VZCZCXYZ0000
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