Petrobras Investors: You Sould Have Seen This Coming

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As an investor in a company, you have a say in how the company operates, albeit a small one. Even if you only own a couple hundred shares, those normally come with rights to vote on issues such as board members and executive pay. If you are an investor in Petrobras (NYSE: PBR  ) , though, remember this: there is one shareholder that trumps everything that you say -- the Brazilian government. This was strikingly clear when the company announced its new method for pricing gasoline and diesel, and it sent other investors toward the exit sign.

In reality, though, the announcement the company made regarding its new pricing model doesn't really change how the company operates today. Does this mean that the company is not worth your investment? Let's take a look at this new pricing mechanism and how it will affect the company down the road.

Same old song and dance
This week, Petrobras announced it had developed a new way to set the prices of gasoline and diesel in Brazil. The actual details on how this mechanism works were not disclosed, but it is based on these three core elements:

a) Ensuring that indebtedness and leverage ratios return to within the limits established in the 2013-2017 Business and Management Plan within the next 24 months, based on growth in oil production and the new diesel and gasoline prices;

b) Aligning Brazilian and international prices within a similar period; and

c) Shielding domestic consumers from the effects of international price volatility.

If that sounds confusing, that is because it is. "Aligning Brazilian and international prices" and "shielding domestic consumers" seem to contradict themselves, and they probably do not reflect the best decision for Petrobras' business. For investors in this company, here is one questions worth asking: Are these new fuzzy pricing models any different from what the company had in place already?

Source: Petrobras 3rd quarter investor presentation

For more than 2 years now, the company has taken a perpetual loss on the sale of gasoline and diesel in the country. As a company beholden to the interests of the national government, investors can pretty much assume that this will remain the status quo for Petrobras in the future.

Don't fight the inevitable, work around it
The potential for Petrobras isn't in how much it gets for the price of gasoline and diesel in the domestic market, it's in how much it can export once the offshore fields are up and running. The most realistic way Petrobras can deal with its domestic market is to mitigate its losses. It can do this by reducing the amount of petroleum products it imports for domestic production, which it has to buy at a premium from places like the U.S. and then sell at a discount in country. By meeting Brazilian demand through domestic refining and production, it can cut costs and make the losses on that side of the business more manageable.  

Unfortunately, this will take years of work and billions of dollars of investment to happen, which isn't exactly encouraging for investors. The one thing that it does have going for it is that it is making friends with some very deep-pocketed companies. Both Total (NYSE: TOT  ) and Royal Dutch Shell (NYSE: RDS-A  ) have taken 20% working interest in developing the Libra field. Based on current estimates, these two companies will fork over $40 billion over the next 30 years for this project. Also, Petrobras has signed an agreement with Sinopec (NYSE: SHI  ) to build a $20 billion refinery in Brazil. Based on the plans to build other refineries in Brazil, you can bet that a large portion of that refinery's production will be slated for export to China

What a Fool believes
Despite the persistent drag on earnings from essentially subsidizing domestic consumption, there is still some potential in Petrobras. CEO Maria de Gracas Silva Foster has done a commendable job in cutting over $2 billion from the operational budget through a company-wide efficiency program, and the company has plans to double production to 4.2 million barrels per day. Getting to that level is going to take billions of dollars of investment, and its ability to do so remains questionable. If it can, though, investors should not worry about things such as fuzzy pricing mechanisms.

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