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Panama: Selected Issues

Author(s):
International Monetary Fund. Western Hemisphere Dept.
Published Date:
August 2015
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Panama: Energy and Growth1

A. Executive Summary

1. Panama would benefit from more efficient energy production through increased fiscal space and lower electricity prices. Recent problems experienced by the energy sector in Panama (high oil prices, a drought, and an explosion in a power plant) uncovered some vulnerabilities and weaknesses in the energy sector, with energy subsidies increasing markedly in 2014. More efficient thermal generation and better transmission would allow reducing energy subsidies and/or the domestic cost of electricity consumption. Lower electricity prices would in turn translate into lower inflation. By reducing the amount of subsidies, this would also help reduce the vulnerability of the fiscal accounts in the face of exogenous shocks such as higher oil prices and adverse climatic conditions.

2. The pressure on the fiscal accounts can also be eased by better targeting energy subsidies. Non-targeted subsidies currently represent about three quarters of total energy subsidies in Panama. Better-targeted subsidies would generate substantial fiscal savings without compromising the social safety net for the most vulnerable households.

3. The positive effect of lower oil prices on Panama may be dampened by weaker global demand. Our econometric exercise confirms the prior that Panama benefits at the margin from a surge in global crude oil production, but it is also very sensitive to world aggregate demand. Hence an appropriate assessment of the effect of the recent oil price decline on Panama’s growth performance requires a careful consideration of the underlying forces driving the price slump.

B. Energy Production and Consumption in Panama

4. A mix of private and state-owned enterprises operates in the electricity sector. While energy transmission is provided by the state-owned enterprise ETESA, both generation and distribution are mainly private with minority participation by the state.2 There are over twenty generation companies; the two firms fully state-owned represent about 10 percent of total generation.3 The four largest generation companies provide more than half of the total supply of energy in the country. In terms of energy mix, about 60 percent of energy is generated through hydropower, with thermal energy representing the remaining 40 percent. For thermal generation, Panama is fully dependent on imported oil. Electricity distribution is provided by three companies (EDECHI, EDEMET and ENSA), which operate regional monopolies (see Chart 1), with the state owning about 49 percent of shares in each company.4

Chart 1.Electricity Distribution Companies—Geographic Coverage

Source: Autoridad Nacional de los Servicios Publicos

5. The government plans to increase energy supply through investments. With the economy growing rapidly, energy consumption has been on a steady increase. Despite the soaring demand, investment in generation and transmission has been subdued in the last years (Chart 2). As a result, transmission capacity is below generation capacity, and authorities are of the opinion that thermal generation is inefficient (see also Chart 3). The government announced plans for US$5bn investments in the energy sector during 2015-2019, with 24 percent expected to come from public sources. Investments plans in generation are expected to total US$3.2bn (US$1.3bn in hydro, US$0.9bn in coal, and US$1bn in gas). Investments in transmission, estimated at US$1.2bn, include US$0.5bn for the interconnection with Colombia, and US$0.2 and US$0.5bn for the third and fourth transmission lines, respectively. The construction of the third transmission line started in November 2014, and is expected to be completed in 2016.

Chart 2.Investments in the Energy Sector

(In millions of USD)

Source: Autoridad Nacional de los Servicios Publicos.

Chart 3.Generation costs in LAC

(In USD per MWh)

Sources: Di Bella, et al. (2015), Autoridad Nacional de los Servicios Publicos, and Staff calculations. For Panama, generation costs are average April 2013-September 2014.

6. The services sector and households make up most of the demand for electricity in Panama. Being a service-based economy, more than half of the demand for electricity in Panama comes from the services sector (Chart 4). Thus, the services sector represents a much larger fraction of electricity demand than in other countries in the region and in advanced economies such as the U.S. and Germany. In 2012, households’ demand for electricity represented about 31 percent of total demand, whereas industrial demand amounted to about 10 percent. Oil, on the other hand, is consumed mainly by the transportation and industrial sectors (Chart 5).

