The natural gas industry in Brazil had its development guided, for many years, by the business plan of a single player, which controlled practically all stages of the product value chain.
The activities predominantly performed by this player included basically all forms of introduction of natural gas into the Brazilian economy, such as the production (and mainly the processing and outflow) of offshore natural gas, the importation of natural gas from Bolivia, and the import and regasification of liquefied natural gas (LNG).
Thus, even if a given company obtained the right to produce natural gas in Brazil, it had no choice but to sell the product to the dominant player, since the input of this energy source into the Brazilian economy can only take place after its specification, and all the infrastructure for processing and treating natural gas was held by this single player.
This control also reached the natural gas transport infrastructure, such that virtually all the capacity of the transport pipelines was exclusive to this one company.
In addition to transportation, significant participation also reached most natural gas distribution companies, impacting on the capacity from the supply to the point of consumption.
Although the concentration of such activities in a single player was essential for the initial structuring of the natural gas industry in Brazil, given the need for large investments in an environment, at the time, of much uncertainty, the current reality no longer allows for this configuration. Over time, such structural control of the industry ended up having an impact on the offer of the product itself and the implementation of new investments and projects, resulting in an increase in the price of natural gas due to absence of free competition.
In view of this environment, the Gas for Growth initiative represented, in 2016, the pooling of efforts between the public power and the private sector to map out the main aspects of the natural gas industry in Brazil with a view to preparing a transitional environment in order to finally enable the entry of new players and reduce the influence of the player that had been dominant until then.
The multiplicity of issues identified within the scope of the Gas for Growth initiative led the public power, especially the part responsible for regulatory policies, to deepen its analysis of some specific fronts, understood to be strategic for the final objective of opening the natural gas market in Brazil. One of the fronts considered strategic was taxation, given the importance of thoroughly assessing the challenges faced by the industry now and in the future.
With resources from the World Bank under the META Project, the federal government, represented by the Ministry of Mines and Energy (together with the National Petroleum Agency and the Ministry of Finance, now the Ministry of Economy), hired a specific study on the "Challenges of the Brazilian tax system in the natural gas industry", which would help build a new plan for the industry in Brazil. Machado Meyer was selected in a bidding process to develop the work, which began and ended in 2018, thanks to the joint efforts of the tax and infrastructure/energy areas of the firm.
Based on all the information accumulated, the federal government launched in 2019 the New Gas Market program, which aims to make natural gas more competitive based on four main actions:
- promote competition;
- harmonize state and federal regulations in the sector;
- stimulate the integration of the gas sector with the electrical and industrial sectors; and
- remove tax barriers that prevent market opening and competition.
Based on this important milestone, Brazil entered a new phase of projects in the various stages of the natural gas industry chain. As is natural in any new phase (even more of this magnitude) and in view of the already complex Brazilian tax system, new challenges are being faced and gradually overcome.
This article aims to contribute to the debate on some of the issues that most affect the market today.
Natural gas processing: tax aspects
One of the main challenges to transform natural gas produced in Brazil into wealth concerns access to processing infrastructures, called Natural Gas Processing Units (NGPUs).
While all the NGPUs are held by a single player, which performs the activity exclusively for its own benefit, natural gas processing does not present itself as a relevant tax challenge.
However, with the entry of new players into the market, who will need to access this infrastructure to adapt the crude natural gas produced in Brazil (known in the industry as "rich gas" because it contains several other gaseous hydrocarbon streams), it is now necessary to qualify, from a legal and tax standpoint, the processing activity performed by the NGPU holder for the benefit of the natural gas owner.
The first challenge that emerges from this new activity concerns a potential conflict of jurisdiction between states and municipalities, given the possible concomitant interpretation of both entities as legitimate to charge taxes within their jurisdiction, which are the ICMS and ISS (respectively).
Although the judicial precedents point to the jurisdiction of the states to tax such activities, qualified as a kind of "industrialization to order" operation, the absence of a clear normative rule still represents some legal uncertainty for the sector.
Although the issue related to the conflict of jurisdiction between states and municipalities has been overcome (assuming the prevalence of the current judicial position on the assessment of the ICMS), the absence of state regulation regarding compliance with the principal and ancillary obligations ends up being another tax challenge to be overcome.
This is because the common ICMS legislation was conceived with reference to operations with physical, tangible goods, whose quantification takes place before (and according to) the physical movement of the goods. Natural gas, however, is a fungible product that circulates through continuous flow pipelines, and it is not possible to apply the common rules provided for in state ICMS legislation.
