<B>Red hot gas</B>

José Mario Alvarez de Novales. Professor. Strategic Management. Instituto de Empresa

26 July 2004

The current problem between Argentina and Chile is part of a general situation worldwide, one which has been in our sights for awhile. However, for many it seems to have broken out overnight.

Anyone trying to map the tension between nations tomorrow should make sure to include at least three elements in the outline: energy, water and money.

Overall, energy and water are part of the same problem. Nations with abundant water resources can generate the energy they need using waterfalls, or, in the future, by harnessing the sea’s energy. Nations lacking water but with access to the oceans can turn this latter into freshwater and transport it, thanks to their energy. In a world with a growing demand for energy and a limited supply of it, energy crises rear their heads one after the other. In Argentina last year, the low price of gas compared to other energy sources pushed demand for electricity up 8 percent, gas for vehicles 30 percent and doubled demand for electricity. This was due, among other reasons, to improvement in the industrial situation. But any increase to the overall system requires substantial investment, or lots of money. And that is the fourth variable.

We have witnessed unexpected power cuts in various parts of the world, resulting from the incapacity of the transport network to function when demand reaches a peak. This is particularly so during heat or cold waves. In Europe, demand for air conditioning has risen sharply in anticipation of the coming summer and fear of another heat wave, which left thousands dead in 2003. These increases in demand are not easily met with investments in the short term.

Other kinds of power cuts are produced systematically to save energy when it cannot be acquired, produced or transported. Many Latin American countries have suffered energy restrictions at night or at other times. Argentina’s Interior Minister has had to insure there will be no mass power cuts. Reduction of power to 209 volts is one way to trim consumption, though it saves less than might be expected. Many companies (the PC I'm using now, for example) have stabilization systems which supply the power required even though the voltage is lower. In fact, the measure taken by Argentina was revoked last 30 April.

If consumption increases, the only solution is to augment supply, and that requires investment. However, investment is complex. Power is often transported in the form of electrical energy, which can be generated by gas, coal, oil, waterfalls, windmills or nuclear power. These power stations cost a huge amount of money and need to pay for themselves. But once built, they are not always used. If the price of energy rises (such as oil, presently at $40 a barrel), other kinds of stations tend to be used while the more expensive ones get shut down.

Latin American problems

This is the dilemma affecting Chile, which needs to compensate its lack of cheap gas with production of coal and oil power stations, which leads to higher energy costs. The traditional friendship between Bolivia and Chile has been under strain because of it.

Let us suppose that a company has a gas power station and the price of gas rises. Increase in production capacity would not be frozen if it were the only way gas could be produced, and the market would be deregulated. There would be an increase in the price of energy produced by gas. If the market were not deregulated, and the government – trying to remain popular - were to freeze the price of electricity, two things would happen. First, as long as the price of gas remained lower than electricity, it would continue to be produced without amortizing installations or repaying investment. Electrical power station would fail in the midterm. However, if the price of gas soars higher than electricity, the electric company would not be able to keep up and would very quickly go bankrupt.

This is why Argentina’s electric companies refused to replace gas with diesel fuel, which is much more expensive. The offer made by Alí Rodríguez, president of Petróleos de Venezuela, to Argentine President Néstor Kirchner, to sell Argentina 700,000 cu. m of diesel fuel is not so easily put into practice. It led to an agreement with Bolivia, between Néstor Kirchner and Carlos Mesa, for supply of 4 million cu. m of gas a day during the winter of 2004 and 2 million over the rest of the year. These figures are set to grow to 6 million cu. m from 2006.

We can see that if prices are not deregulated, lack of investors’ incentive would follow. This means that free-market pricing is a requirement to guaranteeing private investment - as shown by the IMF’s response to the capacity increase that has paralyzed Argentina since 2001. Here too, free-market pricing is a complex affair. On one hand, if the market is segmented, as in Argentina, a 40-percent price increase for large industrial consumers might not create an upset in the short term. However, it won’t prevent a greater loss in national competitiveness than that would result from an increase at the same level throughout the nation. In fact, this asymmetry will create bitter controversy and legal battles with the affected companies.

Consequently, Aníbal Fernández has declared that “there is no danger” of requesting the increase. Of course, there is much space between what is said and what actually occurs. If prices are controlled and investment is not encouraged, the only choice will be to turn to public investment in transport, extraction and generation. Argentina’s announcement of creation of a national power company, Enarsa, is a classic way of covering the hole. The idea is to build one new gas pipeline and extend another. What is not clear is how the cost will be met by the “tax profits” up to 2007 as announced, because, among other things, the anticipated profits were to be used to pay off foreign debt. Only months ago, Argentina reached a critical crossroads with the International Monetary Fund, due to the problems it had reimbursing $3.1billion. Argentina owes $82 billion, plus interest, and is asking private investors to write off 75 percent of that. Investors however are prepared to forgive only 35 percent. If Argentina does not become an economically credible nation – which appears doubtful in the short term - no one will want to lend money or invest in its markets that are prone to regulation at ministerial whim.

Chilean conundrum

Rodrigo Rato, the IMF’s new managing director and former vice-president of the Spanish government, has declared his support of upholding Argentine welfare while earning credibility to attract new foreign investment. Rato, known for his political skills, also takes an unwavering stance on deficits, which will likely grow more rigid in the event of any populist spending. Argentina’s extension with the IMF, the IDB, the World Bank and the Club of Paris until 2006 requires payments that include the use of 3 percent of 2004 tax profits for repayment of the debt; the figure is expected to grow in 2005 and 2006. The northwest gas pipeline alone will require investments of $250 million from the state and $750 million from privately-owned Techint, which is involved through two of its subsidiaries: Tecpetrol in exploration and production, and Tecgas in distribution. It is not clear how Techint will finance its investment. Argentina is paying for part of its past and present populist policies. No one knows if the final scheme is the right one.

Chile continues to suffer from breakdown of its relations with Bolivia and the internal tension affecting its neighbor’s gas situation. Bolivians are aware that gas is a scarce resource, one with economic value. The problem is how to capitalize on it. The Pacific LNG project to export gas from Bolivia to Chile and the U.S., promoted by REPSOL, British Petroleum and British Gas, caused such a revolution that in Oct. 2003, 60 people died and the Sánchez de Lozada government was brought to its knees. Bolivians from all social spheres refused to accept that their country would receive 18 percent of the price at the wellhead. They want to re-establish the YPFB, industrialize gas and have that company, not multinationals, sell it. Meanwhile, some want to block the agreement that has already been reached. If that happens, we shall have a hot southern winter.

It would seem logical for Chilean President Lagos to encourage the national petroleum company, Empresa Nacional de Petróleos, to develop a project for importing liquid gas by sea to achieve energy independence. This would make it possible for Metrogas and Copec, Chile’s private gas firms, to put dependence on Argentina behind them. Chile has the economic capacity and solvency to invest the $400-500 million required.

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