30
In this perspective EBX can be seen as a diversified industrial conglomerates, a collections of
autonomous operating businesses, each one maximizing its profitability, that are under the
supervision of a corporate center. According to the engineering visions of the areas enhanced by
Batista, each sector, mining, energy, logistic, oil, offshore services, is as the Lego little combinable
bricks that can be assembled with the most “suitable” other bricks: OGX itself has created a Joint
Venture for a common sub-project with dedicated assets, whose special purpose vehicle is named
“OGX Maranhão Petròleo e Gàs S.A.” for the investments in exploration and production development
for gas reserve in Parnaiba basins, in which OGX holds a participation by 66,67% and MPX by 33,33%.
It’s an important milestone in creating synergy between OGX and MPX: in the Memorandum of
Understanding, signed by the two sister companies, they formalize the intention to execute an
agreement for the SPV to supply natural gas to thermoelectric plants to be developed by MPX in that
area. In brief, the result of this synergy is a developed chain of value for gas production and
exploitation: OGX extracts gas onshore, sharing costs and operational risks with MPX and Petra
Energia S.A., than brings it to the Gas Treatment Unit in construction phase in the Parnaíba Basin,
which will process the gas produced to remove the liquid in it, so a gas pipeline will deliver the ready
processed gas to MPX Parnaíba Thermoelectric Unit (TEU).
Another relevant example of synergic cooperation and interaction among companies that let de-
leveraging the projects risk figures, lowing the costs, avoiding taxes on intermediate goods and
creating value for the Group, is the Superport of Açu3 project. This massive capital transfer will be the
outcome of a perfect synchronization among the expertise staff of MPX, LLX and OSX, each for its
field and activities: in the South of Rio, LLX is now building a $2 billion estimated Açu superport,
which will be powered by MPX and able to host giant vessels equipped by OSX, carrying oil produced
by OGX and minerals extracted by MMX.
The sharing of specific knowledge of one field with another make possible also the realization of JV
dedicated to other marginal affairs that reduce the risks by business diversification: an example is
OGMP Transporte Aéreo, a Joint Venture between OGX SA and MPX Energia S.A.

In conclusion the EBX Group has benefited on numerous aspects from its vision and ownership
integration (Chart 2.1):

 Economy of scale, tax minimization, low costs;

 Brand consolidation, business diversification, risks sharing;
 Efficiency in decision-making process and budgeting choices;
 Sharing of technological expertise and know-how.

3
The third chapter will better explain this project in OSX view point.
31
2.1.2 OGX: company overview

OGX is the oil and gas exploration, production and trading company of the EBX Group.
It was founded in 2007 and in June 2008, the company went public raising 4,1 billion US$4
(equivalent to 6.7 billion Brazilian Reais R$5), the largest amount ever raised in a Brazilian primary
IPO at that moment: as seen before, the EBX Group, represented by Centennial Asset Mining Fund
LLC in Nevada, holds 61% of capital, while the last 39% is of free float.
Its corporate governance is strongly centralized, holding a solid cash position, with 3,6 billion US$ in
cash (as of 31st March 2012 data issue,) enough to fund new investment opportunities (exploratory
concession bids, farm ins, farm out6) and finance the exploratory campaign and production
development for the next several years. Its values are the same that characterize the whole Group,
but one of its competitive advantage is the highly skilled and expertise team of top management:
most members have a track record of works and collaborations with Petrobras, in particular the
previous Chief Executive Officer of OGX, Mr. Paulo Manuel Mendes Mendonça, whom Batista refers
to as "Dr. Oil" (O’ KEEF B., 2011), had been head of Petrobras Exploration Division from 2002 to 2007,
being crucial resource for Lula field discovery and appraisal, the most successful exploratory
campaign in Brazilian history (the focus on Tupi revolution has been treated in the First Chapter).
OGX is the largest private company in Brazilian oil industry, even being a young company that directly
compete with the giant state-owned Petrobras; its ambitious goals and its positive results are the
outcome of a strategy of development based on two main value driver so resumed:
 “Inside” excellence: geological diversification of exploration campaign + experienced
management and qualified professionals;
 “Outside” excellence: strategic alliance with international offshore leaders + synergies within
the Group.
It’s useful and interesting to better analyze each driver in its value creation function for OGX itself
and the sisters companies: the separate treatment is only an exposition order need because, really,
they are interconnected and influence each other.

2.1.2.1 Inside excellence

OGX is conducting the largest private sector exploratory campaign in Brazil, having drilled more than
100 wells till now: it has a diversified, high-potential portfolio, that consists in 30 exploratory blocks,

4
Includes cash and cash equivalents, marketable securities and restricted deposits.
5
Exchange rate used by the company is: US$ 1.00 = R$ 1.8121.
6
With the terms Farm-in/Farm-out is intended the process of partial or total acquisition or sale of concession
rights held by a company; within a single transaction, a company that is acquiring the concession rights is in the
process of Farming-in and a company that is selling the concession rights is in the process of Farming-out.
32
 whose 21 of them acquired during the 9th Bidding Round on November 2007, distributed in the
Campos, Santos, Espírito Santo, Pará-Maranhão basins7, which total extension area is of
approximately 7000 km², under the payment of US$ 813.034, relating to the subscription bonus for
the exploratory concessions rights.

Table 2.1 – OGX portfolio of reservoirs

Potential
Initial
Volume
Basin Block Operator Participation % in OGX blocks Years(*) Occupation
of billion
fee (US $)
boe
BM-C-39 70% (OGX Campos); 30% (OGX
BM-C-40 Ltda.)
BM-C-37 35% (OGX Campos); 35% (OGX
Campos BM-C-38 OGX Ltda. Ltda.); 30% Maersk Oil Brasil Ltda. 3+2 427,89 5,7
BM-C-41
70% (OGX Campos); 30% (OGX
BM-C-42
Ltda.)
BM-C-43
BM-ES-37
BM-ES-38
Espirito- 50% (OGX Ltda.); 50% (Perenco
BM-ES-39 PERENCO 4+2 427,89 0,8
Santo Petròleo e Gàs do Brasil Ltda.)
BM-ES-40
BM-ES-41
BM-S-56
BM-S-57
3+2 428,47
Santos BM-S-58 OGX Ltda. 100% (OGX Ltda.) 1,8
BM-S-59
BM-S-29 3+3+1 269,55
BM-PAMA-13
BM-PAMA-14
Parà-
BM-PAMA-15 OGX Ltda. 100% (OGX Ltda.) 4+2 152,09 0,4
Maranhão
BM-PAMA-16
BM-PAMA-17
50% (OGX Maranhão); 16,67%
(Imetame Energia S.A.); 16,67%
BT-PN-1 (Orteng Equipamentos e Sistemas
Ltda.); 16,67% (delo Engenharia
Mecãnica Ltda.)
BT-PN-4 OGX
Parnaiba 4+2 14,22 1,0
BT-PN-5 Maranhão
BT-PN-6
70% (OGX Maranhão); 30% Petra
BT-PN-7
Energia S/A
BT-PN-8
BT-PN-9
BT-PN-10
Source: OGX and ANP (2012)

7
The oil company also has 5 onshore of gas accumulation in Parnaíba Basins and 4 onshore exploratory blocks
in Colombia. In June 2010 OGX was awarded the contracts as a result of its winning bids for 5 exploratory
blocks in the Open Round Colombia 2010 in the following onshore basins: Mid Magdalena Valley (Valle Medio
Del Magdalena), Lower Magdalena Valley (Valle Inferior Del Magdalena) and Cesar-Ranchería for an extension
of 12,000 km² of land.
33
OGX has so many reserves and a production growth path that rivals some of the smaller members of
the Organization of Petroleum Exporting Countries (OPEC) (BARNES J. 2011).
The complete collection of exploratory blocks under concessions actually hold by OGX is displayed in
Table 2.1, with all the relevant information about the participation percentage, and governmental
taxes paid, the period of concessions the potential recoverable volume.
The aggressive campaign of exploration enforced by OGX has been strengthened by the massive
consolidation of its participation in blocks stakes, also being the only operator for its concession
areas: OGX was in consortia with Maersk Oil Brasil Ltda, for what concerned BM-S-29 block in Santos
Basin, from whom has acquired the whole percentage on 2008/2010 years, and Petra Energia Ltda,
which holds the remaining 30% in the seven onshore exploratory blocks in Parnaiba basins.
In consideration of the strategic role played by the Campos reservoirs, for what concerns oil, and on
Janauary 2011 OGX Ltda carried out for OGX Campos, a partial spin-off of the net assets
corresponding to 70% of its rights and obligations in the concession agreements for the Brazilian
blocks BM-C-39, BM-C-40, BM-C-41, BM-C-42 and BMC- 43, and corresponding to 35% of the stake in
blocks BM-C-37 and BM-C-38, all located in the Campos basin and evaluated US$ 847,788.
Definitely OGX Ltda. continued with 30% of the stake in these blocks, except for BM-C-37 and BM-C-
38 where it retained a 15% stake, and Maersk continued as the operator: on March 2012 the ANP
approved OGX Ltda.’s acquisition from Maersk of an additional 20% stake in blocks BM-C-37 and BM-
C-38, so that it rose from 15% to 35% and the Company became the operator of both concessions,
while the stake held by OGX Campos in the two concessions remains at 35% and Maersk’s has fallen
to 30%. (Figure 2.2).
Campos exploratory blocks of OGX are considered low risk, if compared to ultra deep-water field, so
it has recorded a success rate of 100%.

Figure 2.2 – Bacia de Campos basins, Sector SC-AR4

Source: ANP (2012)

34
A similar path has interested the Parnaiba basins of gas accumulation: on September 2011 OGX
Maranhão (another dedicated spin-off) acquired 50% of the stake in the PN-T-102 block in the
Parnaíba basin from the consortium comprised of Imetame Energia S.A., Delp Engenharia Mecânica
Ltda. and Orteng Equipamentos e Sistemas Ltda, becoming the operator. In 2011 OGX presented to
the ANP the declaration of commerciality and development for the Gavião Real and Gavião Azul
fields, the first two natural gas fields developed by the company, with an estimated available
production capacity of about 6 million m3 /day beginning in 2013.
OGX exploratory acreage located in the deepwaters of the offshore Espirito Santo basin (-1000 m)
count five exploration concession contracts acquired in the ninth round of licensing of the ANP,
which are held in a joint venture partnership with Perenco who retain the remaining 50% interest,
and is the operator. ( see Figure 2.3)

Figure 2.3 – Espirito Santo Basins, Sector SES-AP1

Source: ANP (2012)

Figure 2.4 – Santos Basin, Sector SS-AR2 EP

Source: ANP (2012)

35
Important results have been achieved in the Santos Basin, the fields that mostly attracted
international investors for its pre-salt reservoirs (Figure 2.4): OGX has declared the discovery of the
Fortaleza accumulation ( BM-S- 57 block, both post- and pre-salt layers in the shallow water, -150 m)
through wildcat well OGX-63, and the confirmation of the presence of light oil of 38° API in the Natal
accumulation ( BM-S-59 block) through the appraisal well OGX-74.
Considering the high potential volume of recoverable oil, Santos Basins exploratory rate of success is
about 65%, a relevant value for these depth.

Since its initial public offering in 2008, OGX's resource base has more than doubled from 4.8 billion
barrels of oil equivalent: reservoir engineering firm DeGolyer and MacNaughton, leading consultant
in reserve certification for the oil and natural gas industry8, estimate OGX actual net resource
potential is 10.8 bboe, whose 5.7 bboe of its resource potential is located in the offshore Campos
Basin (shallow water -120 m), with 46 wells drilled (26 wildcat wells, those one that are used for
discovery operations, and 20 appraisal wells, those one to evaluate the discovered accumulations in
order to declare them regular reserves of oil).

OGX currently has nine rigs available for drilling in the Campos, Santos, Parnaíba and Pará-Maranhão
blocks, including six semi-submersible rigs, two onshore rigs and one jack-up; seven rigs are in
operation and the remaining two are currently being mobilized.

2.1.2.2 Outside excellence

OGX objective to reach excellence in the oil sector and being the largest private company in Brazilian
market is more and more a reality, thanks to its ambitious strategy of development and external
collaborations: till now the oil company has invested 5 billion US$ for the intense and robust
exploration operations.
OGX closed the first quarter of 2012 with 354 employees of its own and about 6000 outsourced
workers, responsible for all the administrative, exploration and production of petroleum activities.
In consideration of the particular technology required by offshore drilling activities OGX has
contracted collaborations with suppliers for equipment and know-how which are of first class level
on international scenario:

 Schlumberger: leader for integrated engineering services (4 years contract) + consulting

services for artificial elevation and guaranteed drainage (1 year contract);
8
The estimates were elaborated based on probabilistic and deterministic studies associated to geological and
engineering standards accepted by the Society of Petroleum Engineers (SPE), World Petroleum Council,
American Association of Petroleum Geologists and by the Society of Petroleum Evaluation Engineers methods.
Probabilistic and deterministic methods were used in the uncertainty analysis for discoveries and oil volume to
be potentially discovered.
36
  Baker Hughes: leader for integrated engineering services (1 year contract) + submersible
centrifugal pumping ( 4 years contract);
 Diamond: leader for semisubmersible platform (Ocean, Ambassador, Lexington, Ocean
Quest, Ocean Star for exploration drilling campaign in execution of PEM during the first
phase);
 V&M: leader for tubes (4 years contract);
 MI Swaco: leader for drilling fluids (4 years contract);
 Smith: leader for fishing and drilling tools (4 years contract).

For what concerns the logistic supports and facilities OGX investment include: 8 support vessels
(supplied by Edison Chouest, Norskan and Maersk) and 4 helicopters (supplied by Aeròleo).
The recent events have awarded OGX massive investment and capital expenditures by the start of oil
production in Waimea accumulation in Campos basin: the 2D/3D seismic data collection studied
thanks to wildcat wells explorations, the subsequent appraisal wells positive outcomes declared the
passage to the next phase of development and production ( ANP recognizes 27 years time for it).
The next steps refer to the legal compulsory path in order to declare the commerciality of the
reserves involved: the official environmental permission by IBAMA and ANP approval for
development plan submitted by OGX, that will be further discussed.
The first oil production started on January 31st 2012 through an Extended Well Test (EWT) which
confirmed the high productivity of the reservoir: these operations required specific equipment
acquisition that involved both external suppliers and internal of the Group suppliers (OSX).
The beginning of production in two accumulations, Waimea (BM-C-41 block) and Waikiki (BM-C-39
and BM-C-40 blocks) complex in Campos Basins, of proved reserves is a significant advance in the
company business plan execution: it deserves more attention because it makes the company in
contact with the oil market operators for the gross sale of extracted one, and has given impulse to
the sister company OSX, both for leasing and for shipping activities.

2.1.3 OGX investment for development and production phase

Since their discoveries, offshore fields of oil and gas had mobilized huge resources for the
acknowledgment and the accomplishment of undersea drilling operations.
Main leaders for deep water technology are in north Europe, such as Netherlands companies of level
of Aker Solution, but Brazil, so interested by this new frontier of exploration methods, is now
covering its technological gap in order to benefit from its natural oil bonanza.

The expression “well intervention” or “well work” refers to any operation carried out on an oil well
during its productive life that alters the state of the well and its geometry, providing well monitoring
37
and maintenance. Subsea well interventions present many challenges and require much advanced
planning for their execution: the high cost of subsea activities has, in the past, inhibited the
intervention but in the current context of schizophrenia towards deep water solution, the cost limit
has been overcome. The pre-operational activities necessary for the production of oil have involved
the acquisition of a number of specific offshore equipment and operations following described and
showed by the respective images in the next Figure 2.5 and 2.6

1. A Wellhead Platform (WHP) are platforms made of steel structures installed at the top
operating site on vertical structures that are called jackets, held into the sea bottom, in
shallow water. While drilling the oil well, surface pressure control is provided by a blowout
preventer (.2).

2. A Blowout Preventer (BOP) is a large, specialized valve used to seal, control and monitor oil
and gas wells: they are used at land, subsea and offshore rigs, and are secured to the top of
the wellbore, known as the wellhead.
Blowout preventers were developed to face extreme variable pressures and uncontrolled
flow issuing from a well reservoir when drilled; kicks can lead to a potentially catastrophic
event known as a blowout. Blowout preventers are critical to the safety of crew, rig and
environment.
A typical subsea deep-water blowout preventer system is connected to the offshore rig
above by a drilling riser (.3) that provides a continuous pathway for the drill string and fluids
emanating from the wellbore, while BOP on offshore rigs are mounted below the rig deck.

3. A Drilling Riser is a conduit that provides a temporary extension of a subsea oil well to a
surface drilling facility. Marine drilling risers type is used with subsea blowout preventer (.2)
and generally used by floating drilling vessels (.10); a marine riser tensioner, located on the
drilling platform, provides a suitable constant tension force in order to maintain the stability
of the riser in the offshore environment. Drilling risers are generally attached to fixed
platforms or very stable floating platforms like a tension leg platform (TLP).

4. An Electric Submersible Pump (ESP) is a device which has an hermetically preserved motor
joined to the pump body: the main advantage of this type of pump is that it prevents pump
cavitations9, a problem associated with high difference between pump and the fluid surface.

9
Cavitation is the formation and then immediate implosion of small air bubbles that are the consequence of
forces acting upon the liquid. It usually occurs when a liquid is subjected to rapid changes of pressure that
cause the formation of cavities where the pressure is relatively low.
38
 Submersible pumps are used in oil production to provide a kind of artificial lift, able to
operate through a range of depths. The pumps are typically electrically powered, so the
denomination of electrical submersible pumps.

5. An Umbilical Cable is named by analogy with an umbilical cord: it is a cable which supplies
what is required to an apparatus, as power to a remote electrical device. Umbilicals are
designed for the offshore industry to offer flexibility construction, chemical resistance to
aggressive fluids and gases often encountered in offshore applications. Umbilicals are part of
the BOP (.2) hydraulic system exposed to very corrosive atmosphere and mechanical risks:
the cover material and spiral reinforcement give superior resistance to stress at high
pressures of deep waters.

6. Hub oil seal is a facility which prevents loss of oil when drilled and pumped.

7. Subsea system refer to equipment, technology, and methods provided for offshore oil and
gas developments in case of shallow water depths, where bottom fixed offshore structures
can be used, or in case of deepwater depths, where floating drilling vessels and platforms are
used, and underwater remote controlled vehicles are required.

8. A Christmas Tree is an assembly of valves, spools, and fittings used for an oil and gas well,
water injection well, gas injection well, and other types of well. Its name is due to its
similarity to a decorated tree. The primary function of a tree is to control the flow out of the
well: the surface pressure control is provided by a Christmas tree which is installed on top of
the wellhead, with isolation valves that are opened when the well and facilities are ready to
produce and receive oil or gas. This leads to a processing and storage system or other
pipeline leading to a refinery center. Flow lines on subsea wells (SS, .9)usually lead to a fixed
or floating production platform or to a storage ship known as floating production and
offloading vessel, FPSO (.16).

9. Horizontal Directional Drilling is the method for drilling non-vertical wells. Wells are drilled
directionally for several purposes: to increase the exposed section length across the reservoir
by drilling through the reservoir at a specific angle, to permit drilling into the reservoir where
vertical access is difficult or not possible, more wellheads to be grouped together on one
location can allow fewer rig moves.

39
 10. A Jack-up Rig or self-elevating unit is a type of mobile platform that consists of a buoyant hull
with movable legs that can raise its hull over the surface of sea. The buoyant hull allows
transportation of the unit and all attached machinery to a location: once there the hull is
raised to the required elevation above the sea surface on its legs that reach the sea floor.
Jack-up rigs are similar to drilling barges but safer to operate than drilling barges, because
working platform is elevated above the water level. Generally jack-up rigs are used as
exploratory drilling platforms and offshore, suitable for shallower waters.

Figure 2.5 – Offshore equipment

1 2

3 4 5

6 8 9
0
0

Source: Petrobras, web

1. A Drill Stem Test (DST) is a method used to verify the parameters and production capacity of
a given reservoir in a particular well, so that it’s possible to characterize fluid type, pressures,
permeability, transmissibility and productivity. It permits to obtain important sampling

40
 information on the formation fluid and to establish the probability of commercial production
by setting packers above and below the interval of interest. In this way a unit is isolated and
the formation fluids are allowed to flow into the drill string and analyze. However it is
difficult to completely isolate the reservoir unit.

OGX main concession areas are in shallow water (maximum -150 m of depth): this is characterized by
a minor depth and pressure, if compared to the deep (between -150 m and -1500 m) and ultra-deep
water ( Beyond -1500 m) oil accumulations. In the following Figure 2.7 are displayed the different
offshore production system in depth increasing scale.
Shallow water drilling differs from deepwater drilling in several aspects: shallow water rigs have legs
that reach the bottom of the sea floor, so the platform is fixed to the seabed (FP), giving more
stability and easier access to the facilities. In fact they have blowout preventers (BOPs) above the
surface of the water that are accessible for inspection, maintenance and repair, and can be
controlled in case of an emergency.
Instead to -1000 m the platform is endowed with flexible towers (CT), and to -2000 m a floating
drilling platform (FPS) or a tension leg system are needed (TLP), with long, hollow flexible legs that
connect the platform to the seabed and allow motion. For even deeper waters and tumultuous
waves are preferred spar platforms (SP) which have a large cylinder under the platform: the cylinder
doesn't reach the seabed but is tethered to it by giant cables. The seabed is so far below a deep-
water platform (Subsea System, SS) that submersibles must be used if repairs are needed. Shallow
water, in addition, require some specific marine vessels and facilities that better suits its features.

2. Drillships are simply ships designed to carry out drilling operations: a typical drillship has, in
addition to all of the equipment normally present on a large ocean ship, a drilling platform
located on the middle of its deck; in addition contain a hole which extends through the ship
and down through the hull and allows the drill string to extend to the sea bed. Drillships are
often used to drill in very deep water, which can often be turbulent, thanks to its dynamic
positioning systems.

3. A Shuttle Tanker is a ship designed for oil transport from an off-shore oil field. It is equipped
with off-loading equipment compatible with the oil field in question. This normally consists
of a taut hawser arrangement or dynamic positioning to maintain the position relative to the
field, an off-loading arrangement of pipes, and redundant safety systems to ensure that the
potentially flammable crude oil is handled safely in a harsh environment.

41
 4. A Semisubmersible rig is a buoyant rig that doesn’t submerge thanks to the
inflating/deflating function of its hulls.

5. An Extended Tension Leg Platform (ETLP) is a vertically moored floating structure normally
used for the offshore production of oil or gas. it’s specific for shallow and deep water. The
platform is permanently moored by means of tension legs at each of the structure corners.
They have low elasticity so that all vertical motion of the platform is eliminated.

6. Floating Production Systems (FPS) are essentially semisubmersible drilling rigs, as said above,
but in addition they contain both petroleum production and drilling equipment. Ships can
also be used as floating production systems; the platforms are moored through large, heavy
anchors, or through the dynamic positioning system used by drillships (.10). With a floating
production system, the wellhead is actually attached to the seafloor once the drilling is
completed, rather than being attached up to the platform. The extracted petroleum is
transported via risers from this wellhead to the production facilities on the semisubmersible
platform. These production systems can operate in water depths of up to -1800 m.

7. Spar platforms are among the largest offshore platforms in use: they consist of a large
cylinder supporting a fixed rig platform that doesn’t extend to the seafloor but instead is
anchored to the bottom by a series of cables and lines. It serves to stabilize the platform in
the water and allows for movement to absorb the force of potential hurricanes.

OGX has acquired most of these equipment in order to get prepared for the beginning of production
of commercial oil in two accumulations in the Campos basins: the commercial declaration of Waimea
and Waikiki oil will complete OGX transformation from a pure exploration operator into a mature oil
producer.
Figure 2.6 – Naval technology for floating system

12 14
4 4
4 4
4 4
4
13 4
4
4 4
4
4 4
4 web
Source:
4
4 42

4
 Figure 2.7 – Bottom supported and vertically moored vs floating production system

Source: www.naturalgas.org

2.1.3.1 Waimea first oil production and shipment

OGX concluded its exploration phase in Campos Basin, starting to the gross scale production of oil in
block BM-C-41 on record time for a Brazilian private company: the carbonate reservoirs of the Albian
section (post-salt layer of rock) of the Waimea accumulation was originally discovered through the
drilling of the 1-OGX-3-RJS wildcat well on December of 2009.
In January 2012, OGX received license from the Brazilian Institute for Environment and Renewable
Natural Resources (IBAMA) the Operating License authorizing the operation of FPSO OSX-1 and the
respective subsea structures related to the Extended Well Test (EWT) and the production
development of the Waimea accumulation, in the BM-C-41 block in the Campos Basin: the company
has also presented to the National Petroleum, Natural Gas and Biofuels Agency (ANP) a Declaration
of Commerciality of this portion of the Waimea Complex, proposing the new designation Tubarão
Azul Field.

There OGX concluded the drilling of the horizontal well (.10), named 9-OGX-26HP-RJS Waimea
Horizontal, and through a drill-stem test (.12) has identified excellent production index (PI) of 40,000
barrels per day of 20° API quality of oil: as said before this type of directional well has been preferred
to a vertical one for maximum exposure to the accumulation and rate of oil recovery from the field.
The well has been equipped to perform an EWT in January 2012, whose performance has confirmed
the expectations to register an average of current output of 12.500 boed, and to increase up to
about 40,000 to 50,000bod by the end of 2012.
All the information, both qualitative and quantitative on the rock reservoir and fluid features, will be
deeply studied by the technical team of OGX in order to get prepared for the development plan
execution.

43
An higher flow rate will be obtained, in fact, during its definitive development phase, that will start
once the EWT is completed; during this phase, two more horizontal wells must be drilled in 2012.
OGX has opted for the technology of the floating production systems (.16) that benefits from subsea
systems (.8) for the drilling and pumping operations, and the facilities of drillships (.13), suitably
powered and equipped for the additional activities of first refinery of the crude oil and its temporary
storage: all the wells will be connected to the FPSO OSX-1, the first converted vessel of the sister
company OSX delivered in the October of 2011, during the EWT in Waimea accumulation.
The offshore services provided by OSX is another important example of synergy created within the
EBX Group, that will be analyzed in the next Chapter.

All equipment necessary for this phase of production has already been contracted with well known
global suppliers and most parts has already been delivered:

 a wet Christmas tree (.9) manufactured by GE Oil & Gas, the first to be acquired by a private
Brazilian company, delivered in Rio de Janeiro plant;
 the equipment for the Electric Submersible Pump (.5), already tested at the Baker Hughes
Plant in Oklahoma and delivered to Baker Hughes Brazilian plant;
 the flexible lines for the connection of the first well to the FPSO OSX-1, produced by
Wellstream at Rio de Janeiro plant;
 the control umbilical (.6), built by Oceaneering, also in Rio de Janeiro;
 the well ties and the 10 poles that form part of the FPSO OSX-1 anchoring system;
 the oil and gas storage and discharge vessel, which is connected to the first producing well,
the OGX-26HP: the vessel has been built by Aker, the Aker Wayfarer, and is responsible for
connecting the producing well to OSX-1 and for installation of the mooring system of the
FPSO.
 the first FPSO OSX-1, arrived from Singapore, where it has been converted and upgraded for
the particular oil accumulation features by Keppel Shipyard.

Wet christmas trees and flexible lines will be linked directly to the FPSO OSX-1: four additional wet
christmas trees will be delivered by GE Oil & Gas in the next months, with some of them having been
produced in Brazil so to comply with the local content compulsory regulation. In August 2010, BW
Offshore won a contract of 150 million US$ to provide project management, engineering and
technical services for FPSO project, detailing the equipment required to customize OSX-1 and
delivering a submerged turret production system.

OGX holds a 100% interest in this block and is the designated operator; the declaration of
commerciality is being followed by The Development Plan submission to the ANP: it contains the
estimates for a total recoverable volume by 110 million barrels per day of oil in Tubarão Azul Field,
44
and an average operational efficiency of 97% just recorded, plus additional information on reservoirs
which is expected to be definitely gathered during the first half of 2013.
After almost five months of Extended Well Test operations in the Tubarão Azul Field the Company
has defined an ideal flow rate of 5,000 barrels of oil equivalent per day per well for the first two
wells: since the beginning of the EWT, wells OGX-26 and OGX-68 were tested with flow rates ranging
between 4.000 and 18.000 barrels per day, leading to a better understanding of the reservoir frame.
The data collected indicated the necessity of replacing the centrifugal submersible pump in OGX-26
with another pump with different features in order to adjust the pumping capacity of the well: during
the days needed to replace the pump, the production from well OGX-26 stopped, while the
production unit FPSO OSX-1 has been producing 7.400 barrels of oil equivalent per day from OGX-68,
showing satisfactory levels of pressure in the reservoir.
However in the second quarter 2012 the daily average production has been by 9.100 boepd and the
third production well has begun to be drilled in the Tubarão Azul Field.
OGX team of engineers remains confident they will recover 110 million barrels of oil equivalent at the
Tubarão Azul Field: its production rump up for the productive blocks, split in the short and medium
terms, is displayed on Table 2.3.
The one million boed target for 2019 is based on:

 the OGX portfolio potential volume of oil, just certified by D&M consultant;
 the number of production and injection wells;
 the estimated reservoir rate of success, about 90%;
 projects execution schedule established by the Company.

