UNCLAS SECTION 01 OF 02 PANAMA 002457

SIPDIS

DEPT FOR WHA/CEN

E.O. 12958: N/A
TAGS: ECON EIND ENRG EPET ETRD PM ENIV ECONOMIC AFFAIRS
SUBJECT: PANAMA FACES UNCERTAIN ENERGY FUTURE

REF: A. MEXICO 7368

B. MEXICO 7466

This is the second part in a two part series on Panama's
energy sector.


1. SUMMARY (SBU). Major electricity generators estimate that
Panama's demand for electricity will exceed supply by 2009.
In the absence of investment in additional generating
capacity, Panama could face energy shortages. Only plants
using higher cost gas-generated electricity could be brought
on-line prior to 2009, guaranteeing a steep rise in the cost
per kilowatt hour over the next three to five years.
Construction of cheaper hydro or coal generated electricity
exceed the available timeline. Currently, no new plants of
any type are under construction. GOP reluctance to grant
long term purchase contracts of more than four years in
length has discouraged suppliers of all types from investing
in additional capacity. END SUMMARY

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SHORT-TERM ELECTRICITY CONTRACTS DISCOURAGE NEW PLANTS
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2. (U) Panama's electricity market is divided into three
parts: Generation, transmission and distribution. There are
currently 9 companies engaged in generation, 1 in
transmission and 2 in distribution. Although the market was
privatized in the late nineties, the GOP retained 49%
ownership in the three largest power generators. According
to regulation, the GOP is supposed to contract for 100% of
the projected demand plus a reserve amount. However, since
being burned by high contract prices and low spot market
prices in the initial period following privatization, the GOP
currently only contracts about 70% of demand and buys the
remaining energy at hourly spot market prices. No new power
plants have come on-line since 2003 with one existing plant
going off-line in 2004.


3. (SBU) Former Enron company Bahia Las Minas (BLM), 49%
owned by the GOP, operates several energy generating plants
using a variety of technologies. One of their plants,
however, operates on marine diesel and provides the most
expensive energy per kilowatt

hour. This plant provides the
last marginal energy used during the day but only at contract
prices. BLM will not provide additional energy on the spot
market because their price per kilowatt hour is the highest.
Once that price is on offer, all other providers can sell
excess capacity on the spot market cheaper and at a
substantial profit allowing BLM to only break even.


4. (SBU) BLM General Manager Max Kelly, told Econoff that
BLM was prepared to make a $100 million investment in
converting this plant to significantly cheaper coal
technology if the GOP would return to 10 year contracts for
the output. So far the GOP has declined. BLM faced
bankruptcy in April 2005 but negotiated $45 million in
refinancing over the next 7 years. Because the financing
arrangements consist of balloon payments, Kelly estimates BLM
can survive until 2007 under the current pricing structure
before facing default and bankruptcy. If BLM defaults, Kelly
expects the GOP might seek to take over BLM's assets and
operations.


5. (SBU) BLM is also involved in a long running dispute with
the GOP regarding customs duties assessed on imported
equipment for capital improvements. BLM (and other
generators) had a waiver in effect at the time. Despite a
favorable ruling in court, no refund ($1.5 million) has been
forthcoming. Instead, the Taxation and Revenue authority
(DGI) sought to retroactively overturn these waivers and
assess customs duties on other energy companies who imported
capital equipment during the same time period. This month,
the DGI indicated verbally that it would not be pursuing this
matter further but none of the American providers have been
formally notified.


6. (SBU) AES Panama is also an American Company (49% owned
by the GOP) and produces 100% hydropower electricity.
General Manager David Sundstrom confirmed BLM's contention
that no additional capacity has been built in several years
due to the absence of contractual terms of 10 years or more.
However, in December, AES Panama secured two 9 year contracts
for the period 2009 to 2018. It is not yet clear if the
contractual price is sufficient to incent AES to invest in
new capacity or whether this contract will be serviced from
AES's existing hydroelectricity plants.

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GOP SEEKS REGIONAL SOLUTIONS
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7. (SBU) The sharp increase in global fuel prices has
prompted several regional energy initiatives. Fortunately,
Panama appears to remain uninterested in Venezuela's
Petrocaribe initiative nor has there been any activity
related to the stalled Puebla to Panama Plan (PPP). However,
Panama has enthusiastically responded to President Fox's
Mezoamerican Energy Initiative vying for the site of the
proposed new refinery (Reftels). However, Panama must await
the outcome of the independent feasibility studies and
confirmation of financing by the Inter-american Development
Bank among others.

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COST EFFECTIVE SOLUTIONS ARE LONG TERM
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8. Comment (SBU): The division of Panama's energy policy
between the Ministry of Economy and Finance (MEF), Ministry
of Commerce and Industry (MICI) and the regulatory commission
(ER) has fundamentally hindered the GOP's ability to develop
long term, coherent energy strategies. To protect consumers
and placate voters, the GOP has sought to minimize its short
term energy costs. Without an acceptable profit margin, no
new investment in this capital intensive industry has been
undertaken by the generators. Panama's electricity
generators are waiting out GOP willingness to reengage in
long term contracts. The feasibility, cost and output from
the MezoAmerican Energy Initiative remain to be seen.
Regardless, none of the initiatives outlined by the GOM have
reliable completion dates and are unlikely to come on-line
prior to 2009.


9. Comment cont'd (SBU): When the power runs out, the GOP
could be forced to contract for additional capacity on an
expensive spot market or to negotiate contracts for short
term supply with companies whose only option will be to use
expensive energy generation technology. In either case,
Panamanian consumers will likely demonize the industry and
pressure the GOP to pursue a cap on electricity prices. An
uncertain energy supply could dim Panama's increasingly
bright economic prospects.
ARREAGA