World Review | Argentina’s new government faces challenge with energy subsidies

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Argentina’s new government faces challenge with energy subsidies

Argentina’s new government faces challenge with energy subsidies
Buenos Aires, Dec. 26, 2013: residents took to the streets to protest frequent power outages that plagued Argentina's capital during a summer heat wave (source: dpa)

ARGENTINE President Mauricio Macri must cope with an energy sector in dire straits. Policy over the past decade has been inconsistent and often counterproductive. Subsidies weigh heavily on public finances. However, reforming the hydrocarbon extraction and refining industries should prove far easier politically than solving the country’s challenges in electricity production and distribution, writes World Review expert Noel Maurer.

When President Macri took office in December 2015, he inherited an energy policy that strongly favored oil companies, compensating them for restrictive regulations with public subsidies. Low oil prices give his new government an opportunity to eliminate both the restrictions and the subsidies at minimal political cost.

The power industry, on the other hand, will be far more difficult to fix. Subsidies have grown to massive levels – 8 percent of all federal spending in 2014 – and continue to rise. Prices for end users of electricity need to increase dramatically, but the political cost will be steep. Mr. Macri will have to tread carefully.

Electricity prices have been administratively controlled since Argentina’s 2002 crisis. The government authorized a 72 percent price increase in 2013, but that still left average retail rates at about $0.01 per kilowatt-hour. At that level, the only way to keep the lights on has been to subsidize generators and distributors. The fiscal burden is rising fast: in 2014, power sector subsidies totaled $9.9 billion, up from $8.8 billion in 2013. All told, government payments to the power industry last year were equivalent to 3.6 percent of gross domestic product, accounting for the lion’s share of the country’s budget deficit of 4.9 percent of GDP.

Even with the subsidies, Argentina’s electricity distributors are having trouble meeting peak demand. Edesur, which serves southern Buenos Aires, and Edenor, the distributor in northern Buenos Aires, both posted millions of dollars in losses for 2014. Both companies have been forced to engage in power cuts during times of peak demand, imposing voltage reductions in selected parts of the city.

Almost immediately upon taking office, President Macri declared a state of emergency in the sector, authorizing Energy Minister Juan Jose Aranguren (the former president of Shell Argentina) to take the measures he believes are necessary to safeguard it.

Mr. Aranguren has moved quickly to unwind the complex system of hydrocarbon controls and subsidies. On January 5, 2016 he cut the domestic price of crude oil from $77 to $67.50 – still well above prices on global markets, but a windfall to refiners. In addition, he raised the retail price of gasoline by 6 percent, from $3.86 per gallon to $4.10. Some of the more burdensome regulations have been scrapped and it is likely that direct subsidies will be next, although this will require Congressional approval.

The new government has taken more tentative steps in the electric power sector. Mr. Aranguren has announced that electricity prices will rise. According to a plan announced on January 25, peak rates for small-scale users will rise by a factor of 3.3 – from 0.7¢ (U.S.) to 2.3¢ per kilowatt-hour. That would still leave prices about 40 percent below average producer costs. In addition, the first 150 kilowatt-hours used by households each month would be free, in order to reduce the impact of higher tariffs on low-income families. The government said it will review electricity prices again in six months, with a very real possibility of further rises.

The electricity tariff hikes pose two risks for Mr. Macri: street protests and a potentially recessionary effect as bigger electricity bills force consumers to cut back spending

For a more in-depth look at this subject with scenarios looking to future outcomes, go to our sister site: Geopolitical Information Service. Sign in for 3 Free Reports or Subscribe.

Noel Maurer

Dr Noel Maurer is an associate professor at Harvard Business School in the United States. His research analyses how firms and governments handle political instability and threats to their pr ...

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