Brazil – Crisis of the refining monopoly/Opinion

06/06/2018

The replacement/resignation of the president of Petrobras was not a one-off stumble of Brazil’s oil market regulation strategy, implemented by the Temer government. In fact, if the crisis that led to the change of command at Petrobras – a crisis that is not yet over – led to abandoning the current strategy of international alignment and liberalization of the prices of oil derivatives, it could have serious consequences for Brazil’s energy security. At the root of the problem is the need to attract private investment to the refining sector and to end Petrobras’ de facto monopoly in the sector.

As we now know, controlling fuel prices during the PT era [Lula’s Workers Party] – in order to mask the rise in inflation – was accompanied by the consolidation of Petrobras’ monopoly in the refining sector. Fuel price adjustments did not follow a transparent rule and were subject to discretionary intervention by the Federal Government through the state-owned monopoly, which determined when and by how much prices should change.

The change of this policy –so disastrous for the country and especially for Petrobras – was even more pressing when the company abandoned its necessary-but-ambitious program to build new  refineries, in order to correctly prioritize the ‘pre-salt’ as the destination of its scarce resources after the crisis that hit the company in 2015. It soon became clear that both Petrobras’ significant program of disinvesting in refining (selling refineries and their associated assets) and private investments in new refineries would not happen without removing the uncertainty generated by the lack of an objective rule for defining pricing for oil derivatives.

Meanwhile, these investments in new refineries are absolutely necessary. Today Brazil does not have enough refineries to supply the national demand. In fact, conservative projections show that in a scenario of moderate economic growth, in the absence of new refining capacity, fuel imports will reach a level that may compromise the country’s energy security.

The liberalization of refined products pricing, if done transparently in a monopoly market could, in principle, follow two options: either an official price policy with a transparent and objective rule to align oil derivative pricing with the international oil market, or the practice of an immediate pass-through by Petrobras of international market prices. The difficulty of rationally discussing the criteria for a pricing rule with Petrobras, political actors and the sector lobbies led the government to choose the second option, clearly the inferior alternative. Perhaps it was believed that the credibility of the former president of Petrobras could be the guarantee of the announced strategy.

In a scenario of moderate expansion, imports will reach a level that could jeopardize energy security.

 

As such, a time bomb was set, ready to explode in a situation such as the one that occurred in April when, in less than two months, a perverse combination of rising oil prices and exchange rates led to a 26% increase in the price of diesel in reais. In short, the company clearly underestimated the problem of a monopolist’s lack of legitimacy in determining its own pricing policy.

The economic stress of transporters – a sector where freights rates were brutally compressed by the gigantic growth of the fleet as a result of abundant credit supply, followed by declining demand with the post-2014 recession – coupled with the explosive growth of diesel prices in reais has generated a veritable popular revolt against Petrobras’ pricing policy.

The government, pressured to provide quick answers, reacted in a disorganized manner, without the time needed for adequate technical assessments. The “solution” to the crisis came about through a one-off tax benefit, without any change to the pricing policy. It started from the mistaken assumption that the drop in the price of diesel would be passed on to the truck owner, when in the extremely competitive environment of the transport sector this discount tends to be passed on to freight rate, leaving the truckers in the same distressed situation. In addition, in the haste to provide quick political answers, errors in calculation were made and important characteristics of the fuel market were disregarded.

But what to do in the long run? The problem of price liberalization has to do, as argued above, with the need to attract private investment in refining, correctly abandoned as a priority by Petrobras, which is not in a position to make these massive investments on its own, without having to give up its role in the ‘pre-salt.’ And now these investments take on strategic importance regarding energy security due to the increasing dependence on imported refined products without sufficient storage capacity.

Attracting private investment requires, however, transparent fuel pricing rules that do not generate unnecessary volatility and, in particular, do not create competitive distortions between Petrobras and its competitors and, of course, do not depend on subsidies. This is a complex equation to be solved, but it can clearly be addressed with a bill that regulates, under the technical and neutral oversight of the ANP, the transfer of international prices in a predictable way, but announced at longer intervals than the recent daily transfers from Petrobras.

In this context, it was frightening that a debate that should have been technical and led by political leaders became the monopoly of the manifestation of the opinion of radicals. In an election year, where the future of Brazil will be decided by the victory or defeat of proposals that allow the return of basic rationality in the conduct of public policies and, especially, of economic policy, lost in the last years of the PT era, the silence of the major candidates at the center of the political spectrum during this crisis was surprising. Let us hope that this crisis is the trigger for a rational debate about the immense distortions created by years of populist patches, and their correction.

Edmar Bacha is a professor at the Institute of Economics at UFRJ.

Winston Fritsch is president of WF Consultores Associados Ltda, former Secretary of Economic Policy of the Ministry of Finance and former dean of the Social Sciences Center at PUC-Rio.

 

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