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Brazilian government gearing towards fuel subsidies revision

Hydrocarbon Engineering,


According to Business Monitor International (BMI), Brazil’s fuel subsidies, paid for by the national oil company Petrobras, have proved unsustainable, driving up the company’s heavy debt burden. In addition, heightened rates of domestic consumption as a result of the lower prices have outpaced refining capacity for many years, resulting in heavy import dependence. Planned subsidy reform will help rebalance this deficit.

The current environment of lower crude oil and fuel prices could support a smoother transition from artificially capped prices to more market based pricing. BMI also notes that there will be a reduction in demand as transition takes place. Business Monitor reflects this expectation with a downgrade to its refined product consumption forecast from 2% average yearly growth, over the next decade.

BMI holds that Brazil will follow in the footsteps of its BRIC counterpart India, whose new government announced a reduction in subsidies for diesel and an increase in the wellhead price of natural gas. A strong mandate by both of Brazil’s presidential candidates reinforces expectations that this will take place within 2015 as one of the first order of business.

The subsidy burden

With nearly US$ 40 billion in associated costs paid by Petrobras since taking over subsidy payments in 2011, this policy has had detrimental effects on the company’s debt position, inhibiting their ability to reach production targets and undermining government tax revenues. As a result of continued pricing controls and limited downstream capacity, the NOC has been forced to purchase costly fuel imports to supplement rising domestic demand, resulting in a highly unprofitable downstream sector, which reported a loss of US$ 5.8 billion in H1 2014.

According to Petrobras, the company faced a 5.0% year on year increase in gasoline imports in the first half of 2014, increasing the total cost of imports by 15% year on year. The company experienced a 9.0% decline in gross profit over the same period, aggravating its US$ 139.6 billion debt burden.

While the government has taken steps to increase prices in recent years, raising gasoline by 4.0% and diesel by 8.0% in December 2013, this provided only short term relief. With domestic gasoline and diesel fuels sold at a 20% and a 10% discount to international prices, respectively, the politically sensitive subsidies have created a challenging environment in which to align international and domestic prices, particularly in the midst of a tightly contest presidential election.

Policy reform

BMI reports that the reduction and potential removal of fuel price subsidies will have significant implications on Petrobras’ operating cash flow position, freeing up valuable funds and enabling greater emphasis on exploration and production initiatives. Through Petrobras’ US$ 220 billion 2014 – 2018 spending plant, the company is hoping to expand operations across multiple sectors, compelling the government to implement reforms to free up much needed funds for investment.

Increased fuel prices will also positively impact Petrobras’ weakened downstream sector. As the sole refiner in the country, Petrobras’ insufficient capacity, coupled with rising domestic consumption, has been detrimental to the company’s balance sheet. Brazil’s fuel shortfall will be decreased through pricing reform, tempering high rates of fuel consumption, and by increased refining capacity, with the start up of the 230 000 bpd Abreu e lima facility in November 2014.

After nearly 35 years of fuel pricing controls, the new administration will certainly face opposition to carry out these reforms, given elevated inflation and macroeconomic weakness, BMI highlights. The reversal of these subsidies, however, represents a vital measure through which the NOC may tap into its full productive capacity.

The effects of global fuel price volatility

Falling international fuel prices will fail to address Petrobras’ mounting debt burden, as persistent currency depreciation and rising demand will keep import costs high. According to BMI’s Country Risk Latin America analysts, the Brazilian real will experience continued depreciation throughout the course of BMI’s forecast period as a period of fiscal consolidation begins next year.

While price declines will reduce Brazil’s incentive to decrease subsidies, continued currency depreciation over the next several years will counteract this benefit, resulting in a steady increase in total costs per imported barrel in the absence of reform.

Risk to outlook

BMI have quantified expectations of fuel subsidy reforms under the new administration by reducing their forecast for motor gasoline consumption. 


Adapted from a report by Emma McAleavey.

Read the article online at: https://www.hydrocarbonengineering.com/petrochemicals/03112014/brazil-fuel-subsidies-regime-revision-expected-1557/


 

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