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DE RUEHQT #1920/01 2152245
ZNY CCCCC ZZH
O 032245Z AUG 06
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4985
INFO RUEHBO/AMEMBASSY BOGOTA PRIORITY 5854
RUEHCV/AMEMBASSY CARACAS PRIORITY 1913
RUEHLP/AMEMBASSY LA PAZ AUG 9992
RUEHPE/AMEMBASSY LIMA PRIORITY 0832
RUEHGL/AMCONSUL GUAYAQUIL PRIORITY 0937
RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

C O N F I D E N T I A L QUITO 001920 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR SGOOCH 
 
E.O. 12958: DECL: 08/03/2016 
TAGS: ECON
SUBJECT: PETROECUADOR - A CRUMBLING GIANT 
 
REF: A. QUITO 4525-91 
 
     ¶B. QUITO 1735 
     ¶C. QUITO 1905-03 
     ¶D. QUITO 0579 
     ¶E. QUITO 1973-91 
 
Classified By: EconOff Sara Ainsworth for reasons 1.4 (b&d) 
 







 
¶1.  (C) Summary.  Petroecuador, Ecuador's state-owned oil 
company, has sole responsibility over the country's most 
lucrative resource, yet is suffering from a severe financial 
crisis, a steady decline in production, and a terribly 
inefficient and inadequate refining capacity.  Graft 
permeates all levels of its cumbersome bureaucracy, and the 
company's union tends to reward its most unproductive 
personnel.  

Its equipment and production technologies are 
woefully outdated, yet under-investment and forced oil 
subsidies to consumers cripple the company's budget. 
President Palacio submitted a proposal to Congress on May 17 
that addresses some of these problems but falls short of a 
much-needed overhaul, and which anyway will likely languish 
in Congress in the run-up to the election.  
 
Reforming Petroecuador in any meaningful way will be an uphill battle; 
pumping more money into the company will not cure its ills. 
Even as the company becomes more inefficient and production 
continues to decline, Petroecuador continues to be a magnet 
for political elites that are motivated by manifold 
opportunities for graft and patronage. Consequently there is 
an absence of political will to get the job done.  End 
summary. 
 
Productivity A Rolling Stone 
---------------------------- 
 
¶2.  (U) Oil is Ecuador's most important export, constituting 
60% of total exports in the first quarter, and projected to 
bring in close to $3 billion for the state in crude revenues, 
and another $500 million in corporate taxes from the 
industry.  Petroecuador, the state energy company, has annual 
sales of more than $5.5 billion, and on its own accounts for 
16 percent of Ecuador's GDP.  Last year, the company 
generated $2.3 billion for the treasury, representing 40% of 
the total national budget.  
 
Despite record petroleum prices, Petroecuador is suffering from a severe financial crisis, a steady decline in production, and a terribly inefficient and inadequate refining capacity.  In recent years, Petroecuador has struggled to contract out its undeveloped oilfields. 
Finally, industry service providers are wary of working with 
the company due to its abominable payment record and 
questionable business practices. 
 
¶3.  (U) Petroecuador has changed little since its inception 
in 1989.  Industry contacts told EconOff that Petroecuador's 
performance has spiraled downward in the last ten years due 
to corruption, nepotism, lack of transparency, financial 
hardship, and slow bureaucracy (reftel A).  In 1992, the 
company produced about 120 million barrels per year; today it 
produces about 71.5 million barrels per year, implying an 
annual loss of almost $2.5 billion. 

Natural well deterioration accounts for some of this loss, but increased politicization, manipulation of the company's revenues, lack 
of capital investment and exploration, and poor management 
practices have amplified inefficiencies and financial 
hardship.  Private oil companies have meanwhile taken the 
lead in Ecuador's oil industry, producing about 20 million 
barrels per year starting in 1994 and 120 million barrels per 
year today. 
 
Fossilized Structure 
-------------------- 
 
¶4.  (U) Petroecuador's architects modeled it after 
Venezuela's state energy company, PDVSA, which began as an 
agglomeration of several companies each with its own 
corporate culture and independent operations.  Petroecuador 
was started from the ground up, and the Government of Ecuador 
(GOE) partitioned its production chain into three functional 
arms: Petroproduccion, in charge of exploration, extraction 
and crude production; Petroindustrial, responsible for 
refining; and Petrocomercial, which manages transportation of 
crude oil and local sales of oil derivatives.  
 
It is at once a partner, contractor, regulator and 
producer, and in each of its guises subject to political 
influence from the central government.  Petroecuador's 
schizophrenic mandate discourages cooperation and triples 
bureaucratic procedures.  

Each subsidiary maintains its own human resource, legal and administrative functions, duplicating efforts and increasing inefficiencies and bottlenecks. 
 
