The Petrobras Fiasco

For most people, the phrase “fossil fuel subsidies” conjures up images of governments giving their hard-earned tax dollars to already highly profitable oil companies. That’s what many folks have been conditioned to think by certain activists and politicians, and quite naturally this image evokes outrage.

I have often pointed out that the vast majority of these so-called fossil fuel subsidies are really ways for governments to keep fuel prices artificially low for consumers. This is a subsidy because consumers aren’t paying the true price of the fossil fuel, and the amount of the subsidy is the difference between what consumers pay and the market price. In most cases, the primary beneficiary of the subsidy is the consumer, and the secondary beneficiary is the fossil fuel company, which gets to sell more product than it otherwise might.

In oil-producing countries, the government is typically the entity providing the subsidy. They do so by giving up revenue. For example, in Venezuela consumers can buy gasoline for pennies a gallon. The state-owned oil company, Petróleos de Venezuela S.A. sells gasoline at well below the cost to make it, and the loss of revenue to the government is the amount of the fossil fuel subsidy to the consumer.

Then there’s the Brazilian oil company Petrobras (NYSE: PBR), one of the world’s largest oil and gas companies and the largest company in Latin America. The stock is in our Growth Portfolio, and I personally have owned shares in the company since late 2008, when I bought them following the oil price crash in the second half of 2008. But the Brazilian government also owns the majority of the voting shares in the company, and that’s where things get interesting.

To combat rising inflation, Brazilian President Dilma Rousseff has restricted Petrobras from increasing its fuel prices. But because of strong demand growth in Brazil, the country is no longer self-sufficient in refining capacity. Therefore, Petrobras is actually being forced to import gasoline and sell it at 8 percent below cost. This has resulted in an estimated $8 billion loss for 2012—the company’s first loss since 1999.

Now imagine for a moment what this actually means. Petrobras itself is eating this subsidy, which is benefiting consumers. But the subsidy gets tallied onto the roles of “fossil fuel subsidies”—even though in this case it is costing an oil company money. Taxpayers, activists, and politicians see this outrageous tally of fossil fuel subsidies and get angry at the oil company, which is getting killed by this subsidy.

It boggles the mind.

The consequences have been bad for Petrobras shareholders. While shares of most major oil companies are at least slightly up for the years, Petrobras shares are down nearly 20 percent year-to-date. Reuters reported that Petrobas CEO Maria das Graças Foster has made several requests for fuel price increases, but she has been rebuffed by Brazilian Finance Minister Guido Mantega—who is also Chairman of Petrobras’ Board.

In a bit of good news for shareholders, this past week Mantega announced that fuel prices would be raised in 2012. The company also announced a $15 billion cost-cutting plan that should help the bottom line.

Longer term, Petrobras has major–and, some would say, unique–strengths in that its holdings include some of the largest and most exciting deepwater oil finds of the past two decades, in the Campos and Santos basins off Brazil’s coast. We still expect Brazil’s deepwater resources to allow Petrobras to post among the fastest production-growth rates of any major oil company over the next decade.

That said, Petrobras’ share-price troubles are unlikely to ease quickly. The company is a prime example of the risks inherent in investing in foreign stocks when an unpredictable government is heavily involved in the company’s operations. Petrobras shares are cheap relative to recent years, and it is hard to imagine that things will worsen substantially before they get better. So current investors should continue to hold their shares. But given the Brazilian government’s investor-hostile policies, we would not buy shares now. We are retaining Petrobras A in the Growth Portfolio but lowering our advice to Hold.

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