Natural Gas Supply Behavior under Interventionism: The Case of Argentina.

AuthorBarril, Diego
  1. INTRODUCTION

    Argentina became, in the last quarter of the past century, an important producer of natural gas after some important discoveries of conventional resources in Patagonia. The country followed a rapid and economy-wide substitution in residential and commercial segments, the industrial sector, electricity generation and even transport. Indeed, it has been recognized as part of the group of countries used to illustrate a fast and deep penetration process of natural gas (see Hansen and Percebois, 2010, chapter 4). At the beginning of the 2000s natural gas had a share well above 50% in the primary energy mix and several exports projects mainly to neighbor countries (mainly Chile) were set to take up to 20% of domestic production. More than two decades ago, an evaluation mission by the World Bank (1990) commended the important substitution to natural gas performed by the country, but alerted that unless supply could evolve rapidly too, there could be problems in attending all segments of demand (including exports). The report even conjectured that if the status quo they were observing extended into the future, the country could hit a critical reserve-production ratio in 2002. This prediction actually happened, but with the unfortunate coincidence of a large macroeconomic crisis, an extensive contractual default and the introduction of long-government intervention in energy markets (see e.g. Pollitt, 2008; Cont et al. 2011). In less than two years, the country faced an energy-crunch in the natural gas market which led to mandatory export cuts to Chile, broken contracts (Navajas, 2008) and a command-and-control management of imbalances, while electricity and natural gas prices were kept frozen for main demand segments. (1)

    Earlier quantitative decompositions of the energy imbalances attributed a central role to demand (see e.g. Cont and Navajas, 2004), but after peaking in 2004 natural gas production has been falling consistently. Figure 1 represents the monthly evolution of aggregate natural gas production and domestic consumption from 2003 to 2013. The Figure shows that the fall in production has been matched by a corresponding increase in net imports in order to satisfy domestic demand. Thus, supply and demand behaved in an unrelated manner during the sample period, both contributing at different stages to the widening gap covered by a drastic switch in the net export position. Demand did not show, on this basic accounting, an effect upon supply dynamics, except for demand shocks years with harsh winters or due a very short and mild recession in 2009. Furthermore, the nationalization of the leading firm in the gas market (YPF) in early 2012 did not change the observed underlying dynamics.

    Different arguments put forward by academic studies or policy debates have attempted to explain this phenomenon, depending on the role attributed to firm behavior on the one hand and the policy or regulatory environment on the other. The government or official view attached the culprit of the fall in production to the lack of investment efforts by large firms and in particular YPF (controlled by Repsol since 1999), which ended-up in an expropriation announcement in April 2012. (2) Other views regarded the drop in production as the expected evolution of conventional natural gas resources beyond the impact of regulatory interventions (Ponzo et al., 2011). Others see a central responsibility in energy policy either due to earlier planning pitfalls--like the one waved by the World Bank report mentioned above--or as a contractual disruption in natural gas markets created by an interventionist paradigm adopted since 2002 (see e.g. Navajas 2008; Recalde, 2011). Yet other commentators have mentioned strategic market behavior given the dominant role of YPF, albeit no paper has attempted to model or quantify the argument. Variants of these many explanations put different weights to investment efforts, lack of contractual renegotiation to extend concessions, a too permissive exports program in the late 90s, the under-performance of the major area (Loma de la Lata), departure from border prices embedded in imports from Bolivia and the like. However, these effects have not been tested in the received literature, and the empirical support for many claims relies on casual observation, descriptive statistics or partial relationships that do not control for other effects and therefore do not fit, in our view, into a credible methodological testing. Simple evaluations of production performance are not robust since they do not control for the maturity of areas. Investment performance is endogenous to economic incentives faced by firms. The observed drop in production is more general than a simple pattern attributed to certain areas or firms. Besides, strategic (coordinated) behavior explanations require some collusive behavior that does not fit into observed features such as asymmetries in market shares and excess capacity in the transport system (see Ivaldi et al., 2003 for structural elements that raise the likelihood of tacit collusion) or is contradicted by the absence of a policy reaction function that adjust prices to shortages (strategically engineered by shortages).

    All these arguments were stated before the decision to nationalize YPF in early 2012 and therefore do not consider the empirical evidence on performance that emerged after such drastic change which was a culmination of several years of interventionism in natural gas markets. As Figure 1 shows, the evidence of pre and post nationalization performance in natural gas production in Argentina does not show structural change. Despite government short run expectations, the decline became more severe after nationalization for both the new YPF but in particular for the rest of the firms. This more recent evidence tilts the priors in favor of the central argument made in Barril and Navajas (2011) that associates the drop with depressed economic incentives acting upon mature conventional natural gas fields and hindering investment in reserve additions or new technologies. This is particularly important as Argentina was in 2013 just starting up the development of non-conventional natural gas (3) production with YPF now leading that process, after a substantial correction of price incentives.

    The aim of this paper is to use a basic theoretical framework and empirical modeling so as to contribute to the scrutiny of the likely factors behind the post 2003 sharp fall in natural gas supply in Argentina. The importance of clarifying at least some aspects behind recent production performance is crucial from both positive and normative perspectives. From a positive perspective we attempt to critically evaluate simple unconditioned arguments that explain aggregate production as arising from certain areas or firms and show instead that the phenomena is more general and therefore more market-driven. At a normative level, we hope to contribute to the current energy policy debate, pointing to economic incentives problems behind the status-quo policy and, while modeling the performance of conventional natural gas, helping at calling for the urgency to move towards non-conventional gas development. (4)

    The structure of the paper is the following. In section 2 we provide a basic framework that we claim should be the starting point from where to refer the empirical evaluation of the drop in production. We do so by using a simple supply model of a non-renewable natural resource with a basic framework adapted from the literature (see e.g. Pickering 2008 and Medlock 2009) that allow us to derive an optimal supply from a producer--that in our representation is constrained by regulated prices--and is facing a depletion process (as reserves fall) that raises production costs (i.e. decreases productivity). We do not wish or attempt to proceed to structurally estimate or adjust this simple model to Argentine data. Instead, we use one main representation--the fact that production should be seen as conditional on reserves or, equivalently, cumulative past production--as a guidance to specify our empirical research on a large data base constructed for this paper and used for the first time in an econometric assessment of natural gas production performance in Argentina. In section 3 we account for the characteristics of our data set--a panel of the change in annual production of 168 areas of production between 2003 and 2013, the specification of our econometric equation and the definition and sources of the main variables. Natural gas supply depends on past accumulated production (or alternatively on remaining reserves) that represents resource depletion and on a set of controls to capture basin and area heterogeneity, firm effects, investment efforts, extension of concession contracts, link to an export project and demand effects as a reaction to winter rationing of industrial customers and electricity generators. Section 4 presents the results of our econometric testing and discusses the main results. Finally, concluding remarks and suggested extensions are included in section 5.

  2. SUPPLY BEHAVIOR

    Alternative strategies to model the behavior of natural gas production depend on the use of an optimization framework to derive supply in a manner related to the basic theory of exhaustible resources (5) and the explicit modeling of the exploration (drilling and discovery) process that precedes extraction or production either from geological models or from empirical econometric relationships. (6) In this section we sketch a simple model that is based on an explicit optimization and is simplified to capture the essentials of the factors we perceive as crucial in the particular period of the Argentine natural gas market that we are studying. Our setting is a workable simplification that lacks a detailed description of the exploration process and in particular the channel between exploration...

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