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Cablegate: Nicaragua: The Other Power Crisis


DE RUEHMU #2051/01 2612143
R 182143Z SEP 06







E.O. 12958: N/A

REF: A. 05 MANAGUA 2551

B. 06 MANAGUA 1079

1. (U) Summary: For the past four weeks the power sector in
Nicaragua has been locked in crisis. At the center of the
maelstrom is the electricity distributor,s inability to pay
its power producers. With national elections only months
away, resultant blackouts have taken on an important
political dimension. As a short term solution to keep the
system afloat, President Bolanos sought the injection of $9
million by paying the distributor for the low-end user
subsidies set out in last year,s emergency energy
legislation. This solution was thwarted, however, when the
Liberal Constitutional Party (PLC) and the Sandinista Front
(FSLN) refused to deliver the quorum required to consider the
budget adjustment in the National Assembly. Everyone has a
theory as to the root of the crisis, but the scapegoat of
convenience has been Spanish owned electricity distributor
Union Fenosa. However, the problems of the nation,s power
sector go much deeper. The Instituto Nacional de Energia
(INE), the regulatory agency, requires assistance in
developing a more workable pricing formula and a realistic
vision for meeting the nation,s growing demand. End Comment
and Summary.

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Power Sector in Crisis

2. (U) For the past four weeks, the power sector in Nicaragua
has been locked in crisis. Rolling blackouts have affected
virtually the entire country; in some sections of Managua,
blackouts have totaled seven hours or more per day.
Disgruntled consumers have marched on Union Fenosa, the
nation,s primary electricity distributor. Demonstrations
have been staged in Managua and Leon, leading to tire
burnings and short-lived invasions of Union Fenosa,s
offices. Power producers have threatened to close down
operations because of non-payment. In August, INE Chief
Regulator (for energy) David Castillo cried foul, accusing
power producers of pushing the system to the brink in an
effort to force INE to revise its pricing policies. Shortly
thereafter, Castillo launched public attacks on Union Fenosa
for violating the terms of its contract. On its own
initiative, the Comptroller General reviewed Union Fenosa,s
contract, declaring it null and void. (Note: It is not clear
that the Comptroller General has the authority to cancel
INE,s contract with Union Fenosa.)

Election Year Politics

3. (SBU) It did not take long for the matter to take on a
political dimension, with Sandinista observers declaring that
the blackouts represented yet another example of the failure
of market economics to deliver needed services to the poor,
and clamoring for the return of the power sector to state
ownership. FSLN presidential candidate Daniel Ortega
continued to trumpet President Hugo Chavez, long standing
offer to supply Nicaragua with cheap oil, criticizing the
government for not allowing a company hastily composed of
FSLN mayors to import fuel. (Comment: Ostensibly, the mayors
would sell the oil to power producers or to the local
refinery to produce gasoline or fuel oil at a reduced price,
but how the savings would be passed along to the man in the
street is unclear. What is clear is that the scheme would
deliver cash to FSLN mayors, who could then spend it on what
they liked, including turning out the FSLN vote on November
5.) Presidential candidate Eduardo Montealegre trumpeted
conservation as a possible short-term solution, taking out a
full-page newspaper ad to propose that long life light bulbs
be given to anyone with a lamp, saving up to an estimated
30MW. The Spanish Chamber of Commerce, seeking to protect
one of its leading members (i.e., Union Fenosa), called on
PLC presidential candidate Jose Rizo to mediate. Rizo said
he would talk to PLC member and INE Chief Castillo and
others, but was otherwise non-committal. Edmundo Jarquin
also spoke out, decrying what he termed the &politicization
of INE.8

$9 Million Price Tag

4. (SBU) To keep the system afloat, President Enrique Bolanos
proposed early on that the government inject $9 million into
Union Fenosa under the terms of last fall,s emergency energy
legislation. However, when the day came on September 6 in
the National Assembly to consider his proposal, the PLC and

FSLN refused to deliver the quorum required to consider the
adjustment to the budget. The government will try again the
week of September 18. Empresa Nacional de Electricidad
President Frank Kelly informed Emboff that the government was
also working on a special loan from Banco CentroAmericano de
Integracion Economica (BCIE), in the belief that the $9
million budget supplement would not be passed.

5. (U) The logic of the $9 million payment stems from INE,s
mandate that all customers consuming fewer than 150 kwh per
month receive electricity free of charge ) and two out of
every three customers fit into this category. This
requirement places an even greater burden on the nation,s
paying customers should the government fail to subsidize
Union Fenosa for providing free services. In August, Union
Fenosa estimated that the government owed the company $18
million, though it agreed to an injection of $9 million to
hold the power sector together at least until national
elections could be held on November 5. However, the
situation for the power sector in mid September has become
measurably worse. (Note: The government has injected cash
into Union Fenosa before. In 2005, for example, it injected
more than $5 million rather than accede to Union Fenosa,s
request to raise electricity rates.)

The Root of the Crisis

6. (U) At this point, everyone has floated a theory as to the
root of the crisis, but the scapegoat of choice has been
Spanish owned electricity distributor Union Fenosa, the
government,s contracted electricity distributor since
privatization in 2000. Former PLC legislator and INE Chief
David Castillo has repeatedly criticized Union Fenosa in the
press for violating the terms of its contract, calling for
arbitration and naming the firebrand leader of a local
consumer organization as one of three arbiters to hear the
case. Union Fenosa has not formally agreed to arbitration,
although its contract does allow for it and the company has
reportedly refused INE,s choice for an arbiter.