7. Demand for electricity will keep raising fast. Staff projections indicate expected annual growth rates of real GDP in the range of 6–7 percent over the next five years, with the services sector remaining central to Panama’s growth model.

Chart 4.Electricity Consumption Sectoral Consumption as Percent of Total Consumption

Source: International Energy Agency

Chart 5.Oil Consumption Sectoral Consumption as Percent of Total Consumption

Source: International Energy Agency

C. Energy Prices and Subsidies

8. While domestic gasoline prices follow closely world oil prices, electricity prices are less responsive (Chart 6). The estimated elasticity of electricity prices to international oil prices is of 0.37, whereas for fuel prices it is 0.74. Electricity subsidies, Panama’s energy matrix (60 percent hydro), and regulation (bi-annual revisions for electricity as opposed to bi-weekly revisions for fuel prices) explain the lower elasticity of electricity prices.5 Due to the high pass-through to fuel prices, the recent drop in world oil prices has brought about a substantial decline in inflation, despite an increase in electricity prices driven mainly by a significant reduction in subsidies (Chart 7).

Chart 6.World Oil Prices and Energy Prices in Panama 1/

2010 = 100

Sources: WEO, Autoridad Nacional de los Servicios Publicos, and Staff calculations.

1/ The world oil price is a simple average of Dated Brent, West Texas Intermediate and Dubai Fateh. The price of fuel corresponds to the maximum price at the pump set by ASEP for 95-octane gasoline. The domestic electricity price is a weighted average of prices for different categories and distribution companies published by ASEP. The weights are given by the level of demand (in GWh) in each segment and for each distribution company during January-June 2014.

Chart 7.Inflation in Panama

Source: Panama National Authorities, and IMF staff estimates.

9. Electricity tariffs in Panama are subsidized, and about three quarters of the subsidies are not targeted. Panama has two main electricity subsidies.6 The Tariff Stabilization Fund (FET), established in 2004, is targeted at small users, and is intended to cushion tariffs against movements in international oil prices.7 The Energy Compensation Fund (FACE), established in 2011 amid rising international oil prices, aims to stabilize tariffs to all users. In addition, FACE also compensates three generation companies for forgone earnings due to lack of investments (and the resulting insufficient transmission capacity) by the state-owned ETESA (see Table 1). In 2014, FACE represented about 75 percent of total electricity subsidies.

Text Table 1.Main Electricity Subsidies in Panama 1/
Fondo de EstabilizacionFondo de Compensacion
Tarifaria (FET)Energetica (FACE)
Established2004 (Cabinet Resolution No. 6)2011 (Cabinet Resolution No. 174)
BeneficiariesUsers with consumption < 400KwhAll users
PurposePrevent oil price changes from affecting small usersPrevent oil price changes from affecting users, and compensate generation companies for lack of investment in transmission
FinancingThrough budget and contribution by large consumersThrough budget, loan from Banco Nacional, and contributions to FET 2\

Remaining electricity subsidies are those to the agricultural sector, pensioners, political parties, and subsistence consumption (under 100 Kwh/month)

As the threshold (in Kwh) for users to receive FET subsidy is progressively reduced, excess funds accumulated by FET will be used for FACE

Remaining electricity subsidies are those to the agricultural sector, pensioners, political parties, and subsistence consumption (under 100 Kwh/month)

As the threshold (in Kwh) for users to receive FET subsidy is progressively reduced, excess funds accumulated by FET will be used for FACE

10. Subsidies increased in 2014 due to a combination of external and internal factors, uncovering vulnerabilities in the energy sector (Chart 8). Pre-tax subsidies experienced a marked increase in 2014 on the back of high oil prices, a drought, and an explosion in a large thermal plant (the last two prompted the government to purchase energy from less efficient plants). Total pre-tax subsidies are estimated to have reached US$320mn in 2014,8 or about 0.7 percent of GDP (and 3.2 percent of public sector revenues), while post-tax subsidies are estimated to be about US$60mn higher on account of foregone tax revenues. The bulk of the 2014 subsidies was disbursed during January-August, before the oil price slump.

