ARGENTINE ENERGY SHORTAGE - A CRISIS FORETOLD

C O N F I D E N T I A L BUENOS AIRES 001415

SIPDIS

SIPDIS

WHA/EPSC FOR FCORNEILLE
ESC/IEC/EPC FOR MCMANUS, JISSO
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER
NSC FOR ROD HUNDER
TREASURY FOR TRAN

E.O. 12958: DECL: 7/20/2017
TAGS: ENRG EINV EPET ECON AR
SUBJECT: ARGENTINE ENERGY SHORTAGE - A CRISIS FORETOLD

REF: A. 2006 BUENOS AIRES 2808

B. BUENOS AIRES 1369

C. BUENOS AIRES 1352

D. BUENOS AIRES 1278

E. BUENOS AIRES 1128

F. BUENOS AIRES 880

G. BUENOS AIRES 844

H. BUENOS AIRES 65

Classified By: Ambassador E.A. Wayne for Reasons 1.4 (b,d)

--------------
Summary
--------------


1. (SBU) A combination of an unusually cold winter,
unseasonably low water levels at hydro-electric facilities,
and a 5-year post-crisis legacy of under-investment in basic
electricity and natural gas infrastructure has resulted in
significant energy shortages in Argentina. The consequence:
Over the past month, GoA-mandated cutbacks in electricity and
gas consumption by major wholesale consumers have depressed
industrial production; rolling blackouts in major urban areas
have sparked protests by residential consumers; and cutbacks
in the availability of compressed natural gas used by many
automobiles and most taxis in Argentina have disrupted
transit.


2. (C) After months of public denials by senior GoA
officials, including by Planning Minister De Vido, ("there is
no crisis") and efforts to lay the blame on under-investment
by profit-hungry private energy companies, the GoA has
announced a series of band-aid measures, including purchases
of electricity from Brazil and a "Total Energy" plan to
increase thermo-electric generation via subsidized supplies
of diesel, that are designed to carry the nation through to
(warm weather) presidential elections in October. Notably
absent has been any move to limit consumption by adjusting
domestic electricity and natural gas tariffs that remain far
below market rates in neighboring Chile and Brazil, or as of
yet by encouraging even minimal energy conservation efforts.
Despite growing criticism of the GoA's short-sighted approach
to energy planning, the Kirchner administration appears
positioned to weather this crisis relatively unscathed: The
still-booming economy trumps all and energy shortage
constraints on industrial production will likely only lower
strong GDP growth (projected in the 7.5%-8.0% range for 2007)
by a few tenths of a percent. Like the various corruption
scandals afflicting the Kirchner administration and a number
of recent electoral setbacks for Kirchner-backed candidates
in Buenos Aires and the provinces, the near term impact of
the energy crisis is troublesome for the government but is
unlikely to significantly impact October presidential
elections. End Summary

-------------- --------------
Excess Demand Underinvestment = Capacity Shortfall
-------------- --------------


3. (U) Argentina has the third-largest power market in Latin
America, relying largely on natural gas-fired thermal plants
and hydropower for most of its electricity supply. With
approximately 17-18 gigawatts (GW) of installed, available
generation capacity, 61% of Argentina,s electricity
production is fossil fuel-based (primarily natural gas) and
35% is hydroelectric.


4. (SBU) Following the 2001/2 economic crisis, the GoA froze
wholesale and retail electricity and gas prices at
significantly devalued peso levels, reduced capacity payments
to electricity generators, and changed the structure of
electricity spot pricing so as to make investments in
generation, particularly in marginal (peaking) 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 in the energy sector. Further, private
electricity sector players here (including U.S. companies)
say that the GoA's freezing of energy prices and manipulation
of the methodology used to set market prices have
unilaterally abrogated contracts, effectively confiscating
funds owed to them. The consequence has been a raft of
international ICSID arbitration claims filed against the GoA
that total in the billions of dollars (Refs E and H).