¶5.  (U) Petroecuador's strict legal structure stifles good 
business practices necessary for smooth functioning in the 
global energy sector.  Its endless procedures and approvals 
processes are a major departure from the decentralized nature 
of most oil companies.  Industry contacts told EconOff that 
Petroecuador personnel are known for their indecisiveness and 
untimely decisions; "final" decisions are almost always 
referred to another colleague for approval. 
 
Stone-Age Technology 
-------------------- 
 
¶6.  (U) Petroecuador has grossly underinvested in its fields 
and facilities since its inception.  According to 
Petroecuador's published budget for 2005, it spent $178 
million on investment, while foreign operating companies in 
Ecuador invested a total of $1.7 billion.  Most of 
Petroecuador's current infrastructure is now obsolete. 
Petroproduccion geologists would regularly complain during 
industry roundtables about the company's lack of technology 
and resources for maintenance and new wells; 240 of its 800 
wells were closed due to a lack of funds.  Its warehouses are 
empty; the company often re-uses valves and reportedly pulls 
up old tubing to use in new wells.  Petroproduccion's pumps 
are more than twenty-years-old and its valves are used for 
more than a decade. The industry standard use for both is 
four years. 
 
¶7.  (U) Ten years ago Petroecuador lost its authority to 
develop and administer an independent budget.  Red tape and 
government bureaucracy also inhibit Petroecuador's budget 
execution and contribute to its declining operating budget, 
which must be approved by Ecuador's equally inefficient 
Congress.  As a result, Petroproduccion now owes its 
suppliers more than $80 million in back payments. 
 
¶8.  (U) Government subsidies for refined crude products, 
which are covered using Petroecuador's proceeds from crude 
exports, will reduce its resources by more than $1.1 billion 
this year.  Petroecuador sells a $10 tank of butane for 
$1.60, and a gallon of diesel for less than half its import 
price.  Outstanding debts to Petrocomercial of $450 million 
from electricity generators, the largest beneficiaries of 
subsidized fuel, also reduces Petroecuador's budget (reftel 
B). 
 
Ramshackle Refineries 
--------------------- 
 
¶9.  (C) Petroindustrial runs Ecuador's three oil refineries, 
which have a combined capacity of 176,000 bpd.  The largest, 
Esmeraldas, was built in 1975 and refines just over 100,000 
bpd.  Japanese technology was used for the original design 
and subsequent upgrade in 1980, and it was renovated again in 
1993 using Spanish technology.  Former Minister of Energy 
Fernando Santos told EconOff that the refinery is inefficient 
and poorly maintained; he compared it to a Japanese car 
upgraded with German parts.  He said that of its 2,500 
employees, 2,000 lack the required skills, and that 
Esmeraldas could run with as few as 600 employees.  The IMF 
has long advocated a full-fledged audit of the Esmeraldas 
refinery, and in 2003 estimated that Petroecuador could save 
$300-500 million by shutting it down and importing oil 
derivatives. 
 
¶10.  (C) Domestic consumption of diesel, gasoline and other 
refined products outstrips refining capacity, and imports 
will reach $1.8 billion this year.  Previous upgrades to the 
three facilities to enable heavy crude processing have had a 
limited effect on capacity and have not improved refinement 
processes.  Private investors have no incentive to invest 
under the GOE's current subsidization policies.  The GOE has 
proposed reinvesting revenues from Block 15, until recently 
managed by Occidental Petroleum (Oxy), into Petroecuador's 
refineries. However, as required under Ecuadorian law, the 
GOE would first need to conduct feasibility studies for 
building or upgrading refinement capacity, and a 
legally-mandated tender would take years to secure under 
government contracting regulations.  In the most optimistic 
case, a new refinery would not be completed until 2013. 
Industry contacts tell us that investment is unlikely to 
improve current operations; Santos likened investment into 
Esmeraldas to dumping money into a hole in the ground. 
 
Transparent As Mud 
------------------ 
 
¶11.  (C) Petroecuador's structure and lack of financial 
accountability make corruption endemic. On the financial 
side, each of the various subsidiaries is not responsible for 
its spending practices.  Petroproduccion, for example, has no 
consolidated debt and keeps no accounts receivables figures. 
Santos told EconOff that each of Petroecuador's subsidiaries 
has its own "mafia", and kickbacks for contracts are a 
regular practice.  

Three years ago Petroecuador reportedly tried to contract a company to supply tubing for a well but were unable to locate a company willing to pay Petroecuador 25% of the contract bid.  Another company told EconOff about the phantom "three-percent man", whereby a company must pay a 3% commission to secure prompt payment.  Two GOE henchmen 
allegedly control the assignment of contracts issued by 
Petroecuador in return for "commissions" paid before 
contracts are announced.  Industry contacts allege the 
typical practice for Petroecuador's president is "to pilfer 
the company and get out".  
 
