Will Argentine energy subsidies return?

A return to the heavy subsidies and energy price freezes that characterized Argentine energy policy between 2002 and 2015 could be disastrous for the sector’s future.

According to Alejandro Einstoss, a partner at Argentine energy institute General Mosconi, the sector faces a particularly fragile moment because it is currently in the middle of a difficult public service price adjustment process.

And uncertainty arose over consequences the power industry would deal with in case of a Peronist win in the next elections . “The opposition has not presented its technical teams or a platform regarding the sector,” Einstoss told BNamericas. Although “some specialists and people close to the opposition have given their opinion on the strategic function Vaca Muerta would play in a hypothetical opposition government”, he added.

Argentines head to the polls in October, when center-right incumbent Mauricio Macri will seek reelection against Peronist Alberto Fernández. Fernández’s running mate is Macri’s predecessor Cristina Fernández de Kirchner. Peronists seem in agreement about encouraging Vaca Muerta development.

This bodes well for the formation, but says little about how this development will be encouraged. During her two previous tenures, Fernández de Kirchner ran the energy sector through discretional policies enforced by the federal government, sometimes breaking contracts and ignoring the regulatory scheme.

“To again break contracts [as in 2002] without a renegotiation scheme that’s agreed upon among the parties would be a mistake that could put Argentina in a scenario that is very hard to come back from,” Einstoss said.

HISTORY OF THE SUBSIDIES

Since Nestor Kirchner’s administration froze gas and power prices in 2002, the gap between market price and consumer price of energy has widened.

According to Einstoss, this disparity grew even wider than the historic one created by a price freeze from 1945 to 1955 under Juan Domingo Perón.

Average households spent 4.6% of their salary to cover power and natural gas expenses in 1995, under Carlos Menem. Roughly the same (4.5%) was the case in 2001, right before Argentina suffered a devastating economic and political crisis in December that year.

Once price control measures were put in place in 2002, however, this percentage began to drop gradually, as growing costs and inflation adjustments were not reflected in the final price of energy. The disparity between the fixed price and costs was covered by subsidies that had to rise every year. In 2015, when the Macri administration assumed power, only 0.6% of an average household’s salary had to cover power and gas prices.

That same year, while power prices were stuck at 95 pesos per MWh, producing energy cost around 606 pesos per MWh, meaning subsidies covered 86% of energy costs. Hence, customers paid only 14% of the market price. “Argentine energy was practically free”, Einstoss told BNamericas.

LONG-TERM CONSEQUENCES OF SUBSIDIES

The disparity between the real cost and consumer price in the Fernández de Kirchner years came with a cost, which, however, only slowly materialized. In Argentina, prices are agreed upon with distributors. Together with inflation adjustments, distributors agree to invest in their networks in proportion to agreed returns. But as the state broke such contracts to fix prices, distributors refrained from investing sufficiently.

This in turn led to increasing power outages and slower gas distribution grid expansion. Some provincial power distributors stopped their payments to wholesale market administrator Cammesa entirely, forcing the state-run company to assume large debts.

These developments added to rising federal spending that increased the national debt. At their height in 2014, subsidies (not only in the energy sector) made up 3.8% of the country's GDP.

Most Argentine power comes from gas-powered thermoelectric plants. This means gas producers were hit by a freeze in gas household prices but also in power prices, which affected some of their main offtakers.

Consequently, the country’s subsidy policy also had a gradual impact in gas production. While production went above 50Mm3 in 2004 it fell to 41.5Mm3 by 2013. To compensate for the dwindling production, Argentina began importing expensive gas from Bolivia and elsewhere. In response, the Fernández de Kirchner administration created “Plan Gas” in 2013, a new subsidy that covered production. Under the deal, any excess gas production over 2012 levels would benefit from an artificially inflated price.

A version of Plan Gas carried over to Macri’s administration. The new government made it exclusive to new Vaca Muerta unconventional production and set a declining rate from US$7.5/Mbtu to US$6/Mbtu in 2021 and will then phase out. This plan is currently the source of a legal dispute with Vaca Muerta producer Tecpetrol.

ROLLING BACK SUBSIDIES

The Macri administration also implemented a gradual process of price adjustments that was reflected in significant residential price hikes, as subsidies were slowly phased out. This process took household consumer prices from 95 pesos per MWh to 2,072 pesos per MWh in 2019. In the same period, and in part due to high inflation, the actual cost of energy spiked from 606 per MWh to 2,925 pesos per MWh.

The jump appears significant, but when taken as a percentage of average household income, in 2018 and 2019 the average citizen spent 4.5% of its salary on power and gas, the same as in 2001. While recession makes any price hike hard to swallow for average consumers, current rates seem only out of proportion in relation to the distorted prices set by the previous administration.

Still, the political price paid by an administration that rolls back subsidies can be great. Carla Selman, a senior analyst for Latin America at IHS Markit, recently told BNamericas that price hikes come with the expectation of a better service, which the recent country-wide blackout has put into question.

“Even though the bigger part of the [price adjustment] has already been made”, said Einstoss, “the final portion is still pending. And that is the most difficult part, because it’s the one that weighs most heavily on families’ shoulders.”

If the Macri administration can maintain power and continue its policies next year, energy subsidies are expected to decrease from 1% of the country’s GDP to 0.2%.

Ultimately, Einstoss predicted that the administration’s approach, while bumpy in the short term, will be a boon for the sector in the future. “Ceasing the intervention of regulatory bodies and implementing a competitive price scheme, such as gas auctions, marks a return to normalcy, or compliance with regulatory norms and the honoring of contracts. Looking forward, that will be this administration’s greatest asset,” he said.

Image credit: Alejandro Einstoss and Econométrica.