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No más: The Coming Argentinian Meltdown

Mises Daily: Friday, May 21, 2004 by

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In Greek mythology, the adhesive adjoining feathers to the wooden frame of Icarus's wings melted away when the young man flew too close to the sun, causing him to plummet from the sky.

It seems Argentina is poised to suffer the same fate, differing from Daedalus's headstrong son in that the government's penchant for economic interventionism will undermine a high-flying recovery and scorch other South American countries along with it.

Barely two years removed from an acute financial crisis that resulted in the largest sovereign debt default in history, Argentina is experiencing a revival in commercial activity. The country posted a torrid 8.7% growth rate during 2003, the second highest figure in the world after China. Booming commodity prices, a revival in domestic consumption and an upswing in manufacturing stoked by a sharply devalued peso have prompted the resurgence.

Throughout the first quarter of 2004 GDP growth for the year was expected to remain vibrant, albeit slightly lower, from 4% to 6%. However, the laws of supply and demand in the energy sector, distorted by the interventionist policies enacted a few years ago by the national government in Buenos Aires, threaten to retard Argentina's economic growth for years to come.

Demand for electricity among Argentina's commercial and residential users has gathered pace, at a clip matching the upsurge in GDP. Energy companies are struggling to muster a similar upsurge in supply. Some firms have achieved output 20% to 30% above last year's mark, but with electricity consumption already at the zenith experienced during a typical Argentine winter—June through September—shortages appear inevitable. The country's electricity-generating alternative to natural gas—hydroelectric power—has been stymied by a severe drought further straining supply. Indeed, the country's energy market has had to lower voltage levels to stem the mounting frequency of shortage-induced blackouts.

On cue, the self-appointed defender of Argentine society, the national government, has stepped into the fray to protect its citizenry from the purported depredations of the market. True to form, the left-leaning President of Argentina, Néstor Kirchner, has heaped blame for the burgeoning crisis on Argentina's mostly foreign-owned (even better for the government) energy producers. Even more predictably, Kirchner's bureaucrats have proposed a raft of state-imposed measures (discussed fully below) to remedy a boondoggle of their own doing.

Shackling the market

"They tell us that there won't be any electricity, but gas producers have not made any investments since 1996."

Kirchner's remarks from late March are patently false. Nevermind the fact that a new power plant began operating in 2002, after the country's traumatic sovereign debt default and abrogation of one-to-one link between the peso and dollar. What has made Argentina's energy troubles so acute are the market-debilitating policies embraced by Buenos Aires after the twin national financial blows that occurred at the beginning of 2002.  

Prior to the de-linking of the Argentine and American currencies, natural gas, which is used to generate over half of the country's electricity, was quoted and paid in dollars. Afterwards, by government fiat, rates were denominated in pesos, swapped at one-to-one. As the peso continued its descent in value after January 2002, energy companies were prohibited from raising rates upward to compensate for the depreciation.

Mindful of the wrath emanating from a swindled, irate and newly impoverished citizenry, whose chants of Que se vayan todos (roughly, kick them all out) had prompted the elected president and a succession of pretender replacements to vacate the Casa Rosada in a spate of a few weeks in January 2002, the successor administration refrained from sanctioning energy price hikes. In effect, the state began subsidizing Argentine energy consumption at the expense of producers.

What was originally touted as a short-term decree in January 2002 was not subsequently rescinded, one, even two, years later. With the natural gas price capped at a rate one-third of the price quoted internationally, Argentine patrons have consumed electricity with reckless abandon, exploiting the artificially low rate. Directed by distorted incentives, 1.3 million motor vehicles—as of April 2004—have been converted from petrol (gasoline to Americans), more dearly priced at about 75 cents per litre, to meaner priced natural gas available at 15 cents per litre. Tens of thousands of vehicles undergo the adaptation each month.

As for utility companies, there is no monetary inducement to invest in an expansion of production capacity when the Argentine government prevents these companies from earning the same price for natural gas quoted beyond the country's borders.

As Fernando Navajas, chief economist of Fundación de Investigaciones Económicas Latinonamericanas (FIEL), an Argentine think-tank noted, the country's energy crunch is an example of, "a lesson you learn in Economics 101."

