project: privatization: the global scale-back of government involvement in national economies ||...

PRIVATIZATION OF ENERGY IN ARGENTINA AND BRAZIL: A ROADMAP FOR DEVELOPINGCOUNTRIESAuthor(s): Diane PrestonSource: Administrative Law Review, Vol. 48, No. 4, Project: Privatization: The Global Scale-Back of Government Involvement in National Economies (FALL 1996), pp. 645-663Published by: American Bar AssociationStable URL: http://www.jstor.org/stable/40709849 .

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645

PRIVATIZATION OF ENERGY IN ARGENTINA AND BRAZIL:

A ROADMAP FOR DEVELOPING COUNTRIES

Diane Preston

I. Emergence of State-Owned Enterprises in Latin America

composition of the Latin American economy is evolving. As the states redefine their role in relation to the energy industry, their position has

come full circle. States that had adamantly supported a strong government role in the operation of public enterprises are now encouraging private ownership of those enterprises. Within a relatively brief period of time, state ownership of the electricity, oil, and natural gas industries climaxed and then declined in the wake of mounting fiscal crises. The road to private ownership has not been a smooth one, and Latin American governments have been forced to overcome public opposition as well as political and legal obstacles.

A. Social, Economic, and Political Perspectives

Prior to 1980, state-owned enterprises (SOEs) in Latin America flourished because of a variety of factors common to developing countries. Frequently under military rule, developing countries reinforced the notion of a powerful government by ownership of specific enterprises, and national sentiment in favor of such control ran high.1 A state's sovereignty over its natural resources was a priority, especially in petroleum exploration.2 Overwhelmingly, Latin American countries perceived that "a large public role [for the state] in the economy was . . . necessary for rapid and sustained development, ... to help steer the economy and overcome critical bottlenecks."3 SOEs filled that role in a number of ways.

First, SOEs effectively functioned as safeguards for the future of a developing country's domestic industries. Private firms with inadequate levels of capital

1. Werner Baer & Melissa Birch, Privatization and the Changing Role of the State in Latin America, 25 N.Y.U. T. Int'l L. & Pol. 1. 5 H992V

2. Id. 3. Van de Walle, Privatization in Developing Countries: A Review of the Issues, 17 World Dev. 601,

602 (1989).



646 48 ADMINISTRATIVE LAW REVIEW 645

were often unwilling or unable to fund necessary investments.4 Investment projects involved gestation periods that were too long and profit returns that were too small to justify investment.5 As a result, SOEs benefltted the private sector by "crowding-in" investment; absent the creation of state enterprises, many private domestic and foreign firms would have been unwilling to invest.6

Second, state enterprises were perceived as important social and economic tools. Latin American governments earmarked the SOEs' profits to finance investments in priority sectors of the economy.7 In the 1970s, central governments used the public enterprise as a tool to battle the rising costs of inflation or as macroeconomic stabilization instruments.8 To that end, prices within the public enterprise were either forcibly frozen or were permitted to rise at only a modest rate.9 However, protecting prices within the public enterprise in order to control any increase in the general price level eventually destroyed the financial position and overall efficiency of the enterprise itself.10

Although the vitality of SOEs climaxed during the 1970s and 1980s,11 the debt and inflation crises of the 1970s and 1980s quickly eroded their efficiency and triggered their decline.12 Confronted by increasing deficits, the governments of Latin America could no longer afford to tolerate financial losses and economic inefficiencies.13 Moreover, public enterprises exhibited pervasive weaknesses. Their objectives were often unclear, diverse, or contradictory.14 They were plagued by bureaucratic interference, overly centralized decisionmaking, inadequate capitalization, managerial ineptitude, excessive personnel costs, and high labor turnover.15 Faced with such difficulties, Latin American governments sought to resolve the problems by turning back to private ownership.

B. The Escalation of Privatization

Increasingly, SOEs generated doubts as to the feasibility of state ownership. States began to question their previous conviction that state ownership could

4. Baer & Birch, supra note 1, at 5-6. 5. Id. 6. Id. at 7. SOEs were also able to attract capital from multilateral development banks. Id. 7. Developing countries often employed profits from SOEs to enhance employment and to

invest in social services and housing. Van deWalle, supra note 3, at 602. 8. Jack K. Edwards & Werner Baer, The State and the Private Sector in Latin America: Reflections

on the Past, the Present and the Future, in Latin America: Privatization, Property Rights, and Deregulation 12 (Werner Baer & Michael Conroy eds., 1993).

9. Id. Central governments exerted control particularly over the prices of steel, electricity, and water services. Id.

10. Id. at 13. 11. By the 1980s, most public utility sales in Argentina were by SOEs. About one-half of

Argentina's top 20 firms (by sales) were state owned, and 12 of Argentina's SOEs in utilities, transportation, and energy accounted for three-quarters of all public enterprise sales, employment, and investment. Baer & Birch, supra note 1, at 9.

12. Id. at 11. 13. Van deWalle, supra note 3, at 603. 14. Id. 15. Id. For example, in Argentina, the accounting department of Gas del Estado, the state-owned

gas company, was "at least 12 to 18 months behind" on its own accounting and was unsure as to "who paid and who did not pay their bills in 1990, let alone this year [1991]." At that time Gas del Estado was searching for ways to cut consumers off. Argentine Pipeline Sell-Off Switch, In- ternat'l Gas Rep., Sept. 5, 1991, at 38.



