Petrobras (PBR)

(e) Natural Gas Derivative Contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or “GSA”) to supply thermoelectric plants and for other uses in Brazil, the Company entered into a Natural Gas Price Volatility Reduction Contract (the “PVRC”), which was treated with the company Empresa Petrolera ANDINA, a gas producer in Bolivia, that was treated as a derivative financial instrument under SFAS 133. This contract, was executed with the purpose of reducing the effects of price volatility under the GSA.

The terms of the PVRC provided for a price collar for the period from 2005 to 2019.

Due to the new Hydrocarbons Law of Bolivia (see Note 9(a)), the other party to the PVRC contested the contract alleging among others, “force majeure” and excessive onus. Consequently, on August 12, 2006, the parties agreed to cancel the PVRC.

As a result in 2006 the Company recognized a loss of US$499 by writing of the fair value of assets and liabilities related to this contract.

e) Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with the company Empresa Petrolera ANDINA, a gas producer in Bolivia, that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose of reducing the effects of price volatility under the GSA.

The terms of the PVRC provided for a price collar for the period from 2005 to 2019, with the Company receiving cash payments when the calculated price is above the established ceiling, and the Company making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

Due to the new Hydrocarbons Law of Bolivia (see Note 15), the other party to the PVRC contested the contract, alleging among others, “force majeure” and excessive onus. Consequently, the Company adjusted the fair value asset and liabilities related to the PVRC by recording a financial expense of US$328 during the first quarter of 2006 as a result of the tax increases in Bolivia.

On August 12, 2006, the parties agreed to cancel the PVRC. As a result, on August 14, 2006 the Company received US$41, wrote-off accounts receivable related to the PVRC amounting to US$77, and wrote-off the remaining fair value asset of US$94 as a consequence of the cancellation of contract.

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e) Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with the company Empresa Petrolera ANDINA, a gas producer in Bolivia, that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose of reducing the effects of price volatility under the GSA.

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3. Derivative Instruments, Hedging and Risk Management Activities (Continued)

e) Natural gas derivative contract (Continued)

The terms of the PVRC provided for a price collar for the period from 2005 to 2019, with the Company receiving cash payments when the calculated price is above the established ceiling, and the Company making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

Due to the new Hydrocarbons Law of Bolivia (see Note 15), the other party to the PVRC contested the contract, alleging among others, “force majeure” and excessive onus. Consequently, the Company adjusted the fair value asset and liabilities related to the PVRC by recording a financial expense of US$328 during the first quarter of 2006 as a result of the tax increases in Bolivia.

On August 12, 2006, the parties agreed to cancel the PVRC. As a result, on August 14, 2006 the Company received US$41, wrote-off accounts receivable related to the PVRC amounting to US$77, and wrote-off the remaining fair value asset of US$94 as a consequence of the cancellation of contract.

21. Natural Gas Derivative Contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with the company Empresa Petrolera ANDINA, a gas producer in Bolivia, that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose of reducing the effects of price volatility under the GSA.

The terms of the PVRC provided for a price collar for the period from 2005 to 2019, with the Company receiving cash payments when the calculated price is above the established ceiling, and the Company making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

As of December 31, 2005, the Company recorded an asset based on the fair value of the derivative in the amount of US$547 and a liability of US$144, which was deemed a deferred purchase incentive.

Due to the new Hydrocarbons Law of Bolivia (see Note 9(b)), the other party to the PVRC contested the contract, alleging among others, “force majeure” and excessive onus. On August 12, 2006, the parties agreed to cancel the PVRC. As a result, on August 14, 2006 the Company received US$41 and wrote-off accounts receivable related to the PVRC amounting to US$77.

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21. Natural Gas Derivative Contract (Continued)

The Company adjusted the fair value asset and liabilities related to the PVRC by recording a financial expense of US$328 during the first quarter of 2006 as a result of the tax increases in Bolivia. In the second quarter of 2006, the Company wrote-off the remaining fair value asset of US$94 as a consequence of the cancellation of contract.

d) Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with Empresa Petrolera ANDINA, a gas producer in Bolivia, that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose of reducing the effects of price volatility under the GSA.

The terms of the PVRC include a collar for the period from 2005 to 2019, with the Company receiving cash payments when the calculated price is above the established ceiling, and the Company making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

As of December 31, 2005, the Company recorded a derivative asset based on the fair value calculation amounting to US$547 and a liability of US$144, which is deemed a deferred purchase incentive.

