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Cablegate: Legislation to Reform Ecuador's Electricity Sector

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OO RUEHWEB

DE RUEHQT #1735/01 1982007
ZNR UUUUU ZZH
O 172007Z JUL 06
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4840
INFO RUEHBO/AMEMBASSY BOGOTA PRIORITY 5795
RUEHCV/AMEMBASSY CARACAS PRIORITY 1871
RUEHLP/AMEMBASSY LA PAZ JUL 9954
RUEHPE/AMEMBASSY LIMA PRIORITY 0775
RUEHGL/AMCONSUL GUAYAQUIL PRIORITY 0833
RHMFIUU/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS QUITO 001735

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR WHA/AND
TREASURY FOR SGOOCH

E.O. 12958: N/A
TAGS: ECON ENRG EINV
SUBJECT: LEGISLATION TO REFORM ECUADOR'S ELECTRICITY SECTOR
PRESENTED TO CONGRESS

REF: QUITO 1395

1. (SBU) Summary. President Palacio submitted to Congress
July 10 legislation to reform Ecuador's electricity sector
that would represent a significant advance if passed and
implemented as proposed. The legislation would make it a
crime to steal electricity, recognize almost $1 billion owed
by the GOE to power distributors, and establish government
payment guarantees for long term power purchase agreements
(PPAs). U.S. companies would benefit directly from the
acknowledgment of old debts and the ability to routinely
offset debts to Petroecuador against money owed them by power
distributors. Although not perfect, the proposed reform
would address many of the industry's problems. However,
given the repeated failure by Ecuador's Congress to approve
similar legislation over the last two years, prospects for
passage in this election year are slim. End Summary.

Current System Structurally Dysfunctional
-----------------------------------------

2. (U) Ecuador's electricity sector is riddled with
problems. The inability or disinterest of electricity
distributors to bill and collect from consumers underlies a
culture of non-payment that has created losses for most firms
in the sector. Many consumers, both households and
companies, steal power through clandestine connections. In
addition, the GOE sets the price distributors can charge
consumers below the price at which they purchase power. This
"tariff deficit" creates a systematic loss on the
distributors' books that they are legally unable to recover.
Compounding this burden, Petroecuador sells subsidized fuel
to power generators, thereby passing part of these losses
onto the state oil company. Distributors pay generators via
trust funds, and payment to each generator follows a pecking
order that changes on political whims several times yearly.
In practice, distributors have considerable discretion to
assign funds. Trust funds focus exclusively on current month
billing only, and any debt outstanding from prior months is
disregarded entirely.

3. (U) Investment into the sector is minimal. Generators
are unwilling to pour money into additional capacity when
they are unpaid. Likewise, existing incentives paradoxically
favor investment in high-cost, environmentally-unfriendly
power generation because of fuel subsidies and transfer of
accounts receivables to Petroecuador. The GOE also gives
preferential treatment to power generation in either Colombia
or Peru, because Ecuador pays them 100% in advance to meet
demand local generators cannot supply.

4. (SBU) Ecuadorian state entities, businesses and families
benefit from this dysfunctional system, regularly not paying
for electricity. GOE officials likely siphon off resources
in the form of direct diversions of cash or commissions from
those who receive contracts. State-owned companies control
most of the distribution, with the exception of Guayaquil,
which is served by a municipal-owned distributor, and six
state-owned generators dominate the country's electricity
generation (although private producers do generate energy at
a much lower price). The cascading tradition of non-payment
has technically bankrupted most state-owned companies
involved. Should Ecuadorian businesses suddenly be forced to
pay, the economic basis of many businesses in several
industries would be directly threatened. In the end, the GOE
pays as much as $1.5 billion annually, but the tangled web of
contracts and legal constraints leaves the true cost
difficult to define.

Electricity Sector Reform Legislation
-------------------------------------

5. (U) President Palacio submitted to Congress July 10
legislation to reform Ecuador's electricity sector that would
represent a significant advance if passed and implemented as
proposed. The bill was submitted as urgent and allows
Congress only 30 days to revise and vote on it or it
automatically becomes law. Legally, Congress must hold two
debates and vote before August 6. The Economic Commission
has committed to bringing the bill to the floor for the first
debate by July 18.