FALL 1996 Energy and Environment: Argentina and Brazil 647

"right" market failure.16 Governments began to realize that the information available to them might not exceed that available to private markets; in fact, government's access to information might be worse.17 States also recognized that public agencies were more responsive to political pressures than to consumer preferences.18 Two objectives, therefore, became central to Latin American privatization plans: (1) to dilute the influence of the state in the economy; and (2) to strengthen the role of market forces.19

Funding was also becoming a problem. Within the energy sector, " swift

technological development [requires] constant investment by the government. ' >2° Because the government was often unable to adequately finance public projects, private funding became necessary to protect the government's interests.21 The state benefitted from transferring activities to the private sector when the transfer enabled the government to focus on activities that only government can provide.22

The rate of privatization accelerated after the oil shocks of the early 1980s as a method to reduce external debt, and the goal of privatization evolved to reducing the role of the government within industry and increasing the efficiency of the private sector.23 The newly privatized industries benefitted from accepting foreign investment. Yacimientos Petrolíferos Fiscales (YPF), Argentina's previously state-owned oil company, established a partnership with Brazil's state- owned oil company, Petrobras, to develop gas reserves in Argentina for export to Brazil.24 YPF is currently seeking a partner for development deals in Chile.25

C. The Process of Privatization

1. Redefining the Role of the State

The state may continue to play a significant role even after its decision to relinquish control of a public enterprise. It must select the SOE to be transferred

16. Gabriel Roth, The Private Provision of Public Services in Developing Countries 7 (1987).

Λ 1 Ί J ι / . ία. 18. Id. iy. uaer & Bircn, supra note i, at id. ^u. L,araoso uuuines uirection oj nis rresiaency, uuu summary of world broadcasts zo, kjci.

10, 1994 (translated from Rede Bandierantes TV, Sao Paulo, broadcast in Portuguese, Oct. 6, 1994). [hereinafter Cardoso Outlines Direction] The high rate of investment is problematic when the government "no longer possesses resources to [invest] and society refuses to grant the government these resources by paying more taxes." Id.

η ι TJ Cl. au.

ll. KOTH, supra note ίο, at d. ZÒ. Richard R. Dunn & J.r. Morgan, Privatisation in Latin America: Une òtep in an Ongoing Global

Process, in Privatization: Current Issues (A study of recent privatization in Argentina, Brazil, Mexico, and Venezuela and, by way of comparison, the current programmes under way in France, Italy, and the United Kingdom) 1 (Meredith M. Brown & Giles Ridley eds., 1994). "Measured as a percentage of GNP, external debt [in developing countries] rose from 1980 to 1989 . . ., increasing from 35% to 46% in Latin America." Michael S. Minor, The Demise of Expropriation as an Instrument of LDC Policy, 25 J. of Internat'l Bus. Studies 177, Mar. 22, 1994, at 13.

i.t. rrwanzaiions upen exploration ana rroaucnon upponumues , world wil, /'ug. i^^f, ai ίο. 25. Id.




to private ownership, a decision that merits careful consideration and preparation. The government should consider social costs, legal constraints,26 timing, and whether the supply and demand of investors is adequate. Public sentiment regarding state-run enterprises also is significant both to the state's decision to privatize and to the method of privatization chosen.

Latin American governments have espoused two different approaches to privatization. In one approach, the state would choose a less controversial public enterprise. The prototypical industry should encompass a less socially sensitive economic activity that is generally inefficient and involves a small workforce.27 Brazil followed this approach when it privatized its manufacturing sector, and the government enhanced its opportunity for success by embarking on an "awareness campaign" to heighten public support for the privatization.28 Alter- natively, the state may choose a more visible enterprise that would exemplify the government's commitment to the privatization program.29 Argentina employed this method when it privatized its large oil and gas sectors. The government held this industry out as a model to encourage potential investors and to reduce opposition to its privatization efforts in general.30

2. Overcoming Impediments to the Privatization Process

Even the most prudently planned sale of a public enterprise is not without its difficulties. The planning phase itself may be complex because of the problems inherent in accurately assessing the value of an enterprise in developing countries where the economies often are characterized by weak capital markets, a concen- trated private sector, and a lack of reliable operating data for the enterprise.31 Moreover, governments must assess in an open market the value of an industry run in a previously protected economy.32 Not only is the valuation process complex, but the ramifications of errors in valuation are immense. Too high a price may deter investment.33 Too low a price may create the impression that the government is "giving away" national assets and, as a result, erode public support for the sale.34

Other obstacles must be overcome during the privatization decision, and these impediments increase when the targeted industry is a socially sensitive one like energy. Nationalist sentiments may impede government efforts to reduce its

26. Legal constraints include constitutional, legislative, and contractual constraints. 27. Carlos E. Martinez, Early Lessons of Latin American Privatizations, 15 Suffolk Transnat'l

L. J. 468, 500 (1992). For example, oil production, because of the major role that the industry plays in the state economy, would not be considered a "less socially sensitive economic activity." Id.

28. Id. 29. Id. 30. Id. at 500 n.59. 31. Baer & Birch, sutora note 1, at 18. 32. Martinez, supra note 27, at 502. A variety of methods have been utilized to overcome the

difficulty of valuing nonmarket industries within the market. These include use of market value, cost, income, and the replacement value of assets. Id. at 502 n.61.

33. Id. 34. Id.




role in the energy industry if the public equates state power with ownership of public utilities.35 The state must also address the potential problem of displaced workers that is likely to occur in transferring ownership of an inefficient state-run industry to a more efficient private owner.36 Because such a transfer probably will eliminate job redundancies, ineffective workers may face layoffs.37 Labor's political support of the privatization is, therefore, critical.38

Not only must the government prepare to address social concerns, but also it must overcome legal constraints on its privatization efforts as well. In Mexico and Brazil, state control of the oil and electricity sectors is mandated by their constitutions.39 In Venezuela, the oil industry was nationalized by law.40 As a result, such companies in these countries cannot be privatized unless the law is modified.41 However, several reformations may indicate that change is brew- ing in Venezuela. The laws regarding certain privatizations have been amended, and partial privatization is now an alternative.42 Even if Venezuela attempts to "preserve, as a matter of law, the right to control" the industry, it may assume a more regulatory function by contracting with a private service to manage the enterprise.43

3. Selecting the Method of Privatization

The mechanism selected for privatization will indicate the state's policy ratio- nale for relinquishing control, and a combination of policies often will achieve the greatest result. A broad liberalization tactic will decrease market regulation and increase competitive forces.44 By shifting toward a free-market economy, the government will be forced to eliminate monopoly structures.45 Because replacing a public monopoly with a private one would be counterproductive, the government can advance the reduction of monopolies by establishing a

35. Baer & Birch, supra note 1, at 5. 36. Martinez, supra note 27, at 499. 37. This streamlining effect has developed in Argentina where YPF's workforce was reduced

from 51,000 to 10,600 after to the oil company's privatization. Andres V. Gil, Privatisation in Latin America, in Privatization: Current Issues (A study of recent privatization in Argentina, Brazil, Mexico, and Venezuela and, by way of comparison, the current programmes under way in France, Italy, and the United Kingdom) 15 (Meredith M. Brown & Giles Ridley eds., 1994).