7. (U) While the problems of the nation,s power sector may
converge on Union Fenosa, they go much deeper. The sector as
a whole is extremely fragile, limiting the options that Union
Fenosa has when parts of the system fail. The vast majority
of the power, almost 80%, is generated from heavy oil or
diesel. Ever-rising oil prices coupled with rising local
demand and legal restraints have scarcely given the sector a
chance to breathe since being privatized in 2001-02.
Compounding the problem this year has been low rainfall along
the river basin that fills Lake Apanas, the reservoir behind
the country,s largest hydroelectric plant. Upon entry,
Union Fenosa invested in improving collections and preventing
theft, but was unable to meet its targets. In addition, the
company has been unable to make headway on the 28% loss of
power in the distribution system (as opposed to 14% in the
countries like the United States). The rate of loss is due
to theft, inefficiencies, and the fact that the company is
prevented by law from upgrading its power lines to higher
voltages, where greater efficiencies lie. These voltages are
reserved for the state owned transmission company, ENTRESA.

8. (U) Recently, both the American Chamber of Commerce and
the business federation COSEP publicly identified the root of
the crisis as the failure of INE,s pricing formula to
generate the cash flow needed to keep the system going. The
formula is simply not responsive enough to constant price
hikes, and there is no compensation fund available to smooth
out oil price movements. Between December 2005 and June
2006, the average cost of generating a megawatt hour
increased from $92.15 to $112.70. Prices to the consumer
have also risen, but not enough to compensate for the rise in
oil prices and with a lag time of about 45 days. The result
has been that Union Fenosa has had increasing difficulty in
paying power producers for the electricity they generate.
Compounding matters is the emergency requirement introduced
by INE in May 2005 that has limited power producer profit
margins to 10% -- at once withdrawing the incentive producers
needed to invest in more power at a time that demand was
rapidly approaching supply and raising the risk of investing
in Nicaragua. Additionally, INE has fined Union Fenosa
millions of dollars for power cuts to consumers over the past
six months.

9. (U) The inability of Union Fenosa to pay on time has
created tremendous cash flow difficulties for power
producers. Diminishing working capital has made it difficult
for them to afford next month,s fuel bill and pay for
maintenance. Many plants are 20 years old or more and need
constant attention. Technical failures at three plants
triggered the crisis when they shut down, removing as much as
100 MW from the grid.

How Bad Is It?

10. (SBU) Econoff learned from a major power producer that
Union Fenosa,s top management in Spain is willing to walk
away from the whole mess in Nicaragua if things get any
worse. Clearly, the working environment for the company in
Nicaragua has reached a new low. Union Fenosa reports that
collection rates have dropped precipitously, as customers
refuse to pay for service they are not receiving. A recent
poll indicated that 82% of the population supported returning
the sector to state control.

11. (SBU) This same power producer met with Union Fenosa to
discuss the prospect of exercising a clause in its power
supply contract that allowed it to hand over its plant should
Union Fenosa fail to pay. The contract stipulated a
pre-determined value until September 1, 2006; afterward, the
power plant would have to be reappraised. The producer
believed that after September 1, the value would be much
lower, given the risk of not getting paid. In the end, Union
Fenosa paid the company two-thirds of its arrears for June
and the company stayed past September 1, in hopes that the
government would inject $9 million cash into the system on
September 6. When this did not happen, the company slipped
effectively into the red. Managers told Econoff that they
are now looking to shut down the plant at the earliest
opportunity &to stop the bleeding.8

Crisis Management

12. (U) At the height of the crisis, Union Fenosa had a tough
time soliciting electricity imports from its neighbors to
stabilize the situation. For one, other Central American
countries have also been trying to meet increased demand in a
world with CAFTA. For another, Union Fenosa had to convince
them that it could pay. Union Fenosa finally arranged for
30MW or more additional supply from El Salvador and Guatemala
-- and reportedly with Costa Rica -- on the spot market.
This has brought some stability to Nicaragua,s power sector
as long as good neighborliness holds. For a while Union
Fenosa was able to manage power outages in Managua by rolling
four hours of down time a day through different sections of
the city. When the Geosa power plant dropped its output from
113 MW to 25 MW on September 8, Union Fenosa increased
rolling blackouts in Managua to 7-8 hours a day. Around the
country, individuals and businesses who can afford it have
been buying generators and fuel oil to produce their own
electricity to keep their operations going.

COMMENT: What Needs to Be Done?

13. (SBU) Nicaragua,s power sector needs life support to
keep the sector operating and out of the political fray
during this election year. This can only come in the form of
a sizeable cash injection into the system, such as the one
proposed by President Bolanos. Cash would allow Union Fenosa
to pay power producers and keep the lights on in Managua. If
Bolanos fails to get the money from the National Assembly or
Central American Bank for Economic Integration, the
Nicaragua,s power sector could collapse, forcing the
government at great expense to pick up the pieces, much as in
the Dominican Republic when Union Fenosa walked from that

14. (SBU) Once life support is set in motion, INE needs to
check itself in for long-term rehabilitation. Government
needs to rethink legal changes in 2004 that transferred INE
from the executive to the legislative branch, thus
politicizing the agency. Regulators need to better
understand the sector, employ a pricing system that is
responsive to rising fuel prices, and pursue a workable
vision for meeting growing demand and fueling development.
Laws governing the power sector should be modified to allow
for greater flexibility on the part of the distributor
vis-a-vis the role of the transmission company. We are
expecting the visit of an AID energy expert to review options
with the government and INE in the near future.

15. (SBU) The InterAmerican Development Bank informed us that
the INE recently requested advisory assistance. We should
strongly support granting INE assistance from any credible
source that can counsel INE on best practices, help INE
develop a more workable pricing formula, and encourage INE to
pursue a realistic vision for meeting the nation,s growing

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