Opinion – Marcos Mendes: The fuel price shock

The invasion of Ukraine generated an oil price shock. Executive and Congress move forward with mechanisms to soften the impact. The proposals have an open cost, and could exceed BRL 50 billion (0.6% of 2021 GDP) if widely adopted and for a longer period of time.

The predisposition to state intervention that we see in Brazil does not seem to have a parallel in other countries. A consultation on the internet shows some cases of subsidies and tax reductions at a restricted cost. In the Philippines, for example, targeted benefits of 0.02% of GDP. In Portugal, vouchers to consumers and tax reduction costing 0.07% of GDP. Much less than the Brazilian figures.

It can be argued that Brazil is an oil producing country, and that the government has gained revenue from rising prices (royalties, Petrobras dividends, taxes). Therefore, part of the fiscal gain could be spent to smooth the price increase without worsening the fiscal situation.

However, what is seen in other major world producers that have a market economy, such as Canada, Norway and the USA, is a resignation to higher prices. Aside from some localized measures (provincial tax reduction in Alberta, Canada), there is no comprehensive shock mitigation scheme. The reason for this is that the benefits of the intervention tend to be lower than the direct (fiscal) and indirect costs (discouragement of investment in prospecting, risk of shortages, concentration of income and misallocation of resources).

The mobilization that exists in Brazil is of a political nature: elections, fear of truck drivers’ strikes, interventionist tradition, fragmentation of decision-making power. It remains to evaluate the options on the table.
The most harmful option is the end of parity with the international price of oil. It is in the speech of several candidates and was included – in an unclear way – in PL 1472, approved in the Senate last Thursday. It is about interfering in the decision-making process of Petrobras and its competitors. It will eventually lead to the renationalization of the company and the exit of private companies from the market. Converted into a public agency, Petrobras will lose the injection of private capital that leverages its investments, will have less competitive incentives to research, in addition to being divided among politicians. Their reserves will fall, impoverishing the country. Mexico chose this path, and it has been paying a high price.

Equally bad is the creation of a price stabilization fund. This is the core of PL 1472. The idea assumes that prices oscillate around an average, so that in high periods the fund subsidizes fuel and in low periods the price does not fall proportionately, generating resources to capitalize the fund. The problem is that prices can go through very long periods of high, generating a strong fiscal cost; or low, leading to overcapitalization, which encourages the use of surplus resources to subsidize fuels at times when they are already cheap. Masami Kojima (Fossil fuel subsidies and pricing policy) shows that the fund did not work in the countries where it was adopted. The idea is being abandoned.

A less-worse option would be a subsidy only for diesel, with a previously defined maximum fiscal cost, similar to what was done in response to the truck drivers’ strike in 2018. Even so, there are many distortions generated, as I showed in a text published in another vehicle (available upon request).

Finally, there is the temporary reduction of taxes on diesel, approved in PLP 11/20 and sent to sanction. It has a high fiscal cost and the negative side effects mentioned above, but implementation is simpler than subsidy.

The mobilization around the topic should be taken advantage of to adopt measures in the right direction. For example, curb abuses of market power by Petrobras, via CADE, or demand transparency in the criteria for calculating the parity price, via ANP. The privatization of refineries and the end of privileges to the state-owned company, such as the right of preference in the choice of oil fields in bidding, would increase competition, helping to regulate prices.

Public policies that make freight and fuel more expensive should be revoked, as is the case of the Merchant Marine Freight Additional and the poorly designed Renovabio Program. Price volatility can be mitigated by changing the incidence of ICMS, the latter referred to in PLP 11/20, but pending regulation by the states.