5. (SBU) Frozen domestic electricity and natural gas rates
that remain far below international market levels (Argentine
residential users pay roughly 25% and industrial users pay
roughly 50% of rates users pay in neighboring Chile and
Brazil) have encouraged extraordinary annual increases in
domestic demand, raising generating capacity utilization to
internationally accepted limits. As a consequence,
independent industry analysts have been floating predictions
of Argentine energy shortages and disruptions for the past
three years. Until recently, energy crises have been averted
by a combination of luck (mild summers and winters) and
measures adopted by the GoA to increase short term energy
supply, including negotiations with Bolivia in 2003 to ramp
up imports of natural gas; the unilateral abrogation of
Argentine natural gas supply contacts to Chile in 2004; and
GoA pressure on domestic downstream refiners (including the
U.S.' Esso) to address diesel fuel shortfalls by importing
supplies and on-selling to domestic consumers at a loss.
During this period, the GoA publicly accused
foreign-controlled energy companies and analysts who were
predicting imminent energy shortfalls of crying wolf,
attributing growing energy capacity constraints to
Argentina's remarkable 8 % rates of GDP growth over the past
four years.

-------------- --------------
Current Crisis: Bad Weather Capacity Constraint
-------------- --------------


6. (SBU) The proximate cause of Argentina's current energy
crisis is higher than anticipated increase in electricity
demand due to a very cold winter. Low energy prices have led
to steadily increasing residential electricity demand, as
Argentina's economic recovery has dramatically increased the
sale of power-hungry consumer white goods. National
residential electricity demand, which accounts for roughly
41% of total electricity demand, was up 17.4% y-o-y in June

2007. In the Greater Buenos Aires metropolitan area (which
accounts for a full 55% of national consumption),total
demand was up 10% y-o-y in June 2007.


7. (SBU) On June 14, as a polar front covered much of
Argentina and unseasonably low rainfall limited
hydro-electric production, the maximum design capacity of the
electrical system of 18,400 MW was reached and urban areas
began experiencing rolling blackouts, mostly in lower income
neighborhoods. The GoA responded by requiring distributors
to maintain supplies to residential customers while requiring
large industrial users to cut back consumption by up to one
third during peak consumption hours of 16:00 - 21:00. In
addition, natural gas feedstock supplies to residential
customers were prioritized at the expense of supplies to some
electricity generating plants that were forced to use
significantly more expensive and less energy efficient
imported diesel fuel. Supplies were also cut back to Chile
and to large domestic industrial users who generate their own
power, and to petrochemical and agrochemical companies
(including U.S. players Dow Chemical and Eastman Chemical)
who use natural gas as a raw material feedstock. Industrial
production suffered, with a number of energy-intensive
industrial sectors (steel, aluminum) hit particularly hard.


8. (SBU) In late June, compressed natural gas (CNG) supplies
were also cut in favor of residential heating customers
during the cold wave. Argentina is the world's fourth
largest user CNG, primarily to fuel cars and light trucks,
with expanded consumption driven by CNG prices set
substantially below (already below international market)
gasoline prices. Natural gas represents 15% of total fuel
used in Argentina for transportation. The 35,000-strong
Greater Buenos Aires taxi fleet is largely CNG powered and
cutbacks forced many commuters to use already overcrowded
buses to get to work. The powerful Argentina Industrial
Union announced that power and gas cuts have severely
impacted production at 5,000 companies across Argentina, and
warned the situation might pose a risk to Argentina's
economic growth. Substantial media coverage forced GoA
officials, including Minister De Vido (who had earlier
publicly and repeatedly denied the existence of an energy
crisis) to acknowledge the gravity of the situation and to
take further measures.

--------------
GoA Fix: Emergency "Total Energy" Plan
--------------


9. (SBU) In early July, the GoA won Brazil's support to
significantly increase imports of expensive ($220 KW hour)
Brazilian electricity from roughly 500 MW to 1,000 MW/day.
The GoA also announced an emergency plan to increase
electricity generation by thermo-electrical plants. The
idea, dubbed "Total Energy," is to subsidize, at a cost of
US$300 million over three months, the use of diesel fuel by
electricity generators and industry in order to free up some
5.8 million cubic meters of natural gas for the thermo
plants. Planning Minister De Vido announced that natural gas
shortages should ease as temperatures rise and promised that
CNG sales would shortly resume. Recent higher temperatures
in the country, rain in the Patagonia region and consequent
greater electricity production have eased the crisis in the
past week and CNG supplies in Greater Buenos Aires were fully
restored July 7.

--------------
Energy Crisis: Impact on Growth?
--------------


10. (SBU) With growth averaging over 8% for the past four
years, Argentina's macro-economic performance has
consistently surpassed market projections. In 2007,
Argentina's GDP growth is projected in the 7.5% range - a
growth rate that already factors in a consensus forecast by
local economists that industrial production cutbacks due to
energy shortages will shave about 0.2- 0.3% off of GDP growth
this year. Interestingly, debate among local economic
analysts is less focused on the impact of energy cutbacks on
industrial production than on whether the GoA's weak peso,
high inflation macro policy mix will permit a soft landing
towards more sustainable out-year growth levels in the 5-6%
range.


11. (SBU) June GoA industrial production (IP) statistics,
previewed by President Kirchner July 19, show the increase in
IP down only a nominal 0.1% from the prior month. Anecdotal
evidence suggests that, in anticipation of energy
interruptions during the austral winter, industrial owners
had invested in plant-specific generators or took other
measures to ensure they could operate their plants (at least
partially) in the event of electricity or gas interruptions.
However, according to respected economic think tank FIEL, IP
dropped in May for the first time in 22 months due to energy

shortages. FIEL has been reporting flat IP for several
months now, while the GoA still sees production as
increasing. This difference likely derives from varying
weighting systems for different sectors incorporated by the
GoA and FIEL IP index calculations.

--------------
No Tariff Increases and No Call to Conserve
--------------


12. (SBU) Despite the GoA's late-in-the-game acknowledgement
of an energy crisis, the government has assiduously avoided
supporting the one fix recommended by most market players
here: Increasing below-market gas and electricity tariffs to
allow prices to play their proper role in regulating
consumption. To be fair, the GoA has allowed nominal
increases in industrial electricity rates charged by
distributors over the past two years, including by U.S.
electricity distributor AES and by UK/Spanish gas distributor
Metrogas. But "comprehensive reviews" for gas and
electricity tariffs promised by the Planning Ministry Energy
Secretariat to distribution companies have been repeatedly

SIPDIS
deferred, most recently until sometime in 2008, well after
presidential elections. The GoA has also attempted to
encourage new private investment in electricity generation
capacity by promising that regulated electricity wholesaler
CAMMESA will pay higher rates to new generators. However, in
a July 19 radio interview, Planning Minister DeVido
emphasized that residential electricity and gas rates "will
not be touched." He also repeated a longstanding message
that companies profiting from their investments in
Argentina's electricity sector must meet their "social
responsibility" to invest in new capacity.


13. (SBU) Also striking in its absence has been any call on
GoA consumer to conserve their appetite for cheap energy. On
July 16, Planning Minister De Vido said he would not "insult
the intelligence" of sophisticated and socially responsible
Argentine consumers by asking them to conserve. However, in
a recent meeting with the Ambassador, the head of Argentina's
largest electricity distributor said that Argentina's current
1.2 GW electricity shortfall could be fully compensated if
each of Argentina's 10 million residential households saved
the electricity equivalent to that used by two 60 watt bulbs.

-------------- -
Comment: GoA Shortsighted or Simply Pragmatic?
-------------- -


14. (C) Public anger at recent energy disruptions have
certainly exacted a political cost, but the GoA's band-aid
measures to import more electricity from Brazil and to
subsidize diesel fuel for Argentine thermal plants will
likely see the GoA through to austral Spring elections in
October. Our private energy sector contacts agree that
Argentina is in dire need of a wholesale energy policy
overhaul that includes not only a liberalization of energy
prices but the design and application of a clear
pro-investment energy regulatory framework. Gradual
electricity and natural gas price adjustments after elections
will not be sufficient to compensate for the roughly 1.2 GW
(and growing) gap between domestic energy demand and domestic
production capacity. And additional public and private
thermal and hydro generating capacity due to come on line in
the next two years is only forecast to meet incremental
demand at current price levels -- not to significantly narrow
the current shortfall.


15. (C) The Kirchner administration clearly believes that
cheap energy that expands consumer purchasing power is its
best pre-election strategy, and it has been willing to pay
dearly to import peak demand electricity from Brazil and to

subsidize diesel supplies for domestic generators. The
still-booming economy has kept the government's public
approval ratings high enough that the energy crisis, along
with various corruption scandals and a number of recent
electoral setbacks for Kirchner-backed candidates in Buenos
Aires and the provinces, are viewed as troublesome but not
likely to significantly impact October presidential
elections. While this approach to the energy crisis is
certainly shortsighted, a GoA focused no farther than
upcoming elections views it as eminently pragmatic.
WAYNE