38. Id. 39. Pedro Aspe, Thoughts on the Mexican Privatization Experience; Competitiveness in the Americas, The

McKinsey Quarterly, Mar. 22, 1994, at 65; Privatizations Open Exploration and Production Opportunities, supra note 24.

40. Arminio Borjas, Venezuela: Developments and Trends in Privatisation, in Privatization: Current Issues (A study of recent privatization in Argentina, Brazil, Mexico, and Venezuela and, BY WAY OF COMPARISON, THE CURRENT PROGRAMMES UNDER WAY IN FRANCE, ITALY, AND THE UNITED

Kingdom) 46 (Meredith M. Brown & Giles Ridley eds., 1994). 41. Id. "The first Venezuelan Privatization Law (VPL) . . ., concerning privatization specifi-

cally, was passed on February 19, 1992. . . . The current law basically maintains the general guidelines of privatization, including ways to effect it . . ., mechanisms to reach prices, transfer of rights, rights of workers, and so on." Id. at 44.

42. Id. at 46. 43. Id. 44. Baer & Birch, subra note 1, at 15. 45. Martinez, supra note 27, at 488-89.




regulatory framework prior to or concurrent with the privatization program.46 The regulatory focus should be on establishing a climate hospitable to private investment by eliminating trade restrictions, regulating stock markets to protect investors, enacting antitrust laws, protecting intellectual property rights, and reforming the judiciary to increase its efficiency and credibility.47

Developing countries also should consider deregulating prices in order to create a more competitive environment by allowing market forces to prevail.48 Additionally, deregulation reduces the costs of lobbying and negotiating for licenses or permits.49 Latin America, however, rejected both liberalization and deregulation; instead, it chose to divest public assets.50 Historically, when developing countries sold public enterprises, the entire operation was transferred to domestic or foreign corporations or holding companies.51 Ironically, the re- purchaser itself often was a foreign SOE.52

The structure of an ownership transfer may determine the success of the privatization program, so the method of relinquishing control must be chosen carefully. State control over certain industries previously indicated the extent of state power.53 The actual transfer of ownership, therefore, may be symbolic in developing countries because the state is relinquishing its former "power."54 The form of transfer should be seen to be open, expedient, and fair.55

Instead of actually transferring power, the state may simply reduce its control of the public industry by undertaking leases, licenses, private contracts, or joint ventures. Argentina executed a lease agreement with a private company to run its oil industry, highways, and railroads.56 Argentina also granted licenses to private companies for oil field exploration.57 Bolivia chose to contract out its oil industry to private entities.58 Many governments have undertaken joint ven-

46. Id. at 488. 47. Id. at 489. 48. Baer & Birch, sutora note 1, at 15. 49. Id. 50. Id. 51. Id. 52. Id. 53. Id. at 5. 54. Martinez, supra note 27, at 493. 55. A variety of transfer methods may be utilized separately or in combination with one another

to complete the transfer of ownership. A public auction has the advantage of being in an open forum. Public placements, where shares are placed on the local or a foreign stock exchange, may increase popular support for the privatization because they involve a large section of the population. They can also promote domestic capital markets. Allocating shares to certain classes of individuals, such as employees of the formerly public enterprises or consumers, can further engender support for the privatization of that industry. In smaller scale privatization efforts, a private transfer of shares may be more effective in order to put control of the industry into the hands of a few private owners. Brazil exclusively tailored its means of transfer by using privatization certificates, which were issued to financial institutions or purchased by insurance or pension companies. They enabled the holder to exchange them for shares of privatized industries. Id. at 492-97.

56. Id. at 497. 57. A license grants a private entity the right to engage in an activity customarily reserved to

the state. Id. 58. Id. at 498.




tures with private firms where the firms provide the technology and receive a portion of the profits.59 In return, the government supplies the physical resources and assets.60

The advantages of circumventing actual transfer of ownership are several. First, the transaction is easier to effect.61 By engaging a private firm only as a "manager," the government avoids the symbolism of private ownership of previously public industries, and it bypasses laws that prohibit the disposition of public enterprises.62 Second, the industry may increase efficiency without completely disrupting its business activity.63 Because the government does not relinquish all control of the enterprise, these alternatives to transferring control may be especially attractive to governments that enjoy less than full support for their privatizations.64

II. Argentina A. History

Argentina's privatization program is "perhaps one of the most exciting exam- ples of how free-market policies have gained the upper hand across Latin America, since the President that is leading these policies emerged from the same party that . . . started the movement towards nationalisation of all public services. . . ."65 Since 1907, the Argentine government has developed its energy industry through two major enterprises: Yacimientos Petrolíferos Fiscales (YPF), the state-run oil company, and Gas del Estado (GdE), the state-run gas company.66 Until 1989, the economy was predominately state run, and the "National State, its agencies, and state-owned corporations had the exploitation monopoly and absolute regulatory power over vital areas of the economy," including electricity, oil, and gas.67 Consequently, the period was characterized by price controls, foreign exchange market controls and restrictions, and a limited ability of foreign investors to remit profits abroad and to repatriate capital.68 The Argentine government required prior approval for foreign investments exceeding $5 million or those to be allocated in specific sectors such as energy and electricity.69 Moreover, YPF was the sole source of crude oil for refining, marketing,

59. Id. 60. Id. 61. Id. at 497. 62. Id. 63. Id. 64. Testimony of James A. Waddell, Executive Director, International Privatization Group,

Price Waterhouse, House Small Business Strategies for Small Business, Apr. 14, 1994 (Fed. Document Clearing House Congr. Testimony 31).

65. Rogelio N. Maciel, Argentina: Privatisation of the Natural Gas Industry, 10 J. Energy & Nat. Resources L. 371, 378 (1992).