Chart 8.Electricity Subsidies in Panama

(As percent of GDP)

Source: ASEP and Staff calculations.

11. Energy subsidies should decline in 2015, thanks to lower oil prices and an increase in tariffs. Tariffs have been increased in January 2015 by between 6 and 25 percent, for about one-fourth of consumers. Coupled with lower oil prices, this is expected to cause a significant reduction in subsidies in the short term. The 2015 budget—prepared in September 2014—projects electricity subsidies at about US$350mn. Going forward, the planned investments should help raise the productivity and reliability of the energy sector, thus progressively reducing the need for subsidies.

D. Energy Prices and Growth Estimates for Panama and the Region

12. A simple model of the world oil market is estimated to assess the potential effects of oil-price movements on growth. Both supply and demand considerations are behind the recent drop in world oil prices (see e.g. Arezki and Blanchard, 2004). This section estimates the model proposed by Kilian (2009) to gauge the effect of three different shocks on growth: oil supply shocks, global demand shocks, and demand shocks that are specific to the oil market (e.g. precautionary demand due to concerns on future availability of oil). The first step consists in estimating a structural VAR of the world oil market, including the (log difference) of world crude oil production, Kilian’s (2009) index of real economic activity, and the (log) real price of oil (deflated with the U.S. CPI). The identification strategy is recursive, with the variables set in the aforementioned order9. The model is estimated using monthly data from May 1984 through October 2014 (366 observations). Chart 9 shows the impulse-response functions. A one-standard deviation shock to oil supply will have a persistent (negative) effect on oil prices that will only die out after three years. The effect of world demand shocks is quantitatively similar (with the opposite sign), but takes more time to set in. Finally, an oil-specific demand shock has a large and persistent effect on the oil price.

Chart 9.Model for the World Crude Oil Market

13. The estimated structural unexpected shifts in oil supply, world demand, and oil-specific demand are then used in country-specific growth regressions. Following Kilian (2009), we estimate, for each structural shock separately and for each country in our sample, a linear regression model where GDP growth is the dependent variable and contemporary and lagged values of the shock are the explanatory variables. The estimates below should be interpreted as the overall effect of oil-supply, demand, and oil-demand shocks on the economy, acting either directly or indirectly through variables that are not included in the regression but are systematically affected by the shocks (e.g. terms of trade, or systematic changes in subsidies). For regional comparison, we estimate the effects on growth for 16 countries in the region. The regressions are also estimated for some key sectors in Panama. The samples used in each case are detailed in the Appendix.

Chart 10.Growth Responses to Structural Shocks

Sectoral responses in Panama (left) and responses in the region (right). Effect after 1 year, one-s.e. bands.

14. A decrease in oil prices due to a surge in the global oil supply has a positive effect on Panama, although error bands are not tight. Chart 10 reports the cumulative effect on growth after one year of each shock. One-standard-error bands are plotted alongside the point estimates.10 A positive shock to oil supply boosts growth in Panama, mainly driven by agriculture and commerce. The estimate, however, is within one standard error of zero, indicating that the effect may not be significant.11 The only counterintuitive result relates to the response of construction growth, a series that exhibits ample volatility. In regional comparison, the response of Panama lies in between that of the U.S. and Canada, and stands to benefit more from these shocks than its neighbors Colombia and Costa Rica. The responses of Peru and Dominican Republic are also counterintuitive, and can be due to omitted variables whose effect is picked up by the included regressors.

15. A fall in oil prices due to a slowdown in world demand is, on net, associated with a significant negative effect on Panama. The estimates show that Panama benefits across the board from surges in world demand, with significant boosts to manufacturing, commerce and transportation. In regional comparison, it is the 5th country (out of the 17 included) most exposed to changes in world demand. As a result, drops in oil prices that are associated with lower global demand would have a positive effect that is more than offset by the negative effect of weak global demand. The result is consistent with Panama’s role as a hub for world trade, 5 percent of which passes through the Canal, and a globalized financial system.

