AMBASSADOR HOSTS ELECTRICITY, GAS SECTOR U.S. INVESTOR

UNCLAS BUENOS AIRES 002808

SIPDIS

SIPDIS
SENSITIVE

EB/ESC/IEC FOR SGALLOGLY, MMCMANUS,JIZZO
WHA FOR WHA/BSC AND WHA/EPSC
E FOR THOMAS PIERCE
PASS NSC FOR JOSE CARDENAS
PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE
PASS USTR FOR SUE CRONIN AND MARY SULLIVAN
TREASURY FOR ALICE FAIBISHENKO
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER
US SOUTHCOM FOR POLAD

E.O. 12958: N/A
TAGS: ENRG EPET ECON ETRD AR
SUBJECT: AMBASSADOR HOSTS ELECTRICITY, GAS SECTOR U.S. INVESTOR
ROUNDTABLE

Ref: (A) Buenos Aires 2598
(B) Buenos Aires 2594
(C) Buenos Aires 2683

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Summary
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1. (SBU) Country managers of U.S. players in Argentina's electricity
and natural gas sectors met with Ambassador to review constraints
imposed by GoA regulations, uncertain natural gas supplies for
generation, and frozen retail electricity and gas tariffs.
Participants representing AES, CMS, Duke, Eton Park and E-On
detailed company-specific stories about how GoA regulations and
price controls imposed after the 2001 economic crisis had impacted
their operations and strategic approach to the Argentine energy
market. They complained about unmet GoA contractual obligations
(including late capacity payments electricity generators) and unmet
GoA promises (including delays of promised 2006 tariff review until
after October 2007 elections).


2. (SBU) All participants agreed that electricity and gas regulatory
authorities established during Argentina's 1990s privatization
process were no longer independent. They saw little in the way of
long term vision in the GoA's energy policy mix, but rather a short
term focus on maintaining below market consumer prices in this
pre-election year. They doubted that the GoA would - as it has
promised - move to a less regulated electricity and gas pricing
model by 2008. Finally, most participants argued that, while they
could adapt their operating and investment strategies to a
suboptimal but stable policy mix, the GoA's penchant for changing
the rules of the energy sector game preemptively and without
consultation made it difficult for them to justify investments in
expanded energy capacity the Argentine market needs. Participants
accepted Ambassador's offer to set up a roundtable meeting with
Planning Minister De Vido to offer a forum for the GoA to address
these issues. END SUMMARY.

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Complaints: Politicized Regulation, Lack of GoA Vision
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3. (SBU) In the second in a series of sector-specific roundtables
with U.S. investors (the first was held with upstream and downstream
hydrocarbon investors - see Ref A),Amb met December 13 with
representatives of U.S. electricity generation, transmission, and
distribution as well as natural gas pipeline and distribution
players. Attendees included AES Country Manger Eduardo Dutrey; CMS
CEO Bernardo Velar de Irigoyen; Duke Energy Country Manager
Guillermo Fiad; E-On USA Country Manager Enrique Flaiban; and Eton
Park consultant Federico Ravazzani. Participants reviewed operating
constraints imposed by the GoA's energy sector regulations,
uncertain natural gas supplies for generation, frozen retail
electricity and gas tariffs and discussed how these have affected
their business strategy and investment decisions.


4. (SBU) Participants detailed company-specific stories about how
GoA regulations and price controls imposed following the 2001
economic crisis, had impacted their profitability, operational
viability and strategic approach to the Argentine energy market.
Hydro and thermal electricity generators (AES, CMS and Duke)
complained of GoA electricity pricing formulas for spot market sales
that are roughly 65% below regulated rates charged by generators in
neighboring countries. Generators explained that these rates
covered only their variable costs and characterized the GoA's
below-market pricing formulas as broadly populist, inefficient
(insofar as they subsidize users who can afford to pay more) and as
"indirect expropriation" of generator investments. Further, they



noted that the GoA's regulated wholesaler CAMMESA has only made
payments to them for spot electricity sales through July.