66. Id. at 371-72. 67. Daniel A. Bianchi, Privatization of the Oil and Gas Industry in Argentina - A Model for Latin

America?, 39 Rocky Mtn. Min. L. Inst. 17-1, 17-3 (1993). 68. Id. at 17-4. 69. Id.




and export operations, while GdE enjoyed a monopoly over the transport, distribution, and marketing of gas.70

B. Argentina's Decision to Privatize

1. The Initial Step to Private Ownership

Following two periods of hyperinflation in 1989 and 1990, Argentina began a privatization program to help finance its stabilization policies, including increasing the efficiency of public sector enterprises, providing cash proceeds to reduce the public sector deficit, and reducing the government's external debt.71 In August 1989, the Congress took an important deregulation step and enacted a law to permit the privatization of services rendered by state-owned

companies such as YPF.72 The Congress took a second major step toward privatization in September 1989 when it suspended promotional benefits and subsidies to SOEs.73 Subsequently, in September 1990, Congress abrogated the need for

government approval of private investment.74 Privatizations accelerated when the Menem administration took office in July

1989 and began introducing legislation to open up oil and gas exploration to

private foreign investment.75 Decree 48 established the guidelines for the privatization of the gas industry through the following objectives:

to increase the efficiency of natural gas production, transportation, and distribution; to encourage private risk capital involvement; to ensure a process based on fair and competitive terms in the various restructuring stages; to determine the role of the State in its capacity as regulator of the operation and development of the gas industry and its markets; to guarantee that the benefits resulting from the scheme to be established are passed on to the consumer.76

Decree 633 defined the objectives for reshaping the natural gas industry, the wholesale and retail markets, and the limits on the regulatory powers of the state as well as setting guidelines for the determination of tariffs.77 In addition, this decree "also instructed the Executive Branch to draft a Bill establishing the regulatory framework for the natural gas industry and setting the guidelines

70. Id. 71. Alberto Petrecolla et al., Privatization in Argentina, in Latin America: Privatization, Prop-

erty Rights, and Deregulation I 67, 69 (Werner Baer & Michael E. Conroy eds., 1993); Bianchi, supra note 67, at 17-9.

72. Bianchi, sutra note 67, at 17-5. The Argentine Congress enacted State Reform Act #23,696. 73. Bianchi, supra note 67, at 17-1, 17-5. Congress enacted the Economic Emergency Act

#23,697. Id. 74. Id. 75. Maciel, supra note 65, at 372; Investment Restrictions: Political Support and Opposition, Political

Risk Serv., Dec. 1, 1995, available in LEXIS, NSAMER Library, ARGEN File. When the legisla- ture, military, and bureaucracy opposed Menem's liberalization reforms, he advanced his reforms through unilateral decrees. Present criticism of his programs appears to be subsiding, as Argentines maintain the hope that capital inflows will increase and spur economic recovery. Id.

76. Maciel, supra note 65, at 372. 77. Id. Decree 633 was enacted on April 12, 1991. Id.




for the privatisation [sic] of the industry and the rules for the transition period, which will end when competitive conditions exist in the wholesale market."78

Empowered by the new legislation, Argentina launched an ambitious privatization campaign in the energy sector. The transformation of the economy from public to private ownership began with the sale of development rights to oil fields and two oil refineries belonging to YPF.79 In June 1993, the Argentine government sold 45 percent of its share of YPF in a U.S. $3.04 billion local and international public offering; the balance was owned by YPF' s employees and provincial governments.80 Because oil and gas comprise the most active sectors of the Argentine economy, the effect of the sell-off on public perception of state sovereignty was significant.81 Moreover, during the last two months of 1993 Argentina sold the concession rights of GdE, and plans to continue selling concession rights to several of YPF 's remaining oil fields and the stock of YPF.82

Electricity privatizations were initiated when two major power plants owned by Servicops Eléctricos del Gram Buenos Aires (SEGBA), the electric utility company serving Buenos Aires, merged into one company, Centrales Puerto S.A., which subsequently sold 51 percent of its shares to a Chilean consortium.83 The remaining shares of SEGBA were held by the Argentine government (39 percent) and sold to the employees (10 percent).84 Currently, Argentina is completing preparations for the sale of Edesur and Edenor, two electricity distribution companies - a sale that is expected to provide an additional U.S. $500 million to the Argentine government.85

78. Id. 79. Bianchi, supra note 67, at 17-10. Argentina chose an industry with national import to begin

its privatization program. The country "is one of three principal oil and gas producers on the South American continent and ranks behind Venezuela and Brazil in terms of total production and proven and probable reserves." Id.

80. Privatizations Open Exploration and Production Opportunities, supra note 24, at 41. 81. Oil and gas represent approximately 8% of gross domestic product and 18% of fiscal

revenues. During 1991, production of crude oil averaged approximately 493,000 barrels per day and natural gas production averaged 2,300 million cubic feet per day. Bianchi, supra note 67, at 17-11. In 1992, Argentina's natural gas contribution to the energy matrix exceeded 40%. Out of a total energy consumption amounting to 45.6 million tons of oil equivalent ("toe"), 19.7 million toe were contributed by natural gas. Thus, the country is one in which "the gas industry (production, transport and distribution) has a decisive impact on the process of overall economic growth and, obviously, on the energy market." Jose A. Estenssoro, The President of YPF Replies (Response to Article in the Petroleum Economist, lune 1994), Petroleum Economist, Oct. 1994, at 20.

82. Bianchi, supra note 67, at 17-10. 83. Id. ; Argentina - Electrical Power Transmission and Distribution Equipment, Market Reports (U.S.

Dep't of Commerce), Mar. 21, 1995, available in LEXIS, NSAMER Library, ARGEN File, [hereinafter Market Reports].

84. Market Reports, supra note 83. While the government still owns 39% and the employees 10% of Argentina's electricity distributor, Distrilec Inversora, a joint venture between Argentine, Chilean, and U.S. interests owns the remaining 51%. See Partie Adam, Argentina to Sell Remaining Shares in Edesur Utility, Reuters- Cent. & S. Am., Mar. 8, 1995, available in LEXIS, NSAMER Library, ARGEN File.