Love for liberalization

Prior to the conversion and freeze of natural gas rates in Argentina, the country's energy sector was the envy of South America. Carlos Menem, who assumed the presidency of the republic in 1989 amid another bout of hyperinflation, spearheaded a bold initiative to sell off state companies and assets, among them the government's production and distribution of electricity and natural gas. Argentines of all political persuasions tend to agree that energy privatization was one of the best policies executed by Menem during his controversial tenure.

Private provision of electricity and natural gas reversed the erratic prices, poor investment decisions, limited coverage, mismanagement, theft and waste that characterized Argentina's state companies. The irksome and fairly regular cessations of power—known as apagones in South America—that disrupted commercial and residential consumers' usage were drastically attenuated over the 12 years (1990–2002) of relatively free functioning electricity markets in Argentina. Indeed over that period the average incidence of apagones plummeted from 17 hours per month to five and distribution loss arising from theft was more than halved from 22% to 10%.[i]

According to an official at the Escuela Superior de Economía y Administración de Empresas(ESEADE)—a good friend of the Mises Institute—the energy privatizations were among the best conducted by the government. The market was outfitted with a pro-competitive framework where producers were free to supply and there was only a regulated monopoly in the transportation and distribution networks.

This testimony is corroborated by the president of the association of electricity distributors, Fernando Ponasso, who credits the liberalization of Argentina's energy markets for transforming the country from an energy-dependent land in the 1980s to a regional exporter. He claims that by 2001,  Argentina had become the most efficient energy producer in Latin America.[ii] Who can contest that point (including Kirchner) when the wholesale price of electricity plummeted from $50 per mega-watt hour in 1992 to $22 in 2001?

Fortunately for the energy producers of Argentina, their patrons have reacted to the energy crisis with relative aplomb, not impulsively denigrating privatization for the country's predicament. Despite government efforts to package its self-precipitated demand and supply distortions as being symptomatic of unfettered markets, the energy producers' passive reply has nonetheless convinced Argentines that they did not commit transgressions against the public. Relative to the investment funds and banks that pilfered the savings of Argentines amid and after the country's financial collapse, the energy producers kept their hands clean.  

Contagion

As if Argentina's energy problems were not dire enough, its travails have spilled over to other segments of the Southern Cone.

In an effort to stave off an impending shortage, the government in Buenos Aires passed a resolution in late March barring domestic energy companies from exporting natural gas and electricity unless national demands have been satisfied first.

Although electricity supplies to Uruguay were severed, the bulk of the fallout from President Kirchner's diktat has been absorbed by Chile, a country that relies on its eastern neighbor for almost all of its gas needs—roundabout 18m cubic metres a day—approximately 25% to 40% of its electricity requirements. The blow is especially disruptive because Chilean households and firms painstakingly converted buildings to accommodate domestic power plants that were receiving gas from the proliferation of cross-border pipelines laid in the 1990s.  

In April, the Argentine government compelled domestic energy companies to divert 20% of gas bound for Chile, affecting the more than a half million residential, commercial and production consumers located in the densely-populated central region. The retrenchment of gas imports has also assailed the country's northern mining district, where immense copper mines are spearheading a general economic recovery.

With winter in the Southern Hemisphere fast approaching, rising residential consumption levels are likely to squeeze Chile's electricity providers, compelling them to substitute oil or coal for natural gas, both of which are priced substantially dearer. Broadly speaking, the spectre of electricity rationing and an attendant spike in inflation are poised to undermine what was previously predicted to be Chile's best year of economic growth in almost a decade.

Immensely agitated by Argentina's behavior, the Chilean embassy in Buenos Aires submitted a formal protest on April 7. Opposition legislators in Santiago have clamoured for the imposition of trade sanctions against imports from Argentine companies that enjoy artificially low energy costs.

By contrast, Argentine authorities dismiss Chilean complaints, contending that its export restrictions do not violate a 1995 bilateral energy integration accord. Unmoved by deteriorating relations with Santiago, Buenos Aires claims Argentine energy purveyors were selling more gas than stipulated in the treaty and will honor the minimum levels enumerated therein.