5. (SBU) Electricity distributor AES noted that it was only
partially allowed to implement industrial and wholesale end-user
tariff rate increases negotiated with the GoA and that a full tariff
review for one of its distributors promised by the GoA in 2006 had
been delayed until after October 2007 elections as a matter of
"political expediency." Gas transportation company CMS called
favorable an ICSID ruling directing the GoA to pay it $130 million
in compensation for contractual breaches in CMS' investment in one
of the national gas pipelines. However, CMS complained that the
GoA's ongoing diversion of gas supplies to the domestic market had
forced it to default on contacted natural gas sales to Chile. Gas
distribution company E-On complained that retail gas tariffs it is
able to charge Argentine end consumers are roughly 10 times lower
than rates normally charged in Brazil and Chile and argued that the
GoA was "not respecting the contractual rules of the game" by
failing to approve the pass through of increased costs to consumers.



6. (SBU) All participants agreed that independent electricity and
gas regulatory authorities established during Argentina's 1990s
privatization process had long since been subordinated to the
post-crisis political process and were no longer independent. They
saw little in the way of long term vision in the GoA's energy policy
mix, but rather a short term focus on maintaining below market
consumer prices in this pre-election year. They doubted that the
GoA would - as it has promised - move to a substantially less
regulated electricity and gas pricing model by 2008. Finally,
participants argued that, while they could adapt their operating and
investment strategies to a suboptimal but stable policy mix, the
GoA's penchant for changing the rules of the energy sector game
preemptively and without consultation made it difficult for them to
justify to their Boards of Directors investments in expanded
capacity that the Argentine market needs.


7. (SBU) Ambassador noted that Planning Minister De Vido had earlier
offered to co-host sector-specific roundtables with the Ambassador
to address U.S. investor concerns. Participants agreed that such a
roundtable would offer a forum for the GoA to address broad
regulatory inconsistencies and asked the Ambassador to request a
meeting in January.

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Argentina's Electricity Sector
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8. (SBU) Argentina has the third-largest power market in Latin
America, relying mostly on hydropower and natural gas-fired thermal
plants for most of its electricity supply. With approximately 28
gigawatts of installed generation capacity, 61% of Argentina's
electricity production capacity is fossil fuel-based (primarily
natural gas) and 35% is hydroelectric. Subsidized domestic demand
has raised generating capacity utilization to internationally
accepted limits, and experts are projecting power shortages this
austral summer.


9. (SBU) Following the 2001/2002 economic crisis, the GoA pessified
capacity payments to generators, reducing them to roughly 40% of
their earlier dollar value, and changed the structure of electricity
spot pricing so as to make investments in generation, particularly
in marginal capacity, much less attractive. These interventions
resulted in an electricity sector pricing mechanism for the
wholesale generation market that provides few incentives for new
greenfield investment. Private electricity sector players charge
that, over the last four years, the GoA has undermined the
electricity sector by freezing energy prices, manipulating the



methodology used to set market prices, and effectively confiscating
funds owed to private companies. The GoA has committed to
"normalize" electricity sector tariffs by 2008.


10. (SBU) FONINVENMEM (Fondo de Inversiones en Mercado Electrico
Mayorista:) With voluntary private investment in new electricity
generating capacity limited by GoA price controls and investor
concerns over rapid GoA shifts in sector regulation, the GoA created
a fiduciary fund, FONINVENMEM, to "encourage" new investment in two
new 800 MW combined cycle plants in Buenos Aires and Santa Fe
provinces. The plants will cost $1.2 billion, of which $450 million
is being funded by the swap of outstanding CAMMESA (the GoA's
regulated electricity wholesaler) debt to generators into
FONIMVENMEM equity. The GoA has stated that the remaining $750
million will be funded via a 3-4% surcharge on medium and large
electricity users over the next 5 years, via private pension fund
financing and via new investors.