With the beginning of oil production, OGX has established its oil commercialization division which is
in contact with potential clients in order to negotiate the sale of OGX initial production. The
company, however, in October 2011 signed a commercialization agreement with Shell Western
Supply and Trading (NYSE: RDSA and RDSB) to sell 1,2 million barrels of oil in two tranches of 600.000
barrels each.
On March 27th 2012 OGX Ltda. and OGX Campos began offloading procedures of their first shipments
of oil stored on the FPSO OSX-1: these first transfer were sold to Shell through OGX Austria for a
price equivalent to Brent10 less 5,50 US$ per barrel.

10
Brent crude oil is the best known of the three benchmark crude oils (the other two are “West Texas
Intermediate) WTI and “Dubai”) against which other crude oils are priced. It’s also referred to as North Sea
Brent because it is a crude light (API Gravity 37.5°) and sweet (low sulfur/sulphur content) of UK two North Sea
oils.
45
The sale generated a gross margin of about 64,800 US$11: during the EWT, gross sales revenue net of
costs is registered as a reduction of CAPEX, in terms of Intangible assets12, instead of as income for
the period, which justifies the huge costs and the negative results for this first quarter of production.

At the end of July 2012 Ogx has finished offloading its second shipment of oil, 300.000 barrels to
Shell Western Supply and Trading Ltd (Shell). A total volume of 808.500 barrels of Waimea oil was
delivered and will probably go to Europe for an amount of 79,4 million US$: this shipment is part of
the commercialization agreement signed in October 2011 with OGX’s Anglo-Dutch partner.

2.1.3.2 Waikiki first oil production

The Waikiki Accumulation was discovered by OGX through the wildcat well 1-OGX-25-RJS in
December 2010. This well is located in the BM-C-39 block at about 94 kilometers off the coast of the
state of Rio de Janeiro at a water depth of approximately 105 meters, shallow waters of the Campos
basin; the Pride Venezuela rig initiated drilling activities there on November 2010.
On April 2012 the company had presented to the ANP a Declaration of Commercial Viability of
Waikiki accumulation, proposing the new designation Tubarão Martelo Field in blocks BM-C-39 and
BM-C-40.
OGX expects its first production well, OGX-9-44HP-RJS located in the Waikiki accumulation to be
completed during 2013. As for Waimea accumulation, OGX holds a 100% interest in these blocks and
is the operator.
The Development Plan is being completed and will be submitted to the ANP: OGX estimates a total
recoverable volume of 285 million barrels of oil from this field over the production phase concession
period. The production system planned for the Waikiki complex includes the production units FPSO
OSX-3 and two more WHP (.1), which are being built by the firms Modec and Techint, respectively.

Deepwater drilling is much more expensive than shallow water drilling: the platforms are technically
more challenging to construct. In general, deepwater drilling is riskier than shallow water drilling,
because the pressures and depths involved are greater, for example it’s more difficult to access the
blow-out preventer for repairs.
Nevertheless it represents the new frontier of exploration investments that promise the major rate
of recoverable oil: OGX has deepwater concessions rights in Santos basins, also acquired during the
9th round.

11
Equal to 118,003 R$.
12
Intangible assets are represented by costs associated with the phases for acquisition of and exploration for
oil and gas: the subscription bonus for obtaining concessions rights and, generally, all the expenditures incurred
during exploration and appraisal of such reserves.
46
This round has become the “fighting box” for all the oil companies interested in exploitation of pre-
and post- salt offshore fields in the high potential Campos and Santos basins.

2.2 The escalation towards success

The upstream private company, OGX, whether less developed than the state-owned Brazilian giant
peer Petrobras, which covers all the supply chain acting also in mid- and down- stream activities,
benefits from being a leader of a niche market: differently from PB it has no influences on planning
decisions by the Government and the choice to not enter the logistic and refining activities let it to
focus on profitability.
Since its first steps moved in occasion of the ninth bidding round, OGX has created a diversified
portfolio of projects that have attracted many investors searching for profitable start-ups.

2.2.1 The 9 th Bidding round

Paulo Mendonça, now Special Advisor to the Chairman of EBX Group, with a team of previous
Petrobras executives, in 2007 got prepared to bid for deepwater offshore blocks awarding after the
revolutionary discovery of pre-salt Tupi field. Nonetheless, two weeks before the auction, the
Government removed the deepwater blocks from the bidding: Mendonça and his team adjusted
their strategy, deciding to bid for the acquisition of 21 blocks concession rights in shallower water,
what Mendonca calls "ugly ducklings" since Petrobras disregarded them for awarding bigger
deepwater offshore fields.
Really, these choice is giving very good results with less risks exposure and lower operational costs
suffering, if compared to the deeper fields ones.
The 9th bidding round concluded on November 2007, with 271 exploratory blocks offered, distributed
within 14 sectors, totalling an area of 73 thousand km2, as determined by CNPE´s Resolution
06/2007.
The basins included were: Campos, Espírito Santo, Pará-Maranhão, Parnaíba, Pernambuco-Paraíba,
Potiguar, Santos, Recôncavo and Rio do Peixe.
The blocks has been classified based on the potentiality of the basins and the technology needed to
explore and develop them:

 blocks in mature basins, that have been already explored and developed so the knowledge is
the highest, for a sector of Espirito Santo, Reconcavo e Potiguar that more attract small and
medium companies, playing an important role in social development ;

47
  blocks in basins with high potential for Campos, Santos and a sector of Espirito Santo, that
attract the international oil companies and the most developed domestic ones;
 blocks in basins of new technology frontier, the leas known areas, with more challenges to
accept, for Pará-Maranhão, Parnaiba, Pernambuco, Rio de Peixe.

In addition, to protect the environment the Petroleum Agency (ANP), the Federal Environmental
Agency, IBAMA, and the Environmental State Agencies, OEMAs, analyze all the areas before their
offer at the rounds: as a result, guidelines are published with the requirement levels for the
environmental licensing, necessary step to operate as concessionaires. However, these factors are
periodically under revision, in order to reflect the geological features of new areas to explore, the
evolution in technologies applied during drilling and production of oil, and the dynamics of
surrounding society.
The areas of major impact are organized into 4 classes, in order of decreasing environmental
relevance and associated sea depth:

 area of extreme biological importance, scored 4, corresponding to 0-60 m of depth;

 area of very high biological importance, scored 3, corresponding to 60-100 m of depth;
 area of high biological importance, scored 2, corresponding to 100-200 m of depth;
 area insufficiently known, but probably of biological importance, scored 1, corresponding to
200-500 m of depth.

Depending on the area biological attribution, the requirements for the environmental license
accorded by IBAMA vary and are more or less strict13. Examples of factors that may restrict the E&P
activities in a given area are: sensitivity of the coastal region , as the presence of coralline, sites of
crucial importance for the life cycle of endangered species, such as the sea turtles location for birth
and breeding, the presence of intense fishing and the preservation of biodiversity more in general.

OGX has received from IBAMA (the Brazilian Institute for Environment and Renewable Natural
Resources) the Operating License authorizing the operation of FPSO OSX-1 and the respective subsea
structures related to the Extended Well Test (EWT) and the Production Development of the Waimea
accumulation, in the BM-C-41 block in the Campos Basin.

In order to participate in Brazilian 9th Round for blocks with high exploratory potential, a company
must be have submitted a Cover Letter, containing the Expression of Interest and all the documents

13
One of the most important measures of environmental control that IBAMA exercises in licensing the E&P
operations, is the adoption of Restriction Areas, in case of important factors of environmental sensitivity that
could be impacted by the implementation of seismic activities, drilling and other activities; they further
distinguish between Permanent restriction and Temporary restriction area.
48
and information required by ANP, have paid the Participation Fee14, different depending on sector
classification, and have technical, legal, and financial qualifications.

The Technical qualification of the companies refer to their demonstrated experience in the oil and
gas exploration and production activities: if the company is interested to be the designated Operator
of the blocks for whom bids, its technical qualifications are higher than for a Non operator demand.
In the least case, the company (minimum stake of 5% in the block) has to submit the demand in
consortium with other companies, among whom there’s the operator company (minimum stake of
30% in the block).
The Operator qualification, instead, distinguishes among three categories:

 “A” Operator: the qualified company can operate in any Block offered in Brazilian 9th Round,
but only if has more than 10 years of proved experience in the sector;
 “B” Operator: the qualified company can only operate in Blocks located in Shallow Waters
and Onshore if has from 5 to 10 years of proved experience in the sector;
 “C” Operator: the qualified company can operate in Blocks located solely onshore, having
from 2 to 5 years of proved experience in the sector.

The Financial requirements include the regular documentation of:

 Consolidated Financial Statements of the last three years (mainly Balance Sheet, Income
Statement and Explanatory Notes);
 Independent Auditor Report (OGX external auditor is KPMG);
 Bank reference prepared by the financial institution and the financial guarantees;
 The minimum net equity required based on the category A (minimum 22.000.000 R$), B
(minimum 20.000.000 R$) or C ( minimum 1.000.000 R$).

The Legal Qualifications refer to the documents to be attached that demonstrate the form of control
adopted in the Group and all the information requested by ANP.

All these compliance is converted into quantitative scores that let to classify the different bidding
offers by each company participating at the 9th round: complete the final score others requirements,
the signature bonus (over the minimum established), the local content restriction (with diverse range
established for the specific phase), the Minimim Exploratory Program, PEM, expressed in work units
(WUs or UTs in portoguese) established by ANP based on the potential volume of recoverable oil of

14
The payment varied from a minimum of 45 000 R$ to a maximum of 15 0000 R$; OGX has paid 75 000 R$ for
Campos basins awarded, 110 000 R$ for Santos and Espirito Santos basins. ANP will not reimburse the
Participation Fee if the company later retires from the bidding process, does not become qualified or fails to
receive the operator category it aims to.
49
the block and its geological features, that must be entirely performed during the first exploration
phase.

In conclusion for the evaluation of the bid offered the Signature Bonus is weighted 40%, the Local
Content, 20% (of whom 5% in the Exploration Phase and 15% in the Production Development Phase)
and the Minimum Exploratory Program 40% in the calculation of the final grade.

The maximum score is 100, calculated by the sum of each component evaluated.

The qualification of each company is taken by ANP through the Special Licensing Committee, or
Comissão Especial de Liciação, CEL, designated by ANP Board of Directors.

From the initial number of 67 companies qualified (32 Brazilian and 35 foreign), 42 offered bids
individually or in partnerships, after that 117 blocks were allocated to 24 winning operator
companies, among them OGX. In table 2.3 are collected the winning companies of the ninth bidding
round. In 2008, for Campos basins, OGX was declared the winner bidder, in BM-C-37 block, against
the consortium made up of Statoil Hydro ASA and Anadarko Petròleo Ltda., with 100 points against
49 final points, and in BM-C-38 block, against the consortium formed by Ecopetrol S.A., Galp S.A. and
Petròleo Brasileiro S.A., with 99 points against 83 final points.

50
 Table 2.2 – Ninth bidding round winning companies
Anadarko Petróleo Ltda. Orteng Equipamentos e Sistemas Ltda.
Brasoil do Brasil Exploração Petrolífera S.A Perenco S.A
BrazAlta Resources Corp. Petro Latina do Brasil E&P de Petróleo e Gás Natural
Ltda.
Comp E&P de Petróleo e Gás S.A Petrogal S.A.
Companhia Vale do Rio Doce Petróleo Brasileiro S.A
Construtora Cowan S.A PetroRecôncavo S.A
Construtora Pioneira S.A Queiroz Galvão Óleo e Gás S.A.
Delp Engenharia Mecânica Ltda. RAL Engenharia Ltda.
Devon Energy do Brasil Ltda. Rich Minerals Corporation
Eaglestar Petróleo do Brasil Ltda. Silver Marlin E&P de Petróleo e Gás Ltda.
Ecopetrol S.A. Somoil Internacional de Petróleo do Brasil - SIPEB Ltda.
EMPA S.A. Serviços de Engenharia Starfish Oil & Gas S.A
Karoon Gas Australia Limited Statoil Hydro ASA
Lábrea Petróleo Ltda. STR Projetos e Participações Ltda.
Maersk Oil Brasil Ltda. Synergy Group Corp.
Norse Energy do Brasil Ltda. Tarmar Energia e Participações Ltda.
OGX Petróleo e Gás Ltda. Vitória Ambiental Engenharia e Tecnologia S.A
Ongc Videsh Ltd W.Washington Empreendimentos e Participações Ltda.
Source: BDEP

2.2.2 OGX and competitors at a glance

Brazil presents good conditions for start-up oil companies15: the list of independent domestic oil
companies is steadily growing, especially counting the well-known HRT Participacoes (HRTP3.SA) and
QGEP (QGEP3.SA), the exploration and production division of the Queiroz Galvao construction group.
As already explained, most part of the participants to the Brazilian oil market, starting from the pre-
salt wave of explorations period, are IOCs, as BG, Galp, Shell, Anadarko, Mearsk, Repsol: their
performance of long standing make the comparison with start-ups, as OGX, more complex, since the
benchmark and the life cycle phase of the company are completely different.
However this diversity adds more colour to the painting board of considerations to make on the
competitor analysis: the oil company performance should be evaluated putting more emphasis on
new reserves and production growth, exploration and drilling costs, each of them depending on the
typology of area drilled.

The reserves technical and operational features are considered the prior criteria of evaluation and
the pillars for decision taking in investments planning area in the oil company: the costs associated to

15
The report “Doing business”, annually issued by World Bank, measures and tracks changes in regulations
affecting ten areas in the life cycle of a business: starting a business, dealing with construction permits, getting
electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders,
th
enforcing contracts and resolving insolvency. According to 2012 report Brazil occupies the 126 position, on a
list of 183 countries worldwide.
51
the E&P operations in deepwater fields are serious, and the risks to encounter heavier than for
conventional fields.
The main distinction to do is between deep/ ultradeep water fields and the traditional oil fields: the
first require frontier technology for all the awkward conditions implied in a deeper environment,
while the least face minor risks since its maximum depth is that of shallow water (maximum - 200 m
of depth).

However it’s meaningful to consider the risk/reward profile of the oil company, according to the type
of reserve explored: in case of deepwater projects, the higher risks faced, reflecting the technical
complexity of technology used to drill oil at high pressure and heterogeneous layers of rocks, are
compensated by higher expected profit and reduced time to cash flow generating.
Nevertheless shallow water projects meet minor upstream costs, so that the risks to deal with are
fewer and the profitability index is similarly high: the leading position is covered by OGX with its 17
offshore oil accumulations in exploration phase, whose major part reach a maximum depth by -200
m under the sea level.
The capex/bl value is one of the most eloquent spy of technical risks associated to the oil reserve
type: the historical series shows that the higher the technical risk is, the higher is the capex
associated, and for deepwater projects it’s more and more increasing than in shallow ones.
Some of the cost drivers are steel (average +38% from 2009 to 2011), vessel rate ( average +5% from
2009 to 2011) and electricity (average +9% from 2009 to 2011); however, the key beneficiary of this
increasing costs and need for offshore technology, will be the oil services companies, as OSX
(GOLDMAN SACHS, 2011).

In the following Graph have been captured these dimensions of oil companies, suitably selected: OGX
is the greatest private oil company in Brazil, so the only domestic competitor can be the giant state-
owned Petrobras and the well-established Queiroz Galvao Participacoes SA, meanwhile among the
international oil companies I’ve included those that actually have more exposure in new explored
Brazilian reserves, i.e. BG Group, Galp, Repsol and Statoil, so that they could be treated as start-up,
as well as OGX.
Each of them has created strong value (NPV of oil discoveries/EV before the development phase)
from exploration over the least 6 years, exactly since the pre-salt revolution in 2007: OGX has
created its total value on these explorations, followed by Galp (100%), while Petrobras (51%), BG
(39%), Repsol (25%) and Statoil (15%) have decreasing percentage, due to their longstanding past
performance.

52
On the x-axis I’ve put a “penalty” measure of costs assumed, related to the type of risk assumed on
the reserves: the Capex per barrel ratio is higher for deepwater reserves since the investment in all
the facilities needed is huger than for traditional ones.
In particular for Capex is intended the overall costs for pre-drilling operations, WHP drilling, sub-sea
system of flow lines installation and, in addition, part of the Opex ( usually they cover quite the half
amount) referred to the infrastructure needed, the FPSOs services.

On the y-axis I’ve considered a profitability dimension, the NPV2012 / EV , whose first term, as
estimated by Goldman Sachs research in their 2012 report on the best 360 oil project worldwide, is
referred to the overall ongoing exploration projects, while the second term has been collected on
Bloomberg data stream: in this way it’s possible to only focus on the value creation that, both
domestic and international company, have realized through their investment in Brazilian fields, and,
in addition, to evaluate the weight it has on the whole enterprise value.

The z- dimension of the balls is represented by the total Brazilian reserves acquired by each oil
company in the sample, measured in billion of barrel of oil: this gives the immediate perception of
the desired level of exposure in this emerging market.
The intercept of axis isn’t in the origin but in the average x and y values.

Graph 2.1 – Competitors risk/ reward exposure on Brazilian oil market

500%

OGX
400%

300%

200% Petrobras

Galp 100%

0 5 10 15 QGEP 20 25
BG 0% Repsol
Statoil

-100%

Source: Goldman Sachs, Bloomberg (2012)

In the first quadrant there are the best allocated companies, with the highest value creation index
and the lowest costs associated: the only “star” is OGX, with more than 90% of its portfolio is located
53
in shallow water or on land, has the ideal conditions for the development of projects with rapid
implementation and low cost, both for exploration and for production.
OGX is the only able to keep them at an acceptable level: OGX declares that each barrel of oil it
produces has an average Capex of solely $2.00 and Opex equal to just $16.00 per barrel, so that the
company is going to have a significant margin advantage over most companies, which pay twice as
much (J. Barnes, 2011).
Petrobras sees its giant reserves and potentialities of revenues being bottlenecked by the huge costs
faced, the state-owned company should have covered the pulp-position, considering its great growth
strategy.
Above the medium profitability there are BG and Galp, the “cash cows”, who can improve their
expectations by a more aggressive investment planning in the Brazilian market; among the worst
classified, even if with positive revenues yet, there are QGEP, has difficulties to grow among so many
big competitors, very few reserves and so uneconomical costs, Repsol, whose better profitability is
achieved at the expense of the cost-saving, as done by Statoil.
However Petrobras has acquired the most potential reserves and, in addition, It is the only
designated operator, so these factors really limit the possibilities, for international companies, to
achieve better target of profit generation. Petrobras has cut down its 2020 production target in July
2012, while the capex devoted to offshore investments has increased: as declared during the New
York Presentation of Petrobras Business Plan 2012/2016, the company has dropped the production
target for many times over the past years, passing from 6,4 million boe/d to 5,7 then 4,9 and finally
to 4,2 million boe/d; although the large increase in world crude oil prices, the government has
prevented Petrobras from increase for fuels in the domestic market, in order to control domestic
inflation, causing further losses for the giant oil company.
What is interesting to note is the increasing costs and accumulated delays of Petrobras16, mainly due
to local content restriction: The National Petroleum Agency should has identified failure to comply
with local content in 44 blocks acquired by Petrobras, during 5th and 6th Bidding Rounds (V. Azevedo,
2011, pag. 30), charging approximately 19 million US$ as the necessary payment for the infraction.
Differently OGX has always observed the local content restriction: this legislation has fostered the
EBX inventiveness to establish another “–X factor” enterprise, OSX, that will recover the
technological gap and comply with the regulation imposed.
In the Graph 2.2 I captured other important key figures that are the peak of production of Brazilian
oil reserves, measured in kbeo/d, on the x-axis and commercial breakeven price, that is the oil price
required for a project to cover the different components of cost uplifting (Capex, Opex, Government

16
Transpetro, the transportation arm of Brazilian oil company Petrobras, has suspended the purchase of 16 of
the 24 oil tankers worth BRL5.3bn ($2.7bn) ordered from Estaleiro Atlantico Sul (EAS) shipyard, due to late
delivery: The company ordered these vessels as part of its BRL10.8bn ($5.41bn) fleet-renovation program but
the first vessels delivered by EAS were nearly two years late. (Daniel Lima, 2007).
54
retention, taxes, royalties) plus the necessary margin, in order to generate an IRR at least equal to
the cost of capital (usually 15% for emerging markets), on the y-axis.
Again the intercepts don’t coincide with the origin but are in the medium values: the most virtuous is
OGX, thanks to its lowest break even equal to 30 US$, so low if compared to the top cost of
Petrobras, with 90 US$ required price: it’s the aftermath of all the problems faced in these month
that have shorted the production target, prioritized the exploration expenses.
For the next elaboration I’ve included in the representative sample also Shell: the giant company has
allocated part of its numerous business in Brazil since 1913, so it is one of the pioneer in the local
market; it has a subsidiary, Shell Brasil, and its long track record makes it one of the best allocated
company on the upstream Brazilian market.
However BG and Statoil cover an optimal position, considering the reached peak of production, of 24
kboe/d on the most recent reserves drilled, so OGX has to improve its production profile, in these
months reduced due to a technical problem to the semisubmersible centrifugal pump. Also OGX
team has lowered the production target to 70 kboe/d for 2013, that will break even, instead of 150
kboe/d.
On the taillight there are Repsol and Galp, that have low prices accompanied by low productivity
levels: the cost structure and the productive level are fundamental for reaching medium term value
creation.

Graph 2.2 – Peak production vs commercial breakeven price

110
100 Shell
90 ( x = 80 kboe/d)

80 Petrobras
Statoil ( x = 2500
70 kboe/d)
BG
60
0 5 10 15 20 25 30 35
50
Repsol Galp Peak prod. in thousands barrel/d
40
30
OGX
20
10

Source: author elaboration of data from Goldman Sachs, Company data, Bloomberg (2012)

One of the key figures of revenues for oil companies is the oil price and its reaction to changes in the
commodity market price: the commercial bep is strictly linked to the quotes and, at the same time,
also the profitability on investment ratio is influenced by it.

55
The P/I, calculated as the NPV of Brazilian asset on initial capital invested, is variant for the traditional
ROIC evaluation, that give the short-term health of a company: studying how it reacts to changes in
oil prices can give the idea of the range of variability in the Company revenues, submitted to this high
volatile market, ceteris paribus.

In the following Graph 2.3 has been collected the competitors P/I changes, making the difference
between an upside movement of the oil price (from the basis 112 to 140 US$ / barrel), and the
downside movement (from 112 to 80 US$ /barrel): the entity and the differences (red for reduction,
green for increase) in the two opposed cases displays the Company profitability sensitivity to oil price
changes, and the possibility to benefit more than others in case of ups ( as well as to weaken in case
of downs).

At a first glance OGX is the most sensitive oil company, so there’s more correlation, so it can benefit
more in case of fluctuations in oil price than Petrobras, maybe due to the strong state participation in
the
Company run, in addition to the huge Government retention on profit: the higher prices just can
cover the raised costs of exploration and development, other than the penalizing effective taxes rate.
Once again OGX is more exposed to the opportunity on market, because its costs are relatively lower
than the deepwater projects ones.

Graph 2.3 - PI % change to oil movements

Source: Goldman Sachs 360 projects report, company data

To better capture the importance of price sensitivity, I’ve calculated the P/I Elasticity to changes in oil
prices: the next Graph 2.4 shows, in a radar scheme, how the reaction is highlighted for upside
movements than for downside ones, a positive result for all the competitors, but above all for OGX

56
that is quite completely elastic to up: its 92% participation to oil price % changes is relevant
compared to the average 60% of other companies in the sample.
So if the oil has a fall by 40%, OGX impact is by 63%, the highest among the competitors values.

Graph 2.4 - P/I Elasticity to up/down oil price movements

Petrobras

68%
Shell OGX
92%
64% 50%
50% 63%

40% 48%
Statoil 56% 68% Repsol
50% 53%

68% 72%
BG Galp

Upside P/I Elasticity

Source: author elaboration of data from Goldman Sachs (2012)

Definitely OGX is a volatile company, that is very common for start-ups, but with high potential for
growth and room for profitability.

In the following Table 2.3 I’ve collected the fundamental economics values of the selected
competitors at the closing balance of 2011 in million US$: Petrobras and Statoil had the major gross
revenues and net profit, while OGX null revenue was due to its massive focus on the exploration
phase, operations at high capital absorption and expenses related to geological and geophysical
studies.
The more leveraged companies are the international oil companies, instead the Brazilian competitors
show a cautious level of total debt, likely to observe financial covenants defined for the bond issue
during the funds rising.

In the next Table 2.4 there are reported the second quarterly fundamentals values of the oil
companies in the sample, in order to take a look on the recent performances, even if the quarterly
data are usually more volatile than the annual ones.
First of all there are crucial events for what concerns OGX revenues and the development phase
aftermath: the shipment of the first and second cargo of oil to Shell, has permitted the EBITDA

57
reconciliation17, with an Ebitda/barrel equal to 49 US$; in the second quarter 2012 in the profit/loss
sheet were accounted losses for 80,8 million US$, too, associated to the costs from written-off wells
declared as dry, one in the Campos basin and two in the Espírito Santo basin.
While the most Brazil exposed competitors (OGX, Petrobras, QGEP, Galp) have had negative net
profit, mostly caused by time-lag in the production level and technical-linked costs, the others IOCs
(BG, Shell, Repsol, Statoil), thanks to their highly diversified portfolio of reserves, have had positive
income, the ratios have had a slightly negative trend for all the competitors, sign of the difficult
period for the whole market, more in general.

Table 2.3 – End 2011 competitors main financials

31/12/2011 EUR/US$ 1,27
REAIS/US$ 0,49
mln US $ NOK/US$ 0,17

OGX Petrobras BG Repsol Galp Statoil QGEP Shell

Revenues - 119.646,31 21.073,00 76.354,94 21.341,00 109.751,83 141,61 470.171,00
EBITDA - 354,54 39.222,50 10.026,00 10.806,43 1.327,96 44.517,90 44,33 70.261,00
EBIT - 359,66 21.483,00 7.735,00 6.337,30 814,93 35.788,40 18,06 57.033,00
NET PROFIT - 236,26 16.323,42 4.234,00 2.785,11 549,50 13.393,79 45,15 31.185,00

EQUITY 4.345,82 162.789,57 29.675,00 34.344,61 3.735,65 48.476,35 1.066,12 171.003,00

NFP 2.685,77 130.793,92 31.707,00 55.770,78 9.161,73 82.186,84 271,44 174.254,00
TOTAL ASSET 7.031,60 293.583,49 61.382,00 90.115,39 12.897,38 130.663,19 1.337,56 345.257,00
TOTAL ASSET 7.031,59 293.583,49 61.382,00 90.115,39 12.897,38 130.663,19 1.337,56 345.257,00
Ratios
EBIT/revenues n.a. 17,96% 36,71% 8,30% 3,82% 32,61% 12,75% 12,13%
EBIT/TOT A -5,11% 7,32% 12,60% 7,03% 6,32% 27,39% 1,35% 16,52%
EBITDA/revenues 0,00% 32,78% 47,58% 14,15% 6,22% 40,56% 31,30% 14,94%
EBITDA/TOT A -5,04% 13,36% 16,33% 11,99% 10,30% 34,07% 3,31% 20,35%

Source: author elaboration on data from Bloomberg, Company data (2012)

17
Before declaration of commerciality, gross sales revenue net of costs is booked as a reduction of CAPEX
(Intangible asset) and not as income for the period.
58
 Table 2.4 – Second quarter 2012 competitors main financials
30/06/2012 1,27 0,17
0,49
mln US $
OGX Petrobras BG Repsol Galp Statoil QGEP Shell
Revenues 85,26 33.343,16 5.567,00 17.802,86 5.532,12 31.701,43 60,35 117.068,00
EBITDA 39,03 5.193,46 2.705,00 1.236,98 106,68 13.122,64 - 38,22 11.038,00
EBIT - 46,45 2.588,13 2.032,00 807,72 - 36,83 10.483,05 - 48,88 7.535,00
NET PROFIT - 191,11 - 659,41 283,00 309,88 - 19,05 4.492,42 - 47,07 4.063,00

EQUITY 4.097,38 166.055,61 30.325,00 34.917,38 8.587,74 51.646,51 1.050,50 178.076,00

NFP 4.312,12 141.678,01 34.038,00 45.571,41 9.446,26 80.181,35 114,24 167.756,00
TOTAL ASSET 8.409,49 307.733,62 64.363,00 80.488,79 18.034,00 131.827,86 1.164,74 345.832,00
TOTAL ASSET 8.409,50 307.733,62 64.363,00 80.488,79 18.034,00 131.827,86 1.164,74 345.832,00
Ratios
EBIT/revenues -54,48% 7,76% 36,50% 4,54% -0,67% 33,07% -80,99% 6,44%
EBIT/TOT A -0,55% 0,84% 3,16% 1,00% -0,20% 7,95% -4,20% 2,18%
EBITDA/revenues 45,77% 15,58% 48,59% 6,95% 1,93% 41,39% -63,34% 9,43%
EBITDA/TOT A 0,46% 1,69% 4,20% 1,54% 0,59% 9,95% -3,28% 3,19%
Source: author elaboration on data from Bloomberg, Company data (2012)

59
60
 THIRD CHAPTER
OSX: the “truffle-sniffing labrador”
has found the X-factor in his EBX Empire

“… de' remi facemmo ali al folle volo...”

