HONDURAN FUEL SOLICITATION: FOOL ME TWICE, SHAME

C O N F I D E N T I A L SECTION 01 OF 05 TEGUCIGALPA 000463

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: 03/15/2017
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAN FUEL SOLICITATION: FOOL ME TWICE, SHAME
ON ME

REF: A. A) TEGU 368 AND PREVIOUS

B. B) 06 TEGU 1881

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


1. (C/NF) Summary: The GOH has decided to put the fuel
solicitation process on a back burner. While this offers
hope the planned state takeover of the fuel import sector
might never take place, it leaves the plan with enough life
in it for the Zelaya administration to play political games
with it indefinitely, continuing to make life miserable for
the current group of fuel importers. On March 2, the GOH
reneged on nearly all it had promised over the last month
about moving towards a competitive market in fuels. At the
March 2 meeting the GOH announced it would continue the fuel
import solicitation process (designed to monopolize the
sector under state control),continue negotiations with
ConocoPhillips (the firm that would supply the state under
the nationalization plan),and move forward with a plan for
the state to construct a two million barrel fuel storage
facility (the last piece needed to move forward with
nationalization). At the meeting the GOH also implicitly
rejected the international oil companies' (IOC) proposals for
reforming the fuels pricing formula, mandating instead that
the pricing structure would remain as it is. Pricing
adjustments will not be made more flexible or efficient by
allowing them to move with the market price, but will instead
remain in the hands of the state-run Petroleum Administration
Commission (CAP),which will continue to set prices every two
weeks. Finally, the GOH called on all supporters of the
solicitation/nationalization scheme to rejoin the GOH in its
efforts, apparently extending an olive branch to Juliette
Handal and the Patriotic Coalition. As of March 13, two IOCs
have now filed suit against the GOH, chief negotiator Arturo
Corrales has refused to play any further part, and Minister
Flores Lanza could provide no indication that the GOH has a
clear vision of how to prevent what could be a coming train
wreck. The decision now lies with the IOCs whether this
issue must move to a legal or trade complaint venue for its
resolution. End Summary.


2. (C/NF) The March 2 meeting had originally been scheduled
for February 27, and was generally expected to be the venue
where President Jose Manuel "Mel" Zelaya Rosales would unveil
his new plan to create competitive fuel markets. Given his
strong public statements over the last month, Post also
expected that the meeting would be the decisive showdown with
Handal, in which the President would once and for all assume
a leadership role in the process and marginalize Handal and
her disruptive Coalition. However, we and other observers
became increasingly concerned when the GOH postponed the
meeting and stopped returning calls, leaving all to wonder
what would actually be presented. The meeting was then moved
to March 2, a day when Zelaya himself would be out of the
country, another ill omen. Despite these red-flags, the IOCs
and other participants had little option but to watch and
wait.


3. (C/NF) Representatives of ChevronTexaco -- the U.S. firm
that has been most engaged in seeking a mutually acceptable
outcome to this situation -- described the meeting as "very
bad," and is considering seeking a meeting between their
President and President Zelaya to convey its concerns.
ExxonMobil requested a meeting between its corporate
President and President Zelaya to express its grave concerns,
and has quietly retained counsel, should it need to pursue a
legal case. Even Arturo Corrales, repeatedly put forward as
Zelaya's personal representative to these talks, told
EconChief he felt "disappointed and deceived" by the outcome.
(Note: Corrales was not present at the meeting, and it is
rumored that the current public attacks on his meter-reading
business, SEMEH, are in retaliation for his role in seeking a
market-based solution to the fuels issue. On March 5, the GOH
announced that his contracts would be unilaterally cancelled.

TEGUCIGALP 00000463 002 OF 005


End Note.) Minister Enrique Flores Lanza -- who presented
the GOH position at the March 2 meeting -- refused for
several days to return calls made to either his office or
personal phones. When reached on March 5, Flores Lanza
claimed that the new GOH position was entirely consistent
with the pro-liberalization stance and was little more than
an attempt to create some political room for maneuver while
moving towards free markets. (Comment: For all the reasons
outlined below, Post does not find this explanation credible.
End Comment.)