Due to the new Hydrocarbons Law of Bolivia (See Note 15), the other party involved in the PVRC contested the contract, alleging among other, “force majeure” and excessive onus. On August 12, 2006, the parties agreed to cancel the PVRC. As a result, on August 14, 2006 the Company received US$41 and wrote-off accounts receivable related to the PVRC amounting to US$77.

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d) Natural gas derivative contract (Continued)

The Company adjusted the fair value asset and liabilities related to the PVRC by recording a financial expense of US$328 during the first quarter of 2006 as a result of the tax increases in Bolivia. In the second quarter of 2006, the Company wrote-off the remaining fair value asset of US$94 as a consequence of the contract cancellation.

(e) Natural Gas Derivative Contract

A hedge contract for the pricing of the natural gas (Natural Gas Price Volatility Reduction Contract - PVRC) was entered into in October 2002, with the objective to reduce the risk between the acquisition price and the sales price in Brazil.

The hedge transaction was negotiated with one of the producers that supply natural gas to PETROBRAS and has the same contractual period of the natural gas supply.

Following the regulatory changes in Bolivia, the parties began to interpret the application of this Contract differently. PETROBRAS has been evaluating the possible economic and legal effects of these changes applicable to CRVP.

Following negotiations, the parties decided to close CRVP, with PETROBRAS being entitled to R$ 89.9 million (USD 41.3 million), settled in August 2006. The remaining credits linked to CRVP, to the amount of R$ 167.0 million (USD 76.7 million) were recognized as a loss in the income statement for the third quarter of this financial year.

c) Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with a gas producer that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose of reducing the effects of price volatility under the GSA.

The terms of the PVRC include a collar for the period from 2005 to 2019, with the Company receiving cash payments when the calculated price is above the established ceiling, and the Company making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

As of December 31, 2005, the Company recorded a derivative asset based on the fair value calculation amounting to US$547 and a liability of US$144, which is deemed a deferred purchase incentive.

Due to the new Hydrocarbons Law of Bolivia (See Note 15), the other party involved in the PVRC contested the contract, alleging among other, “force majeure” and excessive onus. On August 12, 2006, the parties agreed to cancel the PVRC. As a result, on August 14, 2006 the Company received US$41 and wrote-off accounts receivable related to the PVRC amounting to US$77.

The Company adjusted the fair value asset and liabilities related to the PVRC by recording a financial expense of US$328 during the first quarter of 2006 as a result of the tax increases in Bolivia. In the second quarter of 2006, the Company wrote-off the remaining fair value asset of US$94 as a consequence of the contract cancellation.

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3. Derivative Instruments, Hedging and Risk Management Activities (Continued)

(e) Natural Gas Derivative Contract

A hedge contract for the pricing of the natural gas (Natural Gas Price Volatility Reduction Contract - PVRC) was entered into in October 2002, with the objective to reduce the risk between the acquisition price and the sales price in Brazil.

The hedge transaction was negotiated with one of the producers that supply natural gas to PETROBRAS and has the same contractual period of the natural gas supply.

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Considering that there is no market quotation for natural gas to cover such a long-term contract as the PVRC, the fair value of this derivative has been calculated based on a simulation that used the reserve model developed by the Company. In addition, taking into consideration the complexity for defining the parameters used in the stochastic model and to adjust the value estimated resulting from the model, we adopt the policy of applying to such result the average difference of results from applicable sensitivity analyses.

The other party involved in the PVRC is contesting, unilaterally, the continuation of the contract, alleging, among other, major force and the excessive onus due to regulatory changes.

Since Supreme Decree 27.801 was introduced by the Bolivian government on May 1, 2006, PETROBRAS has been evaluating the regulatory changes and their possible economic and legal effects on oil and gas companies operating in Bolivia, in addition to any related impact on CRVP.

The current scenario of regulatory change in Bolivia and the controversies concerning the possible economic and legal effects in this contract due not allow the fair value of CVRP to be reasonably estimated as of June 30, 2006. As of March 31, 2006 the fair value was estimated at R$ 439 million, equivalent to US$ 202 million.

c) Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, with a gas producer that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), was executed with the purpose to reduce the effects of price volatility under the GSA.

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c) Natural gas derivative contract (Continued)

The terms of the PVRC include a collar for the period from 2005 to 2019, with PETROBRAS receiving cash payments when the calculated price is above the established ceiling, and PETROBRAS making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

As of March 31, 2006 and December 31, 2005, the Company recorded a liability in the amount of US$141 and US$144, respectively, which is deemed a deferred purchase incentive, which is being amortized into cost of sales on the basis of the volumes anticipated under the PVRC.

