SMUGGLING, UNCERTAINTY AND RED INK IN HONDURAN

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 001792 SIPDIS SIPDIS STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, EB/CBA, WHA/CEN E.O. 12958: DECL: 11/09/2017 TAGS: EPET ENRG EINV EFIN PGOV HO SUBJECT: SMUGGLING, UNCERTAINTY AND RED INK IN HONDURAN FUEL MARKET REF: A. REF A: 07 TGG 0077 ¶B. REF B: 07 TGG 0170 Classified By: Ambassador Ford for reasons 1.4 (b) and (d). ¶1. (C) Summary: Oil industry sources here report that the Zelaya Administration's efforts to manipulate pump prices and control the importation of petroleum products has increased gasoline smuggling. Zelaya still appears publicly in favor of building new import terminals to receive fuel from a sole international supplier, although his officials continue to maintain that their ultimate objective is a liberalized market. Meanwhile, even after squeezing the margins of the fuel importers, the GOH is hemorrhaging cash to keep pump prices fixed in the face of surging international oil prices. The uncertainty surrounding GOH intentions for the fuel market is causing international oil companies to question their presence in Honduras. End Summary. -------------- An Expanding Black Market for Gasoline -------------- ¶2. (C) Since the GOH price formula for hydrocarbon fuels was revised in January 2007 (ref A),the international oil companies have been importing only the minimum amount of petroleum products required by their contracts, at least in the case of premium gasoline, leading to spot shortages, which were reported in the press. However, the shortages seem to have disappeared fairly quickly, apparently because smugglers filled the void. ¶3. (SBU) The Honduran tax on a gallon of gasoline, at 20.9 Lempiras (USD 1.11),is significantly higher than in neighboring countries, making it profitable to smuggle fuel overland. According to oil industry sources, smugglers have traditionally trucked fuel in from Guatemala, where they can legally export gasoline tax free and easily evade Honduran taxes. Oil company representatives and Honduran businesspeople have also reported more exotic forms of smuggling, including boats and even large ships docking at night in smaller Honduran ports and offloading smuggled cargo to fuel trucks. Much of the north coast lacks law enforcement presence, and the area is well known for narcotics trafficking and illegal fishing, lending credibility to fuel smuggling reports. ¶4. (C) More recently, as a result of the disruption and uncertainty the Zelaya Administration has created in the fuel market, it appears the international oil companies are participating in this black market activity themselves. According to Shell manager Mauricio Sierra, one international company, from which Shell buys fuel under a pass-through agreement, has reduced the volume of fuel it sells to Shell by 15 percent, apparently because it can earn a higher price by selling to the emerging "gray market." Sierra said the scheme works as follows: The company sells to middlemen at one Lempira (about 5 U.S. cents)above the contract price paid by Shell. The middlemen then sell to gas stations, primarily independents but occasionally branded stations, for a markup of two Lempiras. This is possible due to the large margins the gas station owners (and the gasoline transporters) are guaranteed on each gallon under GOH pricing formulas. -------------- Background -------------- ¶5. (U) Prices for petroleum products in Hondurans are set by the government using a formula that includes international reference prices. Honduras has no petroleum production or refining capability of its own. It relies 100 percent on imports. ¶6. (SBU) Fuel prices spiked in Honduras, as elsewhere, after Hurricane Katrina disrupted transportation and refinery operations in the Caribbean region in 2005. The price spike ignited strikes by taxi drivers that reduced support both for President Maduro's National Party government and the party's candidate in that year's presidential election. According to Enrique Flores Lanza, legal adviser to current Honduran President Manuel Zelaya of the Liberal Party, Zelaya believes he won the 2005 election due to the strikes and his campaign TEGUCIGALP 00001792 002 OF 003 promise to lower fuel prices by 10 Lempiras or over USD 0.50 per gallon. ¶7. (SBU) Once in office, Zelaya's team decided to contract with a single company to supply Honduras with all of its hydrocarbon fuels. Since the GOH did not own any terminals to receive and store the fuel, it attempted to negotiate rights to use terminals operated by Honduran oil company Dippsa. Exxon has a 50 percent stake in one of those terminals. The negotiations did not succeed. In December 2006 Conoco-Phillips won a public bid to supply the fuel; terms of the bid were never made public. However, with Dippsa refusing to allow the GOH to use its terminals, the supply contract could not be executed. In January 2007, upon returning from meetings with Daniel Ortega and Hugo Chavez in Nicaragua, Zelaya labeled the international oil companies "energy terrorists," issued a decree compelling them to make their fuel import terminals available to the GOH and required them to supply fuel at the prices offered in the Conoco bid (ref A). According to the Honduran Petroleum Association, this resulted in a price reduction of USD 0.22 for premium gasoline. Following outcries from the oil companies and persuasion by the Embassy, Zelaya canceled the decree compelling the use of the terminals (ref B). However, the new price formula remained in place. ¶8. (SBU) According to the international oil companies, the January price