The welfare effects of energy price changes due to energy market reform in Mexico

Abstract

Despite being a large energy producer and exporter, Mexico may soon become a net total energy importer due to a decline in oil reserves and increasing domestic consumption. To increase efficiency in the energy market, Mexican authorities approved a constitutional amendment aiming to open the state-run energy markets to competition in 2013. The reform is expected to raise efficiency and to lower energy prices in the long run. However, it will take some time for the new institutional arrangements to settle and the reform objectives to materialize. The removal of subsidies, which is expected to take place after the reform, will also raise prices particularly in the short run. In this paper, we analyze the effect of likely energy price changes due to energy market reform on household consumption and welfare in different income groups. We estimate the QUAIDS model using the nonlinear SURE method and the Mexican household budget surveys for the period 2002–2012 to obtain elasticities. The results show great heterogeneity in elasticities across energy types and income groups. Specifically, energy demand is elastic with respect to income, but changes in prices have mixed effects among energy types. The welfare effect of the price changes on low-income households will be 9 times stronger than that on the mid-income households and 18 times on and the high-income households. This warrants a compensation package to make the reform socially acceptable.