16. Oil price changes due to demand shocks specific to the oil market seem to have small and not-significant effects on Panama. While, as expected, some sectors (e.g. transport) tend to be negatively affected by oil-price increases related to precautionary demand for oil, the overall effect on GDP growth is not significant. This is similar to several other countries in the region, such as Argentina, Chile, and Uruguay. However, Canada, Costa Rica, El Salvador, Mexico and the U.S. are negatively affected by these shocks, while some exporters of hydrocarbons such as Ecuador and Bolivia appear to gain from speculative demand shocks.

17. The relative importance of global demand factors for Panama is confirmed by model simulations. Chart 11 displays simulation results performed by the IMF’s modeling division (see Andrle et al., 2015). The simulations, carried out in mid-December 2014, assume that the oil price decline between August and December 2014 is 80 percent driven by increased oil supply and 20 percent due to weaker global demand. With those supply and demand relative contributions, Panama would actually not benefit from the recent oil price decline (see red line in Figure 10).

Chart 11.December 2014 Simulations for Panama

Oil Price Decline Due to Weaker Demand (20%) and Higher Production (80%) Decline in Demand (blue), Plus Increase in Oil Production (red)

18. Assessing the effect of oil price changes on Panama’s growth performance requires closely monitoring the supply-demand mix in the crude oil market. The results above highlight the importance of understanding the underlying forces driving the recent drop in oil prices to assess its effects on growth. The April 2015 World Economic Outlook (IMF, 2015) provides an insight into the relative importance of supply and demand factors, suggesting that supply considerations have gained in importance since mid-October 2014, even though global demand still remains weak (Chart 12).

Chart 12.Drivers of Oil Prices

World Economic Outlook, April 2015 (Box 1.1)

E. Concluding Remarks

19. More efficient energy production would create fiscal space and may reduce inflationary pressures. The recent problems faced by the energy sector in Panama (high oil prices, a drought, and an explosion in a power plant) uncovered some vulnerabilities and weaknesses in the energy sector. More efficient thermal generation and better transmission would allow reducing energy subsidies and/or the domestic cost of electricity consumption. Lower electricity prices would in turn translate into lower inflation. By reducing the amount of subsidies, this would also help reduce the vulnerability of the fiscal accounts in the face of exogenous shocks such as higher oil prices and adverse climatic conditions. These improvements require additional investment in the energy sector.

20. The pressure on the fiscal accounts can also be eased by better targeting energy subsidies. Non-targeted subsidies currently represent three quarters of total energy subsidies in Panama. Better-targeted subsidies would generate substantial fiscal savings without compromising the social safety net for the most vulnerable households.

21. The positive effect of lower oil prices on Panama may be dampened by weaker global demand. While Panama benefits at the margin from a surge in global crude oil production, it is also very sensitive to world aggregate demand. Hence an appropriate assessment of the effect of oil price changes on Panama’s growth performance requires closely monitoring the supply-demand mix in the crude oil market.

References
Appendix I. Country Samples
Appendix I Table 1:Samples Used in Growth Regressions
SampleNo. of observations
Panama1996Q1 - 2013Q371
Argentina1980Q2 - 2014Q3138
Bolivia1990Q1 - 2014Q298
Brazil1990Q1 - 2014Q399
Canada1986Q1 - 2014Q3115
Chile1986Q1 - 2014Q3115
Colombia2001Q1 - 2014Q355
Costa Rica1991Q1 - 2014Q395
Dom. Rep.1992Q1 - 2014Q189
Ecuador1990Q1 - 2014Q4100
El Salvador1990Q1 - 2014Q399
Mexico1980Q1 - 2014Q3139
Paraguay1994Q1 - 2014Q383
Peru1980Q1 - 2014Q3139
U.S.1980Q1 - 2014Q3139
Uruguay1997Q1 - 2014Q371
Venezuela1997Q1 - 2014Q371
Appendix II. Oil Price Effect on Output – Evidence for Advanced Economies