11. (SBU) Generators' share of FONINVENMEM investment is roughly
based on their share of domestic generating capacity, though the
GoA's participation formula favors both higher margin hydroelectric
producers and those generators who sell onto the spot market rather
than through long term supply contracts. Of U.S. generation
players, AES holds 20% and Duke 5%. France's Total (which announced
the sale of its Argentine generating assets to a local group and to
Merrill Lynch) holds 28%, Spain's Endessa 23%, and Petrobras 10%.
In exchange for this investment, the GoA has committed to (1) have
the GoA's regulated wholesale distributor, CAMESA, sign a power
purchase agreement to guaranty the profitability of the two new
plants; (2) secure dedicated gas supplies for the new plants; and
(3) eventually transition to a free market in energy after the two
new plants are on line.


12. (SBU) Electricity Generators Collections from CAMMESA: U.S.
electricity generators project continued difficulty collecting full
payment from the GoA/CAMMESA for 2007 power sales. These concerns
are based on the growing CAMMESA deficit due to the mismatch between
regulated prices and power production costs. According to a report
prepared by CAMMESA, a cash deficit of about US$ 580 million is
expected for the November 2006 - March 2007 period. As of November
2006, only payments owed for July 2006 had been paid in full,
leaving August, September and October unpaid.


13. (SBU) ICSID Arbitration Claims: Numerous electricity sector
players in Argentina have filed ICSID claims seeking compensation
for some combination of (1) the GoA's pre-crisis de-linking of power
tariffs from the U.S. PPI; and (2) post-emergency law pesification
of generation capacity cost and variable cost payments by regulated
wholesaler CAMMESA. Pre-crisis capacity payments to generators were
roughly US$10 /MW while current payments total ARP 12/MW.

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AES: Electricity Generation and Distribution
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14. (U) With over $1 billion invested since 1993 and over 1,600
employees, AES operates 6 hydro and gas-fired power plants in Salta,
San Juan, Neuquin and Buenos Aires provinces with the capacity to
produce 2.8 GW, 12% of Argentina's total installed capacity. AES is
the third largest private generator, behind ENDESA (Spain) and
TotalFina/Elf (France). AES also owns three distribution companies,
EDELAP, EDEN and EDES, all in the province of Buenos Aires that
provide energy to more than 750,000 customers.


15. (SBU) AES holds a $60 million in the two new FONIMVENMEM
generation plants. AES filed an ICSID claim in 2002 seeking
compensation for the GoA's post-emergency law pesification of
capacity and variable cost payments to generators and the
pesification and freezing of end-user electricity fees paid to



distributors. In August 2005, AES agreed to suspend this ICSID suit
in exchange for a GoA promise to permit a tariff increases in
distributor AES' EDELAP electricity rates for rural industrial and
commercial (but not politically sensitive residential) clients and
to follow-on with a February 2006 full renegotiation of EDELAP's
rate base. According to AES country manager Dutrey, the GoA
ultimately allowed only a partial implementation of this agreed rate
increase and the promised February 2006 rate base renegotiation was
postponed until after October 2007 elections.

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CMS: Electricity Generation & Gas Pipelines
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16. (U) CMS entered the Argentine market in 1993 in electricity
generation, gas transportation and trading services. Its assets
include three power plants totaling 2000 MW installed capacity, CMS
Ensneada, Centrales Termicas Mendoza and Hidroelectrica El Chocon,
as well as stakes in three gas pipelines, Transportadora de Gas del
Norte (TGN) , Transportador de Gas del Mercosur and the Atacama gas
pipeline from Salta province to Chile.


17. (SBU) In July 2001, CMS filed an ICSID case regarding its
investment in TGN, one of the two privatized Argentine gas
transportation companies, charging that the GoA violated US BIT
obligations via its unilateral modification of the legal and
regulatory framework governing TGN including the pre-crisis
de-linking of gas tariffs from the U.S. PPI and the post-emergency
law pesification and freezing of natural gas pipeline tariffs. In
May 2005, an ICSID tribunal found in favor of CMS and awarded the
company damages of approximately US$ 150 million. This was the
first final award issued of the xx claims pending. The GoA has
filed an appeal to nullify the ruling and the Foreign Ministry has
since publicly pledged to respect final ICSID rulings after the
appeals process has been completed.

