Mexico’s energy reform: market forces not so powerful after all

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One of the main goals of Mexico’s energy reform is to make energy cheaper, thus improving the economy’s productivity and the quality of life of Mexican citizens. The reform seeks to achieve this by introducing competition and market forces in a sector until recently monopolized by the government. The reforms passed in 2014 made drastic changes to the structure of hydrocarbon and electricity markets, introducing competitive bidding and a wholesale market for electricity that would force the retirement of older plants and their replacement by more efficient ones.

The benefits of these reforms, both in the price and quality of energy, cannot be expected to be felt immediately, as it will take time for investment in newer, cheaper, and cleaner forms of energy to materialize and influence average prices. Market forces, however, should be reaching consumers at the pump and passing along the benefit of the slump in international prices, as they have in the U.S. The price of gasoline in Mexico, however, has risen in the past years. Significantly. The government says it is the result of the elimination of subsidies during a transition period to market-driven prices in 2018. It’s actually more complicated.

The adjustable tax

The government of Mexico has historically set the price to be paid by final consumers at the pump. Since the mid 1990s, the government began applying a variable excise tax on fuel (known by the Spanish acronym IEPS) equal to the difference between domestic and international prices. When the international price is higher than the domestic price set by the government, the tax becomes negative, effectively subsidizing consumers, while in the reverse situation, it generates revenue for the government.

From 2006 to 2014 the government was effectively subsidizing consumers. Starting in 2008, however, the government of Felipe Calderón implemented a policy of price increases meant to reduce this subsidy and bring prices closer to the international reference price, U.S. Gulf Coast Regular. As the chart shows, this policy of price increases continued until 2015, when a liter of regular peaked at $13.57 or $51.37 a gallon (right axis) registering an increase of over 50% since 2011 and nearly 90% since 2008.

Source: EIA, INPC, Central Bank of Mexico, and author’s calculations

Despite the increases, until 2014 the price of gasoline in Mexico was below the international reference price, resulting in a negative tax for the government. When international prices bottomed out in 2014, the relationship reversed, and the government began collecting the difference.

The energy reform has eliminated the variable tax and is letting the market set prices, beginning in 2018. In the intervening period (2016-17), the IEPS will have an absolute value of 4.16 pesos/liter for regular fuel, which makes no sense if the goal is to approximate international prices, but which promises to bring significant revenues to the government.

Sources: Mexican Lower House of Congress and La Jornada UNAM and author’s calculations

For many decades the government of Mexico has controlled fuel markets with multiple, and often conflicting, goals. One is revenue collection. When international prices are low, the government reaps the difference. The other is to dampen the effect of sharp price increases on inflation and the purchasing power of the average Mexican. When international prices are high, it shields itself from the punitive effects of such an increase by keeping prices stable. The energy reform will not change this. We should expect price controls on fuels to continue in Mexico in the foreseeable future.


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