Recent research for advanced economies finds that the effect of energy prices on growth has decreased substantially. Table A.2 summarizes the findings of the literature regarding the effects of oil prices on growth. For comparability across studies, the table shows the response of GDP in one year to a 10 percent increase in oil prices. For the U.S., the study using the most recent sample finds no effect of oil prices on GDP (IMF, 2014). Other recent studies find small negative effects for the U.S. (e.g. IMF (2011), Gault (2011), Blanchard and Gali (2007) for the U.S.), while some other countries feature non-significant or even positive responses to oil price increases (see e.g. effect for France, Germany, Italy and Japan in Blanchard and Gali (2007)).1

Appendix II Table 1:Output Effect of a 10 Percent Increase in Oil PricesEvidence for Advanced Economies
StudyCountrySampleEffect after 1 year (in percent)
Quart. Rev. Commodity Prices (IMF, 2014)U.S.1983-20130.0
WEO (IMF, 2011)U.S.Model−0.1
Gault (2011)U.S.Model−0.2
Blanchard and Gali (2007)U.S.1984-2007−0.1
France1984-20070.0
UK1984-2007−0.1
Germany1984-20050.2
Italy1984-20050.0
Japan1984-20070.2
Hamilton (2003)U.S.1949-2005−0.7
1949-1980−2.9
Bernanke, Gertler and Watson (1997)U.S.1966-1995−0.2
1986-1995−2.2
1976-1985−3.9
1966-1975−0.5
Hooker (1996)/1U.S.1973-1994>0
Mork, Olsen and Mysen (1994)/2
U.S.1967-1992−0.5
Japan1967-1992−0.2
Germany1967-1992not signif.
France1967-1992not signif.
Canada1967-1992−0.6
UK1967-1992−0.4
Norway1967-19920.5

Size of shock not reported.

Effects for price decrease are estimated separately, and are only significant for the U.S. (+0.8) and Canada (+0.6).

Size of shock not reported.

Effects for price decrease are estimated separately, and are only significant for the U.S. (+0.8) and Canada (+0.6).

Prepared by D. Cerdeiro.

The energy sector in Panama underwent substantial reforms in the late 1990s, including extensive privatization efforts. See IADB (2013).

The two state-owned generation companies are Autoridad del Canal de Panama and EGESA. The state also retained minority participation in ENEL Fortuna and AES Panama.

The majority shareholder of EDECHI and EDEMET is the Spanish holding Union FENOSA, whereas the majority shareholder of ENSA is Colombian holding Empresas Publicas de Medellin.

While electricity tariffs are set following a specific formula that reflects generation, transmission, and distribution costs, the Cabinet Council can override this automatic procedure by using funds from FACE to compensate the difference between costs and end-user prices.

In addition to the subsidies, energy in Panama is largely tax exempt. While domestic consumption of fuel is taxed, oil and fuel imports are tax free. Furthermore, electricity generation, transmission and distribution are exempt from the ITBMS tax.

The FET subsidy is currently received by users of up to 400Kwh/month, with the threshold expected to reach 300Kwh/month by end-2016.

FACE and FET amounted to $295mn in 2014. The 2014 figures for the remaining electricity subsidies (for the agricultural sector, pensioners, political parties, and subsistence consumption) are not yet available. These other subsidies averaged about $25mn/year over the past three years.

See Kilian (2009, p. 1059) for a justification.

Standard errors for the cumulative response are calculated using the (robustly-estimated) covariance matrix of coefficient estimates.

The effect of oil supply shocks have been estimated in several papers over the past 20 years. Table A.2 in the Appendix summarizes the findings, showing that recent research for advanced economies points to a substantial decline in the growth effect of oil supply shocks. These papers, however, simply ascribe oil-price changes to oil supply shocks without recognizing other possible driving forces.

A recent paper by Alvarez and Valencia (2014) uses a panel data set to estimate the effect of electricity prices in Mexico on manufacturing output. Estimated elasticities range between -0.11 and -0.28 depending on the specification.

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