( by oars we made wings for the foolish flight)

- Dante Alighieri, Divina Commedia Inferno XXVI, 125 –

3.1 OSX Brasil SA

The arduous growth strategy, adopted by OGX management team, has fostered the need for more
dedicated areas that could suitably comply with both the new Local Content Clause of 65%, for E&P
activities, issued by ANP, and supply the sister oil company with highly focused offshore services.
Once again the “truffle-sniffing labrador”, as Mr. Batista likes to describe himself (THE ECONOMIST,
2012), has found a way to further develop his 30 billion US$ worth industrial empire.
The –X factor, multiplying sign that symbolizes the power of profit making and increasing, at a
geometrical pace, shared by each company in the EBX Group, this time comes from naval
infrastructures, provision of maritime units and related operational services.

OSX, Offshore Oil Services Brasil SA (OSXB3.BR), is a publicly-held company listed in the Novo
Mercado, the segment of Bovespa that requires the highest standards in terms of governance: as
seen in the Second Chapter, dedicated to the oil and gas Company of the Group, OGX, it adopts the
policy of maximum accounting disclosure and transparency in communicating with all the
stakeholders, involving the employees in the decision-taking process by the means of meetings and
reunions of Board of Directors, in order to assure the best managing practice.
OSX was founded in September 2007, and in 2008 and 2009 the company bought contiguous areas
along the coast of state of Santa Catarina, in the South region of Brazil, where its shipyard is being
developed; on 30th October of 2009 the Company was incorporated by EBX Group, which decided to
engage in activities related to the shipyard and oil equipment leasing businesses in Brazil, in order to
meet the increasing demand for offshore equipment and services solutions by OGX.

61
In accordance to the 360° Vision, elaborated and enforced by Mr. Batista1, from then on, OSX has
benefited from the sharing of resources and administrative services with EBX Investimentos Ltda, as
cash management and financial administration services, legal advisory, insurance, internal audits,
integrated risk management, information technology, security services and environmental health.
In Chart 3.1 is displayed the capital structure and business diversification of OSX.

Chart 3.1 – OSX capital structure

Source: OSX

As seen for OGX structure, the participation of majority is held by EBX Group with 79% of capital,
while the remaining 22% is free-float, as required by Novo Mercado governance discipline.
However OSX isn’t simply an integrated offshore equipment and services provider, it is an Holding of
three principal subsidiaries companies, that are respectively focused on three sectors: Naval
Construction (Shuipbuilder division), Chartering of Exploration and Production Units (Leasing
division), Services of Operation and Maintenance (O&M division).
This practice of constituting a project-company is becoming more and more popular in the
international environment of energy market, especially for emerging economies, thanks to the
efficiency and cost-reduction obtainable2 through it.

1
See Second Chapter.
2
The earliest applications of project finance in the U.S. were in natural resources and commercial real estate: in
the 1930s, “wildcat” explorers in Texas used production payment loans to finance oilfield exploration, real
estate developers built and financed commercial properties using project finance, since creditors had recourse
only to the project cash flows and assets of the single project. During the 1970s, project finance became a
common vehicle to finance large natural resource discoveries: so did British Petroleum, which raised 945
million $ to develop the “Forties Field” in the North Sea, while Freeport Minerals raised 120 million $ for the
Ertsberg copper mine in Indonesia.
62
3.2 Project finance for OSX start-up

The so-called project finance differs from the traditional corporate finance, where the funds rising
come from internal cash or bank borrowing, because the invested capital are viewed as assets of the
project company, in the form of equity or debt (H.Razavi, 1996, pag. 5).
In this way, the same assets and cash flow generated by the projects, will constitute the only
guarantee for the debt, so that the creditors are unable to make recourse on the other available
resources: this is commonly known as nonrecourse financing or off-balance-sheet financing, because
it doesn’t directly affect the sponsor’s balance sheet. Obviously this debt financing means more risk
exposure for commercial banks, especially whether huge projects are located in developing
countries, so they prefer to intervene in syndicate loans, with a certain time limitations (5 to 10
years).

The equity is provided by the shareholders, of OSX Brasil SA in this specific case, so they receive
dividends payment and make profit or loss depending on the net profit that the project can generate,
while the project debt is supplied by investment banking, insurance, pension funds and multilateral
institutions.

3.2.1 Risks assessment and agency costs in emerging market

The Multilateral Financial Institutions (MFIs) and Multilateral Development Banks, (MDBs), are
international institutions with governmental membership and financial institutions, such as the
World Bank and the International Monetary Fund, IMF, agencies and regional groupings, that lend to
developing countries: some examples of involved institutions are BNDES, the Brazilian Development
Bank3, FMM, the Merchant Marine Fund, a fund that provide resources for the development of the
Brazilian merchant marine shipbuilding and repair industry, SINAVAL, the National Syndicate for
Naval Construction and Repair Industry and Offshore, Export Credit Agency Facility, ECA, which is
supported or owned by a government, and exist to encourage the capital mobilization.
ECAs and investment insurance agencies often work in partnership with MDBs to finance capital and
infrastructure projects in developing countries: the agency asks host governments to counter-
guarantee some project risks, such as expropriation risk, and directly provides loan, guarantee, or
insurance facility (IFC, 1999).
These more focused institutions and agencies, are widely involved in energy-linked projects, both on
debt and equity side, because, differently from commercial banks, they can better meet the long
time financial needs of these infrastructural projects.

3
The correspondent European institution is EBRD, the European Banks for Research and Development.
63
The architecture of project financing is complex and involves different figures and institutions, each
one with a specific function:

 the project company or special purpose vehicle: it’s the independent legal entity that is
established with the specific purpose to realize the project, so it has dedicated assets; it’s the
centre of all the relationships among the counterparties that interact to know and evaluate
the proposed project. The SPV has to persuade them to fund the project, so its management
team must be experienced enough on the related economic field;

 the sponsors: they are the prime shareholders of the SPV, so they provide the capital of risk
to the project. The legal form (public, private or mixed) of sponsors, also defines that of SPV,
since they are the author of the whole operation: they identify the potentiality of a project,
making the primary legal, economic and financial screening on the project they want to
realize, in order to give start to the project financing network;

 the public institution: it plays the regulation role, depending on the nature of the project to
finance. Usually the project implies many risks and environmental impact, so the institution
has to monitor the activities proceeding and requires all the security documents,
administrative approvals, tariffs policy, and often it low the fiscal cost, or the capital cost by
advantageous interest rate and guarantees supplying;

 the banks: they are of crucial importance for the fund raising of the project. Usually they act
in pool, due to the huge capital need, and are big financial institutions with high international
standing. Among them the arranger has to negotiate the syndicate loan conditions on
market, while the underwriters partially finance and subscribe the project, the agent bank
controls the financial inflows and outflows of capital and the stage of repayment of the debt;

 the main contractor: the enterprises that are tendered by the SPV to the construction of the
infrastructure, they respond for the risk of completion and have a strict budget to respect;

 the commercial counterparties: they are the input suppliers and the output buyers from the
project final outcome. The SPV requires contractual pledge from these operators in order to
reduce part of the risks and secure part of revenues that give more stability to the project
itself;

 technical and legal advisors: they are specialists that give fundamentals consultancy services
for the success of the finance project.

64
In the Chart 3.2 the typical structure build for a power (oil and gas) project finance is showed.
Structuring the debt to equity ratio is crucial since it involves the risk directly assumed by the owners,
usually for energy projects equity represents the 20%-40% of the total cost; a more complex scheme
happens when the equity is provided by both private and public corporations, as for the majority of
the cases.

Chart 3.2 – Power project finance framework

Source: Esty (2002)

In the emerging countries, the project finance planning process has to make a robust analysis on all
the implied natural, organizational and political risks: the annual report on the easiness of starting a
new business, made by World bank and IFC, International Financial Corporation, has the aim to
sample countries worldwide and give crucial data set on doing business measure, to take more
cautious and profitable decisions.

The first source of risk comes from the narrow environmental features: the availability of natural
resources, raw material and infrastructure that can impact on the completion time and level of
performance desired.
After that there’s the construction risk which, as in the case of OSX (shipbuilding and facilities
services), is high and project company avoid it by creating an umbrella of trustworthy suppliers of
equipment, looking for high standing international partnerships that best use the technology at the
state of the art: in fact, as better explained in the following paragraph, one of the competitive
advantage of OSX is based on the precious collaboration and sharing knowledge with Hyundai Heavy
Industry.

65
In the phase of preparation of project finance, the lenders also take in account the economic
environment risks that mainly involve the political risk and the stability of regulatory system, sum up
in Country risk4: it includes the probability and damages caused by acts of war, authoritarian regime
and general Government instability that lead to delays, stop or abandon of constructions, but also to
the possibility of renegotiation in fiscal system, taxes, royalties, contracts legislation for specific
economic fields, as the energy industry, and Expropriation risk, or “wealth deprivation”.
This happens when losses incur due to measures taken by the host government that deprives the
investor of its ownership or takes control over its investments.
For what concerns Brazil business environment, its country risk isn’t considered very high, especially
if compared to the neighbor Countries, in fact the World Bank synthetic Index for country risk (that
measure the corruption, political stability, human development) collocate Brazil immediately after
the range of most virtuous countries, with an index of 1,45 ( Italy has been 1,2 scored).
Additional considerations must be done, otherwise, dealing with the system risk: the expropriation
problem is due to the recent adoption of PSA, Production sharing Agreement5, in oil E&P market,
with high retention by the Government, that thins the oil companies net profit; the fiscal and burden
regulation, too, is a problem very perceived in Brazil because it requires more flexibility on one side ,
and more stability on another side (no changes in taxes and renegotiation that lead to worst
conditions for the business development).
The restriction of local content clause (70% of Brazilian services and work) issued by ANP is another
example of cost lifting, even if its goal is to enlarge the work labour force and redistribute wealth,
because it puts many barriers to international companies, that usually have greater financial
possibilities, higher rating and contractual power with financial institutions6.
The key advantage of project finance is that it allows the allocation of specific project risks (such as
completion and operating risk or the risk of political interference or expropriation) to those parties
best able to manage them: the SPV (OSX 1) tender the shipbuilding to the main contractor (OSX
Shipbuilding), with the consulting of specialists of the sector (Hyundai), while for country risk
intervenes public institution and multilateral agencies (BNDES, IBAMA, CENPES, ANP, …) to give
stability and guarantees.
All these aspects make the “host country business environment”: the overall easiness to run a
business in Brazil is displayed in the next Graph 3.1, according to different measures of efficiency, on
a representative sample of 183 countries, basing on the report made by World Bank and ICF about.
The individual score has been determined by an evaluation, for each aspect, on the costs implied, the
time spending required, the number of procedures, and the transparency of the operations.

4
In the Fourth Chapter will be analyzed the Country Risk Premium for Brazil that influence the cost of capital
for project evaluation.
5
For a focus on PSA see Chapter One.
6
For a focus on Local Content Clause see Chapter One.
66
The dotted red line is the overall collocation of Brazil in the sample, equal to 110/183, in the average,
but particular positive is the position on “Getting electricity” factor (51/183) and “Protecting
investor” factor (79/183): the least measure is very important during the loans concessions process.
OSX and, as seen in Chapter Second, OGX, adopt a corporate policy that is focused on the maximum
disclosure possible on the main economic and financial events of the company, benefiting all their
stakeholders.

Graph 3.1 – Brazil rank in easiness of running a business 2012

Source: World Bank, IFC (2012)

For structuring a project finance system, are essential identification of risks, their impact analysis,
their mitigation and allocation through incentive factors. For this purpose, the sponsors enter into
numerous guarantees and contractual arrangement: the practice to combine all these borrowings,
insurance, equity instruments, is called financial engineering and represents the core of project
finance.

BNDES has defined lending conditions more advantageous in case of projects for drillships and FPSO
construction, which require investment of high unit value; the general conditions and covenants are:

 BNDES maximum participation must be 75% of total assets,

 projected cash flow must support credit repayment,
 the Debt Service Coverage Ratio, DSCR7, must be greater or equal to 1.30, 1.20 for projects
with IRR at least greater than 8%,

7
It is a popular benchmark used in the measurement of a borrower ability to produce enough cash to cover its
debt payments, including lease, interest and principal sum (in this sense it services the debt). The higher this
ratio is, the easier it is to obtain a loan. The index may be expressed as a minimum ratio that is acceptable to a
lender; it may be a loan condition or covenant. In general, it is calculated by: DSCR = (Annual Net Income +
Amortization and Depreciation + Interest Payment) / (Principal Repayment + Interest payments). A DSCR by
67
  minimum equity required of 20% of total investment budget,
 as collateral must be provided a parent company guarantee or bank guarantee,
 the total interest rate is composed of: funding cost (LIBOR for FPSO financing) + BNDES basic
spread (to cover operational expenses) + credit risk rate spread (to cover non performing
loans).

Another possible estimation of the project finance loan cost, the spread on the LIBOR, can be made
using the following standard OLS regression (KLEIMEIER S. et al., 2000):

where:

 Maturity refers to loan maturity, in years;

 Guarantee is a Dummy variable taking the value of 1 if a loan has a third-party repayment
guarantee and 0 otherwise;
 Currency Risk is a Dummy variable taking the value of 1 if a loan is exposed to currency risk
(the currency of the loan repayment cash flows differs from the borrower’s home country
currency), and 0 otherwise;
 Country Risk Rank is Country risk rank, an integer ranking of country risk provided by
Euromoney every year, where low risk countries have low ranks and high risk countries have
high ranks;
 is a Dummy variable taking the value of 1 if the borrower is in an industry generally
considered to be rich in collateralizeable (tangible) assets, and 0 otherwise.

This model aims to estimate the determinant of loan pricing for project finance8, the dependent
variable: the regression outcome show that, for what concerns Maturity, a one-year increase in the
term period of the loan, would decrease spreads (even if for all the other loans forms it’s the
opposite relationship), the Guarantee impact shows an high sensitivity to the third- party guaranty,
spread is narrowed by it, the currency risk dummy has a significantly negative relationship with loan
spread, maybe because banks offer lower rates to international borrowers who accept the risk of
borrowing in dollars or another strong currency, finally the Collateralizeable Assets has a surprisingly

less than 1, for example by 0,95, means that net operating income can cover up to 95% of annual debt
payments.
8
The original equation has been elaborated in order to evaluate the factors that influence the cost of loans,
across all the most common forms of financing, as corporate finance, syndicate loans, project finance, and
highlight the most expensive form and its drivers. The author has omitted the regressors that resulted non
significant for project finance spread pricing, basing on the research study, as the size of the loan.
68
 positive relationship with spread, maybe because the project to be financed, relates to the same
collateralizeable tangible asset, so they are considered riskier.

Differently from venture firms, where managers exercise growth options that transform a small
amount of capital into large companies, worth 10 to 1000 times the original investment amount,
project company managers have the duty to transform a large amount of capital into something
worth just a little more ( ESTY B., 2002).
The “best case” scenarios, in project-financed investments, are often only 2 to 10 times the “base
case” scenarios; this upside limitation depends on the nature of the final product: in this case oil
storage and offloading on floating system, its transporting in pipeline system, are “flow type”
projects, affected by physical constraints on capacity and on output quantities, since they depend on
non modifying factors, as the standard length and the maximum capacity of pipelines. However the
return (the net asset value as a percentage of investment cost ) distribution of venture-backed
investments is highly penalizing in the majority of cases, as showed in a study conducted by Esty,
basing on data from the Thomson Financial Securities Project Finance database: the average return is
by 19%, but only a quarter of the investors earn more than the mean return, since the median is at
4% value of return. That’s why investors can decide to earn more, at less probability, with venture-
backed investment, or less, at higher probability, with financed project investment. The following
Graph 3.2 displays the venture-backed asset return, while Graph 3.3 the project finance asset return:
the project finance hypothetical distribution of asset return is more positive skewed than the venture
capital investment return distribution.

Graph 3.2 – Return distribution on venture- Graph 3.3 – Hypothetical distribution of project-
capital backed investment financed asset returns

Source: Esty (2002) Source: Esty (2002)

To appreciate the capacity of value creation of project finance the Benjamin (1999) suggests to start
from Modigliani and Miller’s theory of agency costs: according to the capital structure irrelevance
proposition, building a project finance network should be irrelevant on the resulting enterprise value.
Nonetheless this preposition implies some unrealistic assumptions, as the absence of market
69
imperfections (taxes, transaction costs, asymmetric information): instead project finance creates
value by minimizing the net costs associated with these market imperfections.
Even if project finance is really time-spending and expensive, due to its complex texture of
relationship to create and agreements to sign (so it has sense for big project of infrastructure
construction), it has a great advantage in terms of information costs.
Since insiders have better knowledge of the real value of a company assets, there are problems of
adverse selection: it happens when the overvalued companies are the only that look for external
equity.
This problem is reduced in case of project finance, because the transparent nature of projects allows
a continuous monitoring of construction and of the status of the investment.
This is one of the most important difference with other start-up, financed with venture capital,
where it is extremely difficult to monitor development.
With segregated cash flows and dedicated management, there are few possibility of
misrepresentation of the real situation, and this translates into a lower cost of capital for the project.
Furthermore project finance reduce all the other well known investment distortions, as the
overinvestment in negative NPV projects, that are more expensive and submit covenants to respect,
or underinvestment in positive NPV projects.
By using project company they can isolate the project risk and reduce the probability of risk
“contamination”, that happens when a poor outcome of one project causes financial distress for the
parent company.
A greater leverage ratio usually lead to a second best condition of investments, a sub-optimal for the
profit maximization function, because it increases the default probability of the company and
creditors are reluctant to give other loans.
We can measure this agency cost, AC, using the following formula (FONTANA F. et al., 2001):

with

is the state of nature from whom the NPV of project is positive and major than
is the state of nature from whom the NPV of project is positive and major than +

is the enterprise value at time 0,

is the levered enterprise value at time 0,
is the enterprise value at the nature state that realizes at the end of the debt period,
is the breakeven price value of 1 US$ at the debt period term,
70
 is the debt value to repay,
is the realization cost

The agency cost, due to debt at time 0, is equal to the difference between the enterprise value, that
is financed only with equity, , and the leveraged enterprise value, .
Since creditors are aware of this value reduction caused by leveraging, at the borrowing signing, they
discount this inefficiency lessening the total amount of allowed credit:

the maximum debt value is reduced by the potential enterprise value that should have been
realized in the states of nature included between and .
However debt is advantageous in fiscal terms: so the optimal debt exposure is a trade-off
between underinvestment cost and interest tax shield benefit.
With project finance, the project companies can improve both the debt “overhung” risk reduction
and the fiscal benefit: each separate legal entity can contract more debt on their own, and the tax
advantage is incremental, since the 60% leverage ratio is twice what the sponsor could have had,
under corporate financing.

Another very common agency cost is that related to incentives conflict, the principal-agent problem:
in project finance structure the principal is the sponsor, while the agent is the main contractor that
has tendered the construction. As already said, the least faces the completion risk, so it’s of crucial
importance that it acts in order to maximize the project value.
The turn-key contracts avoid all these problems by transferring to the agent the costs of delays: the
principal pay a predetermined price for the construction, and, in case of breach of timing contractual
clause, the agent is forced to pay a fine.
In such this way there is a part of risk that is charged on the agent; to define the optimal level of
incentive, , on the contractor or agent, in a turn-key agreement, is considered the following
formula of economic profit (SANDRI S. et al., 2001):

with

is the contractor ex-post realized profit,

is the target profit,
is the contractor incentive coefficient,
71
 is the target construction cost,
is the realized ex-post construction cost

The principal pays a fixed, predetermined construction cost, so that the ex-post contractor profit
will be inversely proportional to the increasing value of the unexpected costs, , and of the
incentive coefficient
If is equal to 0, there is no incentive on the contractor, in fact its profit will be fixed to level.
If it is equal to 1, inversely, the risk is completely transferred, as happened in turn-key contracts.

The optimal level of the enforce incentive, , that maximize the contractor and principal equivalent
wealth, basing on their risk aversion coefficient, respectively and , is given by the following
formula:

where
is the maximum possible cost reduction realized by the contractor,
is the construction cost volatility,
is the covariance of the remaining activities profit of the contractor, , and the project
costs ,
is the covariance of the remaining activities profit of the principal, , and the project
costs

The two covariance, expressing the correlation between the costs of the project and the other
activities profit, measure the capacity of risk diversification of the two counterparties: the amount of
risk transferred to the contractor is a decreasing function of its diversification capacity, ,
multiplied by its risk aversion coefficient, , and it’s an increasing function in the principal
diversification factor times his risk aversion coefficient, .

In conclusion, sponsors use project finance in situations where high leverage doesn’t cause financial
distress, since they usually have predictable segregated cash flows and can reduce the agency costs.

72
3.2.2 International awards for the triad signed OSX

The three business run by OSX are examples of project finance practice, in an emerging market:
"Each one of these units will have a different project finance, where we put in 20% equity and we
have to raise 80% in outside debt” has affirmed Roberto Monteiro, ex CFO at OSX.
OSX Brasil SA is, in this optic, a kind of holding company that has direct or indirect interest in the
capital of the other sub-companies, whose core business is the offshore oil and gas equipment and
services industry, integrated with naval construction, chartering of exploration and production units
(E&P) and operation and
maintenance industries (O&M).
OSX Brasil S.A. is the main sponsor for each of its project companies, that, in turn, consist in a
specific area of business which have other dedicated sub-project companies.
The Company has the corporate structure showed in Chart 3.3., each of the main subsidiaries is
headquartered in the City and State of Rio de Janeiro and has acquired others companies that act as
special purpose companies.

Chart 3.3 – OSX Brasil S.A. corporate structure in June 2012

Source: OSX

3.2.2.1 OSX Construçao Naval S.A. (OSX Shipbuilding Unit)

It was organized in July 2009, its business purpose is to provide manufacturing, assembly, repair and
sale of maritime units connected to the activities of gas and oil exploitation and production, such as
fixed and floating production platforms, drilling rigs, and general offshore equipment.
The Açu Shipbuilding Unit, UCN Açu, which will be the largest shipyard in the Americas, include a
manufacturing plant with processing capacity of about 180 thousand of tons per year, in the initial
73
stage, and will be located within the Superporto do Açu in São João da Barra, in the state of Rio de
Janeiro.
UCN Açu has unique conditions for logistic integration, operating efficiency and local industrial
synergies due to its location in the Açu Superport Industrial Complex, especially for what concerns
the other sister companies business installation in the area (logistic by LLX, power by MPX) as the
steel plants (it is expected to process 220 thousand tons of steel per year, with expanding capacity of
up to 460 thousand tons/year), the operational efficiency reachable by the power locally generated
in the Industrial Complex of MPX, with up to 30% cost reduction, the short distance to major oil and
gas producing areas of OGX, 150 km away from the Campos Basin.

The different segment industry collocation in the Açu Superport are showed in Figure 3.1.

Figure 3.1 – Açu Superport industrial complex

Source: OSX

In March 2010, OSX issued 2,45 billion R$ ( equal to 1,4 billion US$) in equity during its IPO, in the São
Paulo stock exchange (Bovespa), which should be enough to fund the construction of its shipyard and
the first production units to be delivered to OGX.

On January, 1st 2011, OSX entered into a sharing of resources and administrative services agreement
with MPX Energia SA, through which they will share the plant of MPX and the related costs.
After obtaining the necessary License to build9 from IBAMA10, OSX began the works in July 2011 and
is currently in the preparation phase for the construction of its Shipbuilding Unit in the Superporto
do Açu , counting a total investments in UCN of 1.7 billion US$.

9
The requirements for obtaining such licenses include preliminary studies of the area, adequate planning of
facilities, and plans to mitigate environmental impacts. Accordingly, the companies must submit to local
74
On October 2011 OSX Shipbuilding SA has signed a 40-years agreement for the installation of UCN
AÇU industrial complex in the Port of Açu with LLX Açu port operations SA, automatically renewable
for an equal period.

On June 2012, through an articulate project finance that has involved the state-run banks Caixa
Economica Federal, CEF, the Brazilian National Development Bank, BNDES, and the Merchant Marine
Fund, OSX has obtained a funding line of 1,3 billion US$, to build UCN Açu, in the form of subsidized
loan: this is a cut-rate form of loan, commonly known in college students financing system, that
provide a subsidy that allows to not charge interests payment or capital repayment on the financed
subject during the predetermined period of grace.
FMM is a Brazilian funding institution for domestic shipyards projects (implementation, expansion,
modernization, construction and repair of ships) that can provide up to 90% financing at attractive
cost of funding (2.0–4.5% interest rate in US$).
The credit line will provide about the 80% of CAPEX, with 21 years of total duration, a 42/36 months
of grace period, for amortization of principal, and 36/30 months of grace period for payment of
interest, with an expected average interest rate of 3,38% per annum, paid monthly.
The funding line will be divided into two disbursement, each of 650 million US$, from the two lender
agents, CEF and BNDES, part of whom will be used to pay off the bridge loans, previously supplied by
the same financial institutions, for the same purpose.
Equity bridge loan is a type of short-term loan, typically for a period from 2 weeks to 3 years, which is
arranged until the project development reaches a step of major creditworthiness, in order to obtain
longer loans. In this case the risk-specific factor that required the MDB borrowing, has been the
construction license pending and the completion uncertainty: considering the unusual circumstances,
the interest rate is more expensive than conventional financing, to compensate for the additional risk
of the loan, and when it will become eligible for more conventional financing sources, at lower-
interest, for a longer term, money received from the new financing would be used to pay back the
bridge loan.

authorities a report called environmental impact assessment/environmental impact statement (EIA/RIMA),

assessing the potential impacts and mitigating factors.
10
On August, 9th 2010, was signed the “Technical Cooperation Agreement” between the presidents of IBAMA,
Abelardo Bayma, and the Environmental Foundation of Santa Catarina, FATMA, Murilo Xavier Flores, in which is
defined competence in licensing the OSX shipyard to be built in Biguaçu Port. One goal of the agreement is to
increase the interaction between IBAMA and Fatma in order to establish the exchange of technical and
operational experience. During licensing, IBAMA will monitor the process at every stage, give various permits
needed to expedite implementation of the project and will supervise the project. FATMA should report on the
progress of the case to the federal agency and consider, during its analysis of the technical feasibility of the
project, the suggestions send from IBAMA; periodic meetings will be held between the two bodies to discuss
technical aspects relevant to the proceedings.
75
In January 2012, in fact, OSX received a bridge loan from the BNDES, related to the Merchant Marine
Fund financing 227,9 million US$ for a period of 18 months at an approximate interest rate of 5.4%,
with principal and interest payable once reached final maturity or immediately after the first
disbursement of the FMM financing.
In April of 2012, in addition, the company, obtained a 200 US$ million bridge loan from Caixa
Econômica Federal, related to the FMM financing, with 18 months payment term, principal and
interest payable upon final maturity or the first disbursement of the FMM financing.
Both bridge loans are supported by bank guarantee letters issued by Banco Votorantim and Banco
Santander.
In addition, the shipyard may access funds from FGCN, Fundo Garantidor de Construçao Naval, to
cover a potential cash deficit from cost overruns.
In February 2010, OSX has entered into a “Technical Cooperation Agreement” for exclusive
technology partnership with Hyundai, the largest shipbuilder in the world, for know-how transfer to
OSX yard; in addition, in order to consolidate this partnership and to share common targets of
quality, Hyundai has signed an “Investment Agreement”, which gives it the right to acquire, through
the subscription of new shares, 10% of OSX Shipyards capital. Under these contracts, Hyundai will
provide engineering assistance for the implementation of procedures for the construction of offshore
equipment and professionals training, also in collaboration with the Institute of Naval Technology,
ITN, a new established professional institute that will provide OSX Shipbuilding with 3.100 technical
qualified personnel until 2013. OSX has achieved also a partnership with SIX, with whom will enforce
the “Almagesto” project for the systems integration in the naval construction sector in order to
reduce errors in transmission of information and waste.
The following Chart 3.4 gives a panoramic on the explained network of credit relationship of OSX.

76
 Chart 3.4 – OSX Shipbuilding project finance structure

Source: author elaboration on company data

The capex distribution, classified per year and activity scope, is showed in the following Table 3.1.:
the total capex for Shipbuilding unit is of 1,7 billion US$, whose 80% has been financed by MMF,
while the peak of 63,6% will be given in 2012. This means that this year the EBITDA will be negative
due to the huge capital investment.

Table 3.1 – OSX Shipbuilding Capex distribution per year/activity

2011 2012 2013 2014

14,4% 63,6% 20,1% 1,9%

DESCRIPTION OSX (US$) LLX (US$)
Dredging and engineering 93 90
Break water 135 129
Quay 262 -
Buildings 339 -
Dry dock 133 -
Roads and paving 146 -
Equipment, engineering and environment 487 -
Others 119 -
Total $ 1.714 $ 219
TOTAL OF US$ 1.933 MM
Source: OSX

77
3.2.2.2 Chalki Participações S.A.