85. Yes, 1995 Was Hard But 1996 Will Open With Hints of Recovery, Lagniappe Letter, Dec. 8, 1995, available in LEXIS, NSAMER Library, ARGEN File.




2. Regulation of the Newly Privatized Gas Industry As a result of its privatization program, Argentina has implemented several

major policy decisions. Within the natural gas industry, the government de- signed a regulatory framework, the goals of which included (a) promoting competitive markets as well as the efficient production of gas; (b) encouraging investments so as to secure its long-term supply while adequately protecting the interests of consumers; (c) regulating the activities of natural gas transportation and distribution by ensuring that tariffs are fair and reasonable; and (d) promoting the best operation, reliability, fairness, open access, nondiscrimination and extended use of natural gas transportation and distribution facilities and services while simultaneously safeguarding the environment.86 Although the new regulatory scheme permitted legal monopolies to survive, it placed limits on private transporters and distributors in order to separate the natural monopoly aspects of gas supply, such as moving gas from sellers to buyers, from the potentially competitive aspects of the industry of buying and selling gas.87

The regulatory framework was created to encourage and ensure market- oriented practices, and it paralleled the organization of the GdE privatization committee.88 The body regulating natural gas consisted of five members, who were nominated by and reported to President Carlos Menem.89 The regulators' annual budget was $5 million, raised through a levy on gas companies.90 Duties of the regulators included building a "tariff framework' ' based on market indica- tors for the first five years after the privatization was completed, soliciting private bids for gas transport and distribution, and leaving the tender open until a "satisfactory" private offer arises.91 The state-owned company could transport or distribute gas only in the absence of a private sector offer.92 Significantly, the government approved a tariff for the sale of gas to residential, commercial, industrial, transportation, and electric power generation consumers.93 The new regulatory framework sought to increase the visibility of the regulation of transport and distribution services by requiring notice of tariff schedules to users.94

86. Maciel, subra note 65, at 373 (describing section 2 of Law 24076V 87. Petrecolla et al., supra note 71, at 71; Maciel, supra note 65, at 374. 88. President Carlos Menem had the power to define the GdE privatization committee's func-

tions as well as the power to choose from several options to dissolve state ownership of GdE, including selling shares or assets and awarding concessions. Similarly, Menem was authorized to determine whether the individual pieces of the sale should go to an open bid tender or public auction. He was additionally empowered to modify existing concessions, change loan arrangements, and order the state to assume all or part of GdE' s debts if the assumption would improve the condition of the respective sale or concession. Argentine Pipeline Sell-Off Switch, Int'l Gas Rep., Sept. 5, 1991, available in LEXIS.

89. Id. 90. Id. 91. Id. 92. Id. 93. Maciel, supra note 65, at 375. 94. Id. at 376. "[Transporters and distributors must file with the Board the tariff schedule

they propose to apply, . . . [and give] [t]hose tariff schedules . . . wide publicity for their better knowledge on the part of the users." Id.




Prior to implementation of Argentina's privatization program, the state- owned companies played a dual role in the economy. They acted both as operators of public services and as regulatory bodies ofthat particular service industry, so that they engendered "all the problems for users that may arise from this highly potential source of conflicts of interest."95 The Argentine government attempted to address these problems by creating a regulatory body to oversee the privatized gas and electricity industries.96 Although the oil and gas privatization stemmed from Argentina's decision to deregulate, the state, nevertheless, de- cided to retain what it considered a "necessary degree of regulatory duties."97 Conceived as "an independent entity," the regulatory board was supposed "to escape undue influence from political or other special interests, in order to secure full objectivity in applying the law and transparency in its proceedings."98 Although the board was established as "the Enforcement Authority," its authority ranged from enacting administrative regulations to calculating tariffs and determining the bases and conditions for awarding transport and distribution concessions.99 In general, the regulatory board was responsible for safeguarding property, the environment, and public safety in the decision-making processes surrounding the transport and distribution of natural gas.100

3. Policies to Enhance the Privatization Process

The deregulatory policies that resulted from the privatization of Argentina's oil industry included concessions and associations that comprised almost 88 percent of private sector oil production.101 Three major decisions have provided the foundation for the success of the privatization thus far. First, the YPF Law,102 which created the regulatory framework for the oil industry privatization, provided for the state-owned oil company's shift to private ownership by Argentina via a stock transfer.103 The YPF Law also authorized the oil company "to take all steps necessary to form associations with or sell to private companies its interests in refineries, oil pipelines, multi-purpose pipelines, . . . storage prem- ises, . . . plants, and drilling and seismic survey companies."104

95. Id. at 377. 96. Bianchi, sutra note 67, at 17-17. 97. Id. at 17-20. 98. Maciel, subra note 65, at 377. 99. Id.

100. Id. at 378. 101. Bianchi, supra note 67, at 17-19 to 17-20. Eighty-two percent of private sector gas production

is a result of the natural gas deregulation. Id. 102. The Law on Transformation and Privatization of YPF S.A. and Federalization of Hydrocar-

bons (the YPF Law) was passed on September 24, 1992. Id. at 17-18. 103. YPF's capital stock consists of shares owned as to 51 % by the Argentine Government (Class A Shares), 39% by provincial governments (Class Β Shares), and 10% by YPF's employees under the "shared property" system (Class Shares). Within a minimum of three years from the date of the sale, the Argentine state and the provincial governments are to dispose of at least 50% of their respective shareholdings.

Id. at 17-18, 17-19. 104. Id. at 17-19.




