47107 WORLD BANK WORKING PAPER NO. 160 Residential Electricity Subsidies Public Disclosure Authorized in Mexico Exploring Options for Reform and for Enhancing the Impact on the Poor Kristin Komives Todd M. Johnson Public Disclosure Authorized Jonathan D. Halpern José Luis Aburto John R. Scott Public Disclosure Authorized Public Disclosure Authorized THE WORLD BANK 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page i WORLD BANK WORKING PAPER NO. 160 Residential Electricity Subsidies in Mexico Exploring Options for Reform and for Enhancing the Impact on the Poor Kristin Komives Todd M. Johnson Jonathan D. Halpern José Luis Aburto John R. Scott THE WORLD BANK Washington, D.C. 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page ii Copyright © 2009 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW,Washington, DC 20433, USA, Fax: 202-522-2422, email: [email protected]. ISBN-13: 978-0-8213-7884-7 eISBN: 978-0-8213-7886-1 ISSN: 1726-5878 DOI: 10.1596/978-0-8213-7884-7 Library of Congress Cataloging-in-Publication Data Residential electricity subsidies in Mexico: exploring options for reform and for enhancing the impact on the poor/Kristin Komives ...[et al.]. p. cm. — (World Bank working paper; no. 160) Includes bibliographical references and index. ISBN 978-0-8213-7884-7 (alk. paper)—ISBN 978-0-8213-7886-1 (electronic: alk. paper) 1. Electric utilities—Subsidies—Mexico. 2. Electric utilities—Rates—Mexico. 3. Subsidies— Mexico. I. Komives, Kristin. HD9685.M62R47 2009 333.793'23—dc22 2008051806 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page iii Contents Acronyms and Abbreviations . v Executive Summary . vii 1. Introduction . 1 2. Residential Electricity Subsidies and Tariffs in Mexico . 5 3. Distributional Incidence of Residential Electricity Subsidies . 15 4. Assessment of Alternative Subsidy Mechanisms . 27 5. Synthesis of Findings and Ways Forward . 45 APPENDIXES A: Evolution of Residential Electricity Subsidies and Tariffs in Mexico . 51 B: Residential Electricity Tariffs in 2006 . 53 C: Tariff Reclassifications, 2002–06. 57 D: Analysis of Subsidies Using CFE Data. 61 E: Analysis of Subsidies Using ENIGH Data . 65 F: Tariff Reform Scenarios. 71 Bibliography . 75 iii 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page iv 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page v Acronyms and Abbreviations CAS Chile’s Means-tested Program (Caracterización Social) CFE Mexico National Electricity Commission (Comisión Federal de Electricidad) DAC High Consumption Residential Tariff (Tarifa Doméstica de Alto Consumo) ENIGH Mexico National Household Income and Expenditure Survey (Encuesta Nacional de Ingresos y Gastos de los Hogares) GDP Gross domestic product HH Household IBT Increasing block tariff IPP Independent power producer kWh Kilowatt-hour LFC Central Light and Power, Mexico City (Luz y Fuerza del Centro) MP Mexican peso MWh Megawatt-hour OECD Organisation for Economic Co-operation and Development Oportunidades Mexico’s conditional cash transfer program for the poor Oportunidades Oportunidades program focused on energy (established 2007) Energéticas Pidiregas Deferred financing mechanism to support private sector energy sector investment in Mexico (Programas de Inversión de Impacto Diferido en el Gasto) RES Residential Electricity Schedule SEDESOL Ministry of Social Development (Secretaría de Desarrollo Social) SENER Ministry of Energy (Secretaría de Energía) SHCP Ministry of Finance (Secretaría de Hacienda y Crédito Público) VDT Volume differentiated tariff Currency Equivalents Currency Unit = Mexican Peso Exchange Rate (Exchange Rates Effective April 3, 2008) 1 US Dollar = 10.557 Mexican Pesos 11503-00a_FM_rev.qxd 1/6/09 9:44 AM Page vi 11503-00b_Exec_Sum_rev.qxd 1/6/09 9:46 AM Page vii Executive Summary This report addresses a pressing issue in Mexico’s electricity sector—the large and growing subsidies to residential consumers and their regressive incidence across different segments of the population. It responds to requests from the Ministry of Energy (SENER) to provide a preliminary assessment of alternatives to the current subsidy system, building on prior collaboration between the Government of Mexico and the World Bank on the distribu- tional impact of public spending, the performance of conditional cash transfer programs and other poverty-targeted programs, and related work on pricing and subsidies for infra- structure services. This study was designed as the first phase of a multiphase program of collaborative analytical work. This first phase provides estimates of the distributional and fiscal performance of alternative subsidy targeting mechanisms to help inform discussion and deliberations on feasible goals and practical approaches over the medium term. A sec- ond phase would address transition paths, specific compensatory mechanisms, and deci- sion processes for pursuing the options that the Mexican authorities deem most promising. Electricity subsidies in Mexico are among the largest in the world (US$9 billion in 2006) and have absorbed a significant proportion of public resources. Subsidies in 2006 were equivalent to about 1 percent of gross domestic product and were more than one-third of total electricity sector revenues. Over two-thirds of electricity subsidies go to residential consumers, and the volume of subsidies to residential customers increased by 46 percent between 2002 and 2006 in real terms. Tariff subsidies of this magnitude impact heavily on the performance of the electric- ity sector and on Mexican society more generally. ■ First, the cost of the subsidies needs to be covered in some way—if not by con- sumers, then by government; if not directly by the government, then by reduced spending on system expansion to meet growing demand, on service quality upgrades, and on operations and asset maintenance. Fiscal transfers to the utilities divert resources from priority social and economic programs and reduce fiscal space for financing priority investments in the electricity sector. The 2006 federal budget for investment in electricity (excluding the Programas de Inversión de Impacto Diferido en el Gasto [Pidirigas]) was 40 billion pesos, only slightly larger in nominal terms than it was in 2001 and less than half the total volume of subsidies. ■ Second, subsidies distort price signals, elevating demand above what it would be if electricity was priced at marginal or average cost. Massive underpricing also mutes incentives for customers to take energy saving measures, such as replacing old equipment and appliances. Higher customer demand requires additional power supply, especially to meet periods of peak demand. Because elevated residential electricity demand tends to lower load factors for the power system, it leads to reduced efficiency in the use of generation and transmission facilities and thus to a higher marginal cost of supplying all customer classes. This has negative implica- tions for economic competitiveness. ■ Subsidies also engender environmental costs. Elevated demand leads to incremen- tal emissions from power plants, including local pollutants responsible for poor vii 11503-00b_Exec_Sum_rev.qxd 1/6/09 9:46 AM Page viii viii Executive Summary air quality (such as particulates and ozone precursors) and global pollutants linked to climate change. Further, standard merit order dispatch rules exacerbate the ten- dency for marginal generating plants (those with low capital costs, but high fuel costs, such as small fuel-oil and diesel-fired facilities) to generate higher levels of pollutants. In rural areas, electricity subsidies for irrigation pumping exacerbate overexploitation of groundwater