Established on January 2010, the Company is engaged in the management of its own assets,
properties and specially for the acquisition of land and investment in other domestic and foreign
companies.
It was acquired by OSX Construção Naval (Shipbuilding Unit) with 99.99% of shareholding interest
and by OSX Serviços Operacionais Ltda. with 0.01% of shareholding interest.
Chalki Participações became holders of proprietary rights on contiguous areas (totaling about 3.2
million m2) to build and develop the shipbuilding business of the Group, in the State of Santa
Catarina: this subsidiary is another example of segregated capital, whose specific purpose is that to
manage investments, and hence, financial risks, on behalf of the Shipbuilding unit company and of
the main sponsor, OSX Brasil.
On March 2011 was sealed an agreement among OSX Brazil S.A , Shipbuilding S.A., Chalki
Participações SA and OSX Services S.A., whose object was the sharing of resources and
administrative services with the subsidiaries for three years, renewable for an equivalent period: this
highlight and confirm the circular business vision that permeates all the EBX Group.

3.2.2.3 OSX Serviços Operacionais Ltda. (OSX Services )

This single purpose company was established on November 2009 to provide operation and
maintenance (O&M) services of maritime units connected to the activities of gas and oil exploitation
and production, such as Fixed Production, Drilling Rigs, Floating Drilling Production Units, FPSO Units,
and further more to provide engineering services.
The team of professionals at OSX Services, is experienced and highly qualified to assure the required
levels of operational security and efficiency of OSX fleet, thanks to continuous training, compliance
with all safety and sustainability standards practiced in the industry11.
In February 2011, was signed a service contract for the FPSO OSX-1 maintenance between OGX
Petroleo e Gas and OSX Services: the remuneration will be calculated based on the reimbursement of
costs incurred in providing services plus a margin ranging from 0% to 10% on the amount of
reimbursement of costs, depending on the operating efficiency of the unit. Prices should observe a
pre-determined gross margin of approximately 5%, taking into account labor, materials, insurance,
mobilization, maintenance, training, tax and commissioning costs.

11
OSX and LLX implemented the Sea Turtles Treatment and Recovery Centre at the Açu Super Port. All injured
animals found in the monitored areas are taken to the centre to be treated, recovered, and monitored until
they are totally healed. The initiative enables to rehabilitate animals found onshore along the 62 km of beaches
that are daily monitored. Care is given by a team of five people, including veterinarians, biologists, and
assistants. Over 3.5 million R$ were invested to build the centre for recovery, monitoring, and veterinary
analyses.
78
In case of accidents on the FPSO, will be under the operator responsibility the removal of equipment
thrown overboard, being aware of the possible danger to fishing activities or navigation. Additionally,
it will compensate any damage caused to third parties, that’s why it take insurance hedge to mitigate
these risks.
Resolution of the service contract would occur in the event of breach of the obligations of the
contract, of any insolvency, any misrepresenting statement, loss or damage to the ship.

3.2.2.4 OSX Leasing division

OSX Leasing business provides offshore units for the oil and gas industry, offering long-term leasing
agreements, to ensure a continuous inflow of revenues to the project company.
The main subsidiary is OSX GmbH12, which was organized on October 2009, through an acquisition of
the capital of BVSARANTATRIA Beteiligungsverwaltung GmbH, a company established under the laws
of Austria, with headquarters in Austria; on November 2009 it changed the name into OSX GmbH.
The business purpose of the Company is to invest in other companies13, it is involved in a series of
loan agreements towards OSX Leasing Group, under the form of subordinated debts: these loans are
provided by the sponsors to the SPV, as a part of its investment in the equity of the project, in the
event of default or bankruptcy, with priority of repayment over capital but not over commercial bank
loans or other senior debt, in fact they’re called junior debts, too.
Once the other creditors have been repaid, the subordinated debt can be satisfied both with interest
and principal payment, but, differently from standard debt, it requires a participation in the equity,
so it allows upside potential of a project, just like equity. The subordinated debt is usually required at
the construction stage of a project to face cost overruns: it is another risk sharing strategy and, at the
same time, a smart way to better the DSCR (debt to service coverage ratio), since the debt-to-equity
ratio of the sponsor won’t include the subordinated debt value, causing a virtuous domino effect
since also banks will easily negotiate larger loans, and more potential investment will be financed
and developed.

OSX Leasing Group B.V. (“OSX LG”)

The Company was organized on November 2009, under the laws of the Netherlands, its business
purpose is to invest in other companies, it’s headquartered in Netherlands. To optimize its tax rate,
OSX Leasing unit has been registered in Austria and operate through subsidiaries (OSX 1 Leasing BV14,
OSX 2 Holding BV, OSX 3 Holding BV, OSX 4 Leasing BV, OSX 5 Leasing BV, OSX WHP 1&2 Holding BV)

12
In German law, Gmbh is the abbreviation for Gesellschaft mit beschränkter Haftung, that is the equivalent of
BV in Netherland laws or ltd. Company in English, S.A in Portoguese.
13
This acquisition was not characterized as a business combination, according to the definitions established in
CPC 15 and IFRS 3 (Business Combinations) as it involves the acquisition of a shelf company without any asset
or liability and without projected cash flow.
79
registered in the Netherlands, too. As a kind of waterfall scheme, OSX LG acts, in turn, as a sponsor
for its subsidiaries single purpose vehicles, financing them through loan agreement and subordinated
debt.

OSX Asia Management Pte. Ltd

A company organized on April 2012, under the Asian Law, headquartered in Singapore, provides
general and corporate services, including sharing human resources and infrastructure.

3.2.2.5 OSX 1 Leasing B.V. (“OSX-1”)

A company organized on December 2009, established under the laws of the Netherlands, with
headquarters in Netherlands: “OSX-1” is the owner of a floating production, storage and offloading
unit, FPSO, of oil and gas.
This SPV represents the first milestone in OSX Brasil growth strategy and run towards the market
share enlargement: the acquisition, conversion, mobilization and final customization of FPSO OSX-1
has been an enthusiastic adventure and the first step of a series of new profitable projects and
investments.
Even if I’ve already explained what is the main function of these complex floating systems in the
Second Chapter, it’s the case to spend some words on the particular structure and importance of the
FPSO15.

FPSO is an offshore production facility that is typically ship-shaped and stores crude oil in tanks
located in the hull of the vessel. Floating production, storage, and offloading systems receive crude
oil from deepwater wells (depth > - 200 m) and store it in their hull tanks, until the crude can be
pumped into shuttle tankers, for the transportation to the coast.
FPSOs generally are a miscellanea of marine and petroleum functions, hence, present many
specialized characteristics from both the involved technical field.
FPSOs eliminate the need to use expensive long pipelines, from the processing facility to an onshore
terminal.
Their disconnectable turret structures of the anchor buoy, typical in the Single Point Mooring system,
are designed to anchor the vessel in that point, leaving it free to move and turn in all the angles,
seconding the wave directions, the wind forces, and the sea drift, permitting the constant flow of oil
and production fluids from undersea field to the vessel, with the possibility of a quick disconnection
in the event of emergency.

14
BV stands for Besloten Vennootschap, which is the Dutch terminology for a private limited liability company:
the company is owned by shareholders, and the shares are privately registered and not freely transferable. This
type of company is the most common form of enterprise in the Netherlands.
15
FPSO have been used to develop offshore fields since the end of 1970's, especially in the North Sea.
80
In the following Figure 3.2 are indicated these fundamental parts of FPSO structure.

Figure 3.2 – FPSO structure

Source: ONIP, Musso B. (2011)

Centennial Asset Ltd., one of the holding companies that controls OSX, acquired FPSO OSX-1 from
Nexus, for 358 million US$, to transfer it to OSX: it had been built by Samsung Heavy Industries Co.
Ltd shipyard, in South Korea, the conversion of the naval ship into an offshore oil production system
and its customization was done at the Keppel shipyard in Singapore, where, on August 2011, the Sail
Away Ceremony took place, and has successively completed its final customization phase, in Rio de
Janeiro, where 8 new modules, weighing up to 700 tons each, were built, other modules were
adapted and 180 kilometers of power cables were installed on the upgraded vessel.
Measuring 271 meters in length, the re-birth FPSO OSX-1 is the first floating unit in OSX fleet, with a
store capacity up to 950 thousand barrels of oil and initial processing of 80.000 bpd, expandable to
approximately 100.000 bpd, with a further capex of 100 million US$.
Next Figure 3.3 shows the FPSO OSX-1 in operation at Waimea accumulation.

It was delivered to OSX 1 BV on October 2011, and on January 31st 2012 successfully started the first
oil production for its major client, OGX, the sister oil and gas company of the Group EBX: OSX-1 is
responsible for performing the Extended Well Test (EWT) in Waimea on well OGX-26HP, located 80
km off the coast at a water depth of -130 m. It has been leased to OGX for a period of 20 years,
through an agreement sealed in the first quarter of 2011, among OGX Petroleo e Gas Ltda, OSX Brazil
SA, OSX Leasing Group BV, OSX 1 Leasing BV.

81
 Figure 3.3 – FPSO OSX-1

Source: OSX (2012)

The Charter Party (OSX 1 Leasing BV) regulates the conditions of pay rent for the chartering of OSX-1
by OSX 1 Leasing BV for OGX: the agreement between OGX and OSX establishes a priority right for
the supply of production units, including their maintenance, that OGX will need in the next decade.
To avoid possibilities of conflict of interests, the day rate paid by OGX will target a pre-determined
15% return on equity for OSX Leasing unit: the leasing agreement will be remunerated by leases paid
on a monthly basis by OGX Ltda. to OSX 1 BV, and the average daily lease due during the period of
the leasing is equivalent to 263.000 US$, readjusted in accordance with the inflationary index of the
sector.

The minimum future revenues of this agreement, discounted at present value, are estimated as
follows:
 up to 1 year 76,2 million US$
 from 1 to 5 years 197,4 million US$
 more than five years 238,6 million US$

totaling 512,2 million US$.

Such margins and returns are in line with market prices and imply capex and opex for OGX very
similar to what was assumed in the appraisal study by DeGolyer and MacNaughton: in fact, Asian
shipbuilders last reported EBITDA margins ranging from 9% to 18%16, with the average margin
standing at 13%, while a return on equity of 15% also seems reasonable considering the high
leverage of the business (with up to 90% of capex financed by debt). To provide protection for OGX

16
The other data estimated by Credit Suisse on the major oil services EBITDA margin are: Yangzijiang 18%,
Cosco Corp. 16%, Hyundai 13%, Keppel Corp 12%, Sembcorp Marine 11%, Daewoo Shipbuilding 11%, Samsung
9%, the average value for the Asian market is 13%.
82
shareholders, the priority right for the company declines if OSX is unable to deliver the unit on time,
if OSX prices exceed market prices for similar units, if OSX has no access to certain technology
requested by OGX.
A supplementary leases may also be charged to OGX if OSX-1 proves that it has incurred additional
expenditures due to cost overrun related to its supplies: this refers to the raw material supply risk,
that happens if actual costs exceed the planned budget by more than 5% (which is the maximum
accepted contingency margin) because of a difference in the quantity of raw material and labor
used. Hence in this cost overrun case, the integration will be debt on OGX, in a “supply-or-pay” type
of clause agreement. The incentive to OSX to be efficient comes by not using the contingency margin.
OGX may terminate the contract in the event of total loss of the unit, if the activity becomes illegal,
in case of an excessive increase in the tax burden, or environmental incidents where OSX 1 BV or its
shareholders are regarded as guilty.
On the other hand, OSX may terminate the contract in case of breach of contractual obligations,
failure to pay, lack of insurance, breakdown of insurance obligation, involvement in insolvency
proceedings: for what concerns the first resolution cause, it is typical of a “take and pay”
agreement17, where the rental periodic payment by OGX is subordinated to the timely and efficient
services and equipment supply by OSX 1 Leasing.
FPSO OSX-1 has achieved British Standard Institution certification, BSI, with 100% compliance to
quality management (ISO 9001), environmental management (ISO 14001) and Health and safety
systems in the workplace (OHSAS 18001) certification.
The operator of the production unit is OSX Service SA. It has obtained an average operating efficiency
of 99% since beginning operations in January 2012 up to September 2012, which represents an
unprecedented result during the initial phase of an offshore production unit: the operating efficiency
is calculated by dividing the actual production for the maximum sustainable capacity of the reserve.
The major or minor efficiency consists in avoiding all the production losses that differently occur in
correspondence to the specific phase18 of the field development: the field production capacity is
crucial to determine the efficiency ratio, too, since it is always related to the size and characteristics
of the reservoir, and the wells or other facilities installed. OSX-1 is currently connected to two

17
Also exists the “take or pay” agreement that enforces the buyer to pay the determined fixed lease, even in
case of lack or delays of the furniture.
18
Usually during the life of an oil and gas field we can identify different consequently phases: the early stage of
life, whose objective is to bring the reserves into production at the minimum capital cost, the development
phase, whose goal is to ramp up to full potential production as soon as possible, the mid-life phase, when
production must be sustained at its maximum levels, the decline phase, when costs and production volumes
must be optimized to achieve maximum profitability and extend the operating life of the field. E&P companies
often are less efficient in operations during the decline phase, when cost minimization and volume
maximization must be optimized: this imposes the necessity to monitor and fix a benchmark on the operation
efficiency in order to improve the performance.
83
producing wells in OGX’s Tubarão Azul field (Waimea accumulation), in the Campos Basin. The
following Chart 3.5 shows the monthly operating efficiency recorded in the first half of 2012.
In the case that operating efficiency of OSX 1 should be at an inferior level than 97%, during any
period of validity of the Leasing Agreement, OSX 1 BV or the OSX Leasing Group BV, may be called to
pay part of the leases, in order to offset this operating inefficiency of OSX-1.
On late March 2012 has concluded its first oil offloading and pumping operation of oil stored in the
tanks to a shuttle vessel, for OGX sale of 600.000 barrels to Shell19.

Chart 3.5 – 2012 OSX Service monthly operating efficiency

Source: OSX (2012)

Project finance build for OSX 1 Leasing BV, has been made up of a bank syndicate led by DVB Group
Merchant Bank (Asia) Ltd., which has financed up to 80% of the cost of acquisition and modification
of the new building OSX-1 FPSO. The loan of 420 million US$, with maturity of 8,5 years at LIBOR +
4.25% rate per year, include a 12 month of grace period, during the final construction of the vessel:
after that term, the normal rate begins even if the modification of the FPSO isn’t complete.
This feature protects lenders from delays and cost overruns, and is a form of incentive on the agent:
in addition, there is a guarantee from OSX, which is in place until the vessel produces its first oil.
This guarantee is a variation element on the non-recourse nature of the project finance:
limited−recourse project finance permits creditors and investors some recourse to the sponsors
assets, which plays the role of a pre-completion guarantee during the project construction period,
which is a common practice in developing market projects. Creditors and investors, however, still
consider the cash generation capability of the project as their primary source of repayment.

19
See Second Chapter.
84
According to the loan contract, the DSCR, which measures every 3 months the payment capacity of
the financial expenses, in relation to EBITDA of the last 12 months, should represent at least 1,2
times the financial expense of the same period; on June 2012, the DSCR of OSX 1 was 1,55 times.
This was the first project financing entered into by EBX, which has attracted many financial
institutions and governmental agencies for the potential upside of the investment: initially, DVB
Group Merchant Bank (Asia, Singapore) Ltd. and GIEK (Export Credit Agency Facility), disbursed 320
million US$ and have to syndicate the remaining 100 million US$, but there was strong interest in the
deal, so that Credit Agricole, ING and Santander agreed to take 50 million US$ and ABN AMRO took a
20 million US$ piece. Eksportfinans was the lender under the 165 million US$ GIEK guaranteed
tranche of the loan. To protect against interest rate fluctuation risks, 3-month LIBOR, the Company
contracted an hedge operation with HSBC and fixed all the LIBOR exposure at an average rate of
1,91% p.a. DVB, GIEK, Eksportfinans, Credit Agricole, ING, Santander, ABN Amro has been involved in
this first project finance for OSX 1 Leasing. In the following Chart 3.5 is displayed the OSX1 Leasing
project finance structure.

In 2010 Allen&Overy20, internationally known legal advisory, has communicated Brazilian oilfield
services company, OSX Brasil S.A. on the "South American Debt Deal of the Year", awarded by Jane's
Transport Finance, and in the same year Marine Money International21 announced OSX the winners
of “Deal of the Year Awards”. The distinguishing winning features have been creativity, difficulty,
execution, innovation, strategic approach and size in a capital constrained market.

20
A&O has a great deal of experience advising in respect of FPSOs and drillships, as well as numerous other
types of offshore support vessels including LNG regasification, vessels and jack-up rigs, semi-submersibles,
pipelaying and cable laying barges, anchor handling tug supply vessels and offshore supply vessels.
21
Marine Money International, celebrating its 25th anniversary in 2011, is the publisher of Marine Money
magazine, the ship finance publication of record.
85
 Chart 3.5 – OSX 1 Leasing project finance structure

Source: author elaboration on company data

3.2.2.6 OSX 2 Leasing B.V. (“OSX 2”)

A company organized at January 2011, established under the laws of the Netherlands,
headquartered in the Netherlands, pursuant to Dutch laws, and is engaged in the ownership of an oil
and gas floating production, storage and offloading unit (FPSO).
The project capex is 1,094 billion US$, financed up to 70%, which increases to 80% when certain
conditions, such as an acceptable reserve report, are met.
As for OSX 1, until the vessel is delivered, OSX will guarantee the borrower obligation for OSX 2: again
this is an example of limited recourse debt.
A Turn-key Engineering, Procurement, Construction and Installation agreement, EPCI, with Single
Buoy Moorings, SBM Inc., has been signed: the builder or developer (the agent), SBM, is separate
from the final owner or operator (the principal), OSX 2, and the project is turned over only once it is
fully operational, “turning the key” over to its owner. With a turn-key agreement the completion risk
is attributed to the hired agent, with an optimal incentive coefficient, , equal to 1. This contract
feature, provides for the sponsor a completion guarantee, that secures the creditors, even if OSX SA
assumes the guarantee role on the debt coverage obligations.
The delivery is estimated for third quarter of 2013; actually the physical progress is by 70%.
The financing agreement, for 850 million US$ loan, was signed in October of 2011, with a syndicate
of international banks led by Itaú BBA, ING and Santander, with HSBC, Citibank, ABN Amro Bank,
Banco do Brasil, NIBC and DnB. This credit line will be disbursed throughout 2012 and 2013, has 12

86
year payment term at an average rate of LIBOR + 4.41% for investment in the construction and
installation of FPSO OSX-2. In May 2012, was disbursed the first tranche of the long-term of 428
million US$. DSCR calculation starts five months after the delivery of FPSO OSX-2, and must be at
least 1.1 (EBITDA/ expenses on the period). The following Figures 3.4 and 3.5 show the status of work
in progress of OSX-2.

Figure 3.4 - Main deck conversion/construction Figure 3.5 - Construction of the turret

Source: OSX (2012) Source: OSX (2012)

OSX 2 was awarded the “Oil & Gas Deal of the Year Americas”, award during Euromoney "13th
Annual Project Finance Americas Deal of the Year Awards", for raising its huge loan for the
construction and implementation of the FPSO OSX-2. In January of 2012, OSX had already received
the "Oil & Gas Deal of the Year Americas" award in the "Project Finance International Awards", in
London.

OSX WHP 1 & 2 Leasing B.V. (“WHP 1 & 2”)

A company organized on June 2011, established under the laws of the Netherlands, headquartered in
Netherlands, which is engaged in the ownership of oil and gas fixed perforation and production units.

3.2.2.7 OSX 3 Leasing B.V. (“OSX 3”)

The special purpose company was organized at June 2011, established under the laws of the
Netherlands, headquartered in the Netherlands, pursuant to Dutch laws, and is engaged in the
ownership of an oil and gas floating production, storage and offloading unit.
OSX 3 has signed a turn-key EPCI contract with MODEC, the conversion and construction of the hull is
in progress at the Jurong shipyard in Singapore.
The physical progress is at 64% approximately, the estimated delivery is on third quarter of 2013.

87
On March 2012, the subsidiary OSX-3 raised 500 million US$ with the international issue of Senior
Secured Bonds, the net revenues of which will be used in the construction of FPSO OSX-3.
The bonds financial maturity is on March of 2015, at interest rate of 9.25%, payable quarterly.
OSX-3 will have a call option exercisable between 15 and 24 months from the date of issuance at
103% of the face value, or between 24 and 36 months at 102% of the face value.
Pareto Securities acted as global coordinator, Joint Lead Manager and Bookrunner in the issuance of
the bonds, DNB Market as Joint Lead Manager and Bookrunner.

The following Chart 3.6 represents OSX 3 Leasing BV project finance structure.

Chart 3.6 – OSX 3 Leasing project finance structure

Source: author elaboration on company data

OSX 2 Holding B.V. (“OSX 2 HOL”) & OSX 3 Holding B.V. (“OSX 3 HOL”)
Formed respectively on September 2011 and February 2012, under the laws of the Netherlands, with
headquarters in Netherlands, the two subsidiaries are engaged in providing general and corporate
services, including sharing human resources and infrastructure, as well as providing collateral
signatures and other guarantees related to obligations assumed by its subsidiary or other entities
under common control.

88
 OSX 4 Leasing B.V. (“OSX 4”) & OSX 5 Leasing B.V. (“OSX 5”)

On February 2012, OSX LG contributed 18.000 EUR to establish the two SPV, OSX 4 and OSX 5,
established under the laws of the Netherlands, headquartered in the Netherlands, pursuant to Dutch
laws: they’re engaged in the ownership of an oil and gas floating production, storage and offloading
unit (FPSO).

In Table 3.2 have been collected the main financials of OSX Brasil and its subsidiaries, comparing the
1H 2012 to 1H 2011 data (in million US).

Table 3.2 – OSX main financials (2012 vs 2011), data in US mln $

OSX Brasil S.A.

1H12 1H11
Gross Revenue - -
Taxes - -
Net Revenue - -
COGS - -
Op. Income - -
G&A (11,96) (9,06)
EBITDA (11,96) (9,06)

Shipbuilding Leasing O&M Services

1H12 1H11 1H12 1H11 1H12 1H11
Gross Rev - - Gross Rev 50,76 - Gross Rev 51,11 19,35
Taxes - - Taxes - - Taxes (4,07) (2,30)
Net Rev - - Net Rev 50,76 - Net Rev 47,04 17,05
COGS - - COGS (6,57) - COGS (40,33) (12,30)
Op. Income - - Op. Income 44,20 - Op. Income 6,71 4,75
G&A (15,78) (10,34) G&A (1,42) (0,24) G&A (3,87) (2,55)
EBITDA (15,78) (10,34) EBITDA 42,78 (0,24) EBITDA 2,84 2,20

Consolidated
1H12 1H11
Gross Revenue 101,87 19,35
Taxes (4,07) (2,30)
Net Revenue 97,80 17,05
COGS (46,89) (12,30)
Op. Income 50,91 4,75
G&A (33,03) (22,74)
EBITDA 17,88 (17,98)
Source: OSX (2012)

89
The first half of 2012 has been very positive for consolidated OSX SA, since it has doubled the last
year EBITDA: from a negative 1H 2011 EBITDA, equal to 18 million US$, the 1H 2012 one is up to 17,9
million US$, and, if we consider the gross revenues values of 2012, it is even fivefold the one of 2011,
with 102 million US$ against 19 million US$.
The main value drivers have been the start of oil production and the consequent full operation of
FPSO OSX-1 and its O&M services: both OSX 1 Leasing and OSX Services, have recorded positive
results, while the most heavy costs suffered has been the OPEX by OSX Services. The
EBITDA/Revenues ratio for OSX Leasing company is very high, by 84%, while OSX Brasil, the holding
company for integrated offshore solutions, as expected, has only recorded general and
administrative expenses.

3.3 OSX key success factors

The company was created during a flourish moment both for Brazil economy and for OGX
enhancement: the country emerging economy has gained the leading role on international arena,
especially, as explained in the First Chapter, as a consequence of the wave of oil discoveries in the
Campos and Santos Basins, and OGX was achieving its success during the exploratory campaign at
the Waimea offshore field.

The main pillars of growth of OSX are:

 developing and attracting shipping market conditions after pre-salt revolution;

 strong demand from OGX and demand in expansion from Petrobras;
 local content compulsory requirement;
 strategic partnership with Hyundai and other consulting firms as Verax Consulting, Planave
Engineering and Technip;
 partnership with Institute of Naval Technology;
 experienced and motivated management and personnel team, composed of former
employees of Petrobras and other leading Brazilian companies.

Each of them contribute to rise the probability of success of OSX.

90
3.3.1 Brazilian Naval industry recovery

After a long period of mediocre activity levels, the Brazilian shipbuilding industry is benefiting from
government incentive programs, as PROMEF, The Fleet Expansion and Modernization Program, but
also from strong demand from the oil and gas market and entry barrier for foreign players, enforced
by local content requirements of ANP.
The Brazilian shipbuilding market is receiving huge inflows of capital, both from domestic sources
and from international ones: nevertheless, the expected supply capacity by Brazilian shipbuilders,
even considering the various new projects that have been announced, is not enough to match the
increasing domestic demand from oil companies, leaving room for additional shipyards in the
country.
Since the beginning of the second half of the 20th century, important incentives had been offered by
the administration of president J. Kubitschek22 who established the Merchant Marine Fund (FMM),
created to finance the sector, beyond governmental subsidies.
The growth observed during the 1960s, continued for the following 15 years, thanks to reforms on
the sector and heavy investments in infrastructure, stated by the military regime; nonetheless in the
early 1980s, economic crisis and the lack of competitiveness of the industry, also due to the easy
subsidies and cheap financing, lead to an inefficient market that fast collapsed.
The first positive signal came in 2004 with the PROMEF launch, designed to give new life to
Transpetro (Petrobras transporting subsidiary) fleet: the program puts as primary target the
investment in human resources training, the technology modernization, the infrastructure expansion,
the universities collaboration, in order to meet the promised building order for 49 new ships and 146
smaller vessels in Brazil. The Brazilian shipbuilding reconstruction has become a priority in the
Government agenda: to this scope has been established the Shipbuilding Guarantee Fund, FGCN,
where it has put 2,45 billion US$, plus 7,35 billion US$ billion in the FMM, new tax incentives have
been implemented and the oil market was renovated thanks to the Petroleum Act, passed in 1997.

The actual situation of the shipyard projects, however, is at a stagnant point, in fact only few
shipyards, even if not yet operating, are in advanced stage of construction and already have
contracts signed with Petrobras, as Brasfels, by Keppel FELS Brasil, in Angra dos Reis, and Estaleiro
Mauá, in Niterói, both in the State of Rio de Janeiro, as Atlantico Sul Shipyard.
Other projects are: EAS, Rio Grande shipyard, located in Rio Grande do Sul, Mac Laren in Rio de
Janeiro. EAS, in particular, has a technological partnership with Samsung Heavy Industries, and its
steel processing capacity should reach 160 kton/year. Unlike OSX, however, four of the total projects
haven’t even secured the environmental license for construction, so they really are at the first steps.

22
See One Chapter for a focus on Kubitschek.
91
Brazil’s port and transportation infrastructure looks particularly poor: among 133 countries in the
World Economic Forum survey, Brazil ranked 127th on the quality of its ports. (M. STANLEY, 2010)
The supply-demand level of Brazilian shipyard market, is unbalanced, according to a study conducted
by the Centre of Study for Naval Management, the local capacity to produce standard hulls and
topsides has a gap of up to 9 units for the next 3/4 years.
This is another reason to invest in the sector and benefit from financial and fiscal subsidies.

Even SBM, one of the global FPSO leaders (with 19 leased units in its current portfolio), has started a
partnership with Maua shipyard in Rio, which is a clear signal of the growth opportunity in Brazilian
naval market. The demand for production rigs is estimated to be around 150 units up to 2020
(PASCHOA C., 2010): the estimate for Petrobras demands, alone, is for 55 units, plus 49 tankers.
Private O&G operators are expected to have a demand for 55 production rigs, including 48 units only
for OGX: the OGX rigs are to be built at the OSX shipyard, which will start being built in mid 2010 and
is expected to be operational by mid 2011.

3.3.2 OGX strong potential demand

The strategic contractual relationship between OSX and its sister company OGX, secures a large order
book for OSX. According to DeGolyer & MacNaughton (D&M) evaluation, OGX has 6,8 billion boep of
resources23, which will require 48 production units for the next 10 years, an investment of
approximately 30 billion US$.
Actually OSX has secured by the oil company an order portfolio worth 4,8 billion US$, including five
FPSOs and two WHPs: in addition OSX has estimated to deliver 10 FPSOs and 11 WHPs to OGX by
2015.
WHPs should be used in the development of Campos, Santos and Pará Maranhão projects, while
Espirito Santo deep-water fields should use mostly TLWPs; FPSOs should also be used in all basins,
connected to one or more fixed platforms; the deliveries are expected to be concentrated in 2015
and 2016, as shown below in Table 3.3, where is reported the current order backlog from OGX.

