4.2. Stabilization Fund for Oil Prices

4.2.1. Origin44

Law number 19.030 passed in 1991 created the Oil Price Stabilization Fund, under the Ministry of Finance. The purpose of this policy is to soften price variations of domestic sales of oil by-products fuels, caused by fluctuations in international quotations.

4.2.2.Characteristics.

The intermediate benchmark prices reflect the medium and long-term price expected in the oil market.

This policy, considers the evolution of oil prices during the prior period and the future perspective of the oil market. Benchmark prices are permanently revised so that they are consistent with changes occurred.

It is possible to define intermediate benchmark prices different from long-term prices expected, only in situations of great fluctuations of international prices or when it is necessary to avoid an excessive non-accumulation or accumulation of resources in the fund.

High or low benchmark prices should not differ in less than twelve and a half per cent from the corresponding intermediate benchmark price45.

4.2.3.Elements46

a. Parity price: is the weekly average quotation observed in relevant international markets of oil by-products fuels, including costs of transportation, insurances and others.

The parity price of each product is fixed by the Ministry of Mining, prior to a report from the National Commission of Energy and is calculated considering average prices observed the previous week.

4.2.4.Operation

The Fund operates with fiscal resources granted by its Law, which are deposited in a special account of the Treasury Service.

Fund contributions and withdrawals are fixed considering parity prices that the country pays or receives in foreign transactions.

The amount of contributions of each product and per each term of parity and benchmark prices will be equal to the addition of the cubic meters sold in the country, resulting from the national production and from those imported during the same period, excluding the amounts subject to specific mechanisms, such as the Merchant Marine in the national territory and the exporters of oil by-products who had paid the tax.

Whenever the oil price is above a certain level, a legal change is made to allow a reduction of oil taxes and when the price falls under a certain level compensation is applied to avoid a decrease in the average rate.

4.2.5. Oil Fund Activation47

Regarding the reactivation of the Oil Prices Stabilization Fund, economist Ricardo French-Davis states that Chile needs more mechanisms against cyclical behavior in order to mitigate the effects of foreign crisis because economic history has been characterized by a marked volatility and absorption of external shocks.

He warns, however, that this Fund may be corrected so that it is not misinterpreted as a subsidy, such as the case of the Copper Fund, since it cannot be argued that Chile is an economy with marked ups and downs. He remarks that during 1975 and 1982 the biggest drops of all Latin America occurred in the country.

The Chilean economy is very sensitive and although it is very ordered, in 1999 growth rates fell from 7.0% to 1.0%. This caused a great shock on the labor force, businessmen and the government due to a decrease in tax receipts.

In the current operation, when the oil price is above a certain level, a legal change is made to allow a reduction of oil taxes and when the price falls under a certain level a compensation is applied to avoid a decrease in the average rate; when the price becomes again the trend or band one, taxes become the habitual ones.

It would be a huge mistake to keep low taxes to support a higher growth of economy since the world has a big problem of pollution and deterioration of environment and fuel consumption generates a negative manifestation.

Another serious mistake is stemmed from the above: diesel – that is more polluting than other fuels, has a lower tax burden and this distortion is favored by price discrimination.

In March 2004, in a discussion generated by an international rise of crude oil prices and its impact on domestic fuels, the Minister of Finance stated that the government would be open to analyze any proposal regarding a stabilization formula without subsidizes. Likewise, in reference to the reactivation of the Oil Fund, he said that if there were other proposals that may assure Chileans that those fiscal funds would not be used to subsidize those who have a sound economic situation, he would be eager to accept them.

Within this context, the Minister specified that US$ 345 millions had been spent in the Oil Price Stabilization Fund, which represented, as an example, approximately four years of the Chile Solidarity operation: an emblematic governmental program for the benefit of the poorest. This is not acceptable and for this reason the government took the initiative of providing a bond of $ 10,000 to benefit those families who had a fixed pension and those for whom an increase in the kerosene or in the transportation meant a relevant part of their family shopping basket48.

4.2.6. Antecedents as of September 200549

The Ricardo Lagos’s Administration, announced two policies to face a rise in oil and benzenes international prices caused by Hurricane Katrina in the Golf of Mexico.

