SAO PAULO PERSPECTIVES ON BOLIVIAN GAS SITUATION

UNCLAS SECTION 01 OF 04 SAO PAULO 000512 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/BSC, WHA/EPSC, EB/ESC/IEC/ENR, EB/ESC/IEC/EPC STATE PASS USTR MSULLIVAN/KLEZNY STATE PASS EXIMBANK STATE PASS OPIC FOR DMORONESE, NRIVERA, CMERVENNE NSC FOR CRONIN SOUTHCOM FOR POLAD TREASURY FOR OASIA, DAS LEE AND FPARODI USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D USDOC ALSO FOR 3134/USFCS/OIO/SHUPKA USDOE FOR GWARD/SLADISLAW DOL FOR ILAB MMITTELHAUSER AID/W FOR LAC/AA TAGS: EPET ENRG ECON PGOV PREL EIND EINV BR SUBJECT: SAO PAULO PERSPECTIVES ON BOLIVIAN GAS SITUATION REFS: (A) SAO PAULO 492; (B) BRASILIA 888 AND PREVIOUS (C) SAO PAULO 464 SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY -------------- SUMMARY -------------- ¶1. (U) Representatives of Sao Paulo's leading industrial federation indicate that while gas supplies from Bolivia remain stable after that country's May 1 hydrocarbons nationalization announcement (refs B-C),Brazilian industries relying on gas are very price-sensitive, and short-term cost increases may affect competitiveness. The primary consumers of Bolivian gas in Brazil are the glass, ceramic, chemical and metallurgical industries. Recent conversion to gas from fuel oil has left these industries more cost-competitive, but also dependent on Bolivian supply. Sao Paulo state Governor Lembo is contemplating a visit to Bolivia at the invitation of President Morales; while regarding the situation as serious, Lembo does not appear unduly alarmed and asserted that even a Bolivian gas shut-off would not be fatal to the state's economy. END SUMMARY. -------------- PROFILE OF BOLIVIAN GAS USE -------------- ¶2. (SBU) On May 5, Consulate staff met with Karla Christina Martins Borges and Diego Zancan Bonomo of the Sao Paulo State Federation of Industries (FIESP) to discuss the use of Bolivian gas in Brazil and the effect of the recent nationalization decree (refs B-C) on Sao Paulo industry. While only 1,300 of the over 130,000 industries in Sao Paulo rely on gas, they are major industrial players and absorb 80 percent of all gas consumed within the state. These industries are concentrated in the ceramics, glass, chemical and metallurgical sectors. ¶3. (SBU) Any disruption in the Bolivian gas supply would have a significant impact on industrial production across southeastern and southern Brazil, according to the FIESP representatives. Sao Paulo state, with a population of about 40 million and a 2005 GDP approaching USD 200 billion, is the single largest consumer. It uses 75 percent of all imported Bolivian gas, which, in turn, accounts for 90 percent of all gas consumption within the state, they said. While total gas usage is less in the border states of Mato Grosso and Mato Grosso do Sul and the three southernmost states of Parana, Santa Catarina and Rio Grande do Sul, the gas-reliant industries in those states depend entirely on imported Bolivian gas. ¶4. (U) Industrial conversion to gas from fuel oil began when the "Gasbol" pipeline connecting Bolivia and Brazil was completed in 1999, according to the FIESP representatives. Conversion to gas was pushed by the government and pulled by industry itself. The GOB promoted gas conversion for two reasons: First, it was seen as one element that would allow Brazil to become "energy self sufficient" in oil (a goal whose achievement has recently been trumpeted); and second, industrial conversion from oil to gas was environmentally friendly. On the other side of the coin, industrial leaders were receptive to gas conversion, Borges and Bonomo said, because inexpensive gas would lessen their production costs and make their SAO PAULO 00000512 002 OF 004 products more competitive. ¶5. (U) The end result was that many industries converted their factories to gas-powered production, which, up to now, has been a good business decision. FIESP representatives reported that the sectors of the industrial economy with the greatest growth over the past 3-5 years were those that converted to gas. Moreover, some of the small- to medium-sized glass and ceramic factories have been able to begin to export due to cost savings on energy. -------------- - LOOKING AHEAD: SUPPLY STABLE, BUT COST TO RISE -------------- - ¶6. (SBU) FIESP representatives did not expect any short- to medium-term disruption in gas supply to Brazil: trade, they explained, is too important to both nations for Bolivian President Evo Morales to make such a drastic political move. For Brazil, the industrial concerns over gas scarcity are clear, but popular uproar over a cutoff in supply would also be pronounced. For example, there are now over one million cars in southern Brazil that have been converted to natural gas. On the Bolivian side, approximately 35 percent of Bolivian tax revenue comes from Petrobras alone and 70 percent of Bolivian gas is sold in Brazil. Moreover, Bolivia is dependent on Brazilian ports for its non-gas exports, and further antagonism of its giant neighbor would be extremely risky. ¶7. (SBU) Notwithstanding Lula's pledge that domestic gas prices would not rise, FIESP representatives do expect short-term price increases, although Brazilian consumers would likely be shielded in the run-up to October presidential elections. They predicted that the GOB might either compel Petrobras to absorb the costs or might increase taxes on gasoline to subsidize natural gas prices. Eventually, however, price