HONDURAN PRESIDENT ZELAYA SAYS HE BACKS FUEL

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000225

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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: 02/02/2017
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAN PRESIDENT ZELAYA SAYS HE BACKS FUEL
SECTOR LIBERALIZATION, BUT TIME IS RUNNING OUT

REF: A) TEGU 0170 AND PREVIOUS

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


1. (C/NF) Summary: President Zelaya says he wants a
market-based fuel sector reform, but the GOH must reach a
deal with the international oil companies (IOCs) before
domestic pressures force him to move back towards a national
import scheme. A recent deal in principle with Honduran fuel
storage owner DIPPSA provides a needed piece for sector
liberalization, but it could also be used as a next step
towards a national import scheme. A recent visit by Conoco
representatives underscored that the pressure is still on
from some quarters to adopt a state-run fuel import monopoly.
President Zelaya has gotten about as much political and
economic benefit from that proposal as he is likely to get.
Any more steps he takes towards a state takeover of the
sector would only erode those gains, and expose Honduras to
lawsuits and loss of investor confidence. Post therefore
finds Zelaya's professed support for market opening credible,
since it is now in his political self-interest to engineer a
GOH exit out of the nationalization scheme. His challenge
will be to craft an exit strategy that preserves his gains
but also convinces the public that liberalization is the
appropriate next step in the GOH's cost-cutting plan.
Zelaya's rhetoric has begun to lay the groundwork for this
delicate maneuver, but GOH actions have yet to catch up. The
GOH needs to close this deal soon, perhaps during upcoming
talks with the IOCs on February 5 and 6. Failing that, the
GOH will engage in talks with U.S. firm ConocoPhillips by
February 9 as a potential monopoly supplier to a GOH-run
national import scheme. Post and the private sector remain
constructively engaged in supporting a policy of
liberalization. The questions now facing Post and the IOCs
are whether Zelaya will keep faith with his new-found market
orthodoxy, and whether he has the ability to deliver on his
promise. End Summary.


2. (C/NF) Since January 25, President Jose Manuel "Mel"
Zelaya Rosales has made several public comments preparing the
ground for a GOH pivot out of the current state-run import
proposal and into a move towards a liberalized market. On
distinct occasions he has called for liberalization of the
market, praised the competitive fuels markets that exist in
El Salvador and Guatemala, and warned Hondurans against
getting "tied to just one company." On February 1, for the
first time Zelaya told the public that if Honduras were to
sign ("aunque firmemos") with ConocoPhillips as a sole source
supplier, there would be no further price reductions for
gasoline as a result of the scheme. Presidential advisor
Arturo Corrales has for several weeks publicly said that any
savings would come from changes to the GOH pricing formula
and not from savings on imports, but this was the first time
Zelaya himself has said this to the public. Minister Enrique
Flores Lanza told EconChief that this tactic had slowly
opened a political space in which Zelaya now feels he can
move towards liberalization.


3. (C/NF) Zelaya has also repeatedly told Ambassador and
others privately that he now supports fuel sector
liberalization, and seeks an exit from this crisis that
includes the IOCs currently operating in Honduras. It was on
Zelaya's personal instructions that Corrales first engaged
with the IOCs in November 2006, and it was Zelaya's decision
to dispatch Corrales and Minister Flores Lanza to El Salvador
on January 18 with orders to seek a genuine accommodation
with the IOCs. Given his penchant for ad-libbing during his
public remarks, Zelaya was almost certainly also the author
of his recent rhetorical shift away from any mention of the
fuel import solicitation. Publicly and privately, Zelaya has
clearly adopted a market-based approach to the fuels issue.
The questions now facing Post and the IOCs are whether Zelaya
will keep faith with his new-found market orthodoxy, and
whether he has the ability to deliver on his promise. In
private discussions, the GOH seems increasingly anxious to

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conclude a deal with the IOCs. A ConocoPhillips delegation
returns to Honduras on/about February 8 to sign the exclusive
contract it won under the previous plan to nationalize
imports. The GOH feels it must reach a market-based deal
with the IOCs by then, or it might not be able to withstand
domestic political pressures to move ahead with the state-run
import scheme and sign with Conoco.


4. (C/NF) In the meantime, the GOH has been locked in a
contest of wills with Honduran fuels importer/distributor
DIPPSA over using DIPPSA storage facilities. Under DIPPSA's
contract with the GOH, DIPPSA is required to allow the GOH to
use the facilities if needed during an emergency, for which
DIPPSA will be paid a fair price. The GOH calculated that a
fair price, based on industry standards, would be USD 0.015
to 0.022 per gallon of throughput. The GOH padded this
figure generously and offered DIPPSA USD 0.03; DIPPSA
demanded 0.065. Unwilling to pay such a high fee, the GOH
noted that DIPPSA was contractually obligated to accept a
fair offer, and threatened to take DIPPSA to court over this
violation of the contract. In the end DIPPSA blinked, and
initial reports indicate that the GOH and DIPPSA have settled
on a price of 0.037 per gallon. Setting this price is a key
component of reforming the port fees portion of the fuels
pricing formula (which the GOH seeks to reduce from USD 0.112
per gallon to approximately 0.06). The international oil
companies (IOCs) cautiously support this effort as a means to
reduce price distortions in the state-run pricing formula and
to deliver cost savings to the Honduran consumer. This and
other fee reductions have been the tent-pole of IOC/GOH talks
since the breakthrough January 18 meetings in El Salvador.