23
See Second Chapter for a focus on OGX.
92
 Table 3.3 – OSX current order backlog
ESTIMATED PRICE CONSTRUCTION
CLIENT UNIT CAPACITY DELIVERY*
(US$ MM) LOCATION
FPSO OSX-
OGX 80K bopd 610 0K SAMSUNG, KOREA
1
FPSO OSX-
OGX 100K bopd 775 3Q13 KEPPEL, SINGAPORE
2
FPSO OSX- JURONG,
OGX 100K bopd 800 3Q13
3 SINGAPORE
FPSO OSX-
OGX Expecting Technical Specifications from Client OSX, BRAZIL
4
FPSO OSX-
OGX Expecting Technical Specifications from Client OSX, BRAZIL
5
OGX WHP-1 30 wells 400 – 450 2Q14 TECHINT, BRAZIL
OGX WHP-2 30 wells 400 – 450 4Q13 TECHINT, BRAZIL
OGX WHP-3 Expecting Technical Specifications from Client OSX, BRAZIL
OGX WHP-4 Expecting Technical Specifications from Client OSX, BRAZIL
SAPURA PLSV N/A 263 4Q14 OSX, BRAZIL
KINGFISH 11 MRs N/A 732 2Q15 – 4Q17 OSX, BRAZIL
PETROBRAS 2 FPSOs 150K bopd 900 3Q16 – 3Q17 OSX, BRAZIL
*Delivery at the shipyard (ex-installation)

Source: OSX

Also other players on the oilfield market, have recognized the potentiality of OSX integrated
solutions business: on March 2012, London-based Kingfish concluded the contract for an order of 11
tankers, paying about 60 million US$ each one.
After OSX-2 and OSX-3, 7 FPSOs and 9 WHPs are to be built in UCN Açu; should all the 48 estimated
production units be built for OGX, OSX would be fully occupied until 2017.
Given the declared massive investment in upstream oil market by Petrobras, strengthened by the
trend of capex increase from other oil companies, and the new technology needed in the pre-salt
context, the consulting group Verax, specialized in the shipbuilding and port industries, has
estimated the potential market opportunity for OSX.
Its study has combined all announced demand for production units for the offshore segment, from
Petrobras, OGX and other players, and has estimated potential additional demand over the next
decades, net of orders already granted: the base-case scenario considers 50 billion boep of total
reserves in Brazil.

The next Chart 3.7 shows Verax estimation of consolidated market demand for OSX units, in 2010.

93
 Chart 3.7 – Consolidated estimated demand for E&P units until 2036

Source: Verax (2010)

Till now, however, the expected backlog of OSX order has suffered from delays, as clearly shown in
the following Graph 3.8, were I’ve compared the official estimated demand from OGX for FPSOs,
WHP and TLWP in 2010, and the changed estimated demand for the same units in 2012.
The shape of the two function is the same, but the 2012 demand seems the delayed and right-
postponed 2010 demand. In fact, comparing the two trend, in the recent estimation, the book
appears flattened, since in 2012 the expected demand of FPSO has gone to zero, and in 2014 has
halved, while WHP has gone to zero in 2014, and halved in 2016.

Chart 3.8 – OGX 2010 vs 2012 estimated orders backlog

Source: author elaboration on data from OSX

94
Another observation is that, the more the estimation is far, the more it is upside biased: it’s easier to
suppose that in the next ten years the oil production will recover the actual cut down, and so will do
the trend of the related demand of units.
But in the near future estimation, the data show a clear shift in the entire function.
This is the outcome of the reduction in production rump up targets for 2013, announced by OGX in
last months, that obviously have influenced all the correlated businesses.
The official adduced reason for this cut down has been a temporary break of the centrifugal
submersible pump system in the Waimea accumulation: the undeniable operational risks and the
appraisal results uncertainty of OGX reserves, lead a serious quantum of volatility to the entire
business of OSX.
However also Petrobras is facing serious delays in production ramp up targets, in fact it has many
times reduced them for the next 5-years of business plan: despite this, Petrobras has officially
communicated to OSX its willing to add the start-up among its new suppliers list, to meet its order for
five deepwater drilling rigs. OSX, in addition, is in negotiation with Ocean Rig, which has already been
awarded for a contract for 21 rigs from Petrobras.
This isn’t the first time that Petrobras looks to OSX for its commitments: during the hot summer of
2012, a subsidiary of Petrobras, the special purpose company Tupi BV, has hired OSX Shipbuilding
Unit for the integration of two FPSO units, with an additional option to hire OSX to integrate a third
unit, for a total amount of 900 million US$, delivery estimated time from 49 to 60 months.

With the seal of this contract, Petrobras has become the fourth client for OSX.
These FPSOs are part of the offshore operations development that are booming after the Brazilian
pre-salt oil and gas discoveries in the Santos Basin: till the wave of discoveries and the new proven
reserves will be developed, OSX will benefit from this excess of demand.

3.3.3 The local content barrier: cost or opportunity?

Brazil government has put an high barrier to the entry for international oil companies, in order to
foster domestic companies development and entrepreneurial initiative, requiring the compliance to
ANP local content restriction.
To sum up, oil and gas operators must buy most of the equipment they need during E&P activities,
from overpriced domestic manufacturer: but other than hurt the interests of international giant oil
companies, this policy has constituted an heavy burden on Petrobras, which needs sophisticated
equipment to drill at sea depth that reach thousands of meters underwater.

95
While boosting local labour hiring and training, this policy has penalized many oil companies, causing
the redefinition of target of production for the lack of suitable competencies, delays in the delivery of
ordered units and cost overrun.
Meanwhile, other start-ups are taking advantage from local content rules, first of all OSX: Kingfish
contracts to OSX have been priced twofold what a Chinese yard would have charged to build a similar
vessel (34 million vis à vis 66 million US$). This is very representative of the price the oil companies
have to pay to achieve high local content requirements of 70% in Brazil, given the under developed
status of shipyard and of services, in the domestic market.
For Açu Superport, where sales taxes are of 2% instead of 18%, is of crucial importance the local
content restriction, since global suppliers are forced to buy and construct in Brazil, if they want a
piece of the oil bonanza. OSX itself, has realized a partnership with the Institute of Naval Technology,
ITN, jointly with SENAI-FIRJAN24, a well-known entity for industrial professional training in Latin
America, in order to increase local occupying among young labor force.
The Professional Training Program, for whom ITN has received 20.000 applications, offers 23 free
courses in Metal-Mechanics, Electricity, Metallurgy, Automation, Oil, Construction and Management
in São João da Barra.

The program will follow three consequent phases:

 in the first phase: “Qualification and training”, the students learn and improve their skills
with the technical assistance and supervision of Hyundai25;

 the second phase: “Supply Chain Strengthening”, is focused on the identification of suppliers
that can develop new materials, equipment and innovative work methodologies for OSX;

 the third phase: “Technological Innovation”, which establishes partnerships with Brazilian
and international academic institutions, focusing on the development and assimilation of
new technologies.

The first classes have been formed on June 2012, with 880 qualified students: SENAI has provided its
facilities and the faculty in the city of Campos for workshops, laboratories lessons, classrooms,

24
Over the past 60 years, SENAI-RJ has been working in training and in the spread of new technologies as a way
to support the technological development of industry of the state of Rio de Janerio. Now the SENAI Institute of
Higher Education uses its experience to promote the skills and expertise of industry workers and provides
technology solutions to businesses through programs of technical assistance. The FIRJAN, is an institution
providing services to businesses, acting as a forum for discussions and information management for economic
growth and social status.
The institute is offering courses post-graduation, whose specializations are more demanded by the market. The
training is based on technical scientific knowledge, linking theory to practice.
25
HHI has a direct stake of 10% in OSX and is in a technical collaboration agreement with the shipbuilding unit
in order to share knowledge through the 40 Korean specialists based in Brazil for 5 years.
96
auditorium, library; with a capex of 6,2 million US$, the training program aims to give scholarships to
its students, providing financial assistance, food and transportation.

A covenant established with FIRJAN/Senai-RJ, the industrial learning and training center, requires
that, at the conclusion of the Training program, they will qualify 3.100 professionals by the end of
2012.
The Institute first educational program, in addition, focuses on the operational demands of UCN Açu,
in order to become a reference center for the shipbuilding and offshore operations industries, and to
stimulate projects and research aimed at upgrading the technology in these segments.
To this purpose the Institute will establish partnerships with excellent teaching institutions in Brazil
and abroad. These collaborations and initiative are a kind of hedge of OSX on execution risk, and
ensure the company’s competitiveness when the Açu Superport will start to operate.

97
98
 FOURTH CHAPTER
A Crystal Ball application for OSX evaluation model

“…Variability is a phenomenon in the physical world to be measured,

analyzed and, where appropriate, explained.
By contrast, uncertainty is an aspect of knowledge…”
- Sir David Cox -

Behind each investment decision, there is a complex and precise appraisal work and estimation of all
the variables that could affect the project outcome. The project success depends on the ability to
identify the key factors of value, in order to maximize the positive effects and minimize the exposure
to overall risk.
The introduction of risk assessment in the evaluation methods has become a fundamental step in the
decision-taking process. This aims to calculate the Net Present Value (NPV) of the project and to
define its optimal risk appetite.
In the Third Chapter I have analyzed the case of OSX, a start-up in the Oil and Gas equipment and
services sector in the Brazilian emerging market: the economic background of Brazil, the wave of oil
explorations in the pre-salt fields, the strategic collaboration with the sister oil company, OGX, and
the complex capital structure of OSX, have widely presented the Company, its key-value drivers, its
weaknesses and its growth opportunity.
In this chapter I want to evaluate one single Leasing and Services project of OSX.
Most of the L&S projects follow a common framework and the study of one of these projects can,
thus, represent the core business of OSX. I have decided to analyze the Leasing and Services units
together as these two businesses are strictly related.
To this purpose I first evaluate their single “Income Statement”, whose data will be next integrated
in the “Consolidated L&S Income Statement”.
Although the capital venture linked investments are known to give higher returns1, the consolidated
OSX L&S project is expected to give a reasonable high IRR.

1
The comparison between the project financed and the capital venture investment return is in the Third
Chapter.
99
4.1 “OSX L&S”: the replicable project

I’ve built the basic model of evaluation using the official data on the OSX L&S contractual obligations,
its financial features and making the most realistic assumptions, in order to have a reliable
representation of this specific project.
The standard project refers to the leasing of one single FPSO, entirely constructed in the Açu
Superport, by OSX Shipbuilder division: this assumption is due to the fact that, once the port will be
finished, OSX will offer its complete gamma of integrated solutions for oil and gas companies, from
the shipbuilding to the offshore equipment. All the data I’ve collected from the official sources of
OSX financial information, refer to the FPSO acquired from Samsung and, next, converted for the oil
E&P operations: this means that the capex recorded, has been about the half of my assumptions (
that consider a new built ship), as the dayrent, that was about 263 thousand US$. In order to use the
realistic data, I’ve adapted them to the major required capex, simply by multiplying the basic leasing
dayrent for 2,11: it’s the proportion that stands between the conversion of an existing vessel and the
construction of a new vessel costs.
However I’ve first elaborated the two distinct Statements, in order to better understand the
structure and the different features of each segment.

4.1.1 OSX standard Leasing contract for OGX: the basic assumptions

The leasing segment, in a standard OSX FPSO project, proposes a typical bareboat chartering
contract2: according to this, the owner, “OSX Leasing 1”, has agreed to make the FPSO available to
OGX Ltda, since the beginning of the operative leasing. From then, until the expiration date of the
contract, the administration and technical maintenance costs are completely charged to the
Charterer (OGX), because it has obtained the full possession of the ship.
OGX, hence, will bear full responsibility for its operation and maintenance (O&M) during the charter
period, and will return the vessel to the owner (OSX Leasing 1) at the end of the contract term.
OGX can decide which company to hire to operate the FPSO: obviously it seals a collaboration with
OSX Operating Services Ltda, in order to benefit from the Group synergies3.

2
A bareboat charter is an arrangement for the chartering or hiring of a ship or boat, where no crew or
provisions are included as part of the agreement; instead, the people who rent the vessel from the owner are
responsible for taking care of such things. The charterer obtains possession and full control of the vessel along
with the legal and financial responsibility for it. The charterer pays for all operating expenses, including fuel,
crew, port expenses and hull insurance The charterer obtains possession and full control of the vessel along
with the legal and financial responsibility for it.
3
In the Second Chapter is explained the concept of the Group EBX, and the 360° Vision of the Chairman, Mr.
Eike Batista.
100
As said, during the life of the leasing contract, OGX will cover all the costs of Opex related to the
operation of the FPSO, and its improvements, as for spare parts , beyond paying a monthly rent to
OSX Leasing 1, only for the utilization of the vessel.
The chartering of production units, rather than acquiring them, allows OGX to replace "Capex" by
"Opex" costs: it’s part of the strategy of OGX in order to manage its cash in the short and medium
term.
In addition, the charterer shall, at its expense, obtain and keep on, throughout the charter period,
the following insurances:

 secure the hull and the machinery,

 provide for protection and indemnity risks for tonnage.

For what concerns the “Cancellation or termination conditions” of the leasing contract, OGX has
limited rights to terminate it, such as in cases of:

 total loss of the unit,

 the developed activity becomes illegal,
 environmental incidents, where OSX Leasing or its shareholders are considered guilty.

OSX may also terminate the Charter Agreement in the event of contractual defaults by OGX, such as:

 failure to pay,
 lack of insurance or breach of insurance obligations,
 breach of contractual obligations,
 involvement in insolvency proceedings or default.

The cost of each FPSO in OSX portfolio, is based on a feasibility study conducted by Technip: to
estimate the overall CAPEX of 1,105 billion US$, Technip used data collected from standardized
projects on the necessary raw materials, man-hours and equipment for each unit, assuming a
minimum local content of 70% (that sometimes, as explained, implies major costs). During the
construction in OSX Shipyard, the disbursement of these costs is made over 3/4 years, and can be
divided into four main stages (including the projecting phase), with capex split as follows: 0,66% at
year 0 for “Engineering” stage, 25% in the first year for the “Material procurement” stage, 35% in the
second year for the “Processing” stage, and 40% in the third year for the “Integration” stage, as
showed in the next Table 4.1. (the input values are in blue)

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The Engineering cost, in which the design and project of the unit are developed, is a sunk cots4. For
each stage of the shipbuilding process, the invested capex are assigned to sub-voices of costs,
according to pre-determined percentage on the total disbursement.

Table 4.1 – OSX CAPEX distribution for construction of one FPSO in Açu Port

Source: data elaborated by the author

The capex destined to the “Procurement” is used for the purchase of bulk materials, equipment and
packages; “Processing” consists in the topsides and hulls construction; the “Integration” cost includes
the final arrangements in the E&P unit.
The linear depreciation of FPSO is made over 25 years for each unit: since the Leasing contract term
is lower than the depreciation period, there would be a residual value at the horizon.
The basic evaluation period of the L&S project, covers 24 periods (in years), also including the year 0
for the engineering studies of feasibility: so my target is to evaluate the profitability of the replicable
project since the first year of evaluation of the investment, at period 0.

For what concerns the financing of the FPSO, as every investment in infrastructure at high capital
absorption, it is adopted the project finance network of relationship: the sponsors are the other
companies of the Group EBX with whom share the business and general administrative, legal,
accounting, human resources costs, OSX Brasil SA, OSX Leasing Group BV, OSX Holding BV, EBX Ltd,
OSX Chalky Participaçoes; the main contractor is OSX Shipbuilding SA, to whom is made the initial
huge investment for the acquisition of the unit; the power output is the L&S contracts with the oil
company OGX.

4
Since it’s a sunk cost, it doesn’t influence the projected cash flow of the project in the model evaluation.
102
OSX use a typical capital structure of 80% debt versus 20% equity to finance its platform, using either
funds from export credit agencies (ECA), multilateral financial institutions (as BNDES) or from private
sources (commercial loans and syndicate loans).
In the model, the average tenor of the debt is 15 years, with a grace period of 3-4 years. The debt has
to be repaid in 11 years, starting from the first year of oil production; the applied interest rate is the
basic spread, by 4,25%, that consider the specific risk profile of the borrower5 plus the US LIBOR 3-
months, that introduces a variability factor in the cost of debt.
The following Table 4.2 shows the financing terms for OSX FPSO.

Table 4.2 – OSX FPSO project finance main terms

Source: data elaborated by the author

The credit line follows two tranches of disbursement: the first one, that represents the 70% of total
debt, is given at the second period (time 1), while the residual 30% is received at the fourth period
(time 3), which coincides with the last year of construction.

Its revenues stream is composed of long-term contracts with OGX: after the construction period, the
twenty-year leasing contract starts, and the leases are paid on a monthly base, according to the
average daily lease, by 550 thousand US$, readjusted in accordance with the inflationary index of the
sector.
However supplementary leases may also be charged if OSX Leasing proves that it has incurred
additional expenditures, particularly with respect to spare parts and components or improvements.

Another important figure of variability has been introduced in the Agreement by linking the rent
payment to a threshold of “operative efficiency” ( it should refer to days of effective production on
the total working days): if it goes down at a level under 97%, which is the required basic value, during
any period of validity of the Leasing Agreement, OSX Leasing unit may be called to pay part of the
leases, in order to offset this operating inefficiency by OSX FPSO.
To measure the efficiency impact on the leasing revenues, I’ve collected the rent data referred to the
1H 2012 Financial Information of OSX Brasil SA: the production has started on January 2012, so I can

5
In Third Chapter is explained the loans condition of BNDES in project finance, especially what are the
elements of the price applied, its spread.
103
calculate the realized average monthly lease from February 2012 up to June 2012, by dividing the
total amount of 90 million US$ by the number of months6.
For each month I’ve also gathered the realized values of operative efficiency, as represented in the
Third Chapter: by comparing these ex-post data with the assumptions of the contract on the basic
revenues and the minimum operative efficiency required, I’ve calculated an elasticity measure for
the % variation in Lease due to a % variation in efficiency, as showed in next formula (1).

(1)

where
is the realized leasing revenue at month m,
is the basic value for annual leasing revenue, equal to 203 mln US$,
is the realized operative efficiency at month m,
is the basic value for operative efficiency, equal to 97%.

In Table 4.3 are showed my results: the ex-post monthly lease is equal to 18 million US$, that
corresponds to a deviation from the basic value, of 16 mln US$, by 8,4%; to a 1% change in efficiency
corresponds an impact on the lease of 8,7 (in positive or negative) on the basic value.

Table 4.3 – OSX Leasing elasticity  vs efficiency

Data from 1H OSX Financial Information

Monthly operative efficiency Realized lease for 1H 2012 87,3 Theoretical lease
February 2012 95% ex-post Lease in mln R$ 184,2 13,8 feb-12
March 2012 99% Exchange conversion R/$ 49% 19,5 mar-12
April 2012 100% ex-post Lease in mln US$ 90,26 21,0 apr- 2012
May 2012 96% ex-post monthly Lease 18,05 15,2 may -2012
June 2012 99,70% D monthly lease 8,43% 20,6 june -2012
mean 98% D monthly eff. 1%
dev st. 2,28%   =Dlease/Deff. 8,70 90,05 -0,21 check!
18,01 -0,04 check!
Base Efficiency 97%
Base Monthly lease 16,6

Source: data elaborated by the author

To test my measure, I’ve compared the theoretical 1H Lease to the realized one, both on total and
on the monthly unit: the errors, as showed in the previous Table 4.3, is by -0,2 on the total values,
and even lower, by -0,04 on monthly values.

6
The official information on the 1H lease rent is by 87 mln R$, that adapted to the major costs of my
assumptions, is equal to 184 mln R$, or 90 mln US$.
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The little underestimation of the theoretical leases could be explained by the possible costs overrun
faced during the O&M activities, as for spare parts, new materials.

In the next formula (2) I’ve inserted the value in the Leasing calculation, in order to compute its
impact on annual leasing revenue.

(2)

In this way a positive differential in the operative efficiency gap increases the leasing rent (Base
Leasingy), while a negative one reduces it.

4.1.2 OSX standard Services contract for OGX

The costs of operating the platforms are recognized by the O&M Services unit: usually operating
costs refer to the costs incurred by the ship owner during the charter period, and mainly cover crew
wages , insurance, the cost of lubricants and spare parts, repair and maintenance operations.
The contract that involves OGX and OSX O&M Services unit, establishes daily costs for operating the
platform at a minimum of 30 thousand US$ and a maximum of 60 thousand US$, which also
comprises personnel training with 40 Hyundai engineers and the Institute of Naval Technology, tax
and commissioning costs.
The following events constitute event of termination:

 any kind of breach of contractual obligations;

 if the vessel or any equipment installed on the ship have structural damage, significant or
total loss, that causes the interruption of services;
 if the services are wholly or partially suspended by any competent regulatory authority and
if such suspension lasts for 30 days.

The main factors that motivated the contract were:

 the synergies generated by the supply of services by the same group that owns the vessel,
 high technical training of staff providing services through the establishment of strategic
partnerships with leading industry players.

As already seen for the Leasing unit, the Opex data collected from the OSX financial information are
underestimated: it varies between a minimum of 30 thousand US$ per day to a maximum 60
thousand US$ per day, which, adapted to my specific project, oscillate between 11 thousand US$ per
day to 21 thousand US$ per day.

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OSX Services unit charges on OGX a pre-determined margin by 5% on average: the range varies
between 0% and 10%, respectively in case of costs lower than estimated or if the quantity of raw
material and labour used exceed the planned budget. So there’s an incentive for OSX to reach
efficiency costs since all savings are gain retained by the unit.
In the next Table 4.4 are displayed the overall basic contractual terms for the L&S on OSX FPSO.

Table 4.3 – FPSO OSX L&S contractual terms (mln US$)

Source: data elaborated by the author

The applied formula for calculating Service unit annual revenue is as following (3):

) (3)

where
is the realized opex at year y,
is the realized service margin at year y.

4.1.3 OSX L&S fiscal treatment

Brazil has no tax consolidation rules: each legal entity is subject to its own corporate income taxes.
The corporate income tax rate in Brazil is 15% and a surtax of 10% is charged on profits that exceed
240.000 R$ per year (approximately 10.800 €): the combined federal corporate income tax rate
applied is 34%.
In addition, the Brazilian Government imposes Social Contributions tax at a rate of 9% for
PIS/COFINS:

 the Social Integration Program (PIS) is deemed as a mean to share the business profits with
the employees, through a mandatory national savings program, financed by monthly
deposits collected as a percentage on the gross sales (about 1,65%);
 the Social Contribution on Gross Sales (COFINS) was created to finance special social
programs enforced by the Federal Government through the collection of a social
contribution (about 7,6%).
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Another municipal tax is for Services providers, named “Imposto Sobre Serviços” (ISS): its calculation
basis is the service revenues. In general, the service tax is due to the municipality in which the
company is established even though the service is rendered in another location; ISS rate varies from
2% to 5%. The overall municipal tax on the gross revenues is by 11,75%.
To better understand the singular fiscal treatment reserved to OSX L&S project, it’s very useful
“Brazil upstream guide” (Deloitte, 2010) and the “Shipping Industry Almanac” (Ernest&Young, 2012),
that clarifies the double fiscal treatment for REPETRO eligible company, as the OSX Leasing unit, and
not eligible, the OSX Services unit.
The OSX Leasing BV is domiciled abroad, in the Netherlands, it’s a private limited liability company
(the liability of its shareholders is limited to their interest in its share capital) that effectively operates
in Brazil.
In most tax treaties, the place of effective management and the definition of “permanent
establishment”, is an important criterion for determining whether a company is subject to the
domestic tax or to the other party tax system: the place of effective management is determined
based on all managerial activities.
OSX Leasing BV is wholly managed and operates in Brazil, hence it submits the Brazilian tax law: in
particular the company benefits from a tax sparing credit equivalent to 20% of its revenues, leading
to a 0% income tax rate in Brazil.
The reason for this tax benefit is the application of REPETRO special regime, granted to the Brazilian
E&P companies; some of the assets that may be subject to REPETRO are:

 Platforms used in the exploration, production and production phases;

 Christmas trees;
 Sub-sea equipment;
 Support vessels.

In 1998 a special regime known as REPETRO provided the total suspension of federal taxes, including
the Import Tax (II), Tax on Industrialized Products (IPI), Contribution to the Social Integration Program
(PIS), and Contribution to Social Security Financing (COFINS), for imports of goods related to oil
exploration and production activities.
To be eligible for the REPETRO benefit, the goods must be bought or leased from a foreign company
to the Brazilian E&P companies : in this case the FPSO vessel leased by OSX Leasing BV to OGX.
OSX Services SA, on the contrary, is a Brazil domiciled company, so the costs of operating the
platforms are booked in the O&M Services unit, which is hosted in Brazil and is charged the municipal
tax by 11,75% on the gross revenues, plus the federal tax rate of 34% on Earning before tax (EBT).

107
4.2 OSX static evaluation model

The frame structure of my evaluation model consists in the classical technique of discounted cash
flow: starting from the current L&S Income Statement for each year, combined with Its balance-sheet
information, the DCF compares the future net cash flow of the project against the initial investment
in plant and equipment.
The difference between the two is the economic value that the project can generate during all its
time horizon: the time period of my evaluation starts from the year of the appraisal (time 0), than
those for the construction of OSX FPSO (time 1-2-3, Table 4.1), in the OSX Shipbuilding division at the
Açu port, plus the twenty years for leasing contract (from time 4 to 24) with OGX, covering 24
periods.

When using the DCF method, there are two important tasks to focus on:

 modeling a plausible future cash flow

 defining a plausible cost of capital to be used as the discount rate.

4.2.1 Modeling a reliable business plan: the static assumptions

The data collection is a crucial phase in a model construction: in order to give a realistic and fair
screening of the OSX L&S project, I’ve deeply analyzed the official sources of financial information on
OSX FPSO-1, the first functioning production unit, putting attention on all the financing terms, the
contractual conditions and obligations with the counterparty OGX, the relationship with the other
companies of the Group, and, in general, the revenues and costs items of the ordinary management.
In the next Table 4.4 there are the basic assumptions I’ve made on the two units for what concerns
revenues and opex.

Table 4.4 – OSX L&S static assumptions

Source: data elaborated by the author

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As explained before the Services revenues is computed charging the average pre-determined margin
of 5% on the opex for each exercise.
I have assumed 17 thousand US$ for O&M services operating costs.
However, it’s possible to manually vary the service margin, in order to appreciate its impact on the
unit revenues, by using the formula (3).
About the fiscal treatment of the two divisions, as explained in the previous paragraph, OSX Leasing
BV is domiciled abroad and, thanks to tax sparing credit and the eligibility for REPETRO system,
applies 0% tax rate on revenues and interest expenses (this is the reason why it has no tax shield),
while OSX Service SA applies the municipal tax (11,75%) on the gross revenues, and the federal
corporate tax (34%) on the net revenues.
In order to have no impact on the 5% margin, the “Municipal tax on Service” amount is entirely
added and, after, deducted, to “Service gross revenue”, so I add the formula (3) in (4), as follows, to
obtain the final Gross Revenue for OSX O&M Service unit, and , next, the “Net Revenues” in (5).

(4)

(5)

The next Table 4.5 shows the basic Income statement for OSX Service unit.

Table 4.5 – OSX O&M Service unit basic Income statement

Source: data elaborated by the author

For OSX Leasing unit, I’ve introduced a measure of operative efficiency in the compute of annual
Leasing revenues, assuming it’s always equal to the minimum required by the contract, 97%; I’ve
obtained the annual Leasing gross revenue by setting a base dayrent of 555 thousand US$ for the
bareboat charter, adjusted for the operative efficiency, as in (2).
I’ve set the item named “Leasehold improvement” to also consider the investments that likely
periodically re made on the plant property, for the damages to the vessel made during the chartering

109
period: this capex is completely added on OGX rent payment, so it has zero impact on the project
profitability, while It moves the “DCapex” statement and the “Net fixed asset” value.
I’ve put a basic value of 1% on the initial capex (1,105 billion US$ for FPSO construction), which
occurs each 5 years (starting from time 4 till time 14), with an annual amortization of 20%, as in
following (6):

(6)

where
is the investment in the vessel improvement charged on the leasing rent
for the 5 year of investment amortization,
is the total capex needed to fund the vessel construction in Açu port, equal to 1,105 billion
US$,
is the assumed 1% on the capex to invest for the improvement expenses,
is fixed to 20%, in order to distribute the investment on 5 years, reducing its
impact on cash flows.

In this way the amortization period for one improvement, exactly covers the 5 years of pause
between two consecutive investment: each year I write an amortization of -2, which is added to the
annual depreciation of -44 for the vessel (its complete depreciation takes 25 years).

The “Leasing (EBITDA)” item is computed using the next (7) formula:

(7)

In the next Table 4.6 is represented the base Leasing unit Income statement: It has no opex, so its
operating margin is by 100%.

Table 4.6 – OSX Leasing unit basic Income statement

Source: data elaborated by the author

110
In the contract is considered the inflationary effect on the level of prices of goods and wages, so that
the rent are adjusted to the new ones: I’ve excluded its impact in the static model.

In next Table 4.7 is represented the OSX L&S Consolidated Income statement, in which I’ve resumed
the previous two separate ones, in order to obtain the project annual Income statement.
The “L&S gross revenues” is simply calculated by adding “Services Net Revenues” (5) and “Leasing
(EBITDA)” (7).