Second, Argentina modified its prior pricing policies so that future private operators could institute and maintain prices that covered all of their costs.105 As a result, the government was compelled to adjust its prices in the months preceding the ownership transfer to overcome the inefficiencies of the company and to incorporate the high cost of Argentine capital.106 However, because the government failed to establish a regulatory mechanism to protect consumers from price increases, the adjustment functioned as a double-edged sword. The consumer did not receive any immediate cost benefit from the privatization. Furthermore, any future efficiency enhancements or reductions in the cost of capital may inure only to private shareholders, not to the consumer in the way of lower prices.107

Third, Argentina revised its financial policies, particularly its tax policies, in order to further entice private investment. To moderate the effect of the price adjustments on consumers, the government reduced internal taxes charged on public fees and prices, especially in the cases of petroleum and electric service deregulation.108 The reduction channeled revenues to private utilities at the expense of future tax revenues.109 The transfer or concession contracts entered into in 1989 and 1992 also incorporated clauses that guaranteed tax stability or special tax benefits.110

4. Financial Impact of Privatization

Argentina has attempted to encourage investment by contracting to give private operators special consideration. In gas privatization, the state committed to supply public property inputs at prices below their opportunity cost.111 In electricity privatization, the state guaranteed future owners of three electric power generation centers a specified level of demand at a higher price than that projected for virtually the entire contract.112

Upon privatizing the gas and electricity sectors, Argentina often reduced or eliminated both the financial and commercial debts of the enterprises.113 Al- though this forced the Argentine treasury to incur additional liabilities, the assets sold by the state became more valuable.114 However, the concession had a correlating benefit to the state: Achieving the state-determined quantitative or qualitative targets for the services transferred required substantial new investment on the part of the new enterprise.115 The debt elimination strategy reflected the expectation that awarding incentives to private owners would increase the

105. Petrecolla et al., supra note 71, at 71-72. 106. Id. at 72. 107. Id. 108. Id. 109. Id. 110 Id 111. Id. 112. Id. 113. Id. 114. Id. at 73. 115. Id.




production and efficiency of Argentina's economy. "At the heart of [Argenti- na's] policy of privatization is the idea that the private sector will invest 21.8 billion dollars in public services [in the period 1992-2000], or 2.4 billion dollars annually, which is equivalent to 1.6 percent of GDP."116

Between 1989 and 1993, privatization had a positive impact on Argentina's economy, including drastically reduced inflation rates,117 no price controls, free foreign exchange market, no limitations on the ability of foreign investors to remit profits abroad and repatriate capital,118 substantial reduction of fiscal and quasi-fiscal state deficits, elimination of required prior government approval for foreign investments greater than U.S. $5 million, no special income tax on excess profits, full oil industry deregulation, and full gas industry deregulation and privatization.119 Privatizations also have streamlined the workforce, but these efficiency gains were achieved at a cost to labor of over 250,000 jobs in state and state-owned industries.120

C. Criticism and Promise of Argentina's Energy Privatization Program

Despite its successes, Argentina's energy privatization program has not been without its critics. The predominant criticism levied against the government focuses on its forfeiture of substantial profits in the gas and petroleum privatizations. When gas and petroleum reserves were auctioned, "the bidders had no practical way to compute the value of the gas, because the private sector lacked knowledge of costing its extraction, transport and sale"121 Buyers, therefore, tended to undervalue the assets to be acquired, and the income relinquished by the state because of the uncertainty may have reached 32 percent of its total income.122 Moreover, the state failed to guarantee competition among bidders, so prices of the assets were grossly underestimated.123

The Argentine economy has much to offer potential private investors. The country has a relatively well developed oil and gas industry, a reasonably good infrastructure, good political and legal security for foreign investments, and a number of international and local companies already operating in the energy sector.124 Argentina serves as a possible model for privatizing the energy sector. Certain countries, especially in Latin America, could learn from the Argentine experience - its mistakes and accomplishments - because they are subject to economic conditions similar to those that prompted Argentina's privatization pro-

116. Id. at 78 (footnote omitted) (figures do not include private investment in petroleum). 117. Bianchi, supra note 67, at 17-5. In 1989, the inflation rate reached 4,923%. In 1993, the

January /April Wholesaler Price Index listed a much lower inflation rate of 1.8%, while the Con- sumer Price Index listed the rate as 3.4%. Id.

118. See Jeffrey Jones, Southern Exposure: Don't Cry for Chauvco, Oilweek, Mar. 21, 1994, at 25. 119. Bianchi, supra note 67, at 17-6, 17-7. 120. Ιδ-Month Forecasts of Fiscal and Monetary Expansion, Political Risk Serv., Dec. 1, 1995,

available in LEXIS, NSAMER Library, ARGEN File. 121. Petrecolla et al., sutra note 71, at 79. 122. Id. 123. Id. at 80. 124. Maciel, supra note 65, at 379.




gram.125 The greatest challenge to countries that choose to initiate a free-market

economy will be preserving the state's regulatory function.126

III. Brazil

A. A "Late Bloomer"

Brazil is one of the more recent Latin American countries to privatize state assets. From late October 1991 to early October 1992, 16 public enterprises were transferred to the private sector.127 The initial privatization of Petroflex, the Brazilian petrochemical company, was accomplished by stock auction,128 and plans have been approved to further privatize the energy industry. Brazil has only recently opened up its electricity sector to private investors. Through "build-operate-transfer" projects, private companies will be able to enter the

electricity sector and could eventually control up to 40 percent of Brazil's electric- 129

ity generating capacity. Unlike most other Latin American countries, Brazil began its privatization

efforts in manufacturing, not in the public utilities sector, to avoid the potential problems of regulating the utilities activity. Moreover, Brazil's severe economic crisis delayed the privatization program. When the monthly inflation rate exceeded 80 percent, structural reforms became secondary to more immediate stabilization concerns.130 However, the primary cause of the delay was the time

required to develop a privatization program that could gain acceptance despite widespread resistance to public asset sales in Brazil. Even in 1990, although the Collor administration had significantly broadened public support for a more

aggressive privatization program, privatization remained a "very controversial issue" in Brazil.131

B. Obstacles to Overcome

1. Energy Industry Requires a Regulatory Framework

Because the energy industry is inherently complex, Brazil is likely to encounter more obstacles when it privatizes public utilities than it did when it transferred

125. Bianchi, supra note 67, at 17-20. 126. Id. 127. Marcelo De P. Abreu & Rogério L.F. Werneck, Privatization and Regulation in Brazil: The

1990-1992 Policies and the Challenges Ahead, in Latin America: Privatization, Property Rights, and Deregulation I 21, 25 (Werner Baer & Michael E. Conroy eds., 1993).

