HONDURAS SUDDENLY LEANING TOWARDS MARKET

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 000149

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: 01/22/2017
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAS SUDDENLY LEANING TOWARDS MARKET
LIBERALIZATION INSTEAD OF STATE INTERVENTION

REF: A. A) TEGU 0086


B. B) TEGU 0091

C. C) TEGU 0098

D. D) TEGU 0134

E. E) TEGU 0135

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


1. (C/NF) Following a tumultuous year in which the GOH
announced it would take over all fuel imports, create a
state-managed monopoly, and perhaps even seize
privately-owned storage facilities, the GOH suddenly seems
poised to scrap those plans and move aggressively towards
market liberalization instead. International oil companies
(IOCs) that only a week ago faced the prospect of being
forced to leave the country are now deep in negotiations with
the GOH. The companies and the GOH are now closer than they
have been in a year to a deal that could hand President
Manuel Zelaya an important political victory but also produce
market reforms that will benefit the companies for years to
come.


2. (C/NF) High gasoline prices in late 2005 following
Hurricanes Katrina and Rita provoked the formulation of a GOH
plan to take over fuel imports. (Under this plan, the GOH
would sub-contract U.S. firm Conoco-Phillips as its
sole-source supplier for fuel.) Since then the GOH has
realized that no economic benefit would likely come from such
a scheme, but Zelaya has clung tenaciously to the plan for
political reasons. Zelaya remains convinced that his
popularity -- indeed, his very election -- was based on his
campaign promise to lower gasoline prices. Over the ensuing
year, Post warned the GOH of the legal problems and the
damage to the investment climate that could result from such
a state takeover. Still Zelaya refused to give up his vision
of lower prices at any cost.


3. (C/NF) Zelaya's patience with this process reached an end
at the inauguration of Nicaraguan President Daniel Ortega.
Days later, Zelaya passed a decree that changed elements of
the GOH-administered pricing formula, to allow gasoline
prices to adjust downward more quickly in the wake of sharp
international price declines. He also announced the GOH
willingness to seize privately-owned oil storage facilities
if necessary to allow the GOH-run import scheme to move
forward. Though the GOH did not seize the installations, the
decree drew shocked international reactions and expressions
of concern from Ambassador. These sharp reactions, combined
with a GOH statistical analysis that confirmed the scheme
would not give him his long-sought savings, convinced Zelaya
to reconsider. At the same time, the threat of asset
seizures and lost markets focused the attention of the IOCs
on Honduras, and brought them to the negotiating table.


4. (C/NF) Both sides met in Salvador on January 18, and
quickly opened a continuing constructive dialogue. Zelaya
needs price savings, and is willing to reform the state-run
pricing formula to obtain them. The companies seek fair
margins, but admit there is fat that can be cut from the
formula. This collaborative effort, if successful, will give
Zelaya the political victory he craves, while taking a major
step towards a market-driven fuels sector in Honduras. In
exchange, the GOH would commit to full sector liberalization
starting in January 2008. All GOH and sector interlocutors
seem genuine in their attempt to reach a sustainable
compromise that respects both investor rights and political
realities.


5. (C/NF) The GOH now understands that if this effort fails,
the result is likely to be a breach between the GOH and the
private sector, loss of investor confidence, and possibly
significant international litigation. The damage done to
Honduras' reputation -- win or lose -- will be severe and
long-lasting, and will undermine everything CAFTA was meant

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to achieve. On the other hand, if these negotiations
succeed, Zelaya could emerge with low gasoline prices and
high poll ratings that he can then use to promote
long-overdue reforms in politically risky areas such as
education, health care, and fighting corruption. The
companies might absorb small losses for the first year, but
in exchange they would remain key market players and win what
they have sought for years: a liberalized market, free of
GOH price intervention, where they can compete fairly.


6. (C/NF) Post assesses that we are very close to having a
deal on the table, but we're not there yet. The companies
must decide if they are willing to accept reduced profits in
exchange for a market reform that may or may not become
reality. The President must be willing to defend his
position and not change his mind when faced with political
opposition, as he has so many times in his first year in
office. Over the next week we will learn if the companies
are willing to strike a deal, and if Zelaya is visionary
enough to grab it.

FORD
FORD