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Duke Energy: Electricity Generation
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18. (SBU) Duke Argentina owns two power generating assets are
located in Neuquen province: The Planicie Banderita hydroelectric
power station produces 479 MW and the Alto Valle gas-fired thermal
station produces 80 MW. Duke also conducts licensed trading and
marketing in the wholesale electric and natural gas markets as of
late 2000.


19. (SBU) In discussions with the GoA, Duke has committed to upgrade
its Alto Valle gas-fired plant to bring 17 MW of unused capacity on
line. In return, Duke has asked the GoA to lock-in scarce natural
gas supplies for this plant. Duke has also submitted plans to
invest roughly $60 million to add 40MW of new generating turbines to
its Neuquen hydro plant if an appropriate package of federal and
provincial tax incentives can be negotiated.

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Eton Park: Electricity Transmission
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20. (SBU) Eton Park, a U.S. investment firm managing over US$5.5
billion, signed in August 2006 a contract with Brazil's Petrobras
Energia Argentina to purchase its 50% stake in Citilec SA, the
company that holds a 52.7% majority share in Argentine power
transporter Transener. Petrobras's earlier takeover of independent
Argentine energy group Perez Companc in 2003 was subject by GoA
anti-trust authorities to Petrobras's sale of Perez Companc's stake
in Transener. Transener is the largest electrical power
transmission company in Argentina. The formerly state-owned company



was privatized in 1993 with a 95 year concession and is considered
to be one of the leading players internationally in long-distance
power transmission. It owns the national high-voltage transmission
network, with over 8,800 kilometers of transmission lines, as well
as the 5,500 kilometer network of its controlled subsidiary Transba.
In addition, Transener's Brazilian division separately operates
over 2,300 kilometers of 500kV lines. Transener's combined networks
are one of the longest 500kV systems in the world, as well as
extensive 125kV and 250kV lines. Eton Park's purchase is not yet
finalized.

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E-On U.S.: Gas Distribution
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21. (SBU) E-On US, a U.S. subsidiary of Germany leading energy
provider, acquired LG&E Energy in 2001. Through this purchase, E-On
now owns interests in three Argentine gas distribution companies:
Distribuidora de Gas del Centro S.A.; Distribuidora de Gas Cuyana
S.A.; and Gas Natural BAN S.A. These three gas distribution
companies in which E.ON US has interests provide 33% of the natural
gas consumed in Argentina, reaching a customer base of over 2.2
million.


22. (SBU) In late 2001, LG&E filed an ICSID suit against the GoA's
pre-crisis de-linking of gas tariffs from the U.S. PPI and later
amended the case to include the GoA's post-crisis pesification and
freezing of these same tariffs. In an October 3, 2006, ruling, an
ICSID tribunal did hold that the GoA violated provisions of the US
BIT. However, at the same time, the tribunal exempted the GoA from
liability for a 17 month December 1 2001 to April 26, 2003 emergency
"state of necessity" period of the Duhalde presidency. While
damages have yet to be calculated by the tribunal, the precedent
this ruling sets is troubling to many ICSID claimants.

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Comment
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23. (SBU) That U.S. electricity and gas sector players see little in
the way of long term vision in the GoA's energy policy mix is
consistent with views expressed earlier by U.S. upstream and
downstream hydrocarbon players (Ref A). Their doubt that the GoA
will keep its promise to move a substantially less regulated
electricity and gas pricing model by 2008 is troubling given the
manifest need to expand domestic generating capacity to meet
burgeoning demand. While the potential for ongoing energy shortages
and blackouts during the peak summer season has been a media staple
for some time, most analysts believe the GoA will be able to muddle
through -- perhaps with some rationing -- until October 2007
elections. But the reluctance of electricity sector players to
invest in new capacity in the face of the GoA's heavy handed energy
policy mix will eventually force the GoA to consider reforms. The
question is when and the only certainty is that substantive reforms
will not be implemented before October 2007 elections.

WAYNE