Identifier
Created
Classification
Origin
07TEGUCIGALPA134
2007-01-23 01:02:00
CONFIDENTIAL//NOFORN
Embassy Tegucigalpa
Cable title:  

HONDURAN GOVERNMENT DIALOGUE WITH OIL INDUSTRY

Tags:  EPET ENRG PREL BBSR NI VE HO 
pdf how-to read a cable
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DE RUEHTG #0134/01 0230102
ZNY CCCCC ZZH
O 230102Z JAN 07
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4706
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
RUEHCV/AMEMBASSY CARACAS PRIORITY 0525
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEAIIA/CIA WASHDC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC PRIORITY 0569
C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000134 

SIPDIS

SIPDIS
NOFORN

STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, EB/CBA, AND WHA/CEN
STATE FOR D, E, P, AND WHA
STATE FOR S/ES-O MMILLER AND MSANDELANDS
TREASURY FOR AFAIBISHENKO
STATE PASS AID FOR LAC/CAM
NSC FOR DAN FISK
COMMERCE FOR MSELIGMAN AND WBASTIAN
STATE PASS USTR FOR AMALITO

E.O. 12958: DECL: 01/21/2017
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAN GOVERNMENT DIALOGUE WITH OIL INDUSTRY
CONSTRUCTIVE BUT INCONCLUSIVE

REF: REF: TEGU 0098 AND PREVIOUS

Classified By: AMB Charles Ford for reasons 1.4 (b,d)

C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000134

SIPDIS

SIPDIS
NOFORN

STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, EB/CBA, AND WHA/CEN
STATE FOR D, E, P, AND WHA
STATE FOR S/ES-O MMILLER AND MSANDELANDS
TREASURY FOR AFAIBISHENKO
STATE PASS AID FOR LAC/CAM
NSC FOR DAN FISK
COMMERCE FOR MSELIGMAN AND WBASTIAN
STATE PASS USTR FOR AMALITO

E.O. 12958: DECL: 01/21/2017
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAN GOVERNMENT DIALOGUE WITH OIL INDUSTRY
CONSTRUCTIVE BUT INCONCLUSIVE

REF: REF: TEGU 0098 AND PREVIOUS

Classified By: AMB Charles Ford for reasons 1.4 (b,d)


1. (C/NF) Summary: The January 18 talks in Salvador between
oil industry representatives and a GOH delegation led by
Minister Counselor for Legal Affairs Enrique Flores Lanza
reportedly made significant progress. The GOH put two
alternatives on the table and the affected oil companies have
undertaken to respond constructively to those proposals by
January 23. The GOH agreed to the talks when a rigorous GOH
analysis suggested the new state-run import scheme would not
save Honduras any money, while incurring significant legal
risks and sending a strong anti-investment message. Industry
concerns over inventory "confiscation" were reportedly
resolved at the table, and talks now center on USD 0.01 to
0.02 per gallon margin reductions each on imports and
handling costs. Post considers it highly significant that
Flores Lanza has reportedly been convinced of the poor
risk/reward ratio of continuing to pursue a strategy of
nationalizing imports. If accurate, this would be one of the
most important defections of this year-long process, and
could open the way to a breakthrough in the talks. The
proposed negotiated solution is not optimal, but it might be
the best obtainable under the circumstances, and it avoids
several far-worse alternatives. End summary.


2. (C/NF) On January 19, EconChief had an extended meeting
with Presidential advisor on fuels Arturo Corrales, who
presented his statistical analysis of the current offers and
a comprehensive review of the current state of negotiations
with the international oil companies (IOCs). On the

