Petrobras has huge margin to reduce price, says expert

There is no legal reason to prevent changes in Petrobras’ pricing policy, and there is enormous scope to change this policy, without breaking any restrictions or legal limits. The pricing policy based on PPI (Import Price Parity), aims to obtain maximum profits in the short term, and benefits only a restricted group of society. These are the conclusions of economist Eduardo Costa Pinto, professor at the IE-UFRJ (Institute of Economics, Federal University of Rio de Janeiro) January) and researcher of ineep (Instituto de Estudos Estratégicos de Petróleo), which is linked to the FUP (Single Federation of Oil Workers).

“The numbers show that it is possible, based on adequate managerial choices, to reduce prices, create economic value and increase investments”, says the economist, who closely follows the business strategies and results obtained by Petrobras. These conclusions are based on technical analysis of the state-owned company’s accounting information and market communications issued by the company’s board, as a way of exposing its business and operational strategies.

Eduardo Costa Pinto, professor at the UFRJ Institute of Economics

Image: Disclosure

In the following interview, Costa Pinto details how the PPI works and how it would be possible to adopt other strategies. It also shows what would happen, for example, with a linear 20% reduction in the prices of all fuels.

Is active government action possible to lower fuel prices?

Eduardo Costa Pinto: Yes, it is possible. Like any company, Petrobras can define the pricing policy for the derivatives it sells. In the case of Petrobras, the federal government is the majority shareholder and, therefore, has the power to choose the majority of the board of directors, the presidency and the board of directors of the company, which is responsible for the elaboration and execution of the pricing policy.

But can the board change the pricing policy as it wants or does it need authorization, for example, from the National Congress?

Petrobras’ pricing policy does not depend on anything other than the decision of its management, taking into account that this policy must protect competitive, market prices.

There is, however, no law, rule or any legal provision that defines exactly what these “competitive” or “market” prices are. However, regulatory or competition defense agencies may file a lawsuit against a certain pricing policy, which may eventually harm competition, constitute dumping, etc.

But the choice and decision rests with the company’s board of directors and, if it is not proven that the policy harms competition, it may be adopted.

And how about the minority shareholder?

The following question arises here: does the management of this pricing policy and the profits obtained interfere in the generation of added value for the minority shareholder? It is necessary to preserve this value, and the question is to define the limits of this restriction.

Article 238 of the Corporate Law (Lei das Sociedades Anônimas) says that the controller of a mixed capital company, despite having duties towards minority shareholders, may “guide the interests of the company in order to meet the public interest that justified its creation “.

If Petrobras changes its pricing policy, no longer following the PPI and adopting, for example, another one that takes into account internal production costs plus a margin, it is clear that there will no longer be profit maximization. Petrobras can make a profit, but it won’t be the maximum profit. So, the minority shareholder can claim that it is a reckless management, which leads him to lose money with the company, hurting his interests.

Won’t the minority shareholder always feel harmed if the adopted pricing policy doesn’t produce maximum profits?

If the rate of profit falls to a level below the minority shareholder’s opportunity cost, I imagine that, legally, this opens up a bigger gap for contestation.

But if the pricing policy, even not maximizing profits, generates added value for the shareholder, that is, the rate of return on their investment exceeds the opportunity cost of the application, it will be much more difficult to contest this policy.

How was it in the case of PPI?

The PPI was a decision taken by Petrobras’ board, in a decision taken at the beginning of the Temer government, in October 2016. It was simply communicated to the public by the company’s executive board. As this was a profit maximization policy, there was no objection by minority shareholders. But, as can be seen now, the social function of the controlling shareholder, the federal government, provided for in article 238, was disregarded.

Which would then be the lowest price that could be charged on fuels, meeting all these requirements?

I did an exercise where the prices of all derivatives could be reduced by 20% in a linear fashion. In 2021, when Petrobras made a profit of BRL 106.6 billion, this 20% cut would reduce profit to BRL 46.8 billion.

Would it be a drop of almost 60% in profit?

Yes, because I am considering that Petrobras would be responsible for the total import of derivatives. I am adding the cost to Petrobras of being responsible for all fuel imports. I am assuming that this price reduction at the refinery would drive private importers out of the market. This would imply a cost increase for Petrobras of almost R$ 30 billion, in addition to the loss of revenue with the price reduction.

Isn’t that a very big reduction in profit?

With this lower level of profit, it would be possible to increase Petrobras’ investments by 25% and distribute 25% of the profit to shareholders. The net margin would fall from 23.7% to 11.8%, still well above the average net margin obtained by the big oil companies, except Saudi Aramco, of 8.2%.

Minority shareholders could not claim a loss in the value of their investment, as the gain would still exceed the opportunity cost of the investment, that is, it would continue to generate shareholder value.

If Petrobras would have to become the only importer, therefore, the information that if Petrobras lowers prices there is a risk of supply is real.

It is real as long as Petrobras does not assume the total imports. But Petrobras has all the capacity to meet this need. The company has the infrastructure, storage capacity, everything that would be necessary to guarantee this operation.

Of course this would reduce the profit margin. Speaking of which, it is good to know that Petrobras, in recent years, has reduced its physical fuel stocks. As the policy is profit maximization, it is consistent to reduce inventories to cut costs. It is a policy that obviously increases the risk of shortages.

Is there data on this reduction in inventories?

Petrobras does not disclose physical inventory data. But stocks are known in terms of their monetary values. In the first quarter of 2022, for example, derivatives prices rose far above the value of inventories, meaning that inventories fell.

Why is this happening?

The explanation is that Petrobras produced and imported at a lower price than it was able to sell. In a profit-maximizing strategy, it makes sense to reduce inventories and earn higher margins by selling at the now peak price what you buy and produce cheaper.

Petrobras’ total cost of producing oil—extraction cost, depreciation and amortization, royalties, etc. — in the first quarter of 2022, it was $41 per barrel.

Taking into account all costs, including refining, the cost of domestically produced derivatives is no more than US$ 53 per barrel. The total cost of oil products produced and imported by Petrobras is US$ 56 per barrel.

On average, in the first quarter of 2022, fuels were sold by Petrobras at refineries at US$ 102 a barrel. This gives an operating margin of 48%.

What is the average margin obtained by other international oil companies?

This margin of 48% is second only to that of Saudi Aramco, the world leader in Saudi Arabia, which is 53%. The others, on average, operate with an operating margin of at most half of what Petrobras achieves.

Can we conclude, then, that there is room to review Petrobras’ pricing policy?

The room for manoeuvre is enormous. Even more considering that Brazil is now a producer and exporter of oil, and high prices in the international market generate income in the Brazilian territory. The problem is how that income is being used. The earnings are going to a restricted group.

The numbers show that it is possible, based on adequate management choices, to reduce prices, create economic value and increase investments.