formula has forced them to sell premium gasoline (30 percent of their volume) at a loss. In addition, they say, the GOH has run months behind in reimbursing them for financing the GOH subsidies on gasoline and diesel fuel (the GOH both taxes and subsidizes these fuels),causing them to incur hefty finance charges. ¶9. (C) From January to August 2007 it appeared Zelaya considered that having mandated a new price formula lowering prices at the pump had fulfilled his 2005 campaign promise. However, groups connected with independent gas station owners, taxi drivers and fuel transporters continued applying pressure to implement the sole-supplier scheme. At the forefront was the "Patriotic Coalition," led by Juliette Handal, who had resigned from Maduro's government as Industry and Commerce Minister. (Comment: Handal resigned after only a few months on the job, largely over a disagreement with Maduro over a pharmaceutical business they both owned as well as over the fact that her portfolio was really run by the Ministry of the Presidency. She took up a crusade against the international oil companies largely as a revenge issue to hurt Maduro and Pepe Lobo, the candidate of the National Party for President. End comment.) Handal apparently persuaded Zelaya to contract a relative of hers, Amcit Robert Meyeringh, to advise the GOH on designing a new scheme for the importation and distribution of petroleum products. ¶10. (C) In August 2007 Zelaya decided to solicit bids to either make fuel terminals available to the GOH or to construct new ones for the purpose of executing the Conoco fuel supply offer, even though there were no indications that Conoco was still interested in following through with the offer. Flores Lanza and Meyeringh told Emboffs at the time that the GOH did not want to build its own terminals (Embassy sources report Honduras has more than adequate present storage capacity). Instead, they hoped that either Dippsa or Texaco, which operate Honduras's existing terminals, could be persuaded to "rent" their terminals to the GOH. However, Texaco manager Luis Vega told Econoff the GOH had not approached Texaco about use of its terminals since February ¶2007. Dippsa, meanwhile, had been involved in months of legal maneuvering with the GOH over contract language allowing the GOH to use its terminals in case of national emergency. Nonetheless, Flores Lanza publicly announced that a bidding process for terminals would be initiated imminently. As of November 2007, no such process has been initiated. ¶11. (C) In conversations with Emboffs, Flores Lanza has stated repeatedly that Zelaya's ultimate goal is a liberalized, competitive market for the importation and distribution of petroleum products. However, he maintains, it is necessary first to break the power of the "oligopoly" that has historically controlled the importation segment. -------------- TEGUCIGALP 00001792 003 OF 003 Paying the Price (Or Not) for Price Controls -------------- ¶12. (SBU) Even after squeezing (or as the companies claim, eliminating) the margins of the international companies that bring petroleum products to Honduras, Hondurans still pay the highest price at the pump in the region, thanks to high fuel taxes and padded margins for fuel truckers and gas station operators. With world oil prices approaching USD 100 a barrel, pump prices would have been scheduled to increase heading into the Christmas season. Food prices were also rising due to higher international prices for grain, most of which Honduras has to import. In October the Honduran Congress passed a resolution freezing prices of 19 food commodities in the GOH "basic basket" through the end of January. On November 5, following a special cabinet meeting, the GOH announced it would keep fuel prices frozen until November 18, 2007 (at a cost of 95 million Lempiras -- USD 5 million),after which they might rise by 15-20 cents a gallon. But when transit workers threatened to strike November 7, Flores Lanza met with them late into the night November 6 and agreed to keep fuel prices fixed until the end of the year. ¶13. (SBU) Congress then made a special appropriation of 300 million Lempiras (USD 16 million) to cover the cost of fuel subsidies through December. This was on top of the 500 million Lempiras originally budgeted for 2007. In fact, though, experts estimate the GOH bill for subsidizing all forms of fuel in 2007 may reach 1 billion Lempiras (USD 53 million). This is on top of the USD 25 million a month that the state electrical company ENEE is losing by selling electricity to Hondurans for less than it costs to produce and deliver it. We have no estimate of how much the treasury is losing due to growing gasoline smuggling. -------------- Comment -------------- ¶14. (C) President Zelaya's attempts to control the price and marketing conditions of petroleum products, which Honduras does not produce, are becoming increasingly costly in both a political and a fiscal sense. It seems unlikely the fuel terminals will ever be constructed. We see two possible explanations for why President Zelaya continues to push the idea of a terminal bid. First, he needs to be seen as continuing to take action to lower fuel prices. Second, it is possible he thinks that, by increasing pressure on the oil majors, he can force at least one of them to leave Honduras and sell its gasoline stations. This could allow local interests, connected to him politically, to acquire the stations cheaply, after which the market could be liberalized. Only one thing is certain: uncertainty leads to corruption, and both are damaging to the investment climate. End comment. FORD