Friday, December 6, 2013

Brazil's Petrobras may end costly fuel subsidy

Brazil's state-run oil company Petroleo Brasileiro SA (PBR, PETR3.BR, PETR4.BR) is expected to decide Friday whether to end an unofficial fuel subsidy that has cost it billions of dollars in lost revenue and raised questions about the company's ability to complete its huge investment plan.

Petrobras, as the company is known, sells gasoline and diesel prices to Brazilian consumers and industry at prices that are below those in global oil markets as part of government efforts to tamp down on inflation. Soaring consumption means Petrobras's refineries can't keep up with demand, and the company has to import expensive fuel from abroad. The losses have raised doubts about the company's capacity to complete the $237 billion spending program planned for the next five years.

Credit Suisse, a Swiss investment bank, calculates that publicly listed Petrobras would have made an extra $12 billion in revenue over the last two years if prices had been adjusted every three months in line with global markets.

The government, which owns a majority of Petrobras's common shares, argues that allowing fuel prices to rise or fall in line with international oil prices could add volatility to the Brazilian economy, and could also pressure inflation, which has been running at around 6% a year for the last four years. The central bank began raising its key interest rate in April to try to bring inflation down to its target of 4.5%, but has had to go much higher than had been initially expected. The monetary authority raised the rate to 10% on Wednesday and signaled more rates are likely in coming months.

"I've said this isn't something that can be improvised, it has to be done very carefully, so you have a methodology that isn't inflationary and doesn't index the economy" Guido Mantega, the country's finance minister and chairman of the Petrobras board of directors, told reporters this week.

The choice requires a careful political consideration by President Dilma Rousseff and her administration. Petrobras's huge spending is an important driver of the economy, and the revenue that could flow from its oil fields could have a profound impact on the economy for years to come. But in the short term, Brazilian voters might reject any surge in prices, just as the president prepares for a re-election bid next year.

Ms. Rousseff holds a comfortable lead in polls ahead of the presidential election scheduled for October 2014. Yet political watchers say the opposition hasn't yet started campaigning in earnest. A slowing economy and rising inflation would provide an opportunity that her opponents would welcome. The political environment is fragile following nationwide street protests that erupted in June, and that have continued sporadically ever since.

At the moment, there is no clear mechanism for Petrobras to adjust fuel prices. Increases come at random intervals without any apparent trigger. That lack of predictability is one of the biggest gripes among investors in the company's shares. When the Petrobras management team proposed the introduction of a more transparent method for raising prices in late October, investors sent the company's voting stock soaring nearly 10% on the Sao Paulo stock exchange.

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"The way it is today, the government is carrying out public policy with a company that's trading on the stock exchange," said Mauricio Canedo Pinheiro, a professor of applied economics at the Brazilian Institute of Economy, part of the Fundacao Getulio Vargas business school. He argues that if the government wants to subsidize fuel prices at all, it should come directly out of the government budget.

The Petrobras proposal would allow automatic adjustments for diesel and gasoline at regular intervals. Prices would be adjusted based on changes in international oil prices, exchange rates and whether the gasoline and diesel were produced at home or imported. It is unclear whether this will be adopted outright.

Analysts have suggested the government may choose to delay a decision and simply award a one-off price increase. It might also provide some greater transparency, but still find a way to allow the government the ultimate decision.

Government officials have been keen to play down any suggestion that there is a rift between the Petrobras's chief executive, Maria das Gracas Foster, and Mr. Mantega over the pricing proposal. Both were appointed by the president, and are considered two of her closest allies in a cabinet.

Petrobras, the finance minister and the president's office declined to comment for this article.

Ms. Foster has previously defended the strong role the government plays within the firm's board of directors. But she has also made clear she must defend the firm's interests. "It's up to me as the president of the company to take [to the board of directors] the numbers that represent the health of the company," Ms. Foster said in an interview earlier this year.

The firm has had four diesel and two gasoline price increases in the last 16 months, totaling 21.9% and 14.9%, respectively. But the sharp depreciation of the Brazilian currency against the U.S. dollar worsened the price differential in the third quarter of the year.

Petrobras's board had been expected to make a decision Nov. 22, but that was delayed a week. The board is now due to meet Friday.

"Petrobras is in a pickle. It needs all this money to develop resources but it's not allowed to raise fuel prices beyond what the government allows," said Karen Hooper, director of analysis for Latin America at Stratfor, a risk-analysis firm.

-Paulo Trevisani contributed to this article.

Write to Matthew Cowley at matthew.cowley@wsj.com

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