Whether this pledge is sustained is uncertain, because some private consultants close to the situation estimate that as much as 50% of Argentine energy exports to Chile may have to remain on the eastern side of the Andes to plug energy shortfalls. What is clear though is that President Kirchner's curb of gas sales abroad will deal another blow to Argentina's battered energy producers, who undoubtedly relish delivering their commodity to Chile where the international, rather than a fixed, price for natural gas prevails.   

A coastal controversy

Besides denying domestic energy firms the ability to sell gas to foreign customers willing to pay full price, the Argentine government has begun to arrange supplementary sources from abroad. On April 22 Kirchner inked a six-month deal with Bolivia to import almost 4bn cubic metres of natural gas per day. The Argentine government has also enlisted Petróleos de Venezuela, S.A. (PDVSA), the Venezuelan state oil company (and fief of demagogue Hugo Chávez), in its search, agreeing to swap fuel for grain and beef.

To seal the agreement with Bolivia, Kirchner had to accede to the caveat that not a single molecule of gas would be re-exported to Chile. Bolivia's defeat at the hands of the Chilean military in the War of the Pacific (1879–83), which deprived the now landlocked country of the nitrate-abundant coastal province of Antofagasta, still galls to this day. From childhood, Bolivian state schools instruct pupils to despise those dastardly Chileans and blame the country's perpetual penury on the outcome of a regional conflict that concluded 120 years ago.

Crippled by rampant unemployment, virtually no access to global capital markets, and saddled with a budget deficit exceeding 8%—underwritten by bilateral assistance, multilateral lenders, and assorted donations[iii]— Bolivia's ills stem from more than the absence of a coastline. Indeed, the interventionist tendencies of the state throughout the country's history have condemned it to poverty. More recently, America's "War on Drugs," namely Bolivia's coca plant, has wiped out one of the country's premier cash crops.

Hence the importance of natural gas reserves to Bolivia. The country is home to an estimated 55 trillion cubic feet. But attempts to export gas have encountered massive resistance from citizens and politicians alike, who balk at the requirement of piping the gas across Chilean (formerly Bolivian territory) and accessing a Chilean terminal. Massive protests against various export schemes forced President Gonzalo Sánchez de Lozada to flee to Miami in October 2003.

In an effort to placate impoverished and revanche-minded compatriots, Lozada's successor, Carlos Mesa, has all but explicitly linked resolving Chile's energy shortages to rectification of Bolivia's inalienable right to a coast. Declaring Bolivia, "an energy power," Mesa said that the country has to "decide on a state policy for export, industrialization, and decision making."[iv] 

At the same time, the Bolivian government has poisoned the domestic investment climate, reneged on plans to liberalize the country's energy markets and levied additional taxes on the oil and gas operations of multinationals.

Meanwhile, the Chilean government is looking as far afield as Indonesia as a source of natural gas imports and is putting up tax dollars to construct a $500m import terminal. Sadly, the state and court intellectuals have entrenched cross-border animosities so deep that individuals or companies from Bolivia cannot sell gas to Chileans who are willing and able to purchase it.     

Unsavory etatist solutions

Besides antagonizing neighbors and rekindling Bolivian irredentism, the Argentine government is scrambling in other ways to ameliorate the country's energy woes. Since the beginning of May, Buenos Aires has incrementally unveiled an "Integral Energy Plan" that combines employing incentives, penalties and augmenting public sector participation, thereby perpetuating the problem—as only a state can.

In order to curtail consumption, Argentine officials have proposed a carrot-and-stick approach, rewarding households and firms that use energy at a level 95% or below of what they drew upon the preceding year. Entities whose demand for gas and electricity exceeds the 95% threshold will be liable to pay 40% and 50% more per cubic metre and Kilowatt-hour, respectively. Other price rises have also been mooted, ranging anywhere from 15% to 100%.

So far only token rate increases have been permitted by the government, involving compressed natural gas, which target drivers of petrol-to-gas converted automobiles and the biggest consumers in the industrial sector.

Diversions of gas bound to foreign markets, especially Chile, will continue indefinitely. New export taxes on liquid fuels and petroleum have also been introduced. Access to buyers abroad is steadily elapsing.  

