Will Higher Domestic Prices Squeeze Petrobras' Profits?

Brazil just announced higher inflation levels, pushing Petrobras to deal with a tougher financial scenario.

Apr 16, 2014 at 5:04PM

Brazilian oil giant Petroleo Brasileiro, better known as Petrobras (NYSE:PBR), is facing a new domestic challenge. Local consumer inflation accelerated last month to its fastest monthly pace since 2003, beating all forecasts. According to the local statistics agency, IBGE, the country's consumer price index increased 0.92% compared with a 0.69% rise in February. As a consequence, the annualized inflation figure rose to 6.15%, the highest level since July and way above the annualized February figure of 5.68%. This is not good.

The financial impact
Unfortunately, this new data made analysts take a closer look and review the year-end inflation figure, revising it upward. The Central Bank of Brazil's latest weekly economist survey raised the outlook for 2014 annual inflation to 6.35% from 6.3% in the previous week.

Petrobras could suffer from this worsening climate, as the rising inflation figures could push the central bank to continue raising interest rates. The company still needs to cover its financial needs for the year, and part of this financing is done locally through so-called "infrastructure notes."These are basically debt notes issued domestically in local currency. In fact, the company announced that it is considering selling $1.35 billion of these instruments.

Petrobras has raised $25 billion this year, and that is not enough, given its investment requirements and a series of setbacks that have so far characterized this year. For example, a contractor recently dropped a 2.3-kilometer steel pipe 5,900 feet down into the Atlantic Ocean, costing $2 million for the pipe alone. If you add in the delays in Petrobras' offshore developments, this fumble gets quite expensive. Petrobras will probably approach the local markets and issue euro- and British pound-denominated global bonds as well. Last month the company completed an offering of $8.5 billion global notes denominated in dollars.

Brazil's monetary authority has performed nine consecutive increases in its interest rate, the Selic, since May 2013. It now sits at 11% compared to a record low of 7.25% in April 2013. This diminishes Petrobras' ability to finance itself at low financial cost domestically.

Are domestic gasoline prices an issue?
Petrobras' prices for diesel and gasoline have increased 8% and 4%, respectively, since Nov. 30, 2013. This is part of a new pricing policy mechanism for oil products that the government put in place, establishing price bands -- a price-controlling method that establishes a price floor and cap -- and two price increases per year of 4% to 8% each.

The main problem is that the company will not disclose any details about when and by how much it will raise domestic fuel prices, which are currently below international prices.

This is not good news for investors, as a big component of profitability is, of course, retail prices. It's especially important considering that Petrobras' production has been stagnant since 2011. Total domestic and international oil and natural gas production in 2013 averaged 2,539 mbbl/day, dropping slightly from 2,598 mbbl/day in 2012. Production for this year will probably remain near these figures, given that no major changes in capacity have been made so far. Now, given growing inflation in a presidential election year, the most likely scenario is that the government will put pressure on Petrobras to keep fuel prices flat. Let's not forget that the company has very close ties with the government, and any plans to modify the current pricing will likely be discussed with government officials. Flat gasoline prices would help keep inflation levels under control and avoid voter discontent, but they would also hit Petrobras' income in real terms.

Bottom line
This inflation scenario puts Petrobras in a tricky situation, as the company will have to deal with increasing interest rates and strong pressure from the government to keep its prices flat. The company has problems of its own, mostly related to having zero growth in output since 2011 and increasing costs to develop its promising offshore ventures.

In macroeconomic terms, Brazil's inflation levels are still healthy and manageable. Many analysts point out that this spike in inflation levels is related to a record-high drought that affected many Brazilian states, driving up the prices of potatoes, tomatoes, and beans, which all have a high weight in the inflation rate. Inflation could cool down a bit as soon as this price disturbance moderates.

One thing is clear, however: Domestic prices cannot continue to grow at these rates for the rest of the year. If this continues, the central bank will probably have to take action, reducing the supply of reals and/or raising interest rates even more.

Play the Energy Boom the American Way With These 3 Stocks
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it’s absolutely free. 

Louie Grint has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers