This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 BRASILIA 001879 
 
SIPDIS 
 
SENSITIVE 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - DAS LEE AND FPARODI 
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON 
DOE FOR SLADISLAW 
USAID FOR LAC/SA 
 
E.O. 12958: N/A 
TAGS: EINV ENRG EFIN KIDE OPIC
SUBJECT: BRAZIL: DISPUTES CAST SHADOW OVER FUTURE ENERGY 
SECTOR INVESTMENTS 
 
REFS: (A) BRASILIA 1696, (B) BRASILIA 1686 
 
¶1. (SBU) Summary.  Investment disputes between U.S. 
investors and Brazil are currently concentrated in the 
country's energy sector.  The majority of the disputes 
involve contracts for thermoelectric plants that were signed 
during a period of drought-induced energy shortage (2001- 
2002) with guaranteed payments regardless of whether any 
energy is produced.  When the drought ended and the 
hydroelectric plants began to enjoy surpluses of less 
expensive energy, however, Petrobras (the GOB's petroleum 
sector parastatal) began to reconsider the high costs of 
maintaining the contingency energy.  Fundamental issue 
revolves around the willingness of Petrobras and certain 
governors to challenge contracts they don't like and the 
inconsistent performance of the judiciary in enforcing these 
contracts.  Although Brazil is actively encouraging foreign 
investment, these disputes with Petrobras and state 
governments have negatively impacted the investment climate 
in the sector.  End Summary. 
 
¶2. (U) This cable provides additional analysis and 
information on the cases submitted for the 2005 Section 527 
Report on investment disputes and expropriation claims 
report (Ref A).  This cable contains business confidential 
information and should be handled accordingly. 
 
Background on Petrobras Thermoelectric Contracts 
--------------------------------------------- --- 
 
¶3. (U) In the context of a 2001-2002 drought-induced energy 
shortage in Brazil, Petrobras was called on by the GOB to 
partner in several gas-fired power plants, inter alia, 
Macae Merchant (with El Paso), Eletrobolt (with former 
Enron), TermoCeara (with MPX Energia stakeholders, which are 
the U.S. power group MDU and Brazil's EBX), and TermoRio 
(with NRG Energy).  In all four cases, Petrobras signed 
contracts essentially guaranteeing the thermoelectric plants 
a minimum payment (to cover operational costs and provide an 
investment return) regardless of whether the plants were 
called on to produce energy or not.  The presence of these 
thermoelectric plants has contributed significantly to the 
current strength of the energy sector (Ref B). 
 
¶4. (SBU) Plagued by the heavy contingency payments, 
Petrobras began to review some its gas-fired power plant 
contracts, particularly those with the private sector, in 
search of a way to cut costs.  The new Petrobras Director of 
Gas and Energy, Ildo Sauer, publicly stated that the company 
wanted to "clean up" its thermoelectric portfolio. 
Petrobras argued that because market conditions had changed 
and it was exclusively bearing the onus of the losses, the 
contracts were invalid.  The losses to Petrobras have taken 
on political overtones as well as the former director of Gas 
and Energy at Petrobras, Delcidio Amaral, is currently the 
leader of Lula's PT party Senate caucus and the president of 
the congressional commission (CPI) installed to investigate 
corruption at the Brazilian postal service.  Petrobras and 
Amaral have been called upon to explain the R$ 2 billion 
"losses" incurred by Petrobras during Amaral's tenure due to 
the thermoelectric plant contracts. 
 
Deals Gone Sour 
--------------- 
 
¶5. (U) As a result of the changed market conditions, 
Petrobras has been seeking to either back-out of the 
contracts and/or purchase its partners' shares in the 
plants.  For example, in January 2005, Petrobras ceased 
making payments to El Paso's Macae Merchant plant even 
though it was under contract to supply gas and buy the power 
generated at El Paso's plant, paying a minimum amount even 
if no power was generated.  Petrobras filed a lawsuit 
against El Paso in New York claiming that the contract is no 
longer valid.   In July an arbitral tribunal decided that 
Petrobras must make its contract payments to El Paso into a 
judicially administered escrow account pending final 
judgment on the case.  A decision by the court is expected 
in November 2005. 
 
¶6. (U) In another case, for more than two years Petrobras 
refused to pay an arbitral award to NRG Energy, a U.S.-based 
independent power producer.  In September 2001, NRG acquired 
from Petrobras a 50% interest in the TermoRio project in Rio 
de Janeiro.  Under the terms of the contract, NRG had the 
right to require Petrobras to repurchase NRG's interests in 
TermoRio under certain circumstances.  In April 2002, NRG 
exercised that right, but Petrobras refused to pay NRG.  In 
March 2004, a Brazilian arbitral panel ordered Petrobras to 
pay NRG US$80 million (plus interest to date of payment). 
Although Petrobras did not challenge the decision in any 
forum and assumed full control of TermoRio, Petrobras 
delayed paying the award.  In September 2004, NRG filed a 
lawsuit to enforce the award in a U.S. Federal District 
Court.  Only on February 25, 2005, did Petrobras pay NRG US$ 
70 million pursuant to a negotiated settlement of the 
dispute. 
 
Thermoelectric Dispute with Parana State 
---------------------------------------- 
 
¶7. (SBU) The thermoelectric disputes also include another 
case involving El Paso and Petrobras, but this time with the 
parastatal Parana State Electricity Company (Copel).  In 
1998, El Paso (60%), Copel (20%), and Petrobras (20%) 
created a joint venture (UEG Araucaria) to build a gas-fired- 
electricity generation plant at Araucaria, in southern 
Parana state.  The contract was for El Paso to construct the 
plant, and Copel to both operate and maintain the plant. 
Although the plant was completed in September 2002, Copel 
operated the plant only briefly because of alleged technical 
problems.  The 20 year contract between Copel and El Paso 
was for energy capacity, thus requiring payment to El Paso 
whether the plant was in operation or not.  Although Copel 
made the contracted payments to El Paso for three months, 
when new Parana governor Robert Requiao entered into office 
in January 2003, he reportedly directed Copel to stop making 
payments to El Paso.  El Paso claims that the alleged 
technical problems are a ruse to enable the state governor 
to take over a majority share of the plant.  El Paso 
initiated arbitration proceedings in Paris and the panel 
hearing the case is expected to reach a decision at the 
beginning of 2006.  As with the Macae Merchant dispute, El 
Paso hopes to reach an amicable settlement because the 
company wants to continue to work in Brazil's energy sector 
-- transitioning from the electricity sector into the oil 
and gas sectors -- which would require maintaining good 
relations with Petrobras. 
 
More Petrobras Contract Problems 
-------------------------------- 
 
¶8. (U) Although many of the thermoelectric plant cases have 
resulted in disputes, some have been resolved through 
negotiations.  The press, however, has reported that the 
negotiations involved a bit of "arm twisting" by Petrobras. 
For example, in May Petrobras management approved the 
purchase of the thermoelectric plant TermoCeara from MPX 
Energia for US$ 137 million; MPX Energia was 49% owned by 
U.S. Company Centennial Energy in partnership with Brazil's 
EBX.  In May Petrobras also formally announced its purchase 
of the thermoelectric plant Eletrobolt, originally built by 
Enron and now belonging to a consortium of banks, for US$ 
65.1 million.  Petrobras has also been in negotiation with 
the Neoenergia (formerly called Guaraniana energy company) 
regarding the thermoelectric plant Termoacu, whose 
construction was halted initially because of a technical 
review by the Brazilian Electric Energy Regulatory Agency 
(ANEEL).  It appears now that Petrobras will increase its 
stake in the company from 30% to 80% and may recommence 
construction.  In short, Petrobras is making a concerted 
effort to cut its losses in the thermoelectric sector by 
forcing contract negotiations and/or buying out its 
partners. 
 
¶9. (SBU) Banco Pactual's Pedro Batista told Rio and Brasilia 
EconOffs that investors have been watching Petrobras' 
renegotiation of its thermoelectric plant contracts with 
concern.  According to Batista, any investors entering the 
market will have to calculate in the risk that contracts may 
not be fully respected. 
 
Shareholder Agreement Problems 
------------------------------ 
 
¶10. (U) Some of the investment disputes involve state 
governments which, following new elections, reneged on 
shareholders agreements.  As detailed in Ref A, U.S. 
companies Mirant and AES, along with a Brazilian partner, 
through a joint venture, purchased 33 percent of the voting 
shares of the Minas Gerais state electric power company 
(CEMIG) for US$ 1.05 billion in 1997.  The purchase price 
included a shareholders agreement giving the joint venture 
certain negative control (i.e., veto) rights over the 
management of CEMIG and the ability to nominate some of the 
executive officers.  However, in 1999, a new state 
government took office and overturned the shareholders 
agreement in a lower state court.  An appeal remains 
pending.  In a non-energy sector case also detailed in Ref 
A, the State of Parana similarly unilaterally terminated the 
Shareholders Agreement.  The State effectively retook 
ownership and management control of its sanitation company 
Sanepar, despite having sold a 40% stake in the company with 
a shareholders agreement that guaranteed minority 
shareholder protections.  The courts have not yet ruled 
definitively on the case. 
 
Comment 
------- 
 
¶11. (SBU) The unwillingness of new administrations to honor 
contracts signed under a previous federal or state 
government makes investors leery of pursuing infrastructure 
projects that require a long-term commitment.  While 
Petrobras' strategy to cut costs makes sense in terms of its 
financial bottom line, the end result has been to relegate 
the expensive thermoelectric plants to the role a of 
contingency source of electric energy, at the additional 
cost of reduced investor confidence.  Although it appears 
that the thermoelectric plants may play an important role in 
the next few years because of delays in moving new 
hydroelectric plants forward (Ref B), that respite could be 
only temporary.  Fundamentally, Brazil (whether at the 
federal, state, or parastatal level) must decide whether the 
security provided by thermoelectric plants is worth the 
associated costs, even when they are not in operation. 
 
¶12. (U) This cable was coordinated with the Foreign 
Commercial Service and the Consulates General in Sao Paulo 
and Rio de Janeiro. 
 
CHICOLA