ECUADOR-VENEZUELA DEAL COLLAPSES, PALACIO CANCELS

C O N F I D E N T I A L QUITO 001906

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR SGOOCH

E.O. 12958: DECL: 08/02/2016
TAGS: ECON
SUBJECT: ECUADOR-VENEZUELA DEAL COLLAPSES, PALACIO CANCELS
CRUDE AUCTION

REF: A. QUITO 01612


B. QUITO 01887

Classified By: EconOff Sara Ainsworth, for reasons 1.4 (b&d)


1. (SBU) Summary. After two months of wrangling over
details, Petroecuador's and Venezuelan PDVSA's plan to swap
Ecuadorian crude for refined products appears finally to have
collapsed. (reftel A) The deal was uneconomical and
technically untenable from the beginning, and Venezuela
apparently determined that the political benefits would not
outweigh the disruptions to its refineries. The deal's
collapse compelled Ecuador's government (GOE) to solicit
offers for over 17 million barrels of crude from Block 15,
recently co-opted from Occidental Petroleum (Oxy). The GOE
originally scheduled the auction for July 27, but after
receiving limited interest, rescheduled the auction to August

4. Many industry insiders also see the postponement as an
attempt by President Palacio to give preference to
state-owned companies, underrepresented in the first set of
bids. End summary.

Crunching Numbers With Political Calculus
--------------


2. (SBU) The oil exchange agreement between Ecuadorian state
oil company Petroecuador and its Venezuelan counterpart
PDVSA, was from the beginning a political calculation meant
to demonstrate the benefits of the Oxy takeover. One energy
insider posits that Chavez and Palacio laid the groundwork
for the deal in May during the EU-Latin America Summit in
Vienna without considering the deal's economic and technical
problems.


3. (U) In the months after signing the memorandum, the GOE
pushed PDVSA to provide concrete numbers that would
demonstrate the economic merits of the deal. Market
fundamentals dictated that the benefit to Ecuador would
fluctuate monthly subject to several variables including
consumer demand and the supply and inventory of crude and
refined products, all of which would affect daily market
reference prices. Another technical barrier to the deal was
the legal requirement that all Ecuadorian crude be shipped by
monopoly firm Flota Petrolera Ecuatoriana.


4. (SBU) An independent energy consultant told EconOff that
former Minister of Economy Borja has ties to presidential
candidate Rafael Correa, and that both are friendly with
Chavez. He suggested that Borja dreamed up the putative
deal's benefits to Ecuador in a public relations campaign
aimed at highlighting the economic wisdom of canceling Oxy's
contract. When Borja couldn't win over the media, the GOE
started asking Venezuela for revised numbers.

Venezuela: Even Ideology Has A Bottom Line
--------------


5. (U) Despite public efforts to demonstrate solidarity with
Ecuador, in the end Venezuela appeared to be motivated by
profit. The agreement would have upset the balance in
Venezuelan refineries, requiring time to switch from treating
Venezuelan crude to Ecuadorian Napo crude. Sending
Ecuadorian crude to Citgo refineries in the US would have
been problematic because shipping through the Panama Canal is
expensive and logistically challenging. One energy insider
believes that in the end Venezuela probably realized that the
benefits, whether political or economic, would not compensate
for the disruptions to its refineries.

Pssst... Wanna Buy Some Crude?
--------------


6. (U) After the collapse of the PDVSA deal, the GOE
announced that it was accepting offers for an eight-month
purchase agreement for 17 million barrels of Napo crude from
Block 15, which would be awarded July 27. Twenty minutes
before opening the sealed bids, President Palacio canceled
the auction. The GOE then publicly announced that the
auction would be postponed until August 4, giving potential
buyers (public and private) more time to present their bids.
According to a Petroecuador insider, Palacio earlier had

asked Minister of Foreign Affairs Carrion to invite the
Indian oil company and other state-owned firms to participate
in the bidding process. In the event, the Indonesian state
energy company was the only state-owned company to bid. On
July 31, Minister of Economy Rodas explained that several
state-owned firms had received their invitations too late to
submit bids. Palacio reportedly disagreed with the manner in
which Petroecuador's Board of Directors managed the auction.
He is now facing an investigation by the Attorney General for
his haphazard decision to postpone.

Comment
--------------


7. (C) The USG should welcome the collapse of the
Venezuela-Ecuador crude-for-refined products deal, but for
Ecuador the underlying problems remain. It spends more than
$1 billion importing refined products every year and
Petroecuador still must find buyers for more than 2 million
barrels of crude produced every month from Block 15.
Government contacts told us that a few well-placed
Ecuadorians have been profiting off the crude sold on the
spot market; they may have played a role in scuttling the
Venezuela deal. New Petroecuador President Galo Chiriboga
(reftel B) has also said he will try to restart negotiations
with Venezuela.


8. (C) Petroecuador is likely to suffer the consequences of
President Palacio's rash decision to postpone the auction.
Four members of the company's Board of Directors have been
scapegoated and replaced in the hiatus between auctions.
Several of the company's best customers have said they will
not submit bids again, including Glencore and Shell Trading.
The crude is likely to continue selling at a steep discount,
as global refineries are reportedly at capacity until
September, and Ecuador needs to offload its oil due to
storage limitations. End comment.
BROWN