Making good on an ominous threat in late March to take the "necessary measures" to supply gas and investment in the stead of private enterprises, Kirchner and his bureaucratic thugs trumpeted the formation of a national energy company. The remit of the state's newest creature—aka Energía Argentina S.A. (Enarsa for short)—is likely to delve into gas and oil exploration off the country's South Atlantic coast, offer a range of goods and services and shore up the energy transportation infrastructure.

Along with engaging in joint ventures with domestic firms and foreign state energy companies, the Argentine government is opening up its creation to private investment. Approximately 35% of Enarsa's shares will be available for purchase by the public with the country's provinces and the national government retaining stakes of 12% and 53% apiece.

In a quintessentially etatist scene, Planning Minister Julio de Vido resolutely announced on May 11 that Enarsa would, "guarantee the presence of an active state."

No más

Despite the Argentine government's belief that the utilization of fait accomplis and fiat will eliminate the country's energy shortages, few of its plans hold water, let alone address the fundamental problem—distorted markets.

The timid price rises announced thus far fail to require residential users to pay gas and electricity prices approaching the prevailing international price. Argentine households, hooked on the drug of government subsidy, are loath to part with the mean price for energy they are accustomed to. As usual, political popularity trumps markets and unfortunately perpetuates Argentina's dearth of energy.

What is more, even if utility rates were allowed to rise by the 100% or so the government has meekly mooted (if not scrapped already), the increase would still reside below the price quoted abroad. Worse yet, those dreadful price controls would remain intact, albeit less onerous.  

Clearly, the burgeoning role of the state in energy production and distribution is rife with ills. Though the refrain may be redundant, it is nonetheless important to briefly reiterate that state companies do not operate by the same rules as private firms do. Whereas governments and their tentacles exist by virtue of compulsory taxation—better known as theft—and are only indirectly accountable at the ballot box, any seller unable to coercively acquire revenue must abide by prices and the attendant profits and losses, an unambiguous gauge of consumer satisfaction.

Furthermore, the advent of a state company charged with mitigating energy scarcities anteceded by a price freeze, testifies to the validity of Ludwig von Mises's insight that one government intervention necessitates another, compounding the Argentine economy's plight and condemning it to added heartache.

Argentina's energy obstructions can be stated as such: markets unhampered by government predations are nonexistent, fostering an atmosphere inimical to investment. Who would want to devote capital to an industry that is systematically forced to receive a mere third of the price for the same commodity sold abroad and suddenly prohibited from offering it to customers who are willing to pay that dearer price?  The anti-market bombast of Argentina's national government does little to attract private investment in this sector either.

Restating the obvious, Kirchner's Cabinet Chief, Alberto Fernández, recently said that the state business, "has no commercial purpose."

Given the present distortions and impending aggrandizement of the state's role in Argentina's energy sector, new investments will remain latent, production and distribution facilities will depreciate without replacement and haphazard government meddling will all conspire to exacerbate the country's gas and electricity shortfalls.

Referring to domestic energy companies that have refused to heed government exhortations, President Kirchner said on May 12, "Everyday there are pressures to return to the old country,"[v] meaning the preceding decade of privatization. For once el presidente is correct, insofar that he is dragging the country backwards, not to the 1990s, but to the 1960s, 1970s and 1980s, when state energy monopolies, mismanagement, theft, waste and the detestable apagones reigned ascendant.

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Grant M.   Nülle is a Research Fellow with the Ludwig von Mises Institute. He can be reached at grantn007@yahoo.com. Comment on this article on the blog.



[i] Kuczynski, Pedro-Pablo and John Williamson, eds. 2003. After the Washington Consensus: Restarting Growth and Reform in Latin America. Institute for International Economics.

[ii] "The laws of economics bites back." The Economist. April 22, 2004.

[iii] "Bolivia: 'The Situation is complex but not yet a disaster.'" Financial Times. March 28, 2004.

[iv] "Interview-Bolivia's Mesa defends decision to block gas sales to Chile, restates sea claim." BBC Monitoring Service. May 4, 2004. (Interview broadcast on Chilean Television)

[v] "Kirchner justificó la suba a las retenciones." La Nacion Line. May 12, 2004.