Order and precatorious



Refinaria de Petroleos de Manguinhos, the worst performing Latin American energy stock this year, is showing investors how Brazil's fuel subsidies are hurting the ability of non-government refineries to make money.

Manguinhos, based in Rio de Janeiro, had been trying to reduce its tax burden by using securities backed by unpaid government liabilities purchased at a discount, known locally as precatorios, a practice the Rio state government was disputing in court. Shares tumbled after Rio issued an October 15 decree to expropriate land where Manguinhos operates, saying that was needed to settle unpaid taxes and for low-income housing.

Chief Executive Officer Paulo Henrique Menezes said Manguinhos can't stay in business under the current fuel policies because state-run Petroleo Brasileiro is selling gasoline below cost to help fight inflation. Petrobras is losing a record $8 billion this year to maintain the subsidies.

"I don't use precatorios to make money, I use them as a survival tool," Menezes said in a telephone interview. "For more than 10 years gasoline has been subsidised by the government and by Petrobras. Petrobras says pretty much every day that whenever it imports gasoline, it loses money."

Manguinhos shares were halted in Sao Paulo for a week after the expropriation decree, and fell 68 per cent when trading resumed on October 23 to 0.27 real, reducing the company's market value to 241 million reais ($115 million). While Manguinhos recovered to 0.34 real at 10:35am on Friday, the shares have lost investors 78 per cent this year, the worst performance among 29 oil and natural gas companies traded on Latin American exchanges, according to data compiled by Bloomberg.

Manguinhos, which has confidentiality agreements with China Petrochemical and Dutch company VTTI on a $727 million farm-oil project, produced 345,308 barrels of refined oil in September, or 0.6 per cent of the country's total. The company was founded in 1954 during the "Oil is Ours" government campaign that also led to the creation of Petrobras in 1953. It was acquired by Grupo Andrade Magro in 2008.

Manguinhos paid 150 million reais cash in taxes last year, and is seeking in court to pay 248 million reais using precatorios, Menezes said. Rio Governor Sergio Cabral says 406 million reais is under dispute, according to a October 15 statement. The company had a second-quarter loss of 95.03 million reais on sales of 476.9 million reais, according to data compiled by Bloomberg. It hasn't reported third-quarter earnings.

Manguinhos' efforts to pay taxes with government securities don't justify the land seizure, said Adriano Pires, the head of the Brazilian Center for Infrastructure, a research firm in Rio de Janeiro. "The expropriation by the governor from the legal perspective scares any private investor," Pires said by telephone. "Everybody knows Manguinhos can only work and make money using a kind of fiscal engineering."

Refining output in Brazil, which was self-sufficient in crude and gasoline until 2009, hasn't kept up with surging consumption as Petrobras faces delays and cost overruns at its biggest projects. Demand is growing four times faster than the economy as consumers who are getting access to credit for the first time buy cars.

Brazil, the world's largest emerging economy after China, will expand four per cent next year after an estimated 1.5 per cent in 2012, according to a central bank survey of economists. "Any private investor should be dying to build a refinery in a country with this demand," Pires said. "They don't do so because there is an economic barrier, which is that the government forces Petrobras to sell fuel below market prices to control inflation."

The expropriation decree was published as Rio police and the army began entering slums near Manguinhos's facilities to reclaim control of areas struck by drug dealing, guns and violence. Rio will host the 2016 Olympic Games.

"Rio de Janeiro's government will expropriate all the Refinaria de Manguinhos area and it will be used for urbanisation and low-income housing projects after the cleaning of soil," the government said in an e-mailed response to Bloomberg questions. "In the area a new planned neighborhood can be built, with apartments, schools, leisure areas, health centers, libraries and other public equipment." Industrial waste and inadequate soil means the land can't be used for low-income housing, CEO Menezes said.

A Petrobras official, who can't be identified due to the company's internal policy, declined to comment on Brazil's fuel subsidies when contacted by Bloomberg. Governor Cabral said earlier this year that the state would use power of eminent domain to seize the building where the BM&FBovespa exchange is located in Rio and turn it into the new State Legislative Chamber.

The exchange's shares fell 3.4 per cent on April 11 after the announcement. Cabral dropped the plan after valuations showed the purchase price exceeded available public funds. Manguinhos filed an injunction against the governor's decree on November 6 at Rio de Janeiro's Justice Court, arguing the state government can't expropriate land owned by the federal government, according to the court's website.

The confidentiality agreements signed with Sinopec and VTTI are to discuss possible partnerships in a project to expand Manguinhos' storage and turn its refinery activity into cleaning pre-salt oil by 2016, according to regulatory filings. The agreements are suspended until a decision on the expropriation is made, the CEO said.

"As a citizen I feel safer every day in Rio with the initiatives to pacify the slums," Menezes said. "But I have no safety as a businessman."


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