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 TEGUCIGALP 00000149 002 OF 002 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