128. Id. at 25; Privatization of Brazil's Petroleum Sector on Track Despite Scandal, Oil & Gas J., July 6, 1992, at 52 [hereinafter Brazil's Petroleum Sector on Track]. Fifty percent of Petroflex voting stock was sold at a premium of 20.8% over asset valuation to three petrochemical companies: Suzano (40%), Coperbo-Norquisa (40%), and Unipar (20%). The Petrobras pension fund, Petrus, acquired another 14% of total voting stock. The total sale was valued at an equivalent of $222.1 million. Id.

129. Brazilian State Set to Offer 7,719 MW in Plant Selloffs and New Projects, Elec. Util. Week, Aug. 30, 1993, at 14. The Brazilian government is still expected to maintain control of most generation for the foreseeable future.

130. Abreu & Werneck, supra note 127, at 132. 131. Id.




ownership of the manufacturing sector. The manufacturing enterprises, especially the steel, petrochemical, and fertilizer industries, did not require "major, simultaneous reform of the regulatory apparatus,'' as will the public utilities.132 Because public utilities are natural monopolies, regulation will be necessary to ensure that public monopolies will not merely be transformed into unregulated private ones.133 An adequate regulatory framework will be necessary to assure, simultaneously, "an attractive rate of return to the capital invested in public utilities, reasonable prices, and consumers' satisfaction with the services qual- ity."134 Regulation is therefore crucial if the exploitation of market control is to be avoided.135 In addition, regulation will provide a significant incentive to increase productivity in those sectors of the economy that are insulated from competition.136

Brazil's earlier experience with foreign control of its public utilities illustrates the potential for regulatory problems. When the state took over the utilities from foreign firms, public services regulations were virtually unenforced because the regulators were not independent from the providers of services.137 Moreover, regulatory authorities historically have not been held accountable for their activity.138 To date, few regulatory mechanisms have been enacted, and dialogue regarding the need for regulation is mostly speculative. "As a result, some projects are being [postponed] until 1998, and 'developers are looking else- where.' "139

The lack of a clear regulatory and legal framework has hindered Brazil's ability to attract assistance in completing several stalled power projects. A concession law, enacted in February 1995, that for the first time allows private investment into the electric power sector is expected to overcome this deterrent.140 The law also authorizes the sale of two electric utilities, but the method of privatization has not yet been determined.141 However, when Brazil's new president, Cardoso, signed the act into law, he attached the provisional measure that encompassed private power generation, but did not delineate the regulations

142 governing private generation.

132. Id. at 25. When the manufacturing sector was privatized, general rules were established to be followed in each privatization, and the program was to be directed by a Privatization Commit- tee, the members of which were to be selected by the President and approved by Congress. Id. at 23.

133. Id. at 34. 134. Id. 135. Id 136. Id. 137. Id. at 35. 138. Id. 139. Mary O'Driscoll, Perils and Profits of International Gas Development, Energy Daily, Feb. 15,

1995. 140. Brazil's President Signs Law to Allow Private Investment in Electric Sector, Elec. Util. Week,

Mar. 6, 1995, at 15 [hereinafter Brazil President Signs Law]. 141. Brazil's President Signs Law, supra note 140. Importantly, the law encompasses, but does not

specifically authorize, privatization of public power. Another separate measure, currently under discussion, must be passed before private power is full ν authorized. Id.

142. Id.




2. Constitutional and Nationalist Detenents

In addition to providing regulatory reform, Brazil must surmount legal and

political obstacles to privatization as well. The "[nationalist pressures ... are

strong" and the "political cost of such initiatives is ... great."143 These potential barriers have led President Cardoso to exclude certain state monopolies, including oil, from privatization during his administration.144 Furthermore, Bra- zil's constitution mandates that the oil industry be controlled by state-owned

enterprises.145 Absent the necessary constitutional amendment, oil will be ex- cluded from the list of potential state-owned enterprises scheduled for privatization.146 While Cardoso has maintained that Petrobras147 should not be privatized because the required resources are unattainable, he has considered "openfing] up some Petrobras fields to competition."148 Cardoso also has intimated that he would support a more flexible policy, short of privatization, that permits joint ventures and the participation of foreign capital in certain fields.149

3. Labor Opposition For most state-owned entities, privatizing means streamlining the workforce

to enhance efficiency. Private ownership often has encompassed massive reductions in the workforce, so labor is generally less than receptive to the prospect of selling a state-owned company to private investors. For most of 1995, Brazil's energy sectors, particularly oil, were bombarded with strikes and threats of strikes to demand higher wages, but also to prevent private sector investment in Petrobras.150 Union leaders stated their opposition to plans to open up the monopoly held by Petrobras to private capital.151 These strikes have left Petrobras and the Brazilian government with losses of several million dollars due to shut-in production and reduced refinery output.152

Ironically, the strikes in Brazil may have enhanced congressional support for ending the state's monopoly in the energy sector and permitting private and foreign investment.153 The work stoppage demonstrated to the government the

143. Arnaldo Cesar, New Government to Continue Wave of Privatizations, Inter. Press Serv., Jan. 3, 1995.

144. Id. 145. Abreu & Werneck, supra note 127, at 33. 146. Id. note 129, at 33. The Collor administration had pressed for an amendment to remove

the state-ownership problem. Although the position of the Congress has changed since 1988 when the constitution was promulgated, absent the unwavering support of the new executive, passage of such an amendment seems unfeasible. Id.

147. Brazilian Petroleum Corporation. 148. Cardoso Outlines Direction, supra note 20. 149. Cardoso Outlines Direction, supra note 20. 1 50. Foreign and Private Investment Needed; South America 's Oil and Gas Industry; 50th Annual International

Outlook Industry Overview, World Oil, Aug. 1995, available in LEXIS, ENERGY Library, ALLNWS File [hereinafter Foreign and Private Investment Needed].

151. See Brazil Faces Anti-Reforms Strike at Midnight, Reuters- Cent. & S. Am., May 2, 1995, available in LEXIS, NSAMER Library, BRAZIL File.