As of March 31, 2006 and December 31, 2005, the Company recorded a derivative asset based on the fair value calculation in the amount of US$202 and US$547, respectively. The reduction from December 31, 2005 is related to the effect, predicted under the PVRC, of recent tax increases in Bolivia due to changes in the regulatory framework for oil and gas activities in that country. See Note 14.

Those new regulations are also causing the other party involved in the PVRC to contest the contract, alleging, among others, major force and the excessive onus.

Based on that, PETROBRAS is currently evaluating how the implementation of such regulatory changes evolves, as well as their effect on the economic and legal environment for oil and gas companies operating in Bolivia, and any correlated impact on the PVRC.

(e) Natural Gas Derivative Contract

A hedge contract for the pricing of the natural gas (Natural Gas Price Volatility Reduction Contract - PVRC) was entered into in October 2002, with the objective to reduce the risk between the acquisition price and the sales price in Brazil.

The hedge transaction was negotiating with one of the producers that supply natural gas to PETROBRAS and has the same contractual period of the natural gas supply.

Considering that there is no market quotation for natural gas to cover such a long-term contract as the PVRC, the fair value of this derivative has been calculated based on a simulation that used the reserve model developed by the Company. In addition, taking into consideration the complexity for defining the parameters used in the stochastic model and to adjust the value estimated resulting from the model, we adopt the policy of applying to such result the average difference of results from applicable sensitivity analyses.

The other party involved in the PVRC is contesting, unilaterally, the contract clauses, alleging, among others, major force and the excessive onus due to regulatory changes.

PETROBRAS, based on a legal opinion, reinforced by constitutional principles, on which one contract is not suspensed in a unilaterally way, maintain the firm commitment to save its credits rights as per the PVRC. Consequently, the contract is still in place.

As of March 31, 2006, the estimate fair value of the PVRC amounts to R$ 439.000 thousand equivalent to US$ 202 million (R$ 1.280.000 thousand, equivalent to US$ 547 million at December 31, 2005). The reduction from December 31, 2005 is related to the recent increases in taxes.

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23. Natural gas derivative contract

In connection with the long-term contract to buy gas (“The Gas Supply Agreement” or "GSA") to supply thermoelectric plants and for other uses in Brazil, the Company entered into a contract, effective October 2002, with a gas producer that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (the "PVRC"), with maturity in 2019, was executed with the purpose to reduce the volatility of price under the GSA. The counterparty to the PVRC is one of the gas producers that sell to the supplier under the GSA contract. Therefore, the PVRC refers to the same volumes of natural gas sold by the counterparty to the supplier under the GSA, and uses the same pricing index as the GSA contract and thus works as an economic hedge. The volume covered by the PVRC represents approximately 43% of the anticipated volume under the GSA.

The terms of the PVRC include a straight fixed for floating price swap for the period between inception and 2004, and for the period from 2005 to 2019, a collar with PETROBRAS receiving cash payments when the calculated price is over the established ceiling and PETROBRAS making cash payments when the price is below the established floor, with no cash payments being made when the price is between the ceiling and the floor.

The PVRC is being accounted for under SFAS 133 as a derivative instrument, since the Company did not satisfy the documentation required for hedge accounting, and is being marked to its calculated fair value with changes in such value recognized in income. At inception, the PVRC had a positive value to PETROBRAS of US$ 169, which is deemed a deferred purchase incentive and is being amortized into income on the basis of the volumes anticipated under the PVRC. The liability was US$ 144 at December 31, 2005 (US$ 153 in 2004) and generated a gain in the amount of US$ 6 (US$ 11 in 2004), net of deferred tax effect of US$ 3 (US$5 in 2004).

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23. Natural gas derivative contract (Continued)

As of December 31, 2005, the Company recorded a derivative asset based on the fair value calculation in the amount of US$ 547 (US$ 635 in 2004), and a mark-to-market (or “MTM”) loss in the amount of US$ 58, net of deferred tax effect of US$29 (a gain in the amount of US$ 365, net of deferred tax effect of US$ 188 in 2004). Such MTM losses represent the decreased value of the derivative during the year ended December 31, 2005. The MTM gains recorded in 2004 represent the increased value of the derivative from inception to December 31, 2004. The derivative gains (losses) are recorded as a component of financial income. The effects of the PVRC were not recognized from inception but the impact was immaterial and has been cumulatively recognized in 2004.

