Do frozen tariffs risk country’s hopes for energy exports?

2nd January 2020

By Martín Trombetta

Do frozen tariffs risk country’s hopes for energy exports?

Alberto Fernández’s difficult balancing act is already becoming evident with regards to his energy sector policies. His business-friendly appointment at the head of the state-controlled hydrocarbons firm YPF, Guillermo Nielsen, had once taken aim at former president Mauricio Macri’s decision to freeze gas prices in the last few months of his administration, and was readying a 5 percent hike to be announced this week. At the last minute, however, Fernández told Nielsen to call the hike off.

</p> <p>The back and forth might be the first of its kind during Fernández’s administration, but it illustrates a wider tension between two often conflicting goals at the heart of his economic program: shielding local production and consumption from rising costs, on the one hand, and incentivizing exports to turn Argentina’s economy around, on the other.</p> <p>Although the energy sector only contributes about 7% to the country’s Gross Domestic Product (GDP), it is seen as a potential source of growth and a new potential source of foreign currency, one of the new government’s main economic goals, according to Economy Minister Martín Guzmán. At the same time, however, keeping tariffs below international market prices is often seen as a practical way to prevent inflation peaks, at the expense of undermining the sector’s international competitiveness. In a global context likely <a href="">not as favorable</a> as it was a decade ago, Fernández might have some tough choices to make.</p> <h2><strong>The future of tariffs</strong></h2> <p>The Kirchner administration was known for its strongly controversial and costly tariff policy. Conceived as an “anchor” to slow down inflation, tariffs on basic services such as electricity and natural gas were held virtually constant in nominal terms for a decade. Since inflation was high in those years, the sector’s real income kept dropping, which required growing compensations from the state in the form of subsidies.</p> <p>After being heavily criticized in terms of efficiency, equity and fiscal sustainability, those subsidies were <a href="">reduced gradually</a> by the Macri administration, from 3% of GDP in 2015 to the current 1.4%. For consumers, however, this meant a big hit: electricity rates multiplied by as much 22 in those four years, almost ten times above inflation.</p> <p>The <a href="">economic emergency law</a> passed last week by Fernández’s administration sets yet another change in energy policy — power and natural gas tariffs will be frozen for 6 months, in line with campaign promises to limit rising energy costs. As a consequence, subsidies might need to be raised accordingly. Most companies whose peso-denominated revenues could take a hit with the new change in policy must face payments to their providers in dollars, so rumors in the market point to the government imposing short and medium term modifications in those contracts.</p> <p>Some issues remain unclear. For instance, it has not been specified whether the gas tariff will be held constant for commercial firms (from manufacturing to electricity generation) or merely for households. As for electricity, in the absence of a contract-renegotiating process in the wholesale electricity market, the difference between the frozen price of electricity in pesos and generation costs in dollars will increase, leading to a need for larger subsidies.</p> <p>With so many uncertainties, the fiscal cost of the measure is also unknown, which constitutes an additional source of concern in the current economic situation. Improvements in the social tariff (a reduced tariff for underprivileged households) might also be part of the equation, as distributive concerns are clearly in order, but no official announcements on the matter have been made so far.</p> <p>Although gas is not exactly a tariff, prices are also heavily influenced by the state, for similar reasons than natural gas and electricity, as policymakers also see it as an anchor to slow down price hikes. Subsidies in the oil sector have never been as heavy as in electricity but, a few months ago, previous YPF president Miguel Gutiérrez <a href="">complained</a> that petrol was being sold 20 percent below what its market price should be, arguing that this could damage the signs of growth seen in the sector.</p> <h2><strong>Vaca Muerta</strong></h2> <p>Argentina’s <a href="">unconventional</a> hydrocarbon resources feature the world’s second-largest reserves of natural gas and the fourth-largest reserves of oil. In particular, Vaca Muerta (and the rest of unconventional formations in the Neuquén basin) contains 75% of such resources. The new administration has shown interest in continuing the development of these key assets for the country’s energetic production, with Nielsen saying the country should be shooting to transform hydrocarbon into a source of dollars comparable to that of agricultural exports.</p> <p>After a meeting between Productive Development Minister Matías Kulfas and Neuquén governor Omar Gutiérrez, also attended by some important petrol businessmen, Fernández’s government decided to reduce export duties on petrol, which was read by many as a strong hint at the future of energy policy.</p> <p>According to a report signed by the former administration’s Energy Secretary Gustavo Lopetegui, natural gas production has grown for the last 23 months in the year-on-year comparison, and has reached 141 million cubic meters per day, while in oil it is 20 months of continuous growth for a current level of a thousand barrels per day. Growth is a consequence of the development of Vaca Muerta, which has compensated steady declines in conventional production (from 2004 and 1998, respectively). In fact, unconventional production currently accounts for 22% of total oil production, rising to 45 percent on natural gas, in both cases mainly due to output growth in Vaca Muerta, where well productivity has multiplied by five, owing to improvements in extraction techniques and learning.</p> <p>In a recent visit to the United States, both Nielsen and new Energy Secretary Sergio Lanziani commented on the importance of finding investors to promote the energy sector, especially Vaca Muerta, conceived as a key factor in the generation of a much-needed commercial surplus.</p> <p>If exporting is the goal, oil will inevitably be a crucial part of the equation due to being a globally tradable commodity, which can be transported internationally with much more ease than natural gas. Exporting gas is a more demanding challenge as, if pipelines don’t connect production sites with potential clients, then liquefaction is necessary, and that is a costly process that experts don’t see as feasible for the country before 2025 — and that’s only if investments start next year.</p> <p>The massive investment and know-how needed to succeed in the area mean that, although YPF plays a key role in Vaca Muerta, association in joint ventures will likely be necessary to spur growth in the oil sector. According to specialists, unconventional hydrocarbons require growing investment to prevent decline, which in the case of Argentina amount to between four and seven billion dollars per year, so as to keep current growing rates.</p> <h2><strong>Short run vs. long run</strong></h2> <p>Few would question the convenience of a large, competitive and modern energy sector. However, the large investments required to develop it clash with the low current level of tariffs, which threaten profitability. Fernández seems to be dealing with a very delicate trade-off &#8211; if the development of the sector is considered a priority, then society will have to tolerate higher tariffs, which today sounds politically risky. In fact, political hassle over “<em>tarifazos</em>” (big hikes in utilities) entailed heavy costs for Macri, even leading him to clash with the Supreme Court of Justice.</p> <p>Many benefits of investment in energy will only become apparent in five or ten years’ time, but higher tariffs are politically hurtful today. Even if famous economist John Keynes had been right when he famously stated that “we are all dead in the long run”, it must be acknowledged that focusing only on short-term concerns is a dangerous path to choose. Only time will tell what Fernández will end up doing about it.</p> <p>

Access full content NOW!

Martín Trombetta

Martin Trombetta holds a PhD in Economics from Universidad Nacional de La Plata, a research grant at the CONICET institute, and teaches at the Universidad Argentina de la Empresa (UADE). His publications have focused on labor markets, income mobility, gender gaps and other topics.