I’ve assumed a fix value for Selling, General and Administrative expenses, “ SG&A”, by 8% on L&S
Gross revenues. “L&S NOPAT” is computed by subtracting the Services corporate tax, which is the
same item in Services O&M Income statement, to the “L&S EBT”.

The “After tax interest expense” item recalls the interest expense as calculated in the “Financial
position statement”. Since it falls into Leasing unit REPETRO fiscal treatment, the tax shield effect is
null.

Table 4.7 – OSX L&S basic Consolidated Income Statement

Source: data elaborated by the author

The long term debt is fixed and structured as already explained in Table 4.2, meanwhile, for the static
model, I’ve set a base value for LIBOR, by 2%, which is the medium value assumed by the interest
rate over last months.
In the following Chart 4.1 is represented the Debt amortization plan, assuming the static value of
6,25% as total interest rate paid on the debt.

111
 Chart 4.1 – OSX static debt amortization model
1000
OSX LeasinG INTEREST EXPENSE
800 OSX Leasing DEBT AMORTIZATION
OSX Leasing DEBT
600

400

200

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

-200

Source: data elaborated by the author

According to the official OSX 1H 2012 financial information, the Leasing and Services subsidiaries at
the of leasing contract, have bank deposits:

 Leasing Deposit of 20,1 million US$: It's the Debt Service Reserve Account, hold by OSX
Leasing unit at the Chartered Bank Singapore as a restricted deposit, which will be liquid to
payback the long-term syndicate loan. In this sense this reserve will serve the debt.

 Services Deposit of 1,5 million US$: OSX Services held Bank Deposit Certificates (CDBs) with
Banco Credit Suisse S.A. This amount will be frozen in an account linked to the borrowing
agreement received for the leasing subsidiary.

These two financial position have been included in the item “Cash equivalent” in the “Consolidated
OSX L&S Income statement”.

The initial cash disbursement made by the Shareholders of 214 mln US$, exactly represent the 20%
of Equity issued at the first year to fund the property plant construction.

In the working capital I have assumed a fixed 90-days for clients and suppliers, in order to move the
“Payables” and “Receivables” items.

112
4.2.2 The cost of capital puzzle: incorporating the Country risk premium

One of the most challenging issue is the consideration of the specific social-political environment of
the company.
In Chapter One I’ve focused on what are the distinguish features of an emergent market, its steps of
development and potentialities of growth: their economies are in strong expansion, the state-of-the
art of technology is fast covering the past gap and the opportunity of attractive profits is more
common.
Brazil is one of the BRIC regions that actually are in a great economic increase: Brazil economy, in
particular, has been stimulated also by the new oil discoveries in the pre-salt areas, that counts for
about 50 billion barrels of oil reserves.
Nonetheless, these economies are characterized by political instability or anti-democratic regime,
strong control from government on the market regulation, high risk of expropriation of profits,
extremely volatile stock market, especially in cases of start-up.
In discounting the future net cash flow of a project placed in an emerging economy, it’s fundamental
to consider the major risks and costs suffered in such this situation.
Riskier projects will use higher discount rate and, hence, have lower NPV: discount rate plays a
central role in the analysis, since allows to compare projects with similar expected cash flows, but
different risks. (GODFREY S., et al., 1996).
Estimations of the cost of capital are typically based on the Capital Asset Pricing Model: according to
this, the equity market is expected to return a premium over risk-free assets ( as US Treasury notes)
to compensate investors for the additional risks taken in holding equities, as follows in (8).

(8)

where

is the cost of capital applied to discount the future net cash flows , equivalent to the
expected return of project i in country x,
is the risk-free rate (usually the yield of a long term US T-bond),
is the beta of a similar investment in a developed country (usually the US),
is the expected return on the market portfolio (usually the S&P500 or a worldwide stock
market index such as the Morgan Stanley Composite Index or MSCI).

The discount rate used in the evaluation of an investment should reflect its level of risks: the only
relevant risks are “systematic” or “covariance” risks, which is the tendency ,for a company return, to
move with the market portfolio returns.

113
These figures of risks are captured in a statistical measure called “beta”, : Beta is the elasticity of
returns of the company’s shares to the market return, technically, the slope of the regression curve
between historical returns of company shares and the historical returns of the market.
On the contrary, investors ignore all unsystematic or “ idiosyncratic” risks when calculating the cost
of capital, since they can eliminate them by diversifying their investments.
Many economists have theorized different ways to incorporate the “Country risk premium” in the
classical CAPM model to calculate the cost of capital: the idea is that the investors require a “quid” of
extra- premium on the equity return, since they accept the major risks affecting a project in an
emerging country, so they pay less for investment with minor probability of success.
Godfrey and Espinosa (1996) identify three types of risks affecting investments in emerging markets:

 political or “sovereign” risk,

 commercial or “business” risk (which reflect the volatility of the local business environment),
 currency risk.

Currency risk is accounted for by selecting a base hard currency ( the US$) to make the analysis, than
converting the local–currency cash flows (R$) into US$, at an appropriate exchange rate (0,49).
The other two types of risks are incorporated into the discount rate by modifying the basic CAPM:
the “credit quality” is often used as a proxy for sovereign risk, that causes an upward adjustment of
the US risk-free rate, while the business volatility is reflected in the additional market risk premium.
The issue is controversial and counts for a wide range of methods. Before explaining the model I’ve
chosen to calculate an appropriate cost of capital, I want to recall the main used models.

4.2.2.1 The Global/local CAPM

Pereiro has adapted and proposed many models of CAPM, as expressed in the paragraph (PEREIRO,
2002, p. 107-114).
Many economists argue that the globalization phenomenon allow the progressive integration among
financial markets allowing an investor located anywhere in the world to rapidly enter and leave any
market: that’s why is reasonable to apply a global CAPM to the emerging market, as follows:

where
is the global risk-free rate,
is the local company beta computed against the global market index,
is the global market return.

114
When the target company is not quoted, may be used the average beta of a group of local quoted
comparables; the model assumes that geographic diversification makes unsystematic risk disappear.
However, it’s difficult to accept the global CAPM in emerging markets where country risk is present:
It may be more plausible in developed markets.

When segmentation seems to be present, the analyst may use the Local CAPM, following reported:

where, in spite of global parameters, are used local rate of returns and local market data; the risk-
free is a composite of global risk-free and the country risk.
Domestic risk factors remain important: empirical evidence has demonstrated that stock
performance seems to be much more linked to the local volatility of the economy than to the
fluctuations and trends of the corresponding industry at the international level.
The country risk premium is usually computed as the spread of sovereign bonds over global bonds of
similar denomination, yield, and term, as the US Treasury bond.
Adding a country risk premium implies the use of a multifactor risk-return model, where the
premium corresponds to the Country idiosyncratic risk.
The problem with the local CAPM is that it tends to overestimate risk: the inclusion of a country risk
premium into the CAPM equation can double-counts risk, since part of it may be already present into
the market risk premium. In addition the impact of country risk is considered both in the discount
rate and in the projected cash flows, without consideration of the degree of diversifiability at the
investor level.
Researchers have confirmed that Country risk explained, on average, about 40% of the variation in
the volatility of market returns; pure stock market risk explained the remaining 60%.
This model is better known as the Adjusted Local CAPM where may be thought of as the amount
of variance in the equity volatility of the target company i that is explained by country risk; hence the
inclusion of the factor in the equation depresses the equity risk premium to partially
counter the overestimation problem.

Adding the country risk premium to the risk-free rate, and hence to the discount rate, effectively
assumes that country risk is fully systematic or non-diversifiable: instead research suggests that

115
public stock returns in developing and developed countries are not highly correlated, so a good
portion of country risk is diversifiable.
Only the part of country risk that is systematic, that cannot be eliminated by the investor’s diversified
portfolio, should be reflected in an increase in the discount rate. In cases where country risk is
completely diversifiable, there should be no adjustment of the discount rate.
In short, simply adding the whole value of country risk premium to the discount rate is merely an
intuitive approach without any theoretical justification (SABAL J., 2004), meanwhile the next
presented models introduce a weight factor that allow to consider only the non- diversifiable country
risk.

4.2.2.2 The Godfrey-Espinosa model

Godfrey and Espinosa (1996) proposed an ad hoc beta model to deal with the problems of traditional
CAPM in emerging markets.

where
is the US risk-free rate,
is an adjusted beta for the asset i in Country x,
is the standard deviation ( the volatility) of returns in the local market,
is the standard deviation (the volatility) of market portfolio returns in the US equity market
is the market portfolio return in the US.

The adjusted beta in the model implies a strong assumption; again, the 0.60 factor (which stands for
, thecorrelation measure between the asset return and the market portfolio of all risky asset in US)
depresses the equity risk premium to alleviate the problem of overestimating risk (as happened in
local CAPM previously seen), and only considering the non differentiable country-risk component.
The low correlation measure (< than 1) of emerging markets suggests that these countries offer
diversification benefits.

116
4.2.2.3 Estrada’s Model

This model (2000) assumes that expected return is a function not of total variance, but rather of the
“downside variance” of local returns. In other words, investors are not averse to total volatility but
just to its unfavorable part.
The model is expressed as follows:

only for ,

where
is a risk measure, the negativity volatility of asset i on market index x
is the return of asset i in market x,
is the mean return of asset i in market x,
is the mean return of asset i in the global market.
N is the number of observations;
Estrada proposed to use downside risk as the risk measure: he defined as the ratio between the
semi-standard deviation of returns with respect to the mean in market x and the semi-standard
deviation of
returns with respect to the mean in the world market. He ran this regression model on 28 emerging
markets using the Morgan Stanley Capital International (MSCI) database over different time periods.
The downside conception of risk is relevant in practice: for instance, it has been suggested that CAPM
problems may be due to the use of variance as a risk measure, and could be avoided if a downside
risk measure were used instead.

4.2.3 Damodaran model: the total equity risk premium

I’ve selected the Damodaran model (2003) for calculating the cost of capital for OSX L&S project in
Brazil.
His model has many advantages: starting from the classical CAPM he incorporate the country risk
premium and the market volatility risk, as suggested by Godfrey and Espinosa (1996).

117
However he takes in count the double-counting error, so the Country risk premium isn’t simply
added to the risk free, but is weighted for the appropriate beta unlevered for the specific sector (Oil
and Gas Services and Equipment).
The risk premium in any equity market can be written as:

The country premium, reflects the extra risk in a specific market, not being a mature equity market.
To estimate the base premium for a mature equity market, we can look at the US market: between
1928 and 2002, stocks in the United States delivered a premium of 4,53% over government bonds, so
in the 20th century suggests an equity risk premium of about 4,2%.
Actually, base premium for Mature equity market is set to 6% (it’s the implied equity risk premium
for S&P500). To estimate the Country equity risk premium, however, the measure of country risk is
to be converted into a Country risk premium. There are several measures of country risk, but one of
the simplest and most easily accessible is the rating assigned to a Country’s debt by a ratings agency
(S&P, Moody’s). These ratings measure default risk, and are affected by the stability of a Country’s
currency, its budget and trade balances and its political stability. In September 2003, the Brazilian
government has dollar denominated C-Bonds outstanding, with ten years to maturity.
S&P rated the Brazilian government C-bond at B+ whereas Moody’s assigned a B2 rating to the same
bond. While ratings provide a convenient measure of country risk, there are costs associated with
using them as the only measure. Ratings agencies often lag markets when it comes to responding to
changes in the underlying default risk. In addition, the ratings agency focus on default risk may
obscure other risks that could still affect equity markets.
There are numerical country risk scores that have been developed: for example the dollar
denominated Brazilian C-Bond is widely traded and both the price and yield of the bond reflect
market views of Brazil. For example in September 2003, the 10-year C-bond was priced to yield
10,12%. Comparing this yield to the 10-year U.S. treasury bond rate of 4,11% generates a default
spread of 6.01% for the Brazilian bond. In Chart 4.2 Damodaran has graphed the yields on the C-Bond
and the U.S. treasury bond and highlighted the default spread.

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 Chart 4.2 – US Treasury Bond vs Brazil C-Bond rates: 1998- 2003

Source: DAMODARAN, 2003.

The trend of Brazilian C-Bond oscillates and is particularly volatile in the last decade, while the US T-
Bond line is more flat.
As previously seen in the other CAPM models, there are many analysts who believe that the equity
risk premiums of markets should reflect the differences in equity risk, as measured by the volatilities
of these market. A conventional measure of equity risk is the standard deviation in stock prices;
higher standard deviations are generally associated with more risk. By scaling the standard deviation
of one market against another, it’s possible to obtain a measure of relative risk.
The country default spreads that come with country ratings provide an important first step, but still
only measure the premium for default risk. To correct this underestimation is sufficient to multiply it
for the volatility of the Brazilian equity market. This yields the following estimate for the country
equity risk premium.

Hence the cost of equity for a Brazilian company, estimated in U.S. dollars, will be 3,03 % (according
to data updated to January 2012) higher than the cost of equity of an otherwise similar U.S.
company, using measure of the default spread.

119
The default spread on the Brazilian C-Bond on January 2012 is 2,07%, the rating based default spread
is 1,75%7, and the annualized standard deviation in the Brazilian equity index against bond market is
1,73 (Damodaran, 2012).
The resulting country equity risk premium for Brazil is as follows:

This country risk premium will increase if the country rating drops or if the relative volatility of the
equity market increases.

The cost of equity for a firm in a market with country risk can then be written as:

In the following Table 4.8 I’ve collected data on Brazil rating based default spread and 10-year CDS.

Table 4.8 – OSX L&S Damodaran model

Source: elaboration by the author on data from DAMODARAN, 2012.

The company exposure to Country risk is proportional to its exposure to all other market risk: this is
measured by the beta.
Beta > 1 will be more exposed to country risk than stocks with a beta < 1.
To compute OSX I’ve gathered the respective data of main comparables in Brazilian and
international market. The following Table 4.9 shows my results: is the average of the competitors
in the same sector of Oil and Gas Equipment/Services, by 1,07; the risk free is the US T-Bond 30-years
yield, of 2,83%.

7
Damodaran has converted Ratings into default spreads basing upon his estimates of typical spreads for each
ratings class. He compute these by averaging CDS spreads and sovereign US$ bond spreads by ratings class, at
the start of every year. The data for Credit default spread has taken from Bloomberg (Damodaran, 2012).
120
I have decided to use the Rating- based default spread, by 1,75%, which represent the credit risk for
Brazil. This, multiplied by the volatility market, measured by Brazil Relative standard deviation, gives
the final Brazil Risk Premium.

Table 4.9 – OSX L&S cost of capital

Source: elaboration by the author on data from DAMODARAN, 2012, Reuters, OSX.

Applying the Damodaran model the final cost of capital unlevered ru is by 12,27%; levering the cost of
capital (as for Modigliani-Miller propositions, 1958) I have calculated the cost of equity levered for
OSX, re, by 16,28%.
I have assumed a constant Debt to equity structure, equal to, which is the average % from an initial
80%-20% to 0%-100% D/E ratio, and is equal to 40%-60%. The ru and rWACC values are identical: as
better explained in the following paragraph, it’s the confirmation of Modigliani-Miller theory of the
irrelevance of the capital structure on the value of the company.

4.2.4 OSX L&S project: the value with static models

The models used to evaluate the value of the OSX Leasing and Services project are the Free Cash
Flow to Firm , FCFF, and the Free Cash Flow to Equity, FCFE.
Starting from the same statement of Cash Flow, that includes the net income, depreciation and
amortization, the changes in working capital and in invested capital, the two methods give the value
of the project considering two different points of view.
FCFF is the residual cash that is available to pay all the investors, both equityholders and debt
holders, after a company has paid its operating costs, net to the movements in inventory and capex.
FCFE is the cash flow available to the company’s common equity holders after all payments to debt
holders, and after allowing for all operating expenditures to maintain the firm’s asset base; It’s an
evaluation model from the perspective of buying equity.

121
FCFE determine the ease with which a business can grow and issue dividends to shareholders,
FCFF gives a firm-wide valuation.

4.2.4.1 FCFF deterministic method

In the FCFF methods the future net cash flow have to be discounted at an appropriate cost of capital:
since it computes the cash flow available for all capital suppliers, the most suitable cost is the
Weighted Adjusted Cost of Capital, rWACC . It considers the specific capital structure of the company:
as already explained, I have assumed a constant D/E ratio, equal to 40%-60%.
Usually the rWACC is higher than ru because the required rate of return for the levered company
discount the cost of default due to debt. Yet, according to Modigliani- Millers (1958) prepositions, in
a perfect market, in absence of taxes, transaction costs, asymmetric information, the value of a
company is independent from its capital structure.
The market value of a company is equal to the discounted cash flow that it can generate in the
future, regardless of the debt. In the real world most of the assumptions are unreliable, so the debt
presence increase the cost of capital.
In the case of OSX, however, the particular tax-free fiscal treatment for Leasing unit, has reproduced
the perfect world theorized by MM, so the result is that the unlevered cost of capital is equal to the
WACC.
Without tax-shield, the debt doesn’t lower the expected value of the project.
The next Table 4.10 reports the operative cash flow statement and the results of NPV and IRR using
FCFF method.

Table 4.10 – OSX L&S evaluation through FCFF

data in million $ 0 1 2 3 4 …… 24
L&S NOPAT (unlevered) 0 0 0 0 141 …… 141
D&A 0 0 0 0 46 …… 44
D Net Working Capital 0 0 0 0 -51 …… 0
CAPEX 0 -276 -379 -442 -11 …… 0
FCFF 0 -276 -379 -442 125 …… 362 Terminal value
NPV 94 ……
IRR 14% ……
Cumulated FCF 0 -276 -656 -1098 -973 …… 2972

Source: data elaborated by the author

The standard project has a Net Present Value of 100 million US$ and its Internal rate of return is by
14%. In Chart 4.3 is displayed the obtained FCFF in absolute value and with the accumulated flows:
after the initial 4 years dedicated to the capex investment for the construction of the FPSO, the cash
generated during the chartering, has a stable trend.

122
 Chart 4.3 – OSX L&S FCFF

500 3500
FCFF Cumulated FCFF
400 3000

300 2500

200 2000

100 1500

0 1000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
-100 500

-200 0

-300 -500

-400 -1000

-500 -1500

Source: data elaborated by the author

The last year the long-term leasing contract expires, so the residual value rises the company value: if
the contract should be extended to other 20 years, the terminal value should accounts for the future
leasing rent, so the assumptions made on residual value are conservative. The payback period is at 9
year.

4.2.4.2 FCFE deterministic method

The FCFE method evaluates the project from the equity holder perspective: the future net cash flows
are discounted at the cost of equity, instead of WACC since the D/E structure changes over a decade,
and debt is totally repaid.
In the next Table 4.11 is reported the cash flow statement of the project, evaluated through FCFE
method.

Table 4.11 – OSX L&S evaluation through FCFE

data in million $ 0 1 2 3 4 …… 24
L&S NOPAT 0 0 0 0 86 141
D&A 0 0 0 0 46 …… 44
D Net Working Capital 0 0 0 0 -51 …… 0
CAPEX 0 -276 -379 -442 -11 …… 0
D Debt 0 619 0 265 -80 …… 0
D Equity (by Shareholders) -214 0 0 0 0 …… 2847 Terminal value
FCFE -214 343 -379 -177 -11 …… 3032
NPV 56 ……
IRR 18% ……
Cumulated FCF -214 129 -251 -428 -438 5096

Source: data elaborated by the author

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The project NPV is 53 mln US$, while the IRR is by 18%: as expected, the IRR to equity is higher than
the IRR to firm. Chart 4.4 shows the FCFE and the cumulated flows.

Chart 4.4 – OSX L&S FCFE

3500 6000

3000 FCFE STATIC

Cumulated FCFE 5000
2500
4000
2000

1500 3000

1000 2000
500
1000
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 0
-500

-1000 -1000
Source: data elaborated by the author

The positive flow at year 1 is the result of the huge disbursement of syndicate loan for the
construction of the vessel; differently from FCFF, the cash flow are more flat for the first decade after
the capex, due to the debt repayment that depresses the cash flows. The payback period is at year
10. At the last year the residual value recognizes the whole equity value, as whether the
shareholders could gain all the residual equity value, so it’s considered such a super extra-dividend.
In the following Graph 4.1 are reported the main profitability ratios of the project: ROI, ROE, ROS.

Graph 4.1 – Profitability indexes on the OSX L&S project

90,00%

80,00%

70,00% Return on Sale

60,00%

50,00%
ROE
40,00% Return on Equity ROI
ROS
30,00%

20,00%
Ret. on
10,00% Investment
0,00%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Source: data elaborated by the author

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The ROS trend is, as expected, flat, since the main source of revenue is the leasing rent.
The ROE line has a steady decreasing trend, in opposition to ROI, which during the last years has a
deep rise. It’s the signal that the excess cash generated, after wholly repaying debt wholly repaid,
over capitalized the equity of the firm – e.g. dividend paid out ratio is too low.

These results are quite similar to the IRR obtained by Credit Suisse in its report on the whole
company OSX Brasil SA. The two methods used, FCFF and FCFE, reflect a static conception of the
possible future scenario on the project realization.
There are numerous factors of variability that impact on the project success, which should be
“manually” set up in the models to include them in the final evaluation of the NPV.
Even if reliable, the results achieved lack of this component of risks: each value driver is, in the real
world, affected by changes and rare negative events.
In the next paragraphs I explain the dynamic model that could take in account all these factors of
variability.

4.3 OSX dynamic evaluation model

Understanding the uncertainty can help to make a better decision.

A risk and an opportunity can be considered the opposite sides of the same coin (VOSE, 2008).
A risk is a random event that may occur and would have a negative impact on the context, while an
opportunity is a random event that could have a positive impact on the situation affected.
In this sense the opportunity is a symmetric risk whose impact could have upward and downward
movement.
The risk is characterized by three elements:

 its variability;
 its probability of occurrence;
 the size of its impact should it happened (either with a fixed value or a distribution).

Understanding the external context of a business, the political stability, the macroeconomic variables
trend, the environmental features, is the prime step towards the definition of the risks or
opportunities that affect its success.
The more risk a company is able to be exposed to, the more it can capture opportunities of growth.
Just knowing what kind of risk to take is not enough: to forecast its occurrence and its effect on the
business it’s necessary to know what is the range of possible events.

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4.3.1 Crystal Ball modeling

Crystal Ball Oracle is a specific component of Excel that can launch the Monte Carlo simulation.
Behind attributing a distribution of probability to the assumed variables, and their severity impact,
Crystal Ball can model correlation and other interdependencies among the variable assumptions.

4.3.1.1 Monte Carlo simulations

In the Third Chapter I have introduced the importance to make an accurate risks assessment,
distinguishing between downside risk (only negative impact) and symmetric risk (both directions
impact).
The quantitative risk analysis (QRA) accounts for every possible value that each variable could take,
weighting each possible scenario by the probability of its occurrence.
QRA achieves this by assigning to each variable of a model a probability distribution: the structure of
a QRA model could be the deterministic model that link the variables together (the cash flow analysis
of a project), but with the introduction of probability distribution function instead of a single value
for each variable.
The objective of a QRA is to calculate the combined impact of the parameters set in the evaluation
model, in order to determine a distribution of the possible outcomes, the NPV and the IRR of the
project.
Monte Carlo simulation is the most popular QRA that, through numerical algorithms, can launch
thousands of possible scenarios, following the probability distribution set for each variable of input.

Monte Carlo sampling got its name as the code word for work that Von Neumann and Ulam were
doing during World War II, on the Manhattan Project at Los Alamos for the atom bomb, where it was
used to integrate otherwise intractable mathematical functions.
In 1908 the famous statistician Student used the Monte Carlo method for estimating the correlation
coefficient in his t-distribution.

Monte Carlo simulation involves the random sampling of each probability distribution within the
model, to produce hundreds or even thousands of scenarios, also called iterations or trials: each
scenario realized by the single trial is independent from the other previous or next simulated.
This method is widely recognized as a valid technique, so its results are more likely to be accepted.

MC uses an approximate technique, but a major level of precision can be achieved by simply
increasing the number of iterations in a simulation.

126
One of the most important advantage in the risk analysis of this model, is the inclusion of very
unlikely events with severe impact, should they occur.
The expected impact of a rare event is determined by two factors: the probability that it will occur
and the distribution of possible impact it would have.

4.3.1.2 Goodness-of-fit statistics

Starting from an historical series of data, Crystal Ball fit the empirical distribution with many
theoretical functions, among the continuous distribution present in its gallery: the user can choose
the best fitted distribution, which will be run by Crystal Ball during the trials iterations in order to
simulate the variable.
During the distribution-fitting procedure, Crystal Ball compute the algorithms to estimate parameters
and assess the goodness-of-fit between the empirical distribution function (EDF)of the collected
dataset, and the cumulative distribution function (CDF) of each possible continuous distribution of its
gallery.
Not all of the distributions in the gallery are applicable to all datasets.
Goodness-of-fit tests typically measure the discrepancy between the observed values and the
expected values under the model built: the goodness-of-fit statistics are techniques used to describes
how well the statistical model fits a set of observations.

Many statistics tests have been developed but two are the most used: the chi-square, 2 ,and
Kolmogorov-Smirnoff, K-S statistics, generally used for discrete and continuous distributions
respectively.
The Anderson-Darling, A-D statistic, is a sophistication of the K-S statistic. (VOSE, 2000)
Goodness-of-fit statistics are not intuitively easy to understand or interpret.
Critical values and confidence intervals for goodness-of-fit statistics analysis of the 2 , K-S and A-D
statistics can provide confidence intervals proportional to the probability that the fitted distribution
could have produced the observed data. It is important to note that this is not equivalent to the
probability that the data come from the fitted distribution, since there may be many distributions
that have similar shapes and that could have been quite capable of generating the observed data8.
The lower the value of these statistics, the closer the theoretical distribution appears to fit the data.

8
This is particularly so for data that are approximately normally distributed, since many distributions tend to a
normal shape under certain conditions.
127
The Kolmogorov-Smimoff (K-S) statistic is known as the K-S distance, because it is concerned with the
maximum vertical distance between the cumulative distribution function of the fitted distribution
and the cumulative distribution of the data.

Further the A-D statistic is generally a more useful measure of fit than the K-S statistic were it is
important to place equal emphasis on fitting a distribution at the tails as well as the main body.

Crystal Ball simulation has been strongly criticized by theorists because it gives approximated
distributions rather than exact solutions.
Validity of the input data is essential, hence the output is only as good as the input.
For this reason, behind choosing the best statistics tests output, the user has to make an “eyeball”
evaluation of goodness-of-fit: by far the most intuitive measure of goodness-of-fit is a visual
comparison of probability distributions.

4.3.1.3 Goodness-of-fit plots

Goodness-of-fit plots offer the analyst a visual comparison between the data and fitted distributions
(CHARNES, 2007).
“Eyeball Test” is one of the best ways to assess goodness of fit, simply by comparing the plots of the
EDF and each candidate CDF, both in the frequency chart and in the cumulative charts: they provide
an immediate picture of the errors made in the approximation and allow the analyst to select the
best-fitting distribution in a more qualitative and intuitive way.
The comparison of probability density functions is usually the most informative comparison: Crystal
Ball gives a charts in which it overlays an histogram plot of the empirical data with a density function
of the fitted distribution.
In this way it is easy to see where the main discrepancies are and what shape of the fitted
distribution seem to best smooth the histograms trend. The same test is made with overlay chart of
the cumulative frequency plots of the data and the fitted distribution.
Another useful test is the difference between probability densities: this plot is derived from the
above comparison of probability density (both of absolute and cumulative frequencies), simply taking
their differences.

128
4.3.1.4 Fitting the best distribution

Whenever the collection of data is awkward, or its quality is scarce, and the user can easily make
some realistic assumptions on the parameters of its function ( for example on the mean value or the
standard deviation ), Crystal Ball allows to build ex-novo some possible distribution functions.
It distinguishes between a parametric and non-parametric distributions functions.

A parametric distribution is based on a mathematical function whose shape and range is determined
by one or more parameters. The difficulty of this technique is that these parameters have to be
calculated and cannot be intuitively captured by observing the shape of the specific function.
Examples of parametric distributions are lognormal, normal, beta, Weibull, Pareto and
hypergeometric distributions.

A non-parametric distributions, on the other hand, have their shape and range directly determined
by their parameters, in an intuitive way: their distribution function is simply a mathematical
description of their shape. Some examples of non-parametric distributions are uniform, relative and
triangular distributions.
Non-parametric distributions are far more reliable and flexible for modeling expert opinion about a
model parameter; changes to these parameters also produce an easily predictable change in the
distribution shape and range.

In my assumptions I have used three specific distribution functions:

 Triangular distribution: it is the most commonly used distribution for modeling expert
opinion knowing the Minimum, Likeliest and Maximum values of a random variable. The
triangular distribution is completely specified by these three parameters which are sufficient
to determine the triangular shape. Based on the precise information about the function to
fit, the shape could be symmetric, right skewed and left skewed. The triangular distribution is
one of the most used distributions because it is so easy to think about the three defining
parameters and to visualize the effect of any changes. Compared to the normal distribution,
the triangular distribution overemphasizes the tails and underemphasizes the middle values.

