What do you get if Socialists took over the Sahara? A shortage of sand!

It’s an old joke, and not a very good one. But in Venezuela, it’s oddly prophetic. Socialists have indeed managed to take the country with the world’s biggest energy reserves and put it through a grinding energy shortage.

How?

News outlets keep calling our energy problem an “electric crisis.”

We think that’s wrong – subtly, but profoundly. There is no “electric crisis”. What we have is something different, we have an electricity shortage.

Try it on for size. The next time the power goes out, tell the first person you see: No hay una crisis eléctrica, hay escasez de electricidad. It’s not just a semantic quibble; it’s a Copernican shift, one that completely upends how you understand what we’re going through.

It primes you to understand that what’s happening with electricity in Venezuela isn’t really different with what’s happening with rice. If you set an artificially low price cap on rice, consumers will demand more of it than suppliers can supply. If you set an artificially low price cap on electricity, consumers will demand more of it than suppliers can supply.

Notice how there is exactly nothing about “Guri” or the rainy season or El Niño or anything else we usually associate with “the electric crisis” in that explanation. In fact, you don’t need any of that to explain the whole of the electric problem. The more we fixate on Guri’s water level, the more we miss the basic drivers of the problem.

For young readers it might come as a surprise but, back in the days we didn’t have an energy problem. Blackouts were extremely rare in Venezuela a generation ago. Electricity was provided by a mix of private and public companies, prices were negotiated with regulators in a way that guaranteed enough was left over to reinvest. Production was not fully private but a sensible price mechanism served as an incentive to ensure demand wouldn’t consistently outstrip supply. Companies (both public and private) charged prices that were at least high enough to make people consider not wasting energy. In real terms, for 2013 the average residential electricity price was about ⅕ of what it was in 2006.

That mixed system stopped in 2007 with the nationalization of Electricidad de Caracas and the foundation of CORPOELEC. Since then, the government has pursued an active unsustainable policy of keeping prices almost completely fixed in a highly inflationary economy, leading the real price of electricity to drop sharply. They even had the nerve to brag about this. Jesse Chacón, who was back then Minister of Electricity, boasted that Venezuela had the lowest electricity price in the world.

After Guri’s dry scare of 2009-2013, there was a half-baked price increase with opaque rules that were never fully revealed to customers (a XXIst Century Socialism classic, like Cadivi). According to Jesse, in 2014 the average price of a KW in Venezuela was US $0.03. He said that in dollars, but obviously he calculated the price at the government’s exchange rate, so the price is calculated at our 6.30 strong BS rate (pun intended).

Electricity markets are quasi-monopolistic by nature, so few economists and even fewer governments think it’s a good idea to let companies set them entirely on their own. In practice, most governments negotiate prices with energy companies, just like the Venezuelan government used to.

According to the World Economic Forum’s Global Energy Architecture Performance Index Report 2014 (in page 84) , Colombia (which is always a good comparison case) had an average industrial price of US $0.10 per KWh in 2014. Brazil and Chile’s pricing for the industrial sector is on the high end, in international perspective: US$ 0.16 and 0.15 respectively.

When you look at energy usage per-capita from 2006 to 2013, according to World Bank figures, the increase is relatively modest, from 2958 KWh to 3245 KWh. Yet the increase was at the expense of a more inefficient use of resources. Unplanned supply cuts became norm outside the capital, and restrictions in consumption of electricity forced some sectors to either shut down at certain times or even buy generators.  

Blackouts and electricity rationing have even made malls buy their own generators (40 out 140 members of CAVECECO own their generators). Some mayors have taken measures to deal with these issues at the local level to avoid shortages in Hospitals. Even Metro de Caracas is partially relying on its own supply of electricity. All these generators can’t rely on economies of scale and have to produce electricity at a much higher price than they would in a functioning market. This is a very inefficient allocation of resources, since a larger functioning electrical company could generate more energy at a much lower price.

Irresponsible pricing is part of the story, a government-sponsored inefficient behemoth (Corpoelec) is the other part. The nationalization of the industry also meant that the electricity company couldn’t care less about who paid their bills or if electricity was lost. From 2007 we saw a large increase in non-paid electricity, which accounts for a combination of electricity theft and waste in transmission. According to 2012 Memoria y Cuenta, most of it is due to plain waste, and lack of maintenance seems to be the main cause, since only around half of the approved projects were executed. As of 2011 Corpoelec reported around 34% of electricity usage as not paid for (an increase from around 22% in 2006). Ecoanalitica projects this figure to be around 44% in 2016.