4. (C/NF) The meeting itself was reportedly primarily a media
show. The GOH invited not only the IOCs, but also
representatives from throughout the fuels distribution chain
(those most opposed to liberalization, since it would
threaten their padded margins) and even representatives of
the taxi drivers' union. The taxi drivers' union, recall,
was the blunt object with which Handal battered the GOH in
late 2005 and early 2006, paralyzing the city with road
blockages and precipitating adoption of the nationalization
plan. The absence of Zelaya and Corrales at the meeting, and
the presence of several vocally anti-liberalization groups
clearly stacked the deck against any market-based outcome.
(Comment: Interestingly, Handal herself was not present.
Rumor has it she was touring the countryside, drumming up
grass-roots support for a possible run at the Presidency.
End Comment.) Mario Canahuati, former Ambassador to the U.S.
and President of private sector umbrella group COHEP, was
also present at the meeting, allegedly to represent the
interests of the private sector. In our view, Canahuati is
already campaigning for President, and emerged from the
meeting to declare unhelpfully that he has always supported
the Patriotic Coalition but also price reform, and that he
favors increased competition in the sector, but also the GOH
plan to construct the new fuel storage facility.


5. (C/NF) The meeting produced a seven-point communique,
which appears in every respect to be a rout of market reform
and liberalization.

(Point 1) The GOH will maintain the current pricing formula.

Analysis: Reforming this formula (especially in light of
continuing losses being absorbed by the IOCs) had been the
key focus of over a month of quiet talks between the GOH and
the IOCs. No mention of any current or future reform is made
in the communique, calling into question the GOH's good faith
in engaging in those talks.

(Point 2) Negotiations with ConocoPhillips will continue.

Analysis: These talks had all but ended by February 24, and
the GOH had successfully laid the blame for the breakdown on
the U.S. citizen consultant and on Conoco. Conoco's only
role in this process would be as monopoly supplier to a
GOH-run national fuel import regime. Restarting these talks
therefore has only one obvious purpose: to allow the GOH to
once again pursue a nationalization scheme.

(Point 3) The bid solicitation process will continue and the
GOH will seek court authorization to take over DIPPSA's
privately-owned fuel storage facility.

Analysis: Obtaining control of these fuel tanks would allow
the GOH to move forward with its state-controlled fuel import
plan. Fifty percent of one storage facility is property of
ExxonMobil, so there are potential implications for U.S.
investor rights in such a decision. Because the current
lawsuit is based on a clause in a contract that Exxon became
party to when it purchased its stake in the tank farm,
however, the legalities of such a decision are unclear.

(Point 4) The current state-run fuel pricing mechanism will
not be reformed, but instead will remain in the hands of the

TEGUCIGALP 00000463 003 OF 005


GOH's Petroleum Administration Commission (CAP).

Analysis: Prices will adjust only once every two weeks, and
that decision must be approved by the political authorities
within the GOH (at times, this has meant requiring approval
by the President himself). The CAP is presided over by Lucy
Bu, a long-time ally and former special assistant to Juliette
Handal.

(Point 5) The GOH will move forward with a plan to build its
own 2 million barrel fuel storage terminal.

Analysis: Industry experts, including the U.S. consultant who
proposed this scheme in the first place, admit that there is
already an oversupply of fuel storage in Honduras. There is
therefore no economic justification for this new project.
Rather, building these tanks appears intended solely to give
the GOH the freedom to pursue its intended position as sole
importer of fuels into Honduras. In short, this project is a
clear signal that the nationalization scheme has not been
rejected, but merely postponed until the GOH has all the
pieces in place to make it happen. As for the existing
privately-owned storage tanks, which would become stranded
assets under such a scheme, the U.S. consultant once told
Post, "They (Esso, DIPPSA, and Texaco) can sell their tanks
for razor blades."

(Point 6) Any market reform will happen only in the
medium-term, and only after a full discussion among all
involved sectors.

Analysis: Post supports both transparency and participatory
decision-making, but in the context of this document and
given the participants to this meeting, this point appears to
signal that the GOH is prepared to put off adopting
market-based reform indefinitely. The lukewarm language and
long timelines in this point are jarringly discordant with
the pro-market rhetoric Zelaya had been invoking recently.

(Point 7) The full text of point seven reads: "We call on all
sectors, organizations, and persons who have supported this
process to continue supporting the government in its efforts
to find more favorable alternatives and fair fuel prices for
the Honduran people, based the laws of the free market."

Analysis: Given the composition of the audience and in the
context of all of the above, point seven is perhaps the most
disappointing. In it, the GOH appears to extend an olive
branch to the Patriotic Coalition, the taxi drivers' union,
and all the other anti-reform elements that had until
recently driven this process towards state-control. Where
the GOH had been on the verge of dealing a decisive blow to
this group, it now appears the GOH has instead once again
empowered them. This is certain to re-ignite the underlying
dispute and to protract any resolution for months or perhaps
years. By that time, with its own storage tanks in hand, the
GOH could decide to simply take over the sector itself.
Despite this point's token mention of the free market, the
"process" to which this point refers is one aimed at
increasing state intervention in the sector, and when those
that supported this process think of "more favorable
alternatives" they are not thinking of price efficiency and
competition, but rather of state controls and subsidies.