ConocoPhillips offer, Corrales noted that the final version
of that offer contained two significant changes: the
inclusion of a hefty price premium for product delivered to
the southern port of San Lorenzo, and a clause making the new
offer a package deal rather than a la carte. The
consequence, Corrales said, was an "unbalanced offer" in
which a low-ball headline price for super unleaded gasoline
delivered to the Atlantic ports was compensated by higher
prices for other products and other ports. Modeling this
offer using empirical data from 2004 through 2006, Corrales
determined that the Conoco offer would have cost Honduras USD
3.43 million more in imports in 2004, and saved it USD 2.9
million in 2005 and USD 6.2 million in 2006. The net savings
overall, he says, is therefore only USD 2 million per year on
average, on a total import bill of more than USD 650 million
(that is, less that 0.3 percent savings). Given the numerous
assumptions implicit in his model, Corrales dismisses this as
"within the statistical margin of error" and therefore is
confident in saying that overall the new deal would not
really save Honduras any money at all.


3. (C/NF) Corrales presented this analysis to Minister of the
Presidency Yani Rosenthal on Tuesday, January 16 and a
convinced Rosenthal urged the President to consider these
results. President Zelaya sent the lead GOH official on the
fuel issue, Minister Flores Lanza, to receive the same
briefing and report back. After several hours of detailed
review, Flores Lanza reported to the President that Corrales
was correct. Following the extensive discussions with
Ambassador earlier that day, Lanza's conclusion reportedly
convinced Zelaya to dispatch Corrales and Flores Lanza to
Salvador for talks with the IOCs. According to Corrales,
Flores Lanza -- long one of the staunchest supporters of this
poorly-planned scheme to nationalize fuel imports -- was
persuaded by the evidence and has now switched his position
to one of seeking an accommodation with the IOCs, as long as
such a deal delivers the needed political victory for the
President.


4. (C/NF) In the meantime, the GOH is no longer convinced
that an exclusive contract with ConocoPhillips makes sense.
The GOH's own analysis reveals that savings will be

TEGUCIGALP 00000134 002 OF 004


negligible, and Zelaya has expressed concerns about the
reliability of a partner with no investment on the ground in
Honduras. Post has made it clear that ConocoPhillips is a
first-class company, and that we have no doubts it would
fully honor its contract, if signed. However, to avoid the
possibility of lawsuits from other companies or breaches of
international treaties, any GOH contract with ConocoPhillips
should not infringe upon the rights of existing investors.
Given the potential legal conflicts with existing investors
(as vividly demonstrated last week by the GOH's announced
intention to take over privately-owned fuel storage
facilities),the GOH appears to be considering carefully
whether the meager (or zero) savings from an exclusive
contract with ConocoPhillips is worth the negative political
consequences a state takeover of the sector would entail.


5. (C/NF) In Salvador, in a series of separate meetings on
January 18, Corrales delivered his presentation to each
company and initiated a negotiation based on technical and
financial factors, while also reminding the companies of the
political context. Flores Lanza was reportedly calmly
supportive and incisive, and offered the companies two
options: buy their fuel imports from Conoco and maintain all
their other downstream operations; or present the GOH with
alternatives to the current plan that deliver similar or
greater savings than the bid solicitation would deliver.
According to press remarks, Shell is considering the first
option, while Texaco and Esso told EconChief that they prefer
the second.


6. (C/NF) Corrales said he would grade the companies' degree
of constructive engagement in these talks as: Texaco A ,
Shell B , and Esso D. Texaco and Shell each brought senior
officials, listened politely, asked probing questions,
admitted their role in perpetuating this problem, and agreed
to consider the GOH offer and propose a compromise by
Tuesday. Texaco representatives told EconChief on January 18
that the talks were more open than previous meetings had
been, and that both sides seemed genuinely engaged. Esso, on
the other hand, was represented by a public relations person,
and reportedly opened their meeting by literally banging on
the table and demanding a USD 0.10 per gallon immediate price
increase. Despite such provocations, Corrales and Lanza
remained focused and continued talks for several more hours.
At EconChief's urging, Esso's Country Manager said on January
21 that he was going to contact Flores Lanza to reaffirm that
while talks got off to a rocky start, Esso remains optimistic
and seeks a mutually acceptable outcome.


