Mexican Energy Reform: A trigger for competition in the Mexican energy sector – Antonio Massieu ’13

Editor’s note: The following post was written by Barcelona GSE alumnus Antonio Massieu (Competition and Market Regulation ’13). Antonio is Senior Associate at Santamarina & Steta S.C. in Mexico City. 

Flickr / CC
Mexico City illuminated at night / Flickr / CC

The energy industry in Mexico is experiencing the biggest paradigm shift in the past seven decades, since the oil expropriation in the late 30’s. The energy reform that was recently enacted will dramatically change the way the energy sector is developed in Mexico, meaning the most significant economic happening since the execution of NAFTA, in 1994. Said reform will shake the Mexican energy industry vigorously, transforming a monopolistic sector operated by two state companies that performs the vast majority of the productive sector activities, into an open-market industry where players can freely participate through clear and transparent rules, under the regulation of operators and agencies endowed with broad powers. The profound changes brought by the reform occurred both in the substantive areas of the industry and in the institutional structures that shape the energy sector. In one hand, the new legal framework redefined the way the activities that constitute the productive chains of the hydrocarbons and electricity sectors are carried out; in the other hand, the institutions responsible for supervising and regulating the market performance were considerably strengthened.

Naturally, as a new market emerges, market problems also emerge. Therefore, it will be essential that the new Mexican energy market is wrapped by rules and institutions that seek to correct eventual market failures that arise, and that through their actions, establish an appropriate competitive process that yields benefits to competitors, to final consumers, and of course, to the Mexican State.

Oil&Gas

Modifications made to the Mexican Oil&Gas sector meant undoubtedly, the most important change in the whole energy industry, as a result of the energy reform. Said sector becomes an open market, where Petroleos Mexicanos (Pemex) –formerly the State-owned company that carried out all Oil&Gas exploration and exploration (E&E) activities, will compete against other players from the private sector. This competitive process is implemented through tenders conducted by the federal government, where both the private sector and Pemex will freely participate, in order to be granted with contracts for substantive E&E activities. Transparency will be an element of the utmost importance during the bidding rounds, since it will secure that Pemex and the private sector compete on equal grounds; in other words, a fair and clean competition process will only be possible as long as the federal government does not favor Pemex –which despite its participation in the open market, will remain as a state owned company- or any other bidder in the development and further resolution of the aforementioned bidding rounds, or allow any anti-competitive practices to take place (such as collusive behaviors among the bidders).

pemex
A fair and clean competition process will only be possible as long as the federal government does not favor Pemex / Flickr / CC

As for midstream activities, the energy reform introduced a new market dynamic that will foster a more effective and fair competition process. Currently, the activities of transport, storage and distribution that are developed through the pipeline grid will be operated and managed by a new government agency, the National Center for Control of Natural Gas (CENAGAS). This entity will assume control and ownership of all pipeline infrastructure that today belongs to Pemex[1] – which, due to its economic features, constitutes a natural monopoly-, and administer the activities carried out there. The CENAGAS will operate as a figure internationally known as an “ISO” (independent system operator), and will be obliged to fulfill important mandates, such as granting open and non-discriminatory access to the grid to all participants (including Pemex) and avoid problems of vertical integration in regulated activities, among others.

[1] More the 75% of the pipelines in Mexico belong to Pemex.

Electricity

The electricity sector in Mexico will also be transformed significantly by means of the energy reform, since it will stop being a vertically integrated industry where a State-owned company (Federal Electricity Commission “CFE”) conducts all activities of the productive chain industry, in order to be transformed into a liberalized sector where undertakings (both public and private) will compete against each other in an open market, aiming to satisfy the needs of consumers.

For such purpose, a wholesale spot market will be put into place. Said spot market will seek to replicate international models in order to foster competition among different companies that will be able to generate, trade and supply energy to final users. Domestic supply will be carried out by CFE –at a regulated tariff-, acquiring energy through tender processes, while industrial supply will happen through a free competition process, where generators, suppliers and consumers will complete transactions at market, non-regulated prices. In order to regulate the new market structure, the Government created the National Center of Energy Control (CENACE), which will serve as an ISO, aiming to operate and control the electric grid.

CENACE will be in charge of different relevant tasks, such as the granting of open access to undertakings participating in the electric industry, controlling the allocation of power into the grid (both demand and supply), surveilling the continuous bids posed by market participants into the spot market (in order to avoid coordinated anti-competitive effects) and coordinating the transactions executed by the market players, as well as the configuration of the market, in terms of possible vertical integration in the performance of activities by companies. This market will be particularly interesting in terms of competition policy, since CENACE will be in charge of regulating the operation of a natural monopoly –the electric grid- which is owned by one of the participants of the market, the CFE, which will compete against other undertaking in the activities of generation and supply of power; this represents a very unique case in the world, and will be added as one of the main challenges that Mexican authorities will face with the implementation of the energy reform.