Considering that there are no market quotations for natural gas for such a long duration as that of the PVRC, the fair value was calculated based on simulation using a mean reversion model developed by PETROBRAS. The most significant model assumptions at December 31, 2005 and 2004 include starting prices of crude oil of US$ 56.91 and US$ 39.53, respectively, per barrel, an average fuel oil basket (i.e., the price index of the GSA) of US$ 42.50 and US$ 23.58, respectively, per barrel and a volatility of crude oil of 23% a.a. (25% a.a. in 2004). Other parameters of the model, including the long run average of crude oil, fuel oil spread to crude, correlations and inflation indexes were estimated based on historical averages.

A US$ 1 (one United States dollar) per barrel increase in the market price of crude under the PVRC would result in a US$ 12 increase in the fair value of the derivative at December 31, 2005 (US$ 24 increase at December 31, 2004).

As indicated above, the accounting impacts recognized are in accordance with SFAS 133, whereas the economic impact and cash flow results of the transaction are to fix the price paid for natural gas imports within a range and to receive or pay cash for price fluctuations under the GSA beyond those capped amounts. Such ceiling and floor amounts in the PVRC allow the purchase of natural gas at a price level appropriate to PETROBRAS, which then sells the gas in local market to distributors at a price level that will allow the sustained development of the natural gas market in Brazil.

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(e) Natural Gas Derivative Contract

A hedge contract for imported natural gas (Natural Gas Price Volatility Reduction Contract - PVRC) was entered into in October 2002, with a view to reducing the risk of local and import price volatility. The hedge operation was negotiated with one of the producers of natural gas supplied to Petrobras and has the same maturity term as the Gas Supply Agreement.

Considering that there is no market quotation for natural gas to cover such a long-term contract as the CRVPGN, the fair value of this derivative instrument has been calculated based on a simulation that used the reserve model developed by the Company. In addition, taking into consideration the complexity for defining the parameters used in the stochastic model and to adjust the value estimated resulting from the model, we adopt the policy of applying to such result the average difference of results from applicable sensitivity analyses.

As of June 30, 2005 the fair value of CRVP reached approximately R$ 1.115.000 thousands.

Any gains that may be realized by the difference between prices established in the two contracts related to the quantities effectively transported will be reflected in the Company’s price policy, applied to the distribution of gas, with a view to sustained development of the natural gas market in Brazil.

Natural gas derivative contract

In connection with a long-term contract to buy gas (Gas Supply Agreement or “ the GSA”) to supply thermoelectric plants and for other uses in Brazil, we entered into a contract, effective October 2002, with a gas producer that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (or PVRC), matures in 2019 and was executed with the purpose to reduce the volatility of price respective to the GSA.

At inception, the PVRC had a positive value to us of U.S.$169 million, which is deemed a deferred purchase incentive and is being amortized into income on the basis of the volumes anticipated under the PVRC. The liability was U.S.$153 million at December 31, 2004 and generated a gain in the amount of U.S.$11 million, net of deferred tax effect of U.S.$5 million.

The PVRC is being accounted for under SFAS 133 as a derivative instrument, since the Company did not satisfy the documentation required for hedge accounting, and is being marked to its calculated fair value with changes in such value recognized in income. As of December 31, 2004, we recorded a derivative asset based on the fair value calculation in the amount of U.S.$635 million, and a mark-to-market gain in the amount of U.S.$365 million, net of deferred tax effect of US$188 million.

See Note 23 to our audited consolidated financial statements for the year ended December 31, 2004.

Natural gas derivative contract

In connection with a long-term contract to buy gas (Gas Supply Agreement or “ the GSA”) to supply thermoelectric plants and for other uses in Brazil, we entered into a contract, effective October 2002, with a gas producer that constituted a derivative financial instrument under SFAS 133. This contract, the Natural Gas Price Volatility Reduction Contract (or PVRC), matures in 2019 and was executed with the purpose to reduce the volatility of price respective to the GSA.

At inception, the PVRC had a positive value to us of U.S.$ 169 million, which is deemed a deferred purchase incentive and is being amortized into income on the basis of the volumes anticipated under the PVRC. The liability was U.S.$ 153 million at December 31, 2004 and generated a gain in the amount of U.S.$ 11 million, net of deferred tax effect of U.S.$ 5 million.

The PVRC is being accounted for under SFAS 133 as a derivative instrument, since the Company did not satisfy the documentation required for hedge accounting, and is being marked to its calculated fair value with changes in such value recognized in income. As of December 31, 2004, we recorded a derivative asset based on the fair value calculation in the amount of U.S.$ 635 million, and a mark-to-market gain in the amount of U.S.$ 365 million, net of deferred tax effect of US$188 million.

See Note 23 to our audited consolidated financial statements for the year ended December 31, 2004.

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