7. (C/NF) The talks, while quite technical, basically focused
on three elements: financial losses on inventories caused by
the sudden change in sales prices; changes to the import
pricing formula; and the proposed "onshore" price
adjustments. The first issue, initially presented as a
potential deal-breaker and likely impetus for legal suits
over "confiscation," was essentially resolved at the
negotiating table "in about three minutes," according to
Corrales. Of the eight lempira price reduction that affected
inventories, he explained, about six came from changes in the
international price or changes to the Honduran price
calculations by shifting from a 22 day rolling average to a
10 day rolling average (thus bringing forward last week's
sharp drop in international prices). These are largely price
adjustments that would have occurred anyway over the next 10
days (when the next inventory deliveries were to be made).
Thus, the financial losses on inventories to the importers
are limited to 10 days of losses, which Corrales estimated at
about USD 150,000 per company. (On January 21, Esso told
EconChief it estimated these losses at approximately USD
200,000.) Corrales dismissed this as a minor issue made to
seem major for bargaining purposes. Such a relatively small
loss, he said, could be recovered by the companies by
slightly tweaking the pump prices over the coming weeks.
Corrales told EconChief (and Esso later confirmed) that this

TEGUCIGALP 00000134 003 OF 004


arrangement was accepted in principle by both sides at the
bargaining table, thus removing the inventories issue as an
obstacle to a settlement.


8. (C/NF) The second issue under discussion is the import
price, which is currently based on Platt's Gulf Posting
prices with slight adjustments. The new proposal eliminates
the adjustments, and instead offers a fixed premium based on
product and delivery port. The net change according to the
GOH is close to zero, proving that current import prices are
basically "fair" and that price gouging is not taking place.
Esso argues that the new formula will cost it an additional
USD 0.035 per gallon (a figure not supported by the
spreadsheets produced by Corrales). Corrales replies that
the net impact is very sensitive to the weights applied (such
as product mix and delivery port) as well as to the specific
premium given in each case. He is confident Esso's alleged
loss could be minimized or eliminated by massaging the
weights in the revised formula. Esso has agreed to consider
this offer carefully and produce a proposal.


9. (C/NF) The third issue under discussion is the array of
non-standard "onshore" costs, including a credit for leakage,
a guaranteed margin for the importer, inspection costs, and
others. These fees and costs currently total USD 0.113 per
gallon, but the GOH calculates that they should be reduced to
between USD 0.05 and 0.06 per gallon. This reduction would
include shifting a portion (about USD 0.004 per gallon) of
late fees to the importers in recognition that some demurrage
is the fault of the companies, whereas currently 100 percent
is attributed to the GOH. It also proposes equally sharing
the costs for product inspections (about USD 0.0015 per
gallon),since those inspections benefit both the companies
and the GOH equally. The largest reduction would be the
elimination of the guaranteed profit margin for importers
(USD 0.045),which was inserted into the formula by Honduran
oil importer DIPPSA to make it more competitive with the
IOCs. All participants reportedly agree that fee is not
justifiable, and Esso even objected to it as "unethical" in a
letter to the GOH several years ago when the fee was first
imposed. (Comment: DIPPSA's former owner Jose Lamas likely
saw the writing on the wall last year and realized that
without this guaranteed margin enhancement DIPPSA would be
worth far less to a buyer and might even fail. He therefore
sold it promptly to Henry Arevalo, who then sold 50 percent
to IOC Trafigura. The loss of this margin likely negatively
impacts DIPPSA earnings and therefore valuation. We can't
imagine Trafigura will be pleased to learn it has bought into
a depreciating asset. End Comment.)


10. (C/NF) As a result of the Salvador talks, this
negotiation -- which only a week ago threatened arrests,
confiscations, and lawsuits -- is now focused instead on a
USD 0.02 margin reduction on imports and a USD 0.01 to 0.02
margin reduction on fees. The GOH will attempt to resolve
the former using formula weights, and the latter will be
negotiated. In exchange for this deal, the companies would
remain in the country doing business, would not have to
contemplate a mutually assured destruction policy of
international lawsuits, and would win what they have most
sought: a reform to the current unsustainable pricing
formula and a broader liberalization of the sector. This
liberalization would be codified in a GOH document with
specific steps and milestones, beginning January 2008.