 The Lognormal distribution: Unlike the normal distribution, the lognormal distribution is
bounded on the left by zero; however, it is unbounded on the right just as the normal
distribution. This makes it useful for situations where values are positively skewed and
cannot be negative, such as the total return on stock when the stockholder’s potential loss is
limited to the amount invested, or for sales of a product, which cannot be negative.

129
 The lognormal distribution takes its name from the fact that it represents a random variable
whose natural logarithm follows the normal distribution. Like the normal distribution, it has
two parameters, Mean and Standard Deviation. Examples of two Lognormal distribution are
given below in the Graph 4.2.

Graph 4.2 – Lognormal distribution shapes

Source: Vose (2008)

Central Limit Theorem9 shows that the product of a large number of independent random
variables is Lognormally distributed. For example, the volume of gas in a petroleum reserve is
often Lognormally distributed because it is the product of the area of the formation, its
thickness, formation pressure, porosity and the gas (liquid ratio).
Lognormal distributions often provide a good representation for a physical quantity that
extend from zero to + infinity and is positively skewed.

 The Weibull distribution is widely used in engineering practice to model the time until
occurrence of an event, where the probability of occurrence changes with time. In this sense
the process has memory, as opposed to the Exponential distribution where the probability of
occurrence remains constant, it is memoryless. Its Parameters are: Location, L, where −∞ < L
< ∞, Scale, s, where s > 0 and Shape, β, where β > 0. It can take a variety of shapes, from an
Exponential to a Normal distribution, as showed in the next Graph 4.3.

Graph 4.3 – Weibull distribution shapes

Source: Vose (2008)

9
The Central Limit Theorem (CLT) is an asymptotic result of summing probability distributions. It turns out to
be very useful for obtaining sums of individuals. It also explains why so many distributions sometimes look like
the Normal distribution. The sum  of n independent random variables x(i), where n is large, all of which have
the same distribution, will asymptotically approach a Normal distribution with known mean and standard
deviation.
130
 The Weibull has been applied to problems in the areas of tidal height, efficacy of medical
treatment, insurance claims, maintenance of street lights, rock blasting, and spare part
planning.

 The Gamma distribution is a continuous distribution, right skewed and bounded at zero, It is
a parametric distribution based on Poisson mathematics, used often for modeling rare event
probability. For this reason the Gamma distribution is extremely important in risk analysis
modeling, with a number of different uses: in meteorology, inventory theory, insurance risk,
economics and queuing theory.
Parameters are Location, Scale, s > 0 and Shape, β > 0. Examples of the Gamma distribution
are given below in Graph 4.4.

Graph 4.4 – Gamma distribution shapes

Source: Vose (2008)

4.3.2 OSX L&S risk assessment

In the First Chapter I have focuses on the Brazilian oil market.

The opportunity to make great profits by sharing a portion of the giant reserves in the pre-salt, in the
Campos and Santos Basins oil fields, has attracted many investors: international standing oil
companies such as Repsol, Chevron, Statoil, BG, Royal Dutch Shell, and a huge inflows of capitals.
For these reasons the President of Brazil, Dilma Roussef, following his predecessor Lula, has adopted
strict regulations and new contractual terms to better take control on all the Brazilian oil profits.
The passage from Concession Rights Agreements to the Production Sharing Agreements has thin out
the oil companies (both domestic and international) revenues, while the local content clause and the
strict environmental authority control have risen barriers in the domestic oil market.
The QRA potentiality stands in the possibility to convert all these events into variables of risks that
directly impact on the business cash flow analysis.

131
OSX is an integrated offshore solutions for the oil and gas exploration, production and first refining
services. Its sector is strictly linked to the Brazilian oil and shipbuilding market and regulations.
The Leasing and Services project undergoes all the typical risks of pre-completion, related to the
construction of the vessel in the Açu port, to post-completion or operating risks, specific risks of the
core business (L&S), sovereign risks, linked to the macro variables of Brazil Country economy, and
financial risks, related to the debt repayment pledge.
In the next Table 4.11 I have collected all the main figures of risks, classified per area, type of impact.

The symmetric risks figure are also opportunity to have positive impact on the project cash flows.
In order to introduce all the risks presented in Table 4.11 into the FCFF and FCFE deterministic
models, I have analyzed their past events and their impact and connections with OSX L&S project
features. In some cases I have collected the historical series, in others I have made assumptions on
their probability distribution, based on all the official documents and contractual obligations of OSX.

For what concerns “Sovereign risks”, I have captured them in the Country risk premium, into the cost
of capital: as explained in the previous paragraphs, by using Damodaran model, I have adapted the
classical CAPM model to a specific premium for Brazil sovereign risk, weighted for the beta of the
sector (Oil and Gas equipment/services).

I have excluded “Currency risk” because OSX is naturally hedged through the business itself: when a
shipping company arranges its financing in US $ and both freight revenues and operating costs are
denominated in dollars, the firm has created a “natural” hedge and foreign exchange exposure is
limited; furthermore all the official financial information issued by OSX adopt US$ as the base
currency.

132
 Table 4.11 – OSX L&S risks assessment
STAGE AND TYPE OF RISKS DESCRIPTION IMPACT DIRECTION
Pre-completion risks

The construction and completion of

the vessel is behind the pre-
determined deadline, due to: DOWNSIDE RISK

TIMING OR DELAY RISKS  Lack of resources in the

quantity or quality needed;
 Lack of required technology;
 Delays or refusal in the
concession of the
environmental license by
IBAMA

Operating risks (post-completion)

Rise or fall in operating efficiency

SYMMETRIC RISK
due to:

 Oil production volume;

THROUGHPUT RISK  Efficiency of costs;
 Working days/ tot days.

UPSIDE RISK
Increase in efficiency thanks to
learning-by-doing effect.

Operating costs are different than

expected due to: SYMMETRIC RISK

SUPPLY OR INPUT RISK  Quantity of raw materials

and labour;
 Quality of raw materials and
labour.

Oil spill during O&M Services, sea DOWNSIDE RISK

ENVIRONMENTAL RISK pollution, loss in production
volumes

MARKET RISK Inflation rate, IPCA, increases leasing SYMMETRIC RISK

rent but also operating costs.

OGX, the charterer, could be illiquid DOWNSIDE RISK

DEFAULT RISK and interrupt to pay rent or could
default.

133
 Sovereign risks

 Expropriation risk; DOWNSIDE RISK

POLITICAL AND LEGAL  Political stability;
RISKS  Changing legal rule.

Financial risks
SYMMETRIC RISK
INTEREST RATE RISK LIBOR can vary during the debt
tenor.

Source: data elaborated by the author

I have assigned each distribution function to the variable assumptions by cross-checking the best
goodness-of-fit statistics and plots tests.

4.3.3 Pre-completion risks

The pre-completion risks (downside risks) involve all the problems and unexpected accidents that
delay the infrastructure realization, postponing the beginning of the related businesses.
OSX L&S standard project submits these risks during the construction phase in the Açu Superport:
OSX Shipbuilding SA is responsible for the completion of the vessel in three years, so at the fourth
year the leasing contract should start and expire after twenty years.
If, during the construction, the raw materials and labour required are not enough, both in quantity
and quality, the finalization of the FPSO could be postponed for one year. This event lead to delay all
the time line of the L&S project, so the project horizon of evaluation will be transferred from time 24
to time 25. This is a possible event, but not so probable: only in the worst hypothesis the
construction could delay. Another similar risk that has in common the time and effect of the
operative pre-completion risk, is the regulatory risk: the Brazilian oil market is strongly controlled and
strictly regulated by a variety of public institutions, starting from the environmental authority.
OSX, in fact, must primary receive the environmental license by IBAMA in order to established its
drilling platforms: without the permission the project is locked, and so are the future cash flows.
The IBAMA refusal is another event not probable but possible, whose occurrence has the effect to
postpone the overall project.
Since the operating and regulatory pre-completion risk are rare events with relevant consequences, I
have introduced them in my evaluation model by setting a simple Dummy Variable.
It sums up the two negative events and assumes the True value 1) if the construction is completed
and the environmental license is obtained in time, Faulse 0) if the one of the two risks verifies (9) The
pre-completion risk probability is set to 2% which is voluntary low according to its nature of rare
negative event.
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Pre-completion / regulatory risk = (9)

The 2% probability setting is made up with an “=SE(…)” function entered in the Dummy variable cell:
only for probability > than 98% the Dummy for pre-completion risk give “0” output and, next, the
time “25” appears in every statements with the respective items and the “Residual Value” column,
after the contract expiration at time 25. The next Table 4.12 reports the dummy variable.

Table 4.12 – OSX L&S pre-completion risk

Source: data elaborated by the author

The probability is a uniform distribution among 1% and 100%, obtained through the “=CASUALE()” Excel tool.

4.3.4 Post-completion risks

The post-completion risks refer to the core business operating risks: its costs, the contractual
obligations, the availability of raw material and technology, in order to offer an adequate service of
O&M on the FPSO. Their probability is higher than rare events. These kind of risk/opportunity can
affect the project in a double directions: if the L&S equipment could overperfom the fixed
benchmark, they can reach major level of efficiency and obtain higher revenues.

4.3.4.1 “Operating efficiency” assumption

The “Operating efficiency” is a specific clause introduced in the contract conditions in order to
protect OGX interests during the production operations: as explained in the deterministic evaluation
models, I have inserted this fundamental variable in the revenues base formula, setting the default
value by 97%.
In the dynamic model I have chosen the “Triangular” distribution to best fit the empirical data: the
Minimum is fixed at 95%, the Likeliest at 97% and the Maximum at 100%. Considering the high level
of ex-post efficiency reached by OSX, the choice of the likeliest value at 97% is a conservative
assumptions, since it is the base value required by contract, too.
In Chart 3.5 I have collected the realized monthly efficiency of OSX FPSO-1 related to the first oil
production started in January 2012: they have realized an average value of 99%.

135
The Crystal Ball setting Parameters are displayed in the next Figure 4.1, with the frequency and
cumulative charts.

Figure 4.2 – “Operating efficiency” assumptions CB settings

Source: data elaborated by the author

Throughout the thousands of scenarios simulated by CB, 97% is the most probable value run from
the Operating efficiency assumption distribution path.
For one single scenario Crystal Ball runs the 20 random values for Operating Efficiency, following the
Triangular distribution set, which will be applied into the (2) formula for the compute of Leasing
revenue for one single year of Income Statement.

4.3.4.2 “Learning-by-doing” assumption

OSX Brazil has sealed a technological partnership with Hyundai (which also own 10% of OSX
Shipbuilding) that grant a fast improvement in the equipment and technicians skills: this is one of the
key success factor of OSX, therefore I take in account its positive impact on the project evaluation
models.

Being this another expert opinion, as defined by Charnes (2007), I have fitted the function with a
Triangular distribution, again, assessing reliable and conservative parameters ( in order to not put a
upside biased variable), as showed in the next Figure 4.2.

136
 Figure 4.2 – “Learning-by-doing” assumptions CB settings

Source: data elaborated by the author

For what concerns this upside opportunity of improvement, it is coneptually linked to the efficiency
reached during the O&M services. In order to accounts for this positive connection I have adjusted
the (2) as follows:

The annual adjusted for Learning Leasing revenue could be higher or, at least, equal to the base
leasing revenue (2).

Crystal Ball allows to introduce correlation factors among the variable assumptions fitted: in this way
the model can reflect the real connections among the considered variables.

Since the efficiency definition also implies the costs efficiency I have set the “learning-by doing”
function with a correlation factor by -0.7 with the “Operating costs” assumption (cell I31 for first
year) for the same year, as showed in Figure 4.3.

Once the operating costs move upward, the Learning-by-doing assumption is automatically set with a
downward adjustment for the same year: the leasing revenue isn’t penalized, but it can’t benefit
from the “Learning” upward adjustment.

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 Figure 4.3 – “Learning-by-doing” assumptions CB settings

Source: data elaborated by the author

4.3.5 Supply or input risks

The volatility of operating costs also affects a shipping company cash flow and profitability: in the
case of OSX, the opex are expected to vary between 30/60 thousand US$ per day.
As explained in the 4.1.2 paragraph, dedicated to standard Services contract for OGX, the Services
revenues strictly depends on the operating costs recorded each year: its margin has an upper bound
of 10% and a down bound of 0% and varies depending on the operating costs.
As for the Leasing revenues calculation, I have crossed the ex-post services revenues and opex (from
OSX quarterly financial information) with the contractual terms.
The services revenues variability, hence, depends on two factors: the service margin and the
operating costs recorded each year. I have linked them through a linear function, expressed in (3).
To simulate its variability I have made two other variables assumptions: the “Service margin” and the
“Operating costs”. Operating costs can be easily fitted by a triangular distribution function, as
showed in the next Figure 4.4: the Parameters are expressed in annual costs.

Figure 4.4 - “Operating costs” assumptions CB settings

Source: data elaborated by the author

138
The service margin (0%-10%), instead, is simulated through a linear regression function easily computed by
Excel with “=PREVISIONE(..)”. The input for x values are the operating costs, while those for y values are the
2
service margin: the linear function obtained in output is displayed in the following Graph 4.5, with R statistics.

Graph 4.5 – Service margin linear regression on operating costs

Annual services margin vs

operating costs
12%
y = -0,0088x + 0,2
10%
R² = 0,9643
8%
6%
4%
2%
0%
0,0 10,0 20,0 30,0

Source: data elaborated by the author

The R2 is meaningful: more than 90% of the y variability is explained by the x variability through the
linear function.
This result confirms the goodness of my assumptions on the correct calculation of OSX Services
annual revenues: at the minimum operating costs correspond the maximum service margin, in fact
the line slope is negative.

4.3.6 Market risk

Market risk generally refers to the price volatility risk: one of the most volatile market is that of oil
and derivatives products, especially if involving an emerging economy. The cost of fuel oil, which
represents a relevant cost during shipping travel, is usually linked to world oil prices, so the business
is exposed to the commodity prices oscillations. In addition, petroleum market is the most affecting
market on the general level of prices: the US historical series of inflation rate seems to follow the
lagged oil market path (represented by West Texas Intermediate Price, WTI ) as showed in Graph 4.6.

However this exposure to world oil market cannot be generalized to the Brazilian energy market: as
explained in the First Chapter, Brazilian oil market is strongly regulated and controlled by
Government institutions.
The oil price level, in particular, has been a crucial point of the anti-inflationary policy enforced in the
past decades by the previous Presidents of Brazil.

139
 Graph 4.6 – US inflation rate vs WTI oil price (1982/2011)
160,0 7
OIL WTI
6
140,0 % US INFLATION
5
120,0
4
100,0
3

80,0 2

1
60,0
0
40,0
-1
20,0
-2

0,0 -3

Source: data from World Bank, Bureau of Labor Statistics, elaborated by the author

The “inflation nightmare” started since the two oil shocks, in 1973 and 1979, with dramatic
aftermaths on the Brazilian level of prices. Brazil was an oil importer Country (80% of the oil used in
Brazil had to be imported), completely exposed to the international oil market: the crisis sharply rose
energy costs. From then on, the Government adopted a series of policies aimed to shoot down the
inflation rate: all oil product prices have been regulated, from ex-refinery prices, to distribution
prices and retail prices. BRANDAO (1998) explains how was regulate the oil prices market in Brazil.
Inflation has been a significant feature of Brazilian economic development.
In the 1940s the average rate of inflation was 10%; in the 1950s it was 19%, in the 1960s nearly 45%,
in the 1970s 34%. It then jumped to a steep 428% in the 1980s, and reached its maximum of 2708 %
in 1993. Two schools of thought have tried to explain the Brazilian inflation in these decades.
The structuralist school considered inflation to be due to inelastic supply within given sectors of the
economy; they regarded inflation in underdeveloped countries as a normal feature of economic
development.
The monetary school of thought, by contrast, see inflation as the output of the government deficit,
which increased the money supply in order to cover it, leading to inflationary pressure. The years of
rocketing inflation, had caused the Brazilian economy to enforce an automatic price adjustment
mechanism: this mechanism, which had become part of the indexed economy, gave rise to an inertial
component of inflation.

140
The indexation system led to distortions of relative prices in the first half of the 1980s: wages, public
service tariffs and the prices of crude oil products had been set below the inflation rate. When the
rate of inflation was very high domestic nominal prices had to be adjusted frequently in order to
avoid any deep plunge in real values.
In the following Graph 4.7 I have gathered the historical series of international oil price index, the
WTI, and the Brazilian main inflation index, The Wide National Consumer’s Price Index , IPCA10.

Graph 4.7 – Brazil IPCA inflation vs WTI oil price ( 1982/2012)

160,0 90,00%
WTI OIL PRICE 80,00%
140,0
IPCA % 70,00%
120,0
60,00%
100,0 50,00%
80,0 40,00%
60,0 30,00%
20,00%
40,0
10,00%
20,0 0,00%
0,0 -10,00%

Source: data from World Bank, Banco Central do Brasil, IBGE, elaborated by the author

It’s clear the effect of systemic adjustment started in the 1980s and the huge current spread
between the international oil price levels and the artificially steady inflation rate in Brazil since the
middle 1990s, which keep domestic oil prices low.
In fact the reduction of regulated prices, in real terms, was a measure adopted by the government to
try to restrain accelerating inflation. Hence, whenever the government makes an adjustment to the
prices of petroleum products, this is strongly influenced by the current level of rate of inflation.
The basic assumption was that the price of oil would remain at its high 1979 level: the intrinsic
problem, however, is that this emphasis did not change after oil prices began to decline.
On the contrary, the Government set energy prices.
In conclusion the oil prices influence the services companies through the inflation adjustment
system.

Inflation effect is a crucial component in the shipping market: OSX L&S contracts envisage the
inflation impact on cash flows, defining, in case of change in inflation rate, an annual adjustment

10
IPCA, is used by the Central Bank for monitoring the objectives established in the inflation goal system and
adopted from July 1999 on for signaling the monetary policy. IPCA refers to families with income between 1
(one) and 40 (forty) minimum wages, whatever the source of this income, and living in the urban areas of the
region. It covers many sectors of the economy, among them the oil sector.
141
(symmetric) for leasing rent of the vessel, and the annual reduction in Services unit margin
(downward). OSX has indexed the L&S prices to IPCA level.
I have collected the historical monthly series of Brazilian inflation rate measured by IPCA: through
the “Fit” tool Crystal Ball gives different possibilities of data fitting using the continuous distribution
function of its “Gallery”. Crossing the goodness-of-fitting statistics and plots output for each
proposed distribution, I have chosen the Weibull distribution function. In the next Figure 4.5 is
displayed the different criterion for the selection.

Figure 4.5 – IPCA goodness-of-fit output

Source: data elaborated by the author

The “Frequency comparison” chart shows the output for the “Eyeball” and statistic tests:

 the grey bars of the histogram are the representation of the empirical data collected on IPCA,
while the green line is the fitting made by Crystal Ball, following the Weibull distribution
function;
 the Chi-Square is not meaningful, while the K-S is very low, hence it should best fit it.

The line seems to smooth the data in a correct way. In the “Frequency difference” chart is
represented the fitting in terms of difference on the empirical frequency data: the bars are inside the
bounds, so it is accepted. The “Cumulative comparison” chart gives the fitting on the cumulative
distribution: the Weibull fitting follows enough the data trend.

Inflation rate has opposed effects on the two units: it is proportionally correlated for Leasing unit and
inversely correlated for Services unit.

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Therefore, operating costs are expected to be relatively constant and to rise with inflation, reducing
OSX Services annual revenue: to this purpose I have set in Crystal Ball assumptions, a positive
correlation by + 0.8 between “Operating costs” variable and “IPCA” inflation variable assumed.
In Figure 4.6 is reported the correlation graph between Operating costs (Triangular distribution) and
IPCA (Weibull distribution).

Figure 4.6 – Operating costs/ IPCA correlation setting

.
Source: data elaborated by the author

With this setting each single scenario run will give in output a value of annual operating costs higher
when the annual IPCA value is increased, so to better reflect the real market effect on Services unit.

For what concerns Leasing positive adjustment, the formula (2) is corrected each year for the
inflation rate value as follows:

The annual Leasing revenue is indexed to the annual IPCA simulated by Crystal Ball from the
empirical data.

4.3.7 Environmental risk

The environmental risk involves the costs suffered in case of damages on the environment due to a
malfunctioning of the complex offshore drilling platform. The responsibility to pay for the fine is
charged to the designated Operator of the FPSO, which is OSX Services unit.

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Oil spill are very common accidents that happens during the production operations: their
environmental impact severity depends on the total volume of oil spilled in the shallow or deep
water. In 2011 a notorious oil company, Chevron, was in the media cyclone eye after an oil disaster
in the Gulf of Mexico waters. A leak of about 15000 blpd from a shallow water crude oil pipeline in
the Main Pass Area of the Gulf of Mexico11 has led Chevron to stop its offshore Louisiana Main Pass
pipeline. The company was obliged to pay a fine of 17 mln US$ for the damages caused.
Each year a number of oil spill happens worldwide, causing grave and expensive damages and
pollution in the environment: the incidence of these spill varies depending on the volume of oil
released. Fortunately, the major oil spill are also less probable events than the smaller oil spill: these
are rare events that, when happen, could cause great financial distress in the oil company.
To this purpose I have introduced this rare dramatic events in the cash flow analysis of OSX L&S
project. I have primary collected the official data on the historical world oil production, covering a
decade from 1978 to 1997. The time period has been chosen in order to have data coherent to the
historical global oil spill list I have found. In the next Table 4.13 there are the oil production data, in
thousand barrels, classified for geographic region of production: the base data where average of
production per day. The sum of each component has given the daily aggregated production, then
converted in the last column, in the year world oil production.

Table 4.13 – World oil production (1978/1997)

Algeria Angola Argentina Australia Azerbaijan Brazil Canada China ColombiaDenmark Ecuador Egypt
Norway Oman Qatar Russia U.S.S.R. Arabia Sudan Syria Emirates Kingdom United States
Equat. Guinea Gabon India Indonesia Iran Iraq Kazakhstan Kuwait Libya Malaysia Mexico Nigeria
Venezuela Vietnam Yemen Other World OPEC Persian Gulf North Sea

YEAR Avg production WORLD oil WORLD oil

prod./day prod./year
1978 6.633 32.354 17.312 114.233 170.532 62.244.271
1979 6.944 34.239 17.322 119.210 177.715 64.865.884
1980 6.789 34.938 13.827 109.014 164.568 60.067.297
1981 6.481 34.886 10.736 98.754 150.857 55.062.875
1982 6.603 31.665 11.433 89.723 139.425 50.889.959
1983 7.028 30.638 11.889 87.573 137.128 50.051.770
1984 7.695 30.714 12.323 88.806 139.538 50.931.433
1985 8.245 29.417 12.562 86.108 136.332 49.761.172
1986 8.334 31.217 12.770 92.750 145.072 52.951.176
1987 8.726 30.698 13.427 93.757 146.609 53.512.227
1988 9.006 31.417 14.230 99.419 154.072 56.236.207
1989 9.077 30.898 15.778 103.507 159.260 58.129.841
1990 9.385 31.786 15.052 106.125 162.348 59.256.851
1991 9.508 33.165 13.009 105.709 161.391 58.907.601
1992 9.915 31.003 14.419 108.689 164.025 59.869.167
1993 10.044 29.874 15.309 110.619 165.846 60.533.751
1994 10.339 29.839 15.683 113.317 169.177 61.749.717
1995 10.873 30.142 15.934 115.966 172.915 63.113.958
1996 11.364 30.447 16.318 118.568 176.698 64.494.698
1997 11.676 30.730 17.266 123.031 182.703 66.686.551

Source: data from EIA, United States Energy Information Administration, elaborated by the author

11
The Gulf of Mexico has been the site of the worst-ever US offshore oil spill in the recent years, when the well
of BP, Macondo, released more than 4 mln barrels of crude in the sea.
144
I have gathered the oil spill data, classified between smaller volume worldwide released ( until 25kb
per year) and major oil spill (greater than 250kb per year): for the two categories the Table 4.14
reports the total number of spills per year, the absolute frequency and the volume of oil released.
Table 4.14 – Total Oil Spill (1978/1997)
conversion factors data in thousand barrell
tonn x 7,3 = barrel
gall x 0,0034 = tonne
YEAR TOT tot oil spill/year until 25k barrel > 250k barrel oil
N.of spill in thousand barrel oil spill abs.freq. spill abs.freq.
1978 302 6705 247 8
1979 346 10679 272 8
1980 382 4209 294 3
1981 288 1590 248 1
1982 284 1021 228 0
1983 270 6544 222 4
1984 257 907 240 0
1985 218 1346 208 1
1986 316 1344 250 2
1987 318 1014 282 0
1988 289 2432 274 2
1989 306 2154 291 2
1990 395 1393 382 0
1991 306 8307 283 3
1992 321 4011 305 3
1993 308 1886 291 1
1994 308 2352 288 2
1995 220 575 214 0
1996 202 1452 168 2
1997 136 1208 110 0
Tot. 5772 61.130,00 5097 42
Mean 289 3.056,50 255 2
Variance 60 2831,42 57 2

Source: data from Schmidt, Oil Spill Intelligence Report (1996), elaborated by the author

I have converted the original measure of gallons and tons into thousands barrel of oil by using the
indicated factors of conversion. Elaborating the data I have next computed the “Oil spill probability”
as follows in (10).

(10)

The environmental risk assessment, as the other risks, requires the measure of probability, the range
of variability, and how impact on the models of evaluation. Since I have distinguished the two cases
of environmental damages, each probability is a conditional probability: given the event Oil spill
probability in a specific year, I need the relative probability of a 25k barrel oil spill and the relative
probability of 250k barrel oil spill. According to the probabilistic theory of Bayes (1983), the
conditional expected probability is equal to the product of the two events probability: the oil spill
probability is the conditioning event, while the specific volume oil spill probability is the particular
event that I want to measure.
The following (10) and (11) give the related formulas.

145
 (11)

(11)

I have computed the and comparing the number of

realized events in one yeat, as reported in the Table 4.14, with the total number of spills happened in
the same year. In the following Table 4.15 are the historical distribution of the two conditional oil
spill probability.

Table 4.15 – Historical distribution of conditional oil spill probability

YEAR Conditional probabilityConditional probability
until 25k oil spill >250k oil spill
1978 0,008810023% 0,0002853%
1979 0,012942755% 0,0003807%
1980 0,005393516% 0,0000550%
1981 0,002486880% 0,0000100%
1982 0,001611247% 0,0000000%
1983 0,010749426% 0,0001937%
1984 0,001662230% 0,0000000%
1985 0,002581309% 0,0000124%
1986 0,002007748% 0,0000161%
1987 0,001680316% 0,0000000%
1988 0,004100307% 0,0000299%
1989 0,003523456% 0,0000242%
1990 0,002273762% 0,0000000%
1991 0,013042037% 0,0001383%
1992 0,006366135% 0,0000626%
1993 0,002943114% 0,0000101%
1994 0,003562279% 0,0000247%
1995 0,000886326% 0,0000000%
1996 0,001871795% 0,0000223%
1997 0,001465546% 0,0000000%
0,08996% 0,0012654%
Source: data elaborated by the
0,00450% author
0,0000633%
0,00386% 0,0001059%
The last feature of risk definition and measurement refers to the impact on the evaluation models:
since I have the volume information of the spill, I can compare this volume of oil loss to the total
production of one single FPSO in thousands barrel for a year.
I need to build the oil production schedule, as OGX has made with the D&M geological study on the
oil field reserves in the Waimea accumulation, Campos Basin.
The management presentations always declare what are the expected goal of production and the
time line to reach them for all the duration of a reserve.
I have adapted the theoretical phase of development of an oil reserve to the study of feasibility
conducted on OGX reserve:

 Waimea total potential volume to produce is about 1,6 bln barrel of oil,
 the duration of a reserve takes 20 years about,
 they have estimated to use a maximum of 20 FPSOs for the total accumulation exploitation,
 the peak of production of 900 mln bpd will be reached at year 13.
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 The data assumed on the production rump up is displayed in the following Table 4.16.

Table 4.16 – OGX oil production targets (data in barrels of oil)

Production first stage Production rump up
-25000 oil spill 25k b/y

Period of production 1 2 3 4 5 6 7
Prod/d 20.000 30.000 50.000 80.000 90.000 100.000 120.000
Prod/year 7.300.000 10.950.000 18.250.000 29.200.000 32.850.000 36.500.000 43.800.000
N. of FPSOs 1 2 3 4 5 9 14

1 FPSO prod/d 20.000 15.000 16.667 20.000 18.000 11.111 8.571

1FPSO prod/year 7.300.000 5.475.000 6.083.333 7.300.000 6.570.000 4.055.556 3.128.571

efficiency loss -0,34% -0,46% -0,41% -0,34% -0,38% -0,62% -0,80%

efficiency loss corresponding to 25k oil spill/year

Peak of production 1,4 mln b/d

-250000 oil spill 250k b/y

11 12 13 14 15 16 17 18 19 20 TOT
324.000 486.000 826.200 826.200 413.100 206.550 185.895 74.358 37.179 22.307
118.260.000 177.390.000 301.563.000 301.563.000 150.781.500 75.390.750 67.851.675 27.140.670 13.570.335 8.142.201 1,6
18 19 20 20 19 17 13 4 2 1

18.000 25.579 41.310 41.310 21.742 12.150 14.300 18.590 18.590 22.307
6.570.000 9.336.316 15.078.150 15.078.150 7.935.868 4.434.750 5.219.360 6.785.168 6.785.168 8.142.201

-3,81% -2,68% -1,66% -1,66% -3,15% -5,64% -4,79% -3,68% -3,68% -3,07%

efficiency loss corresponding to 250k oil spill/year

Source: data elaborated by the author

Crossing these assumptions data, I have calculated the oil production volume per year and divided
per the total number of required FPSOs in each year: in this way I have computed the single FPSO
volume of production per year till the disinvestment phase.
I have considered the 25k barrel oil spill event only for the first to stage of production, in which the
level is lower and couldn’t be possible to have a loss higher than the effective oil produced. While the
rump up of production submits the 250k barrel oil spill event.
Since the loss in oil production is equivalent to days of less work, the most important impact that the
oil spill have is on the operating efficiency: the percentage of loss in volume of oil can be converted
into a measure of efficiency loss, that directly impact in the formula for the leasing revenue
computation.
The 25k oil spill events are more probable ( a medium value of 0,0045%), but with lower inefficiency
impact (-0.51%), while the 250k oil spill have impact that are multiples of the previous ones (-3.38%),
but with a remote possibility to happen (0,0000633%).