5. (C/NF) Confusing to the IOCs, however, was a simultaneous
public exchange of letters between the GOH and
ConocoPhillips, in which Conoco said that once the storage
issue is resolved, the firm would enter into an exclusive
delivery contract with Honduras. The pressure to negotiate a
deal with DIPPSA was therefore also in the interest of those
who oppose liberalization and instead want to see state
control over the sector and a sole-source contract signed
with Conoco. As a result, both the pro-liberalization and
pro-nationalization forces see the DIPPSA deal as a victory
for their cause. President Zelaya claims he pursued a deal
with DIPPSA as part of putting the pieces in place for fuel
sector liberalization. Many others, however, continue to
push for the nationalization of the sector and see this same
agreement with DIPPSA as an important step along that path.


6. (C/NF) Further clouding the issue was the surprise
lightning visit on February 1 by a senior representative for
Conoco. Following closed-door meetings with Minister Enrique
Flores Lanza in which the DIPPSA deal was presumably
presented to Conoco, the representative held a press
conference in which he announced that "We don't want to be
involved in any expropriation or nationalization. Those are
words we don't like." He went on to say, though, that once
the GOH has guarantees of terminal availability, Conoco would
sign a contract to supply the GOH with fuel. In an email
following his visit, the Conoco representative told EconChief
that "things are proceeding quite well now. Conoco should be
signing (an exclusive import contract with the GOH) next
week." The contract with DIPPSA, once signed, therefore also
benefits Conoco in its quest to secure exclusive rights to
supply fuel to the GOH.


7. (C/NF) These recent positive developments are in keeping
with Zelaya's public and private assurances, but they do not
irrevocably commit the GOH to a path of market
liberalization. Reaching a deal with DIPPSA does not close
the door to a GOH takeover of the sector, should Zelaya fail.
The IOCs are impatient with the GOH's political posturing,
but most continue to bargain in good faith. In a telcon with
Ambassador, senior executives of Esso (ExxonMobil) expressed
their frustration with the lack of clarity in the process and
the poor communication from the GOH on developments.

TEGUCIGALP 00000225 003 OF 003


Ambassador explained that this issue has much political
baggage in Honduras, particularly for President Zelaya. It
is taking a significant amount of effort by Zelaya to
convince the public that a GOH shift away from the announced
nationalization of imports and towards liberalization is the
right move. Zelaya says he has reconciled himself to this
course of action, but he must now get Honduran public opinion
on-board, and that will take time. Ambassador urged the
companies to continue to support this effort, recognizing the
political risks Zelaya is running and the public and private
maneuvering that might be required. The IOCs met Flores
Lanza, Corrales, and Minister of the Presidency Yani
Rosenthal on February 2 to continue talks. Esso delivered "a
hard message" emphasizing its support for the reform process
but also the urgency of moving quickly on it, given
continuing losses that the companies face. The GOH presented
the IOCs with a pricing formula reform proposal, and
requested feedback by February 5.


8. (C/NF) Comment: Regardless of whether Zelaya can deliver
liberalization of the fuels sector or opts to pursue
state-run importation, setting a reasonable price with DIPPSA
for storage was a necessary step. Conclusion of those talks
was something of a step forward. Post is optimistic that
Flores Lanza's public comments about that deal clearing the
way to create a government administered import regime are
intended to keep pressure on the IOCs to bring their best
offers to the table as soon as possible. Zelaya has
realized, and is trying to communicate to the public, that
the savings from any state-run sole-source contract would be
slight. It appears he also understands that the legal and
political damage from pursuing a nationalization scheme could
be significant. Therefore, he faces the choice of either
pocketing the political benefits and price cuts he's already
obtained and moving on to liberalization, or of pursuing a
national import plan, poisoning investor relations, and
exposing Honduras to multiple lawsuits, all with little
likelihood of additional cost savings. Since Zelaya is both
a populist and a political pragmatist, we expect he will take
his winnings and move on, rather than pick a fight that he
will ultimately lose even if he wins. We don't discount the
chance that certain other players will take one more run at
the nationalization scheme. But, if Zelaya can withstand
those pressures, we think his political instincts might work
to our advantage in finally moving Honduras towards a
competitive fuels market. End Comment.

FORD
FORD