CENACE  operates and controls Mexico's electric grid. / photo
CENACE operates and controls Mexico’s electric grid. / photo credit

Regulators and entities of the energy sector

One of the great challenges of the reform is to establish an institutional framework capable of operating the new emerging energy markets in Mexico, in which various companies (public and private) will interact in a competitive environment, hitherto unknown for the country. Of course, in order to accomplish this goal, it is imperative to create strong institutions, with high degrees of independence, able to issue clear regulations and impose heavy penalties to regulated undertakings.

Both regulatory agencies[1] and ISO’s will need to follow closely the development of the energy markets, and make sure that competition is achieved. Unlike what happened with the IFETEL, which is the independent body responsible for regulating the telecommunications market in Mexico, regulators and ISO’s in the energy sector were not endowed with broad powers in competition policy matters. In this sense, and despite some of its powers seek to create conditions of competition, these institutions will have to interact closely with the Federal Competition Commission, in order to timely detect and punish anti-competitive practices in the industry, in order to correct market failures and increase consumer welfare.

[1] Regulatory Commission of Energy and National Hydrocarbons Commission

Conclusions

Energy reform emerges as a great opportunity for Mexico to join the global trailblazers in the sector. At first glance, the work has been done satisfactorily, as sufficient legal and institutional conditions for implementing competitive markets were generated, where agents will interact correctly, generating consumer welfare. However, the correct development of the industry will depend not just on the rules and the institutions itself, but on the right behavior of both authorities and undertakings. Possibly the only advantage that Mexico has to be the second-to-last country in the world to undertake an opening process of this nature, is that it had the opportunity to study similar processes, and learn from positive and negative experiences in other countries. Now the challenge is to test that knowledge, and build a successful energy sector that can boost growth in the country.

Listen to a radio interview with Antonio Massieu on hydrocarbons in the Mexican energy sector (in Spanish, September 2014)


1 More than 75% of the pipelines in Mexico belong to Pemex.

2 Regulatory Commission of Energy and National Hydrocarbons Commission

Collusion in auctions and the role of communication to sustain it: a microeconomic approach

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2014. The project is a required component of every master program.


Collusion in auctions and the role of communication to sustain it: a microeconomic approach

Author:

Giuseppe Leonello

Master Program:

Competition and Market Regulation

Paper Abstract:

Collusion among bidders in auctions is an important topic in competition economics since it decreases the seller’s revenues and the social welfare. In this project the focus will be on the role of communication among bidders for the incentives to collude.

In the literature, communication among bidders has always been treated as an exogenous variable. This assumption will be relaxed and the choice of communicate will be endogenous and function of the expected collusive profits and the expected costs of collusion represented by the risk to be catch and punished.

The auctioneer can monitor the market and the auction process to discover the collusive agreement, exerting a costly effort.

The model will find the minimum level of effort needed to make bidders not having incentives to communicate and collude. However, the auctioneer will exert this level of effort only when the expected gains are higher than expected costs. For this reason, in some case the optimal choice for the auctioneer will be to lead bidders to collude even if this will not maximize the social welfare.

Government interventions to reach the not collusive equilibrium will be discussed. In particular, they will take the form of an increase in the punishment when bidders are discovered to collude and the subsidization of the cost needed to exert the optimal level of effort.

Competition and the Hold-Up Problem – Guillem Roig ’08

Editor’s note: The following post was written by Barcelona GSE alumnus Guillem Roig (Competition and Market Regulation ’08). Guillem is currently a PhD student at the Toulouse School of Economics in France.


Competition and the Hold-Up Problem: a Setting with Non-exclusive Contracts

words-roig

The paper

Why some of us do not spend the desired time and resources to nurture and improve the relationship with our parents, friends or business partners? Because once the time and resources are spent, we are afraid of possible opportunistic behavior. Economists frame opportunistic behavior in simple trading relationships where a buyer and seller are able to undertake specific investment into the exchanged good. Fisher Body, a manufacturer of body cars, refused to locate their body plants adjacent to General Motors assembly plans, a move that was necessary for production efficiency.

To fight opportunistic behavior we cannot rely on “good faith” alone, but we need to establish institutions to reduce its occurrence. Many modern societies have written laws, neutral courts of justice and arranged reasonable rules to resolve disputes. Yet, what happens when a sound and solid institutional system does not exists? In this paper, I consider situations where investment contracts cannot be enforced and I explore how the introduction of competition among the sellers of an homogeneous good gives the right incentives to undertake profitable specific investment.

