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Saturday, January 18, 2014

Power cuts in Argentina: a crisis foretold

By Miguel Braun
For The Herald

Argentina was until recently an oil and gas exporter. The reform of its electricity regulation during the 1990s was hailed by experts as one of the most efficient and advanced in the world. For instance, a World Bank study notes that output increased by 52% and wholesale prices halved between 1992 and 1999. The US Energy Information Administration lists Vaca Muerta, Argentina’s shale gas deposit in the province of Neuquén, as the second largest in the world. Why then is the country suffering from an energy crisis that left thousands of people without electricity and protesting in the streets during the heat wave in December?

The short answer is that irresponsible government policies led to an excess of demand over supply of electricity. Residential energy prices were kept artificially low following the economic and financial crisis of 2001-2002, leading to an increase in demand above what would have been reasonable. For example, my last monthly energy bill was around US$20, a value not conducive to energy saving measures, especially when compared to the rising cost of other goods and services. At the same time, low prices meant that as costs grew, the energy bill paid by consumers covered a diminishing proportion of the costs faced by electricity distribution companies. The government’s response was to pay subsidies to these companies. However, these subsidies were insufficient to cover the cost of new investment necessary to face the growing demand. The government is currently stuck with an energy subsidy bill of 2,6% of GDP, around half of the overall fiscal deficit.

The demand for energy grows closely with the growth of GDP. Assuming an average growth rate of 5% per year, Argentina should incorporate around 1.000 MW/year to its electricity supply. This growth was achieved between 1992 and 2001, but stalled between 2002 and 2007, when supply remained basically unchanged. Despite this lack of growth in supply due to low investment, there were no serious problems in the electricity market during the first Kirchner administration, because the system was operating with excess supply. In 2002, excess supply was around 35% of total production, according to CAMMESA, the company responsible for the wholesale electricity market. As demand continued to grow and supply stalled, excess supply fell to around 5% in 2008, leaving the system vulnerable to sudden peaks in demand and its ensuing power outages. Supply started growing again in 2007, fuelled by an increase in public spending, including importing of natural gas from Bolivia, liquefied gas from Qatar and other destinations and fuel oil from Venezuela, an expensive and inefficient solution which has transformed Argentina into a net fuel importer with an energy deficit of U$6,500 million in 2013.

The mismanagement of the energy sector lies at the root of the government´s economic woes. Importing fuel contributes to the drainage of Central Bank reserves, since fuel has to be paid with actual dollars. This drainage in turn generates uncertainty regarding macroeconomic stability, and fuels speculation regarding a future devaluation, feeding the rise of the black market dollar, currently trading at almost 12 pesos. At the same time, the government allocates public funds to buy fuel and pay for energy subsidies to keep prices low. This accounts for 2.6% of GDP, half of the overall fiscal deficit, as mentioned above. Since Argentina has no access to credit, this deficit is being funded by transfers from the Central Bank to the treasury, which leads to an increase in the money supply and fuels inflation and furthers macroeconomic instability and demand for dollars by the public. Finally, the government has imposed energy rationings on private sector companies, which stalls production in key sectors and harms economic growth and job creation.

The political consequences are yet to play out fully, but already the government has suffered at the ballot boxes last year due to economic problems, even before the electricity cuts, which have confirmed many citizens´ suspicions regarding the costs of populism. It is clear that a reform is necessary in the energy sector in order to increase private investment and generate more supply of electricity in order to absorb increasing demand and avoid future blackouts. This reform needs to generate clear incentives for private companies to invest in generation of electricity, and the easiest way to do that is for investors to receive market prices in an open, transparent market from wholesalers. The experience of 1992-1999 shows that a well-organized market can increase supply and at the same time reduce prices. The challenge would be how to manage the transition, since prices can take a couple of years before they fall. There are several projects in the Argentine Congress proposing a social tariff for electricity, in order to avoid price increases for the most vulnerable.

The opportunity is especially feasible given the wealth of shale gas that Argentina has available in Vaca Muerta. US manufacturers and residential consumers have benefitted from the reduced cost of gas thanks to shale, and the country has found a renewed source of industrial competitiveness. With the right incentives for private companies, Argentina could do the same, becoming once again an energy exporter, increasing industrial productivity, lowering inflation and providing clean and affordable energy for everyone.

* Miguel Braun is executive director of Fundación Pensar (PRO)

@braunmi

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