Yesterday, the first round of the public hearings referring to the adjustment of gas energy rates. In this report, we provide a brief description of the sector and future prospects, with explanatory notes, on the concepts used in this entry.

Protection as a strategy

The Supreme Court ruling that rolled back the gas rates at its 2015 level, forced the national government to draw up a new rate increase scheme for this year. The government proposal was published on the Enargas site, prior to the round of public hearings scheduled on the weekend of September 16, 2016.

It proposes a gradual increase in the price of gas paid to producers, which at first will be considerably lower than the initial proposal, but which in the medium term (2020) will gradually converge to USD 6,8 per MBTU as shown in the following table:

What is the justification for setting a target of 6,8 USD/MBTU in the long term? It's pretty simple. This is the maximum price paid for the import of gas by ship, including the cost of regasification (the latter, because the import by ship is in the form of liquefied gas).

In technical terms, what is sought is the convergence of natural gas prices to the marginal cost of market supply.

Economic logic indicates that, at least with inelastic demand, this could be the market price of gas if it depended on the free play of supply and demand.

In fact, it could even be argued that during the winter months natural gas has a higher price, given that gas scarcity and infrastructure limitations prevent the market from being fully supplied with gas and electricity plants must generate part of the energy with even more expensive fuels, such as diesel, whose price exceeds 11 USD/MBTU.

Current situation

The high marginal cost of supplying the market is the consequence of the energetic politics implemented during the last decade. In 2002, gas prices were pesified and frozen, without a long-term adjustment mechanism being established for them.

With the depreciation of the peso and the rise in international fuel prices, this led to their prices falling behind the international level, reaching more than 60% below the import cost. As a result, investment in the sector has plummeted and production has contracted by 16% in the last decade.

Likewise, as demand continued to increase in line with economic and population growth, and without promoting the replacement of natural gas with other energy sources; This quickly generated a supply deficit.

Consequently, and conditional on the fact that Bolivia's natural gas import possibilities are limited, the country had to resort to the use of LNG or liquid fuels, which are much more expensive. Under this scheme, the cost of energy - largely subsidized by the state - became increasingly higher.

Tariff scheme update

The current tariff scheme seeks to correct some of these errors, setting a price more related to market mechanisms (although without ceasing to be regulated), probably more attractive for investment and with a long-term path in dollars and, therefore, less subject to erosion by inflation.

However, it is precisely because of the current situation that it is not logical to take the marginal supply cost as a reference for all demand.

Although 6,8 USD/MBTU is the cost of importing LNG, the production cost of the rest of the supply is much lower. Thus, setting this price for local natural gas implies the transfer of a significant income from consumers to oil companies, to a greater or lesser extent depending on the type of field in question.

According to YPF presentations, the cost of gas extraction (including investment in exploration and an annual return on capital of 13%) is currently located at 5,0 USD/MBTU.

Beyond this, from the most orthodox economic theory this scheme could be perfectly defended. After all, if the lawsuit validates a price of 6,8 USD/MBTU, companies could charge it.

After all, isn't this what happens in other markets with inelastic demand? Yes, but there are two reasons why the situation is different in the case of natural gas.

• First of all, the hydrocarbon companies They exploit a resource that is the property of all Argentines. It is not a good created by them. Thus, an appropriate policy should seek to maximize the income obtained by consumers (or the national government) in the long term.

This implies encouraging supply and providing adequate prices to encourage investment, but also balancing the impact on consumption given that, without income, said energy would not be generated. After all, what is the advantage of having natural gas resources if it ends up costing more than what Japan must pay to be supplied with LNG? In countries that have greater energy resources, they are cheaper and this is an advantage for their industry and their population. Not only an advantage for the companies that exploit them.

• Secondly, the justification of the traditional theory depends crucially on the action of competition, according to which, if there were a way to produce these goods at a lower cost than what demand pays, this would encourage supply and would reduce the price. This is indeed a possibility in the case of Argentine gas. But it must be considered that these mechanisms have not operated for the last thirteen years.

Thus, the marginal cost is so high precisely because the supply had no incentive to respond. Switching to a scheme like the one suggested when supply cannot respond quickly (as happens in gas production) will always imply an initial period of extraordinary income for the producer. In other words, distortions of the past generate an artificially high profit for the new investor.

Final comments

In this way, and under the previous considerations, there is a way to understand the government proposal. This is a productive development policy, which seeks to develop the industry based on an initial incentive of high prices. In other words, the scheme that is being attempted to be dismantled for the textile and electronics industry (benefited for years by strong import restrictions) is being put together for the oil industry.

It is true that there are important differences between the two types of industry. Energy plays a strategic role for the country's development, and Argentina's possibilities to reduce production costs are much greater in the case of gas than in the protected sectors during the last decade, in which it seemed very difficult that they would even come close to import parity.

But there are not so many differences in the way the policy is applied, which repeats all the usual errors of Argentina's protectionist policies: unconditional benefits without demands or punishments for companies.

Regarding the latter, a modification that has emerged from the public hearing concluded on Sunday, September 18, which represents a novel aspect, and a counterpoint to what was expressed in the previous paragraph: the government will not allow companies to transfer dividends abroad. gas companies as long as they do not comply with their investment plan and that, even if they are executed, they must have the authorization of Enargas, for this purpose.

Likewise, the final regulation and adaptation of these points is estimated to take place in the general public hearing to be held in the second half of October.

Recovering natural gas production must be a strategic objective of the national government, and it is indisputable that this requires a path of clear prices that are significantly higher than those that were in force in the last decade. But not just because production is recovered can any internal price be validated. Otherwise, the advantages of being a country rich in gas (conventional and unconventional) will only be for the companies that extract it.