The revolution in Brazilian fuel markets

Guest author: Winston Fritsch, Managing Partner of Struttura Project Development and Finance Ltd. and a member of the Economics Department of PUC-RJ

In the last few years, Petrobras has definitively abandoned the projects of two refineries in the states of Ceará and Maranhão and decided to sell most of its existing refineries - comprising about 50% of its refining capacity - maintaining only those in the central markets of Rio and São Paulo, near Brazil’s largest oil production areas and potential reserves. When completed, some national private distributors and a few foreign groups will own the existing refineries located in the states of Rio Grande do Sul, Paraná, Minas Gerais, Bahia, Pernambuco and, away from the main markets, the Manaus refinery.

The discussion of the impact of divestments made by Petrobras has traditionally been carried out with an emphasis on reducing its high level of indebtedness, which rose dangerously from the end of 2014 under the simultaneous impact of the collapse of world oil prices, of the Lava-Jato investigations, and of the recession and stagnation of the Brazilian economy. However, the most lasting effect of the end of the refining monopoly will be a real revolution in domestic fuels markets. The sudden change in the competitive process in these markets will affect the formation of prices at gas stations, generating greater competition in supply and encouraging both the increase in efficiency of refiners and volume of imports - hitherto inhibited by the monopoly – generating large long-term gains for the consumer and for the large domestic ethanol sector.

The main driver of this radical change in fuels markets will be the end of Petrobras's

current absolute discretion in the formation of their prices, which until today has hindered the free importation of refined products by private agents, and stimulated nefarious, recurrent government interference trying to manage these prices to control inflation or, more recently, please truckers. Today, the price is formed arbitrarily by Petrobras, which, despite different costs between refineries, equals prices nationally, generating cross-regional subsidies and produces several other distortions. The main one is to inhibit imports, which only happen when the price fixed by Petrobras deviates substantially from the import parity, and always in a discontinuous and modest way. Another important distortion is the reduction of the potential area of influence of the most efficient refineries, artificially restricting their production.

The greater competition brought about by the end of the monopoly will change all of that, in a very positive way for the economy, consumers and shareholders of Petrobras. First, there will be a definitive end to government interference in oil prices that has cost its shareholders no less than R$ 100 billion between 2010 and 2014. Second, in each regional submarket defined by a dominant refinery, prices must become disciplined by the import price (plus logistical and tax costs) and competition between adjacent refineries. This should force refineries, now under private management, to seek increased efficiency and lower production costs to increase their geographic area of influence. Third, in areas where the new owner of the refinery is also one of the distributors - which should be the predominant model - there will be a defensive movement from the other existing distributors in the region of logistic influence of the refinery, which will increase their import capacity to be able to counter potential abusive price increases by the local refiner.

This mechanism will mainly be felt in the so-called Integrated Market, which covers the areas of influence of the refineries from Rio Grande do Sul to Pernambuco, where there are adjacent regional submarkets with great competition in distribution. In the so-called Neutral Market, comprising a huge area that encompasses the Midwest, part of the North (outside the influence of the Manaus refinery) and part of the Northeast (outside the influence of the Pernambuco refineries), the price-dynamic is different. In this market, traditionally hit by cabotage by Petrobras, it is already increasingly served by imports, through ports like Suape and Itaqui and, in the future, also by Santarém.

This Neutral Market, inland, centered on the area of high-productivity export-oriented agriculture, with an expanding income and frontier, is the fastest growing in the country. Between 2010 and 2020, the volume of gasoline and diesel consumption grew around 70% in the region, against just 23% in Brazil, according to data from Leggio, a specialist consultant. This trend is expected to continue with the profound transformation of the logistics infrastructure that is underway in that region. The construction of new railroads, waterways, ports, highways and ancillary equipment will alter the costs of internalizing cheap imports from the Gulf of Mexico, contributing to further increase competition in distribution, falling prices and a consequent increase in consumption.

Finally, the double impact of the end of arbitrary interference in gasoline prices, which directly determine the price of ethanol in Brazil, and the growth in demand for fuels will have a very beneficial impact on Brazil’s ethanol markets. This will also be particularly important in the Neutral Market, contributing to consolidate the clear current trend of transition from sugarcane to corn as an input for ethanol plants, by attracting new corn ethanol plants to the dynamic consumption center, a gigantic grain-producing region.

Image: Klaus / Pexels