6. (U) The most important piece of the reform is the GOE's
guarantee to cover the tariff deficit and that it
specifically recognizes an accumulated deficit of up to $950
million incurred between April 1, 1999 and December 31, 2005.
The Ministry of Economy must calculate a revised deficit
taking into account several complex rules outlined in the
proposal within three months after the legislation is
approved. It creates a Ministry of Economy fund to
compensate distributors, which would open the door for more
complete payment to electricity generators. However, the
deficit guarantee is unlikely to cover all of the generators'
outstanding debt.

7. (U) It also permits the Ministry of Economy to guarantee
payment to power generators if the generator has participated
in a public competition and entered into long-term power
purchasing agreements (PPAs) to sell all of their production
to Fondo de Solidaridad companies for at least five years, at
a price below the predicted average annual market rate.
(Comment: State-owned electricity and telephone companies
belong to the Fondo de Solidaridad, a quasi-governmental
holding company whose subsidiaries are exempt from government
procurement rules. End comment.) In order to qualify for the
guarantee, the purchasing distributor must be certified by
the Central Bank and Ministry of Economy as "efficient".
Payments based on this guarantee would be made directly to
the company owed, without passing through the distributors'
hands. The legislation officially recognizes the outstanding
debt owed to generators for electricity provided but not paid
for in prior years; however, it does not propose a method of
paying this debt and prohibits the payment of accrued
interest on these debts.

8. (U) The bill also requires a series of immediate steps to
clean up and administer the Fondo's mismanaged accounts. The
Fondo would be required to hire independent management,
select board members and administrative personnel based on
relevant qualifications, and define and implement a Code of
Ethics. Finally, the bill would require Fondo power
distributors to enter into PPAs for at least 75% of the power
they purchase over the next five years.

9. (U) The legislation codifies the common practice of
routinely offsetting outstanding payments with Petroecuador
fuel purchases. Power generators that purchase fuel from
Petroecuador and sell power to distributors will be able to
routinely offset these accounts against one another, without
the need for a special Presidential Decree each year.

10. (U) The bill allows the GOE to subsidize power
consumers, but would require it to target specific social
groups and the subsidy must be formally incorporated into the
annual budget. Subsidies would be paid to the Fondo, who in
turn must credit the subsidies directly to Fondo companies.

U.S. Firms in the Sector
------------------------

11. (U) Two U.S. companies sell electricity to the
state-owned power distributors, Machala Power (owned by Noble
Energy) and Electroquil (Duke Energy); each is owed
approximately $50 million to date and both have filed
international arbitration proceedings to recover these
losses. Machala, the largest U.S. investor after Oxy's
expulsion, is a low-cost producer that has invested more than
$370 million in a natural gas platform, processing plant, and
an electricity generation plant (reftel). Eighty percent of
the money owed to Machala is outstanding from previous
months. Without a steady revenue stream, its headquarters in
Texas is unwilling to invest an additional $125 million to
double the plant's output. The company told us it is hopeful
the bill passes to help guarantee payment, however the
payment guarantee only for PPAs undercuts its attempts to
sell electricity on the spot market. The interest payment
exclusion also undermines Machala's international arbitration
claim exceeding $200 million in interest and other damages.

12. (U) Duke Energy, in contrast, has benefited from the
transfer agreement between distributors and Petroecuador, and
passed off much of its outstanding payments to Petroecuador


in exchange for fuel. It has been a big proponent of
codifying this exchange agreement into law and would benefit
from the inclusion of the provision in the final law.

Comment
-------

13. (SBU) Four attempts over the last two years to reform
Ecuador's power sector have failed. While the proposed law
is an imaginative step forward, it is unlikely to pass in its
present form, or be implemented as intended. Indeed,
congressional approval of such sweeping reforms in an
election year is unlikely. Several Congressmen directly
control local electricity distributors and electricity sector
unions are extremely well organized, militant, and viscerally
opposed to changing the status quo. Should the law pass as
proposed, the Ministry of Economy would certainly pay some
distributors, however the funds are unlikely to cover old
debts to generators and non-payment by Fondo companies is
likely to continue. The prospect of government guarantees
could dramatically improve the performance of U.S.
investments unless distributors collude to impose prices
below generating cost. The value of government guarantees or
of public recognition of debts is directly related to the
price of oil and inversely to corruption in the sector. In
the end, investment in Ecuador's electricity sector is
unlikely to increase in any measurable way even under the
best form of this legislation.
JEWELL

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