increases will work their way through the system to consumers. This concerns FIESP because on the micro-economic level, industrial competitive gains and nascent export initiatives could be jeopardized, and on the macro-economic level, increasing gas prices could create inflationary pressures. ¶8. (SBU) The FIESP representatives indicated that the timing of price re-negotiations will be critical because of the highly-charged political environment across South America and the constant sensitivity to costs that Brazilian export industries face. The question of who negotiates with Brazil will also prove imperative to Brazilian business interests. (The Brazilian delegation that arrived in La Paz May 10 included both Petrobras President Gabrielli and Minister of Mines and Energy Rondeau.) The FIESP representatives believed that if the issue were left solely to Petrobras, the company would seek to pass along the full extent of price increases to consumers. The company has taken a harder line than Lula, stating emphatically that it will not make further investments in Bolivia under the currently proposed tax- and profit-sharing arrangements. FIESP representatives noted that if negotiations are conducted government-to-government, Lula's already conciliatory tone with Morales could box him into agreements of political expediency at the cost of industrial competitiveness in Brazil. -------------- SAO PAULO GOVERNOR MAY VISIT BOLIVIA -------------- SAO PAULO 00000512 003 OF 004 ¶9. (SBU) Also on May 5, Sao Paulo Governor Claudio Lembo (see ref A) told CG that he had received a letter of invitation from President Evo Morales to visit Bolivia. The Bolivian Government wants to thank Lembo, who met with the President of the Bolivian Congress when the latter visited Sao Paulo recently, for several small services. These include arranging a kidney transplant at a Sao Paulo hospital for a Bolivian child and working with the municipal government of Sao Paulo to open a plaza where Bolivian immigrants can hold street fairs and other events. Lembo received the invitation before the nationalization decree and occupation of Petrobras facilities. He has not decided whether or not to accept the invitation. If he does, the visit would take place Friday, May 26, and last just over 24 hours. His foreign affairs advisor, who originally supported the trip, has now advised against it in light of fallout from the nationalization. ¶10. (SBU) Lembo expressed the view that, although Sao Paulo state depends heavily on Bolivian gas, a shut-off would have a "serious but not dramatic" impact on the state, which also has access to hydro-electric energy. He is tempted to go to Bolivia, if only because he thinks as a conservative (Lembo was President of the pro-regime ARENA party during the military dictatorship),he could sow confusion among the leftists and populists, and could complicate Lula's campaign bid (though Lembo acknowledged that this foreign policy flap was unlikely to affect Lula in the polls). He conceded that the Bolivian situation is delicate and that if he goes, he should say as little as possible publicly (though he might tell Morales in private that he's making a big mistake),since the controversy is between two national governments and he is a mere "provincial" leader. He is not terribly concerned about possible political risk for himself, except that his conservative colleagues might criticize him. ¶11. (SBU) If he goes to Bolivia, Lembo would be accompanied by Sao Paulo State Secretary of Energy Mauro Arce, a Captain from the state Military Police, and the Bolivian Consul General in Sao Paulo. He has not discussed the visit with PSDB presidential candidate (ex-Governor) Alckmin or PSDB Sao Paulo gubernatorial candidate (ex-Mayor) Serra, nor does he intend to involve them in any way if he does go to Bolivia. Lembo does not believe the Bolivian gas situation will have any impact on Brazil's upcoming national and state elections. He believes Morales took the action to placate the Bolivian indigenous community, though he also recognizes the influence of Hugo Chavez, whom he thinks someone should take down a notch or two. -------------- COMMENT -------------- ¶12. (SBU) "Wait and see" seems to be the operative tone thus far among Sao Paulo's gas consumers affected by Bolivia's nationalization effort. And while most analysts expect that the overall impact on the national economy of a Bolivian gas cut-off or a substantial price increase would not be significant, the competitiveness of certain industries, particularly steel, would be hurt. Steel exporters, among others, have already postponed investments in capacity expansion in Brazil due to the strong Real and do not have much margin to absorb energy price hikes. In the event Brazil is forced to swallow significant gas price increases, SAO PAULO 00000512 004 OF 004 and assuming Petrobras passes along much or all of those increases to consumers - not a foregone conclusion - we would expect industry to seek relief from the GoB on other cost elements. Specifically, business leaders might intensify their already sharp criticism of GoB policy on the interlocking issues of the strong Real and high real interest rates. Given its commitment to a floating exchange regime and inflation targeting, however, the most the GoB would be able to offer would be targeted tax breaks. END COMMENT. ¶13. (U) This cable was coordinated/cleared with Embassy Brasilia. MCMULLEN