11. (SBU) Post has been working closely with the World Bank
to identify resources to support the GOH's announced
intention to move over the medium term towards a liberalized
fuels market. The World Bank has already done a study of the
Honduran fuels market and has identified an expert who could
come to Honduras to advise the GOH on next steps. This would
fit with Zelaya's professed intent (as confirmed to
Ambassador) to establish a firm timeline with concrete steps
towards such a market opening, which the GOH prefers to call

TEGUCIGALP 00000134 004 OF 004


"competitiveness" instead of "liberalization." In a January
18 meeting at the World Bank, Minister of the Presidency
Rosenthal was presented this option by World Bank officials.
Rosenthal, who is no longer the lead official on the fuels
topic, took the offer on board and promised to get back to
World Bank staffers in "a couple of weeks."


12. (C/NF) Comment: Post considers it highly significant that
Flores Lanza has reportedly been convinced of the poor
risk/reward ratio of continuing to pursue a strategy of
nationalizing imports. His continued support has been one of
the primary reasons for President Zelaya's reluctance to
follow his own instincts to abandon this scheme and instead
seek lower prices through a market-based reform. In his
public remarks just prior to the Salvador meetings, Minister
Flores Lanza had again begun referring to the GOH seeking a
legal way to compel Texaco to allow use of its storage
facilities. Lanza had made similar comments on January 13,
raising the spectre of expropriation (as reported by Post on
January 14). Since that time, the GOH has told Post that no
expropriation is being invoked, but rather a pre-existing
clause in the GOH contract with DIPPSA (which the GOH argues
also covers Esso's joint venture storage facility with
DIPPSA). Because no such clause exists in Texaco's contract,
any GOH move to take over those facilities would have
required some other legal justification. If a deal were
struck with the IOCs, this plan to seize storage facilities
would likely be abandoned as unnecessary and
counterproductive. If Flores Lanza has finally accepted the
need for a negotiated exit strategy, this would be perhaps
the most important defection of this entire process, and
could open the way to a breakthrough in the talks.


13. (C/NF) Comment continued: We are also very pleased to see
that the mutual suspicion between Flores Lanza and Corrales
appears to have lessened, as Flores Lanza reportedly now
accepts both that the numbers are persuasive and that
Corrales is not a mouthpiece for the IOCs. According to
Corrales, Flores Lanza was favorably impressed that Corrales
was just as demanding with the IOCs in the El Salvador talks
as he had been with the GOH over the previous weeks. Both
Corrales' objective mathematical analysis and Flores Lanza's
influence with the President will be needed for any
negotiated settlement to be accepted by the GOH.


14. (C/NF) Comment continued: The proposed negotiated
solution is not optimal, but it might be the best obtainable
under the circumstances, and it avoids several far-worse
alternatives. The status quo is neither politically
sustainable nor financially justifiable. A short-term win
for Zelaya in exchange for a medium-term overhaul of the
sector serves the interests of investors and the GOH alike.
To IOC grumbling about these margin reductions, the GOH
responds that this will only be a USD 0.01 to 0.02 and only
last for one year, whereas the IOCs benefited from the padded
USD 0.045 margin adjustment for several years. Finally, Esso
(and presumably the other IOCs as well) understands that if
it refuses to negotiate flexibly and creatively, and in the
end is nevertheless forced to accept a GOH takeover of the
fuel import sector, its credibility will be damaged in the
eyes of all governments in the region. With an increasingly
populist wind blowing throughout the region, this would be an
invitation to similar moves by other governments elsewhere in
the hemisphere. A negotiated solution that champions
market-based reforms, on the other hand, would send a
positive message to consumers throughout the region while
defending the long-term enlightened interest of the IOCs.
End Comment.

Ford
FORD