There are also other elements of complexity, such as the times and movements of liquid derivatives of natural gas, obtained from the processing activity. Such liquid derivatives, such as liquified gas derived from natural gas (LGNG), can be transported by other modes, which would induce compliance with the common rules for issuing tax documents, generating conflict with the special rules applicable to natural gas.
These are just some of the tax challenges of the activity of processing. Many others are still under discussion for regulations at national level.
Regasification of imported LNG: tax and customs challenges
In addition to tax challenges, the structuring of imported LNG regasification projects faces customs complexities, which are being resolved by the competent authorities on a one-off and successive manner.
Among the customs challenges faced in implementing imported LNG regasification terminals are the need for customs clearance at the terminals, which are often designed in conjunction with stationary Floating Storage Regasification Units (FSRU), and the application itself of the customs procedure of temporary admission with total suspension of taxes for these goods.
The possibility of customs clearance of such terminals and especially of the FSRUs that make them up is an example of recent improvement of customs legislation to accommodate this new reality of the natural gas industry. The legal gap, which generated legal uncertainty, was resolved with the publication of Ordinance No. 473/20, of the Federal Revenue Service of Brazil, significantly reducing doubts with respect to the legal feasibility of such projects.
Other aspects, however, still need to be better regulated, such as the temporary admission of FSRUs in the economic use mode itself with total suspension of taxes, direct discharge and customs clearance procedures, the ancillary obligations applicable for receipt, storage, and regasification of LNG (notably when there is access from third parties in the terminal or shared loads), among others.
It is worth noting that third-party access to LNG terminals is also susceptible to the same type of conflict of jurisdiction between states and municipalities faced in processing activities, and the legal interpretation is similar.
On the other hand, the times and movements of LNG in the context of import, storage, and regasification thereof are quite different from those found for processing activity. It is therefore appropriate to have specific regulations that take account of such distinctions.
Importation of natural gas and LNG: conflicts of jurisdiction
The import of natural gas from Bolivia, through the Brazil-Bolivia Gas Pipeline (Gasbol) and the import of LNG may also face tax challenges related to conflicts of jurisdiction between the states in defining what entity has standing to charge the ICMS on importation.
This controversy arises from the possible inconsistent interpretation among the states regarding the criteria legally relevant in defining in which state the "legal consignee" of the import operation is located: for example, would it be the state in which the importing establishment is formally recorded, where the goods enter the Brazilian territory (citygate of Corumbá, in the case of natural gas imported from Bolivia), where the respective customs clearance occurs or where the regasification activity occurs (in the case of LNG)?
Case law points to certain criteria, recently reinforced by the judgment on the merits of Internal Rules Appeal No. 665.134/MG, under the general repercussion framework (in a context of operations not related to the natural gas industry).
However, there are still three civil lawsuits (ACOs) pending a decision that specifically deal with the case of natural gas imported from Bolivia. Given the peculiarities (in the most various senses) of natural gas, there would be greater legal certainty after the judgment of these specific cases, in which such particularities were brought to the debate.
Natural gas transportation: tax challenges
The activity of natural gas transportation is, without a doubt, critical making the supply and demand of the product viable in Brazil, given its continental dimension and the concentration of production and processing in a few states.
Moreover, as it is a product placed into a real “grid industry", the connection between the sources of input and the points of distribution and consumption of natural gas is decisive for the optimal functioning of the sector. Other relevant aspects of this industry are the dynamism resulting from the continuous flow of natural gas and its essential nature for Brazil's own energy security, considering the importance of this input for the generation of energy by thermal power plants.
While the natural gas industry was dominated by a single player, the transport aspects of the product were not so relevant since the entire capacity of the transport pipelines was purchased by a single company and all the natural gas transported was owned by the same company.
The opening of the market to new players necessarily depends on the supply of natural gas transport capacity to third parties with the aim of enabling new trading flows with the product, thereby encouraging the competitiveness desired and price shock at the end of the chain.
Given this need and the physical characteristics of natural gas itself (which does not allow for perfect physical identification and binding of each molecule input into the transportation grid to its respective holder), a unique model was conceived in Brazil (but already adopted in other countries) for contracting for transportation capacity based on the quantities of natural gas input and withdrawn from the transport system. It is called an "entry-exit model".
According to this model, different players (sellers and buyers of natural gas, technically referred to as "shippers") can contract their own capacities to input natural gas into each carrier's transport system and remove it.