In the following Table 4.17 I have sum up the empirical distribution on the oil spill probability, that I
have built on the management data.

147
 Table 4.17 – Oil Spill empirical distribution of efficiency impact
Period leasing Impact on Oil spill
FPSO operative eff. distribution
ANNO 1 -0,34%
ANNO 2 -0,46%
ANNO 3 -0,41%
ANNO 4 -0,34% potential
ANNO 5 -0,38% loss up to
ANNO 6 -0,62% 25k boe/y
ANNO 7 -0,80%
ANNO 8 -0,68% more probable
ANNO 9 -0,61%
ANNO 10 -0,43%
ANNO 11 -3,81%
ANNO 12 -2,68%
ANNO 13 -1,66%
ANNO 14 -1,66% potential
ANNO 15 -3,15% loss at least
ANNO 16 -5,64% 250k boe/y
ANNO 17 -4,79%
ANNO 18 -3,68% less probable
ANNO 19 -3,68%
ANNO 20 -3,07%

-0,51% mean 25k impact

-3,38% mean 250k impact

Source: data elaborated by the author

As for the other historical series, I have assigned a distribution function to the empirical dataset, by
Crystal Ball fitting tools. I have chosen the Gamma distribution for both the two environmental risks.
The next Figure 4.7 shows the usual tests to fitting the data.

Figure 4.7 – Oil Spill probability distribution assumptions setting

Source: data elaborated by the author

148
The statistics tests output are meaningful in all the cases, and the eyeball tests suggest that : the
Gamma distribution reflect the empirical distribution, giving more probability to the lowest values,
while higher values have quite null probability of incidence.
The final version of (2) with the introduction of (10) or (11) adjustment for oil spill probability (S) of
Leasing revenue, for each year is as follows in (12):

(12)

4.3.8 Default risk

OSX L&S standard project is anchored to the sister company OGX, the oil and gas company of the EBX
Group. In the Second Chapter I have analyzed the potentiality of growth of OGX: in the last years it
has acquired many shallow water fields, conducting an aggressive E&P strategy in Campos and
Santos Basin. It is a start up, as OSX, and is affected by all the related figures of risks:

 Volatility risk in stock market,

 Execution risk in the E&P operations,
 Environmental risk,
 Liquidity risk,
 Credit risk,
 Interest rate risk.

OGX is listed in the Bovespa stock exchange: Moody’s has attributed a B1 rating ( which corresponds
to S&P B+ rating), which is a medium value in the existing range of ratings, but implies the possibility
to default into few years: it falls into the Speculative Grade investments, issued by not prime issuer,
considered with substantial credit risk. The obligor, OGX, currently has the capacity to meet its
financial commitments, but adverse business, financial, or economic conditions will likely impair the
obligor's capacity or willingness to meet its financial commitments.

Since OGX orders backlog represents the main source of revenues for OSX, a change in the company
financial health could heavily reflect onto OSX value.
OGX default is a rare event among Pre-completion risk, whose effect is the interruption of chartering
relationship, or a substantial reduction of the next annual payment. The estimated default
probability is of 2,44%, as defined by Standard&Poor’s (2009) in its “One –Year Global Corporate
Default Rated By Refined Rating Category, 1981-2008”.

149
In order to introduce it in the evaluation models, again I have used a Dummy variable to set the 2%
probability of dramatic event, as follows in (13):

OGX default /breach of payment10 (13)

The true event 1) is OGX default, which I have set at a fixed year 10 because in their financial
information is considered the period more crucial for OGX enhancement.
The Dummy variable assumes true value only in the 2% of cases: again with the “= SE(…)” Excel tool,
only for probability > then 98% will activate the OGX default event, while the probability is a uniform
distribution among 1% and 100%, obtained through the “=CASUALE()” Excel tool.

However, if this rare event happens at year 10, the impact is:

 the zero revenues for L&S units at year 10;

 the negative “domino effect” on the next OSX L&S revenues for the following 3 years (11-12-
13), in which their gross revenues are weighted for an increasing factor of reduction,
respectively equal to 0,5 – 0,6 – 0,8.

The next Table 4.18 shows the dummy variable and the negative impact split in 4 years if the event is
true.
Table 4.18 – OGX default dummy variable
10 11 12 13
OGX Default/breach of payment 1 0,5 0,6 0,8
Probability of default at year 10 98,43%

Source: data elaborated by the author

In this way the effects have an inter-temporal dependence, as happens in the reality: when a company is
illiquid, it is improbable that the next years it could recover all its financial distresses.

4.3.9 Financial risks

The main figure of financial risks for OSX L&S project, is the exposure to the floating rate LIBOR -3 m,
which is the variable component of the debt price.
To simulate a reliable path during the years from 4 to 15 (the tenor debt period), I have collected the
historical series of monthly US LIBOR -3m from 1992 to 2012. To fit the data I have selected the
Lognormal distribution function, which is considered the best fitting shape for interest rate: the
following Figure 4.8 shows the Crystal Ball settings LIBOR variable assumption.

150
I have selected a pre-determined range of variability among 0% and 5% in order to give more
“memory” to the most recent data on LIBOR: since 2000 the LIBOR doesn’t overwhelm the 5% value,
so it is unrealistic a steeper increase in LIBOR rate over a decade.

Figure 4.8 – LIBOR fit settings assumptions

Source: data elaborated by the author

In addition OSX has enforced a financial hedging, by assuming long position on interest rate swap, in
order to limit the excess variability in the LIBOR value during the debt repayment period.

4.3.10 OSX L&S dynamic risk evaluation results

Once having completed all the settings for the variables distribution assumptions, Crystal Ball is ready
to launch a Monte Carlo simulation. I have set the number of total trials to 10000, in order to rise the
precision and accuracy of computations made by CB.
Each single trial or iteration, depict a scenario which is composed of the 24/25 periods of financial
statements: each single period, on its own, gives in output an independent value (referring to the CB
dynamic variables), so there is no inter-temporal correlation, except where specifically set (as for
what I have made in the OGX default rare event occurrence).

151
For each iterations, in every period, however, CB run a random sampling from the variables
distributions assumptions, considering all the correlations that I have set among some functions
(between “Operating costs” and “IPCA Inflation” or between “ Learning-by-doing” factor and
“Operating costs”).
I have defined as “Forecast Cells” (the results to whom build the distribution) the Net Present Value
and the Internal Rate of Return obtained from the two evaluation models, FCFF and FCFE.
CB gives in output four different continuous distribution functions, built for each forecast value,
following their variable functions assumptions.
The statistics window automatically displays most of the descriptive statistics that are used by
decision makers. The percentiles window and overlay chart present views that can also be helpful for
interpreting and comparing output distributions.
In the following Charts 4.3 and 4.4 are reported the distributions results for my models of OSX L&S
evaluation project: in red are the IRR values beyond the 95% confidence interval.

Chart 4.3 – OSX L&S IRR distribution at 95% conf.(FCFF model)

Forecast: OSX FCFF IRR
9.648 T rials Frequency Chart
,030 289

,022 216,7

,015 144,5

,007 72,25

M ean = 15%
,000 0

14% 15% 15% 16% 16%

Certainty is 95,00% from 15% to 16%

Source: data elaborated by the author

Chart 4.4 – OSX L&S IRR distribution at 95% conf (FCFE model)
Forecast: OSX FCFE IRR
9.698 T rials Frequency Chart
,028 274

,021 205,5

,014 137

,007 68,5

M ean = 20%
,000 0

18% 19% 20% 21% 22%

Certainty is 95,00% from 19% to 21%

Source: data elaborated by the author

152
The display range covers the standard deviation value of 2,60 that count for 9666 trials on 10000.

Surprisingly the two distributions of project IRR, obtained through the two evaluation models of FCFF
and FCFE, give mean value that are higher than the values obtained by using deterministic models.
Furthermore, the minimum value assumed by the two IRR, at a confidence interval level of 95%, are
the output obtained in the deterministic model of evaluation: according to Crystal Ball computations,
the investors at least could gain the default value found in FCFF and FCFE in the static models (
without risks assessment) with a certainty of 95% (Value at Risk analsysis).

FCFF IRR mean value, computed by Crystal Ball, is by 15%, against the 14% obtained in the static
model, and so the FCFE IRR dynamic output is by 21% against the 18% obtained with deterministic
evaluation models.
The introduction of dynamic variables has unexpectedly rise the project value: contrary to what is the
common thought, that risks management simulation approach could underestimate and penalize the
firm value, adding risks figure, I have obtained the opposite effect.
This because, as discussed in the risk assessment paragraph, the risk could be symmetric, becoming
an opportunity of creating value.
Although having set the key value drivers ( the operating efficiency, the operating costs, the service
margin) in such a way to vary on a reliable range of values, the final outcome, on average,
demonstrate that the project has good performing fundamental values.
In order to better capture its meaning is useful to analyze the key statistic figures for the two output,
in Table 4.19.

Table 4.19 – Statistics on OSX project IRR results (limited trials)

Statistics OSX FCFF IRR OSX FCFE IRR
Trials 9648 9698
Mean 15% 20%
Median 15% 20%
Mode --- ---
Standard Deviation 0% 1%
Variance 0% 0%
Skewness -0,11 -0,11
Kurtosis 3,20 3,14
Coeff. of Variability 0,02 0,03
Range Minimum 14% 18%
Range Maximum 16% 22%
Range Width 2% 4%
Mean Std. Error 0,00% 0,01%

Source: data elaborated by the author

When excluding the extreme marginal tails of distributions, the two shapes seem to be quite similar
and following a Normal distribution function: it is a meaningful result because the Normal
distribution is the most replicable and known function, whose proprieties are easily computable and
153
interpreted. A Normal distributed function describes a trend more easy to forecast and give expected
values (the mean statistics) more reliable ( according to the Central Limit Theory). The two statistics
box give important information on the IRR shapes.

For what concerns the measures of location , which define where the distribution is centered, mean
The Mean value is the average of all the generated output values of the models: it is very important
because it represent the expected value of the IRR. The Median is the value in the middle of the
distribution: it is the value above and below which the model output has generated equal numbers
of data. It is interesting to note that in both the distributions the mean value coincides with the
median value, which is typical for Normal distributions.
FCFF IRR is centered in 15%, while FCFE IRR is centered in 20%, respectively 1% and 2% more than
the static evaluation outputs.

The measures of spread, next, expresses how dispersed are the distributions: the main statistics is
Standard Deviation, which is the volatility of a function. This value is very important because it
explains the riskiness of the project, and help managers or investors to define the risk-appetite they
can accept. OSX L&S project evaluation outputs, in particular, have two range of variability so
different.
In the FCFF statistics box, the width range is by 2% (14% to 16%). This means that from the point of
view of the entire firm investors, the profitability is quite assured with a confidence of 95%; the
standard deviation is very low.
In the FCFE statistics box, instead, the range is wider, exactly twofold the previous one: a 4%
variability (between a minimum 18% to a maximum 22%). This implies a more volatile return for
equity holders, mainly due to the leverage effect that add risk to the project value. Also the standard
deviation is higher than the FCFF one. The diverse dispersion values further increase if it is
considered the entire distributions.

The measures of shape are Skewness and Kurtosis statistics: they often are analyzed in conjunction to
determine whether an output is approximately normally distributed.
A positive skewness means a longer right tail, while a negative skewness means a longer left tail; zero
skewness is typical of symmetric distribution centered in the origin value.
The IRR distribution statistics show a kurtosis of 3, in fact the two shapes at the limited display range,
are quite symmetric and bell-shaped, similar to Normal distribution.
The following Chart 4.5 and 4.6 display the IRR distributions with the maximum value range.
In these charts the curve assume shapes different from the Normal distribution function: the kurtosis
is more positive for both the functions and there are marginal values also in the left tails. The two
functions, again, appear to have similar shapes.
154
 Chart 4.5 –OSX L&S IRR (FCFF) Chart 4.6 –OSX L&S IRR (FCFE)
Forecast: OSX FCFF IRR Forecast: OSX FCFE IRR

10.000 T rials Frequency Chart 10.000 T rials Frequency Chart

,056 561 ,048 477

,042 420,7 ,036 357,7

,028 280,5 ,024 238,5

,014 140,2 ,012 119,2

M ean = 15% M ean = 20%

,000 0 ,000 0

12% 13% 14% 15% 17% 15% 17% 19% 21% 23%

Source: data elaborated by the author Source: data elaborated by the author

The statistics box referred to the entire distributions, in fact, report values somewhat different, only
by including the last 1000 iterations of the Monte Carlo simulations, as showed in the next Table
4.20.

Table 4.20 – OSX L&S IRR statistics on entire distributions

Statistics OSX FCFF IRR OSX FCFE IRR
Trials 10000 10000
Mean 15% 20%
Median 15% 20%
Mode --- ---
Standard Deviation 0% 1%
Variance 0% 0%
Skewness -1,71 -1,39
Kurtosis 8,75 7,44
Coeff. of Variability 0,03 0,04
Range Minimum 11% 14%
Range Maximum 17% 23%
Range Width 5% 9%
Mean Std. Error 0,00% 0,01%

Source: data elaborated by the author

The skewness is more negative, while the Kurtosis is clearly different from the Normalized statistics
of the previous table: the FCFF IRR curve is more leptokurtic than that of FCFE IRR, with a value of
8,75. The variability measure is more marked, with a 6% spread range for FCFF curve against 9% for
FCFE curve. The minimum value, however, doesn’t fall to negative values: at the first percentile the
FCFF IRR make a negative profit for – 1,27% (comparing 11% IRR to the cost of capital, by 12,27%),
FCFE IRR destroys value for -2,27% (comparing 14% IRR to the cost of capital, by 16,27%).
Even if similar, the two distributions imply very different riskiness exposure.
The equity evaluation for the OSX project, as expected, is more risky than the investor perspective: to
better appreciate this divergences in the next Chart 4.7 I have built, by using CB tool, the overlay
chart for IRR different distribution outputs.
This overlay chart adds more value to my considerations on the output distributions.

155
Firstly, the two shapes, which appear very similar in the previous Chart 4.5 and 4.6, are clearly
different when compared in the same graph, with a range of x values that goes from – Infinity to
+Infinity. The blue area, representing OSX FCFF IRR distribution, is centered in 15%, where has a peak
of probability: the FCFF curve is leptokurtic (positive excess kurtosis with respect to normal statistics),
sign of major concentration of probability in the mean value.
The red area represents OSX FCFE IRR distribution, which appears definitely right shifted, since its
range cover higher values of returns, but also affected by more dispersion: the kurtosis is lower, the
margin values are more probable than the FCFF respective values.

Chart 4.7 – OSX L&S IRR overlay distribution comparison

Overlay Chart

OSX IRR FCFF/FCFE frequency comparison

,151

,113 O SX F CF F IRR

,076

,038
O SX F CF E IRR

,000

10% 14% 17% 21% 24%

Source: data elaborated by the author

As seen before in the numerical statistics box, the FCFE takes the riskier perspective of equity
holders, who require a risk premium on the IRR expected (20% versus 15% mean), but could more
probably gain less. Its distribution is more flat, the peak is lower than that of FCFF distribution, the
values are more dispersed along the x axis.

There is another fundamental result to highlight in the Chart 4.7: the “ Fat Tails risk”.
Many economists and statisticians have demonstrated that the world, most of time, isn’t Normal,
and the assumptions underestimate some crucial figures of risks that, when happen, have dramatic
consequences. The fat tails problem is the demonstration that Normal distribution is an
approximated exemplification of the variability existing in the world, which hides in the extreme
values of distribution a relevant portion of probability: the famous known phenomena of “ The Black
swan theory” (Nassim Nicholas Taleb, 2007) is the metaphor for those rare negative events that
surprisingly have a probability in the left extreme value of the distribution.
156
In the previous Chart 4.7, the “Black snows” are evident in the left tails of FCFF and FCFE: about 14%
for FCFF IRR and 11% for FCFE IRR. These two possible IRR outputs are lower than the deterministic
model outputs and, as already said, destroy value for the project.

For what concerns the OSX L&S NPV distributions, the same considerations can be valid. The
following Charts 4.8 and 4.9 show the two distributions at 97% level of confidence, with a display
range set to the Standard Deviation of 2,60.

Chart 4.8 – OSX L&S NPV 97%conf. (FCFF) Chart 4.9 – OSX L&S NPV 97%conf. (FCFE)
Forecast: OSX FCFF NPV Forecast: OSX FCFE NPV

9.648 T rials Frequency Chart 9.658 T rials Frequency Chart

,031 300 ,030 288

,023 225 ,022 216

,016 150 ,015 144

,008 75 ,007 72

M ean = 204,7
,000 0 ,000 0

114,9 157,5 200,1 242,7 285,3 66,5 104,9 143,3 181,7 220,0
Certainty is 97,00% from 152,7 to 254,4 Certainty is 97,00% from 99,1 to 193,6

Source: data elaborated by the author Source: data elaborated by the author

The two Charts appear very similar and with a bell-shape: the limited display consider 9660 iterations
distribution, so in the 4% of the total distribution is hidden the non-normality of the distributions.
The two previous charts seem to show that the minimum range starts from positive values.
This result incomplete, in fact the next Table 4.21 the entire distributions statistics show the total
range of values for OSX NPV distributions.

Table 4.21 – OSX L&S NPV statistics on entire distributions

Statistics OSX FCFF NPV OSX FCFE NPV
Trials 10000 10000
Mean 200,5 143,3
Median 203,9 146,1
Mode --- ---
Standard Deviation 33,3 30,2
Variance 1109,4 911,9
Skewness -1,74 -1,74
Kurtosis 8,94 9,05
Coeff. of Variability 0,17 0,21
Range Minimum -67,6 -91,6
Range Maximum 289,5 223,1
Range Width 357,2 314,7
Mean Std. Error 0,33 0,30
Source: data elaborated by the author

The mean values coincide with the median, the discrepancy in the variability is less marked. The
percentile accumulation, here, is more meaningful: near 0% - 1% there are negative output of NPV in
both the two distributions ( -67 for FCFF, -91 for FCFE). The value of kurtosis is high, too.
157
The Charts 4.10 and 4.11 replicate the previous results on IRR distributions. The distribution are
leptokurtic, the two shapes are quite the same, except for the more dispersion of FCFE NPV values, in
the extreme left fat tail, while the FCFF NPV distribution has a bigger left tail.

Chart 4.10 – OSX L&S NPV distribution Chart 4.11 OSX L&S NPV distribution
Forecast: OSX FCFF NPV Forecast: OSX FCFE NPV
10.000 T rials Frequency Chart 10.000 Displayed
,057 574 600

500
,043 430,5
400

Frequency
,029 287 300

200
,014 143,5

100
M ean = 200,9
,000 0
0
-48,4 35,7 119,8 203,9 288,0 -70 -11 49 108 168
Certainty is 99,94% from -48,4 to 283,6

Source: data elaborated by the author Source: data elaborated by the author

The values of NPV are less volatile than IRR, but the first percentile involves negative values, too.
The value of OSX L&S project for the equity holders could be really low in a portion of probability
density function: the NPV is lower for equity. In both the distributions, however, the major values are
concentrated on the positive outcomes. The Chart 4.12 better shows the comparison between the
two NPV distributions, again highlighting the riskier nature of FCFE perspective.

Chart 4.12- OSX L&S NPV overlay distribution comparison

OSX NPV FCFF/FCFE frequency comparison

0,090

0,080

0,070

0,060
Probability

0,050 OSX FCFF NPV

0,040 OSX FCFE NPV

0,030

0,020

0,010

0,000
-98 -08 82 172 262

Source: data elaborated by the author

158
4.3.10.1 OSX L&S project Sensitivity analysis

An additional tool of Crystal Ball is the sensitivity analysis, made for each forecast variables, the NPV
FCFF/FCFE and IRR FCFF/FCFE. In the following Figure 4.9 I have selected the sensitivity analysis
output for only IRR distributions because it better highlights the leverage effect on the equity value.

Figure 4.9 – OSX FCFE/FCFF IRR sensitivity analysis

Sensitivity Chart
Target Forecast: OSX FCFE IRR

-100,0% -50,0% 0,0% 50,0% 100,0% Sensitivity Chart

Target Forecast: OSX FCFF IRR

Op.Eff. 1 -100,0% -50,0% 0,0% 50,0% 100,0%

Op.. Eff, 1
Op.Eff. 2

Op.. Eff, 2

Op Eff. 3

Op.. Eff, 3

LIBOR 1
Op.. Eff, 4

Op. Eff. 4
Op.. Eff, 5

Op. Eff. 5 Op.. Eff, 6

Op.. Eff, 7
LIBOR 2

Source: data elaborated Op.. Eff, 8

by the author
Op. Eff. 6

The main result is that the most decisive variable is the

Op..“Operating
Eff, 9 Efficiency” assumption: for the
LIBOR 3
first 6 years this variable explains the greatest percentage in the IRR variability, with a positive
Op.. Eff, 10
impact. In particular the “Op. Eff. 1” (the Operating Efficiency of the 1st year of leasing contract)
Op. Eff. 7
contribution to variance is by 19%.
The peculiarity of equity analysis is that it is the only variable to be affected by “LIBOR” variation
assumptions, especially in the first two years of repayment. The two process, in some way, are
memoryless, since they attribute more effect and weight to the most recent information.
In order to better appreciate the sensitiveness to “Operating Efficiency” variable, I repeat the MC
simulation, changing the setting for that assumption.
The maximum impact could be reached enlarging the rang of variability, from 95%/100% to
90%/100%.
The following Figure 4.10 shows the new settings for the variable.
159
 Figure 4.10 – Operating Efficiency downward correction

Source: data elaborated by the author

Since the elasticity measure is very high, I expect IRR and NPV distributions left shifted: the new
setting introduces a downside risk with relevant impact on the output variability.

The following Chart 4.13 shows the most sensitive output, OSX L&S IRR (FCFE) with the new set
parameters.

Chart 4.13 – OSX L&S IRR new setting distribution (FCFE)

Forecast: OSX FCFE IRR

400
350
300
Frequency

250
200
150
100
50
0
11% 13% 15% 17% 19%

Source: data elaborated by the author

The first important outcome is the mean value, from 20% to 17%: a reduction in 3%, that lead to an
economic profit of only 0,73% ( the spread on the cost of capital, by 16,27%).
The value has been destructed, but the shape of the IRR distribution is now Normal: the fat tails have
disappeared, and so the high variability.
In next Table 4.22 are reported the statistics for the output distributions: all the forecast distribution
seem to behave as a Normal, with Kurtosis at 3, mean centered to the median. The major dispersion
of FCFE output has been reduced: the project implies to assume less risks by the equity holders.

160
The variability is of 7% for IRR FCFF output range, 10% for the IRR FCFE distribution range.

Table 4.22 – OSX L&S main statistics on new setting

Statistics OSX FCFF NPV OSX FCFE NPV OSX FCFF IRR OSX FCFE IRR
Trials 10000 10000 10000 10000
Mean 62,3 30,1 13% 17%
Median 65,8 32,8 13% 17%
Mode --- --- --- ---
Standard Deviation 51,4 44,2 1% 1%
Variance 2638,4 1957,9 0% 0%
Skewness -0,44 -0,48 -0,40 -0,31
Kurtosis 3,58 3,71 3,49 3,38
Coeff. of Variability 0,82 1,47 0,06 0,07
Range Minimum -216,2 -217,2 9% 11%
Range Maximum 226,9 171,2 16% 21%
Range Width 443,1 388,4 7% 11%
Mean Std. Error 0,51 0,44 0,01% 0,01%

Source: data elaborated by the author

The minimum value for NPV is more relevant than the previous outputs. The final considerations are
on the “fat tail” problem: in the next Chart 4.14 and 4.15 are showed the distributions comparison.

Chart 4.14 – Overlay IRR FCFF/FCFE Chart 4.15 – Overlay NPV FCFF/FCFE
OSX IRR FCFF/FCFE frequency comparison OSX NPV FCFF/FCFE frequency comparison

0,090 0,050
0,080 0,045
0,070 0,040

0,060 0,035
Probability

Probability

0,030
0,050 OSX FCFF IRR OSX FCFF NPV
0,025
0,040 OSX FCFE IRR OSX FCFE NPV
0,020
0,030
0,015
0,020 0,010
0,010 0,005
0,000 0,000
8% 11% 14% 17% 20% -248 -148 -48 53 153

Source: data elaborated by the author Source: data elaborated by the author

The FCFE IRR and NPV distributions appear less volatile and the fat tails have disappeared.
This could means that the most negative rare events for OSX L&S project are those downside risks
linked to the post-completion phase of oil production: the core business is focused on the long-term
relationship between OGX and OSX.
The success and value creation driver of OSX is the efficiency reachable during the O&M services on
the FPSO: improving the costs managing, the technology used, avoiding work dispersion and delays,
they can eliminate the “fat tail” risk, holding high level of profitability, granting a range of variability
that exclude the extreme negative events.

In the end, I have run different setting of simulations, in order to better capture the impact on OSX
IRR and NPV distributions, moving the range of “Operative efficiency” variable ( changing the base

161
95%-100% into 90%-100%) and the Dummy on the two rare events, “IBAMA/completion”
assumption and “OGX Default” assumption.
I have collected the main statistics of each combination and compared only the “Minimum range”
with the “Width Range”: my objective, in fact, is to control for the downside effect, and its volatility,
rather than on the upside one, because it is the main variable to take in account when making a
quantitative risk analysis.
In table 4.23 are reported the results ordered in decreasing range of values.

Table 4.23 – OSX downside impact comparison

Sta tistics OSX FCFF N PV OSX FCFE N PV OSX FCFF IR R OSX FCFE IR R
Range Minimum 121,6 72,0 14% 18%
Range Width 174,4 155,0 3% 5%
Range Minimum -67,6 -91,6 11% 14%
Range Width 357,2 314,7 5% 9%
Range Minimum -157,8 -152,1 10% 12%
Range Width 415,1 353,2 6% 10%
Range Minimum -216,2 -217,2 9% 11%
Range Width 443,1 388,4 7% 11%

BASE MOD EL W IT H OU T D U MMIES

BASE MOD EL (95% / 100% + D U MMIES)
R AN GE 90% / 100% W IT H OU T D U MMIES
BASE MOD EL + R AN GE 90% / 100%

Source: data elaborated by the author

As expected, the most optimistic output is that obtained excluding the Dummy variables on rare
negative events, which add upside opportunity on the evaluation models.
The most pessimistic setting model ( with the Dummies effects and wider range for Operating
Efficiency), as previously discussed in the sensitivity analysis, lead to very low range: the obtained
minimum, and the total variability, is quite threefold those of base model.
What is interesting to note is that the highest variability among the statistics outputs is obtained
when controlling for the catastrophic events, ceteris paribus. Just eliminating the two negative
impact of pre-completion and default risks, the value range jump to the right on the x values of OSX
L&S project NPV and IRR distributions.

This result is a confirmation of how important is to make a correct risks assessment when evaluating
project investments, especially in an emerging Country.

162
 CONCLUSIONS
The quantitative risk analysis proposed in the Fourth Chapter on the case of OSX Brasil SA, has
introduced dynamic assumptions in the base evaluation models, FCFF and FCFE.
The Monte Carlo simulations has built four different distribution of probability for each defined
forecast variables of output: the respective NPV and IRR of the standard project “OSX Leasing and
Services”.
Through the Crystal Ball settings, has been possible to mimic the real context of the project, giving in
output not a single value, but a range of possible realizations with the related probability of
occurrence. The more flat is the curve, the more dispersion in values it has and, therefore, the more
risk exposure it implies.
The simulations has been run with different settings of the most sensitive variables, in order to stress
the models and appreciate how the evaluation method is valid.
The results have showed leptokurtic curves, especially in the case of FCFF values of IRR and NPV, with
the presence of “fat tail” on the left.
This particular aspect has showed the importance to introduced rare events with dramatic
consequences that are hidden in the extreme value distribution.
The mean value, however, are higher than the static evaluation results, that confirm the importance
to make a more accurate analysis of all the possible risks or opportunity to take in account when
evaluating a project.
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