6. (C/NF) On March 9 EconChief followed up with Corrales, who
admitted he "could not say he was optimistic." Corrales
"hoped and prayed" the GOH would do the right thing, since he
did not see what other alternative it has, but he said its
actions over the last week have been like "running back into
a burning building you've just escaped." Corrales said if
the GOH is to have any hope of salvaging the situation, it
must immediately undertake to reform the pricing formula,
explicitly and publicly end the nationalization process and
the solicitation for a monopoly fuels provider, and engage

TEGUCIGALP 00000463 004 OF 005


the IOCs in talks on liberalizing the fuels sector. Even if
the GOH were to do all of that, he said, it is unclear if it
could repair the damage done. Corrales agreed with EconChief
that the GOH by its action destroyed whatever credibility it
had with the IOCs. Two of the IOCs (Shell and Trafigura)
have now filed suit against the GOH, and at least one other
(Esso) has retained counsel.


7. (C/NF) Post sees little that could entice the IOCs back to
the table to negotiate with a government in which they no
longer have any faith. Corrales agrees, and told EconChief
that he has refused the President's request to play the
intermediary in any attempt to re-engage with the IOCs. He
said his credibility with the IOCs had been destroyed by the
GOH's actions and that if he were to re-engage he would
appear to the IOCs to be complicit in the GOH's duplicity.
On March 13, Minister Flores Lanza told EconChief that he
understood the IOCs have likely lost faith in the process and
agreed that the GOH must move beyond words to actions. That
said, two weeks have passed and the GOH has not yet decided
how it plans to proceed. Flores was unwilling to commit to
more than saying the GOH will work to clarify its position,
perhaps over the coming week. Ambassador and EconChief have
each made it clear to the GOH that Post put its credibility
on the line in bringing the IOCs to the table, and we were
gravely disappointed by the GOH failure to follow through on
its commitments from those talks. As a consequence, we are
no longer in a position to offer informal policy advocacy on
this issue. In our view, the decision now lies with the IOCs
whether this issue must move to a legal or trade complaint
venue for its resolution.


8. (C/NF) Comment: When he first came into office in January
2006, Zelaya talked a great game about free markets and
international trade, and we believed him. Yet from the time
of CAFTA's April 1 entry into force, Zelaya has done little
to act on his words, and much to call into question his real
dedication to free markets (detailed extensively ref B).
Yet, when Zelaya claimed in January 2007 to have embraced
free markets as the solution to his fuel sector concerns, we
again believed him. Once again, his government's actions
belie his words. We are deeply disappointed that Zelaya has
again failed to marshal the political will to make the right
choice. Worse, he led all participants to believe he would
carry out this plan. They invested a great deal of time and
prestige in a good faith effort to negotiate a mutually
acceptable solution, only to find themselves ambushed once
again at a media circus event, as if we were back in the bad
old days of summer 2006. Worse, the GOH inviting the most
disruptive elements back into this process suggests that
Zelaya has returned to form -- provoking crises in order to
ride to the rescue, yet unwilling to spend the political
capital to avoid such crises in the first place.


9. (C/NF) Comment, continued: The historical precedents are
ominous. Zelaya, for example, twice undercut his own
negotiating teams in the 2006 wage dispute with teachers. In
each case, Zelaya encouraged the teachers to reject the deal
his own negotiators had put on the table and press for more.
The crisis dragged on and three successive negotiating teams
were formed and then replaced. Finally, Zelaya acceded to
every demand the teachers had made, despite the severe fiscal
dislocations that decision implies for future GOH budgets.
If this analogy of the teachers talks holds in the fuels
case, it suggests Zelaya does not actually intend to resolve
this matter. He might instead allow it to smolder
indefinitely, and perhaps even stoke the fire from time to
time when it seems politically expedient to do so. This
might be the normal game played in Honduran domestic
politics, but the IOCs cannot continue for much longer down
this path while losing money each day and living in a world
of uncertain investor protections. February's last-ditch
negotiations were a leap of faith by the IOCs, and it now
appears that faith might have been repaid with betrayal.

TEGUCIGALP 00000463 005 OF 005


Unless Zelaya were to reverse this latest policy shift, Post
does not see how this process can be saved, and even that
might not be enough.

Ford
FORD