And if you think electricity theft is just about illegal connections in residences, think again. The public sector plays a big role, with ministries and State-owned enterprises chronically late on their power bills. In 2013, Corpoelec said one of the major challenges to collect money was to follow up on over-due bills in the public sector, big users and social residences.  As usual, official data is thin on the ground and then years out of date, but according to the Minister, as of 2010 the debt of the public sector to Corpoelec was BsF 4 billion (even at the highest rate at the time this was more than US$ 400 million). Part of this debt has had to be written off.  

People point to lack of investment, draught and so on as the reason behind our dilemma, but few have been talking about the roots of the problem: price controls and a company that is not performance oriented.

Price controls are like Meth. We love them. They give us all a short term boost that allows us to fool our future selves into thinking that our almost free consumption is sustainable. Politicians are no exception, they love the boost they get in the polls and fool themselves believing that they can handle the future consequences. Utilities is a sector in which correr la arruga is particularly tempting. They are capital intensive industries, in which assets last a long time. Once the investment is in, to produce a unit of electricity is cheap.

The irony is that in the long term, an extra unit is really costly. So you end up needing very big new investments to get production to keep up with demand. In the short term it may seem like a great idea to provide a public service at laughable rate. But even if your State-owned utility is run by the world’s most honest and hardest working managers, fixing prices below investment guarantees investment can’t keep up with demand. Shortages follow price controls as surely as night follows day.

Political leaders tend to see price controls as either a great policy or one too costly to lift. But once the real economic damage is done, it’s done. Bringing prices to a more rational level not magically solve our problems. It’s an unavoidable first step, but it’s only a first step.

But keeping price controls in the industry and acting as if that’s not a major problem, is like telling a patient with an emphysema that even if they stop smoking cancer will not go away, so there’s no problem in lighting a cigarette.

Moving forward, as a country we will have to make difficult choices and accept that we were living way above our means. Venezuela can no longer afford irresponsible politicians promising a free lunch.

12 COMMENTS

  1. “Shortages follow price controls as surely as night follows day.”

    Price controls is the cause of most the problems in Venezuela today.
    The day people understand this and reject politicians that offer to reduce prices by decree will be the day the country will be in its way to becoming a developed country.

  2. I’m all against price controls doesn’t make any sense at all to charge below cost (cost of production, maintenance, updating/upgrading). However, in today’s Venezuela I fee,l and this is just my opinion, that any extra income from a public enterprise will not be towards improving or increasing the service. The extra income will end up in some new “Mision”, somebody’s pocket, etc. Supposedly, there have been millions of dollars approved and allocated to improve the electricity generating system since 2010, but we don’t know where that money went.

    Also, when prices increase, as they should, I hope the burden doesn’t fall only on those who pay. I really don’t want to pay for the 44% who doesn’t.

    • We agree that the resources shouldn’t go to waste in an administration like the current one. That’s why we believe that the electrical company should be performance oriented and transparent. However, this doesn’t make it a good idea to keep the prices low even under the current regime. We know that clientelism and corruption are important problems, but waiting to solve this before acting is not a good policy. It’s similar to what happens with gas prices.

      Regarding the 44%, is not that they rob electricity. The majority is simply wasted because of lack of maintenance. We explain this in the article. In fact, its difficult to think that small households that rob electricity could account for so much consumption. Of course, it’s important to decrease electricity theft. But, we don’t see this as an excuse to keep prices low.

  3. Anything of recoginezed value that is given away for free will – in time – have infinite Demand, resulting in shortages. It’s human nature.

    In this extreme case of unbalance both the supply and demand side eventually breakdown.

  4. Great post guys!

    This piece is very relevant for a new administration trying to solve the electricity “crisis”:

    “…Keeping price controls in the industry and acting as if that’s not a major problem, is like telling a patient with an emphysema that even if they stop smoking cancer will not go away, so there’s no problem in lighting a cigarette.”

    The incentives to avoid raising prices are clear enough using this metaphor. Will the new govt be responsible enough to take the long-term-sensible decisions (not only on the electricity sector but on all malfunctioning sectors of the economy) despite the short-term drawbacks of doing so?

    La pregunta del millón, si me preguntas a mi… Not sure our current MUD would be down with this approach..

    • Yeah, yeah, raise the prices, ok, let’s say that gutting 10 to 15% of a monthly salary in the bill isn’t high enough to “cover the costs”, BUT, do not forget that is more important to FORCE THOSE WHO STEAL THE POWER TO PAY FOR IT. Which applies for the water too.

  5. […] But because indirect subsidies are, almost by definition, poorly targetted, they tend to spill, generating some unforeseen windfalls to a few crafty people who find an angle on the system. Take this: the folks over at Reason have a pretty comprehensive report on Venezuelans who turn watts into bits (and $) leveraging the lowest electricity prices in the world. […]

Leave a Reply