The framework of this disruptive contractual model (considering the traditional Brazilian reality) in the tax system was also a significant challenge, especially at the state level, since ICMS is also levied on inter-municipal or interstate transportation services.
The regulation of this transport model was understood as one of the priorities to give support to the other initiatives to open the market, which was done by means of Sinief Agreement No. 03/18 (especially with the changes brought about by Sinief Agreement No. 17/19).
Although the tax basis for this activity is already structured, there are still other improvements that tend to be implemented with the maturation itself of the natural gas industry in Brazil, such as the interconnection of the pipeline systems owned by the different transportation companies and the establishment of grid codes, which will also trigger new tax challenges.
Thermoelectric generation from natural gas: tax challenges
Although not a new challenge in itself, the new phase of the natural gas industry tends to intensify the tax obstacles to the activity of thermoelectric generation from natural gas. This is due to the fact that natural gas is a transitional fuel to less polluting and more environmentally friendly sources and helps preserve Brazil's energy security. It is also due to the firm demand for gas created by thermal power plants in Brazil, which makes other investments in the industry as a whole feasible.
The main tax challenge relating to thermoelectric power generation from natural gas arises from the different ICMS assessment systems for transactions involving natural gas and electric power.
This is because the ICMS tax arrangement applicable to the natural gas supply chain is the traditional one, whereby the tax must be collected from the state where the selling establishment is located. Thus, the seller collects the ICMS tax on the sale of natural gas to the state in which it is located, indicating on the tax document the amount of tax due for the respective recording of a credit by the purchaser of the product. These tax credits may be used by the purchaser to offset other ICMS debts it may ascertain in its transactions, in compliance with the non-cumulative tax principle set out in article 155, paragraph 2, subsection I, of the Federal Constitution.
The ICMS assessment system for transactions involving electric power is different, since the Federal Constitution itself establishes that the tax will not be levied on interstate transactions. The logic of the constitutional legislator in establishing such an assessment system was to assign the product of the ICMS tax collection to the states where electricity consumption occurs, since its generation tends to be concentrated in a few states, usually privileged due to natural circumstances. Consumption, on the other hand, occurs throughout the Brazilian territory. At the time when this system was conceived, the Brazilian electric grid was less diversified and massively composed of hydroelectric plants, which do not depend on inputs taxable under the ICMS.
Exit of goods exempted or not taxed under the ICMS are exceptions to the principle of non-cumulativeness, which leads to reversal of entry of tax credits related to previous transactions (except if the ordinary legislation of the specific state authorizes the maintenance of such credits).
Additionally, the company acquiring the electric power in interstate transactions (such as a state energy distributor, for example) will have to pay the ICMS tax on its transactions selling the power within the state, which are often subject to higher rates than those for products in general (in the state of Rio de Janeiro, the ICMS tax rate on electric power corresponds to 28%, while in the other operations it is 18%, for example).
Analyzing the tax levied on the supply chain of natural gas for thermoelectric generation, it is possible to identify, therefore, a significant tax challenge related to the incompatibility of the ICMS assessment arrangements, which leads to cumulative taxation and, ultimately, higher cost in the electric power generated via natural gas, thus reducing the competitiveness of these projects.
The form usually adopted by states to mitigate the effects of the incompatibility of the ICMS taxation systems for natural gas and electric power is the use of special taxation arrangements (mainly through the granting of tax deferrals) or the granting of tax benefits (such as exemptions, in which situations there are other legal and political complexities for the valid institution of such incentives).
The incompatibility of ICMS assessment arrangements on transactions involving natural gas and electricity is, therefore, the main tax challenge to be faced with respect to natural gas thermoelectric projects.
Challenges in other sectors
In addition to the issues mentioned, which have not been completely exhausted and call for further inquiry and analysis, other important segments for the natural gas industry also face relevant tax challenges, such as fertilizer plants, the "Fafens" (regarding the fertilizer tax system, mainly imported fertilizers); intensive consuming industrial segments (sectors such as glass, ceramics, etc.); the chain for the sectors vehicular natural gas (VNG) and heavy fleet LNG; and the natural gas flow activity itself, among others.
Although the challenges are many, one may note a constant evolution in the business environment of the natural gas industry, contributing attract investments and generate wealth in Brazil. In this respect, a united effort between public authorities and the private sector is fundamental in formulating public policies that give support and legal certainty to the most modern and efficient business models for the industry.