In these types of models, the equilibrium payoff of the sellers is a measure of their indispensability, which directly depends on the outside option available to the buyer. The trading partners invest efficiently only when the trading outcome is the most competitive. When competition is the most severe, investments do not effect the outside option of the buyer and each seller appropriates his marginal contribution of the trading surplus. Any other equilibrium gives the seller incentives to over-invest. Sellers’ investments not only generate larger trading surpluses but also reduce the outside option of the buyer. The asymmetric partition of the trading surplus generates investment inefficiencies.

In a related article, I study how the configuration of the market structure is affected by the way an endogenous number of suppliers compete in the market. With non-exclusive trade and a common buyer undertaking cooperative investment, I obtain a direct link between the level of competition and investment that affects the market structure of the supply side of the market. Trading outcomes that are more competitive are associated with a larger and more homogeneous distribution of investment among active suppliers, and an equilibrium with no investment might occur in trading outcomes that are less competitive. Buyer’s investment works as a mechanism to incentivize competition and this becomes more effective the more competitive the trading outcome is. The paper gives a theoretical insight for the coexistence of first with second tier suppliers and predicts situations where investment does not materialize.

Download the full working paper [pdf]

The process

I started this project in September 2012, after a short visit at the University of Arizona where I meet a group of law academics working on the design of trading contracts. I soon became interested in topics of contract theory and organization design and researched in the area of transaction cost economics.

The upturn of the project came in May 2013 when I benefited from an ENTER exchange program at the Universitat Autònoma de Barcelona. I presented my work in a series of seminars and the suggestions of Prof. Inés Macho and David Pérez Castrillo were invaluable at that stage of the project. I dismissed the design of complex trading contracts and I went back to basics. I concentrated on framing the problem of transaction costs without any established formal institution.

In my model, I never talk about investment contingent contracts or contract enforceability, I only allow for the interaction of economic agents in the market. In many situations, we might not need a complex and sophisticated institutional framework but we just must allow “the invisible hand” to function.

Toulouse School of Economics
Toulouse School of Economics

The working paper series of the Toulouse School of Economics are free and accessible online, so for further information please check out my articles here!

Multimarket Contact and Collusion in the Ecuadorian Pharmaceutical Sector – Master Projects 2014

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2014. The project is a required component of every master program.


pills

Multimarket Contact and Collusion in the Ecuadorian Pharmaceutical Sector

Authors:

Jerónimo Callejas and Igne Grazyte

Master Program:

Competition and Market Regulation

Paper Abstract:

The paper analyses the effects of multimarket contact on prices in the Ecuadorian pharmaceutical sector and its capacity to serve as a tool to facilitate collusion. We estimate the effect that the multimarket contact has on firms’ price setting behaviour by applying multimarket contact models and simple econometric techniques. Our findings show that multimarket contact has a positive effect on multivitamin prices in Ecuador and could indeed be helping to sustain collusion between firms.

Conclusions:

We have tried to estimate the possible effect that multimarket contacts might have on prices and collusion in the Ecuadorian pharmaceutical industry. For the purposes of this paper we have chosen to limit our analysis and only focus on the market for multivitamins defined at the 4th ATC level. To test our predictions we tried to replicate simple techniques used by Ciliberto and Williams (2013), Evans and Kessides (1994) and Coronado (2010). We have constructed a multimarket contact index and estimated its effect on prices by using IV and then Panel Data with fixed effects estimations and also correcting for endogeneity.

As seen in section 5, our model gives robust results and provides a reasonable confirmation of our expectations: the coefficients predicted by the two models (IV and panel data with fixed effects) have the correct sings and are highly significant. Our results show that the IV estimation alone is insufficient to successfully solve all endogeneity issues, however we find that using panel data with fixed effects and also instrumenting endogenous variables (MMC) we can successfully remove the endogeneity problem from the proposed regression and obtain unbiased estimates. Our analysis shows that average multimarket contact index has a significant positive effect on price, thus confirming our predictions that the contacts between firms in different product markets can lead to higher prices for pharmaceutical products. Although we believe that this result could be indicative of possible collusive practices in the sector, the actual existence of collusion could only be confirmed by direct evidence, such as direct contacts between firms with the aim of setting prices or sharing markets.

Due to time constraints we were only able to conduct our analysis in one market and using only simple estimations and models of multimarket contact index. Therefore possible future extensions to this paper could include estimating the effect of the multimarket contact index in other markets, possibly taking into account both private and public markets; or to estimate the effect of multimarket contact by using more complex models, such as nested logit model used in Ciliberto and Williams (2013).

Read the full paper or view slides below: