GAS "NATIONALIZATION" -- MORE POLITICAL SHOW THAN

UNCLAS LA PAZ 000870

SIPDIS

SIPDIS

STATE FOR WHA/AND
TREASURY FOR SGOOCH
ENERGY FOR CDAY AND SLADISLAW

E.O. 12958: N/A
TAGS: ECON EINV ENRG EPET BL
SUBJECT: GAS "NATIONALIZATION" -- MORE POLITICAL SHOW THAN
ECONOMIC REALITY


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Summary
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1. Despite President Morales' claim that hydrocarbons
"nationalization" will bring in billions of dollars of
additional income for the state, in fact, the Morales
administration's actions will not significantly impact future
GOB revenues. Although "nationalization" will not boost GOB
hydrocarbons revenues by billions of dollars as publicly
claimed by the government, it has certainly been a political
victory, with President Morales' approval ratings spiking to
81 percent following the issuance of the nationalization
decree in May 2006. The GOB's bungled implementation of the
nationalization decree and the new operating contracts has
somewhat tarnished the government's image in 2007, but
nationalization remains exceedingly popular. End summary.

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The Impact of the Nationalization Decree
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2. Despite President Morales' claim that hydrocarbons
"nationalization" is his administration's greatest
accomplishment, "nationalization" basically implemented the
2005 law passed by former President Carlos Mesa during his
administration, generating very modest additional revenue.
According to our estimates, Morales' nationalization decree
boosted government revenue by some USD 224 million in 2006
(largely as the result of a transitory 32 percent tax on two
large petroleum fields),and it will not materially increase
revenue in out years. Only Petrobras was significantly
impacted by the fee, as it operates the two large fields
affected by the transitory tax.

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So Why the Large Increases in Revenue in 2006?
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3. GOB revenue from the hydrocarbons sector amounted to USD
409 million in 2004, USD 863 million in 2005, USD 1.5 billion
in 2006, and a projected USD 1.3 billion in 2007. The
increases in GOB revenue resulted from three main
factors: increases in the price of gas sales (sales to Brazil
increased from USD 2.15 per million cubic feet in 2004 to USD
3.80 per million cubic feet in 2006),increases in the volume
of production (gas production increased from
35 million cubic meters per day in 2004 to 41 million cubic
meters per day in 2006),and the implementation of the direct
hydrocarbons tax by the 2005 law passed by former President
Carlos Mesa (the companies paid USD 695 million in IDH in
2006). Only USD 224 million of the 2006 revenue resulted
from the Morales administration's "nationalization" decree,
which imposed a temporary 32 percent tax on the large fields
operated by the Brazilian company Petrobras. Once the new
operating contracts enter into force, presumably in 2007,
this temporary tax will disappear.

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The Impact of the New Contracts
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4. International gas production companies operating in
Bolivia signed new contracts in October 2006. The government
erroneously claimed that the new 23 to 30 year contracts
would yield billions of dollars in additional revenue for the
state. The contracts were approved by congress in November

2006. Subsequently, the GOB realized that the versions of
the contracts approved by congress were incorrect, because
the state oil company YPFB had provided congress with the

wrong documents. Many of the approving laws contained
typographical and substantive errors. The GOB proposed a
short law to amend superficial errors, which was approved by
the lower house and blocked in the senate. The senate held
hearings the weeks of March 19 and 26 to decipher the
confusion, including why YPFB supposedly signed two versions
of a particular annex with Petrobras. Opposition leaders,
and far-left members of the MAS, have asserted bad faith on
the part of the GOB. On March 30, the senate approved 41
production contracts, while debate continued regarding the
remaining three.


5. The GOB's main accomplishments with the signing of the new
contracts were convincing the companies to drop their pending
legal claims against the 2005 law and solidifying the law's
mandates of contract migration and paying the 32 percent
direct hydrocarbons tax (IDH). Although, in addition to
requiring companies to pay the pre-existing taxes and
royalties, the contracts imposed another variable tax to be
paid to YPFB, they also allowed companies to deduct certain
general taxes. Based on GOB revenue predictions, it seems
that in 2007, the increased costs of the YPFB tax, perhaps
less than USD 100 million, may be roughly offset by the
deduction of certain general taxes, including the value added
tax. According to Petrobras, some fields will even be paying
less to the GOB under the new contracts than they were paying
previously. Under Petrobras' prior contract, including the
32 percent IDH which it was paying under protest, Petrobras
paid the government around 60 percent of the value of its
production. Under its new contract, it will pay around 54
percent in 2007, but that percentage will increase to around
61 percent by 2010.

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The Impact of the Argentine Gas Sales Agreement
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6. With the signing of a gas sales contract with Argentina in
October 2006, the GOB opened up the possibility of expanding
Bolivia's gas production by 50 percent. The possibility of
supplying this additional market encouraged the companies to
agree to sign new contracts. The ability to meet the terms
of this agreement will depend on the construction of a USD
1.5 billion pipeline, almost all in Argentina, and private
companies' willingness to invest in production and
exploration in Bolivia. Given the ongoing legal uncertainty,
such investment has not yet been forthcoming. If the
investment eventually pans out, the significant increase in
production would mean a significant increase in GOB revenues.
If production increases by 50 percent by 2010, as required
by the contract, the GOB predicts that revenue will reach USD
2.4 billion by 2010, a 60 percent increase over 2006.
However, given the current lack of investment, reaching these
production figures within three years will be near impossible.

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The Lost Bonanza?
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7. It is difficult to predict what would have happened to
sector investment if the gas wars, the 2005 law, the
nationalization decree, and the new contracts had never
happened. However, it is certain that foreign direct
investment in the sector has declined to the minimum
necessary to meet contractual obligations, amounting to USD
197 million during 2006 compared with the 1998 peak of USD
600 million. According to Petrobras' explanation of typical
gas investment cycles, Bolivia should have received another
large wave of investments, similar to what occurred in 1998,
around 2004. However, investment hit rock-bottom in 2005 and


remained there during 2006 due to the ongoing legal
uncertainty and GOB plans to increase state intervention in
the sector. The companies were hopeful after the signing of
the new contracts that they could finally make long-term
plans, but because of the GOB's failure to send correct
documents to the congress for approval, the uncertainty has
continued. Without increased investment, gas reserves will
continue to decline. Current production, already at its
maximum, is insufficient to meet Bolivia's contractual
obligations with Brazil and Argentina and domestic demand.
Without additional investment, Bolivia could be forced to pay
contract penalties. Additionally, Bolivia has likely lost
the opportunity to supply a greater share of the Brazilian
market than it currently does, because Brazil is looking for
alternatives to reduce reliance on Bolivian gas.

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The Political Fallout
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8. The GOB's nationalization decree and the signing of new
contracts boosted the administration's popularity, as around
85 percent of the population supports "nationalization."
However, the congressional hearings regarding YPFB's
negotiation of the contracts, GOB errors, and possible secret
negotiations by former YPFB adviser Manual Morales Olivera
with Petrobras, have somewhat tarnished the government's
image. (Note: In response to the scandal, the GOB replaced
Manuel Morales as YPFB president with Guillermo Aruquipa on
March 23. End note.) The failure to revamp the state oil
company YPFB, to negotiate the take-over of five key
companies, and to secure additional investment in the sector
has also reflected poorly on the GOB. Recent polls show that
52 percent of the residents in La Paz, typically a region of
strong support for the Morales administration, disapprove of
the GOB's handling of the gas contracts. (Note: This has
not affected President Morales' popularity, however. A March
poll put his approval rate at 65 percent, the same level as
in the month of February. End note.)

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Conclusion
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9. After the GOB signed new operation contracts with natural
gas production companies in October 2006, the press announced
that the four largest gas fields would have to pay an
additional 32 percent tax to state-owned oil company YPFB.
The assertion regarding the large fields was not true, but it
led the public to believe that the contracts would
immediately yield an enormous windfall for the country. In
fact, the new operating contracts will not significantly
impact GOB revenue in comparison with what it would have been
under the terms of the old contracts plus the direct
hydrocarbons tax imposed by the 2005 law. Some fields will
even be paying less under the new contracts than they were
before, although the government take will increase over time.
The instability which began in 2002 and has been perpetuated
by the Morales administration has cost the country
hydrocarbons investment and market opportunities, which would
have broadened the tax base. It remains to be seen if the
sector's decline can be turned around and the promise of the
Argentine market fulfilled, but short-term prospects are
negative. In sum, the GOB's revenue gains from the
nationalization decree and new contracts appear to be
marginal compared with the potential loss of investment due
to the "nationalization's" damage to the investment climate.
End comment.
GOLDBERG