Firstly, the Empresa Nacional de Petróleo should refine the amount of crude oil required by the country, thus preventing an increase in the prices of diesel, kerosene and benzene.

Secondly, a Bill of Law setting forth the creation of a Stabilization Policy for Fuel Prices, to prevent consumers from paying constant increases in international oil costs. This policy will be financed with resources from financial profitability of the monies accrued in the Copper Stabilization Fund.

Governmental announcements to stabilize fuel prices caused a great controversy.

As regards the way, the President of the Republic is criticized for his resolution to use the funds of the Empresa Nacional de Petróleo ENAP to finance the governmental initiative without even consulting the board of directors50.

This is more serious if we remember that a Bill of Law, promoted by the Executive Power itself to introduce better practices of corporate government in state-owned companies is pending.

While the opposition has proposed a system of more independence for those companies, with professional directors, the government has only proposed the incorporation of independent directors who may act as a counter-balance against those who are designated by the President of the Republic.

The presidential decision reveals that this proposal would be dead letter in a system like the current one, in which the directors of the state-owned companies do not have, in practice, any autonomy to act.

For this reason, it would be advisable to design a truly autonomous administration system for state-owned companies, which safeguards the interest of all Chileans and which does not stand for an operational wing of each governmental term of office.

The declaration of the government is also disturbing in the sense that this operation could be performed because ENAP is a state-owned company. This buries the idea of incorporating private capitals and suggests that the regulatory role state-owned companies are assigned. With such a criterion, state-owned companies should also be justified in all strategic industries.

As regards the content, the idea to stabilize fuel prices is a hidden price fixing, since all parameters are subject to revision by the authorities.

The authorities have left a wide margin of freedom for a discretional management, which is far from the stabilization mechanisms.

The message projected is negative because it disregards the fact that it is important for the economy to have prices showing the real scarcity of fuels and that, therefore, it may give producers and consumers proper guidance in their decisions.

What happens with the Oil Fund during elections?51

Election times are not good for Ministers of Economy because when a government is about to finish its term, it is inevitable to lose political power. The looks are increasingly directed towards the actors of the next period.

The own pressures of elections dim the lights of economic authorities, since the political world is not as virtuous as to completely relinquish the use of fiscal instruments in the name of election goals. For this reason, in political science and economy a theory of the political-economic cycle has been formulated, which indicates that governments intend to use policies within their reach to influence in the welfare of the population in the periods previous to elections52.

The countries aware of these temptations tend to protect themselves institutionally from the menace of political-economic cycles.

The independence of the Central Bank is, for instance, one of those prudent inventions that is helpful in this sense. There cannot be the slightest doubt that the structural balance is another institutional invention in this regard. Indeed, both institutions have the merits of going beyond this dimension. But they are not guarantee enough.

The intervention of the fuel markets is an evident support to the theory already mentioned and with a cost that may be further significant to the treasury.

In practice, the announced measures set provisional ceiling prices of gasoline until June 30th, 2006. It is difficult to think that prices may be decontrolled at the moment if the result is a significant rise.

It is difficult to predict a future evolution of crude oil price; this is a scenario that cannot be dismissed.

Although it may be discussed, this specific phenomenon could justify the application of temporary policies until the refining market would calm down.

In fact, the normalization of this market, though slow, is under way. In any event, it does not seem very reasonable to have blamed the oil company.

Subsidies must be analyzed. But the reactivation of the Oil Fund and a longer setting of gasoline prices is definitively another kettle of fish.

Prices must reflect the relative scarcity of products. If this does not occur, the assignment of resources is distorted since it invites using more oil than is pertinent under the current circumstances.

Moreover, it deprives the Treasury from resources that may have a superior alternative use. The discussion regarding ceiling prices of fuels is usually and wrongly mixed with that of specific taxes.

These prices have their own logic, although it may be discussed if, beyond current values of crude oil, they are fixed in a proper level. It would be useless to use them as a mechanism for price stabilization.

The somewhat complicated and questionable argument about the reasons why the interests of the Copper Compensation Fund, used to infuse capital into the Oil Fund are not in the estimation of the structural balance is perhaps a good example of the political stroke received.

In this case, it was demonstrated that election times are not good for those in charge of the public finance53.