152. See Foreien and Private Investment Needed, supra note 150. 153. Id.




extent of union power should the Petrobras monopoly remain intact.154 More significantly, since the strikes began, popular support for the strikes has waned, and congressional criticism of Brazil's privatizations has been suppressed.155

C. Focus on Petroleum and Electricity

While Brazil has been preparing its petroleum and petrochemical industries for privatization, inflation has proved difficult to curb and could ultimately hinder the transfer of these industries. Basic materials such as petroleum, petrochemical products, and steel are already high priced, and the government's phaseout of subsidies to force companies manufacturing these products to adjust to competitive market conditions would put additional upward pressure on prices.156 Escalating input prices may translate to significantly higher prices for consumers who purchase goods whose manufacture depends heavily on previously subsidized raw materials.157

Because the power industry had been dominated by " world- scale" projects,

the military governments that initiated these projects frequently disregarded cost control.158 As a result, most of Brazil's five regional generating companies owned by Eletrobras have been saddled with debt.159 Eletrobras has been unable to increase its charges or borrow from abroad to raise the money that it needs to expand the system or refurbish it.160 Privatizing all or part of the industry may enable Brazil to more easily obtain loans from multilateral lenders, such as the World Bank and the Inter- American Development Bank, because those institutions are more inclined to extend credit to "mixed-capital entities."161

The rapid expansion of Brazil's economy means that additional power- generating capacity must be added quickly, and private ownership could provide the solution to this capacity problem. To that extent, the Independent Power Production Law was effected in July 1995 to allow private companies to generate and sell electricity.162 Additional legislation was ratified on December 15, 1995, permitting subsidiaries to be created from Eletrobras, and the massive privatiza-

154. Id. 155. See Brazil, IBC Int'l Country Risk Guide, July 1995, available in LEXIS, NSAMER

Library, BRAZIL File. 156. The 1992 Outlook: Gradual Recovery, Brazil Serv., Jan. 8, 1992. 157. Id. 158. Brazil Gets Ready to Privatise, Energy Economist, Nov. 1994, at 15. 159. Id. Eletrobras has accumulated debts of approximately $30 billion. Id. Privatization is the

only way that debt-ridden Eletropaulo, the electric utility serving Sao Paulo (Brazil's major business and financial center) can raise enough funds to make much needed investments in new generating facilities to meet growing demand. Allowing the private sector to participate in Brazil's electricity sector through build-operate-transfer projects will enable utilities to increase electric rates without first obtaining approval from the federal government. Currently, all electric tariffs in Brazil are equal, causing some regional electric utilities to lose vast sums of money. Brazil to Privatize Part of 1,457-MWSão Paulo Utility; Reforms Statutes, Indep. Power Rep., Mar. 12, 1993, at 12 [hereinafter Brazil to Privatize].

160. Brazil Gets Readv to Privatise, subra note 158. 161. Brazil to Privatize, supra note 159. 162. See Brazil's President Signs ΊΡΡ LAW,

' Clearing Way for Private Power, Indep. Power Rep.,

July 14, 1995, at 13.




tion process that had begun in July with the sale of Escelsa, an electricity distributor, gained momentum.163 Although Eletrobras has been slated for partial privatization, its size and the cross-ownership between Eletrobras and its subsidiaries have complicated such efforts.164 To increase the potential for success, Brazil's government has requested advice from consultants regarding the model for privatization, creating an independent regulatory agency, interconnecting the transmission grid, and setting tariffs.165

The privatization law and the sale of Eletrobras provide a " golden opportunity

for investors" and enhance Brazil's stature as the largest private power market in the world.166 The fears of investors who traditionally have been apprehensive about Brazil's "unformed regulatory environment" may be allayed by the creation of an adequate regulatory scheme.167

IV. Conclusion

Developing countries, and those in Latin America in particular, encounter barriers to privatization not indigenous to more developed nations. Only through foresight and advance planning can a government successfully surmount these obstacles. The government must overcome popular opposition to reducing state ownership of the energy industry through an aggressive marketing campaign. The state must stress the benefits of foreign investment in traditionally nationalistic countries. It must also make an affirmative effort to choose a method of privatization that will maximize support and minimize opposition. It is critical that the government analyze, understand, and address the political climate within the country. Lack of popular support could undermine the position of the party in power, allow for entry of a new party that is less supportive of privatization, and frustrate previous gains made in moving toward a market economy.

The legal and constitutional barriers in Latin America, especially in regard to the energy industry, necessitate creative privatization strategies. Often new regulatory schemes must be enacted merely to permit the privatization to take place. Even in the absence of legal or constitutional barriers, developing nations must not overlook the importance of effecting regulations to control the privatized industry. Such new regulations should monitor the activities of newly private companies to prevent the development of monopolies. They should also

163. 3, 500-MW Brazilian Utility Split in Two in Preparation for Auction, Elec. Util. Week, Jan. 8, 1996, at 17 [hereinafter Brazilian Utility Split]. See Winner of Brazilian Distribution Firm Seeks Partner for 130-MW Expansion, Indep. Power Rep., Nov. 3, 1995, at 13 (describing the effects of Escelsa's sale to private owners).

164. Brazilian Utility Split, supra note 163. 165. Id. The government has also requested advice as to whether Eletrobras should be sold as

one entity or whether its generating plants should be sold individually or in packages of more than one plant. The recommendations will be considered by the Council of National Privatization, which will make the final determination regarding the privatization structure. Id.

166. EU /Mercosur: Free Trade Agreement to Be Signed on December 20, Eur. Energy, Nov. 17, 1995, available in LEXIS, ENERGY Library, ALLNWS File.

167. Id




create incentives to increase productivity. However, the new regulators must maintain their independence from the companies that they regulate so as to preserve their objectivity in promulgating and enforcing regulations.

Ensuring that adequate regulatory structures are in place prior to the privatization will foster the confidence of foreign investors. Proper regulation should encourage foreign companies to enter the energy industry in developing countries. However, the developing country must strive to maintain a balance between promoting sufficient regulation and engaging in overregulation, which may deter foreign investment by severely restricting a company's activity.

Although the state will have given up actual ownership of the public enterprise, it retains a significant role in monitoring the country's economy. Adequate control of the private enterprises will ensure that the economy and the public are protected and that overreaching by the new firms will not occur. The state alone can determine the success or failure of privatization efforts by the actions that it takes prior to and after the transfer of ownership.



project: privatization: the global scale-back of government involvement in national economies ||...

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