India/Brazil: A tale of two subsidies

FT Lex, October 20, 2014

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“The value of Petrobras . . . is a growing value. Everyone who has invested in Petrobras will make lots of money.”

President Dilma Rousseff of Brazil was in rousing form when defending the country’s state-owned oil company in an election debate on Sunday. She once chaired its board. But the good news was slightly marred by Ms Rousseff’s admission that some may have made their Petrobras money by siphoning it off the company directly.

And if this did not make Petrobras’ minority shareholders feel glum about destruction of value, they could also have looked at India this weekend for a contrast. At the stroke of midnight Delhi time on Saturday, the market took over setting diesel prices after the government ended subsidies. These were a burden on the state and made profits less predictable at refiners (many themselves state-owned).

Petrobras’ R$225bn (or $102bn) market value dwarfs any of these companies – even India's state owned ONGC, which like Petrobras is both a producer and a refiner. But the Brazilian government requires Petrobras to apply its own fuel subsidies. Prices are kept under control to stop inflation rising further. Between 2011 – a year after a $70bn equity offering to foreign investors – and 2013, Petrobras’ net income was R$78bn overall. But its refining division, partly because of the subsidies, posted net losses of R$51bn. And this year the Brazilian real’s weakening against the US dollar may make importing fuel dearer.

The Indian government has been canny. It picked the fall in oil prices to deregulate. The first breath of market forces was thus a Rs3.4 price cut per litre. The drop in crude prices is the equivalent of Rs5, HSBC thinks, so refiners could either pass more on to consumers or increase margins. Such opportunities do not often present themselves. The case for reforming Petrobras’ pricing must get through an election first. It trades 8 times forecast 2015 earnings. To quote Ms Rousseff, there is muito dinheiro(a lot of money) at stake.