Over the years, Petroecuador personnel have been implicated in smuggling rings that extorted more than $100 million annually in government oil, and in selling precursor chemicals used to make cocaine (reftel C). 
 
Sindicato Stonewalling 
---------------------- 
 
¶12.  (SBU) Industry sources have told us that Petroecuador's 
labor unions control major decisionmaking within the company. 
 Workers engage in strikes or slowdowns on a regular basis in 
order to demand greater benefits or block changes.  Many 
suggest Petroecuador's unions were key in recent government 
decisions to expel Oxy and to squash the PDVSA-Petroecuador 
deal to refine crude.  Union members went on strike in March, 
for example, shutting down production at five key 
Petroecuador production facilities to demand the expulsion of 
Oxy and to extract federal funds from the GOE (reftel D). 
 
¶13.  (SBU) Efforts to reduce the unions' strength have 
failed.  Of the 33 Petroecuador workers dismissed in 2003 for 
sabotage and terrorism, 27 were reinstated and returned to 
their posts after the Ecuadorian Supreme Court ruled in their 
favor.  Each worker received almost $20,000 in compensation. 
New Petroecuador President and former Minister of Labor Galo 
Chiriboga has long ties with organized labor, and most 
insiders expect that he will continue to cede to union 
demands. 
 
Petrified Personnel 
------------------- 
 
¶14.  (U) Petroecuador has long had a reputation for hiring 
incompetent employees out of nepotism and for political 
reasons (reftel E).  In the last sixteen years, Ecuadorian 
presidents have appointed twenty heads of Petroecuador.  Many 
have had little or no experience in the oil industry; former 
president Fernando Gonzalez, appointed last April, was a 
lawyer and a vocal proponent for the cancellation of Oxy's 
contract.  Petroproduccion Vice-President Jaime Crow has 
experience in the downstream business but little background 
in his subsidiary's primary exploration and production 
functions. 
 
¶15.  (U) Lower-level technical staff within Petroecuador are 
paid significantly less than employees of private companies. 
Petroecuador's most talented employees often leave to pursue 
higher-paying jobs with private energy companies.  A 
Petroecuador employee cannot expect a clear career 
progression within the company.  Each change of senior 
management in all three subsidiaries results in significant 
turnover and politicization. Promotions and preferences are 
based on employees' ties to the current power brokers.  
 
All of this cripples employee efficiency.  While Oxy produced 
100,000 bpd with 318 employees, Petroproduccion produces 
190,000 bpd with 1,500 workers, suggesting that each of Oxy's 
employees is three-times more efficient. 
 
Comment 
------- 
 
¶16.  (U) On May 17 President Palacio submitted a proposal to 
Congress that would resolve some of Petroecuador's problems 
but which falls short of a total overhaul, and which will 
likely languish in Congress during the run-up to the coming 
elections.  Under Palacio's proposal, one of five members of 
Petroecuador's Board of Directors would be elected by 
technical experts, Petroecuador's president would be required 
to have at least fifteen years of industry experience, and 
nepotism and conflicts-of-interest in board appointments and 
the presidency would be forbidden.  The proposal would create 
planning, audit and administrative functions at the 
parent-company level, develop a human resource management 
system, enact contracting laws that include at least three 
offers, and mandate a yearly external audit by an independent 
international accounting firm.  The proposal would allow 
Petroecuador to issue bonds to increase its financial 
resources, deduct its costs and investment budget. 
 
¶17.  (C) Although the proposal attempts to address some of 
the company's inefficiencies, privatization would still be 
the best solution to instill a culture of accountability and 
efficiency within Petroecuador, but this is politically 
unpalatable.  Attempts during the Sixto Duran administration 
to adopt privatization were met with staunch opposition by 
the oil labor unions, which successfully convinced the 
populace that privatization was a scheme to line the pockets 
of an already wealthy handful of Ecuadorian businessmen. 
 
¶18.  (C) Reforming the state company in any meaningful way 
will be an uphill battle, and will require more than pouring 
money into Petroecuador or assigning it a robust budget. 
Increasing transparency, instituting independent audits and 
oversight, separating Petroecuador's budget from central 
government resources, injecting private capital and 
accountability, and increasing and enforcing regulations are 
some useful prescriptions.  Cultivating an awareness of 
Petroecuador's corruption in the Ecuadorian public and 
encouraging the public to demand accountability from the 
steward of its country's most valuable natural resource might 
be helpful in pushing politicians to reform the system. 
Presidential buy-in for reforms is important but not enough. 
Two years ago, former President Gutierrez purged Petroecuador 
and demanded reforms to combat corruption, but his tenure in 
office was short-lived.  Ecuador's revolving door presidency, 
and congress's ability to block change, makes pushing reforms 
more difficult. 
 
¶19.  (C) Even as Petroecuador becomes more inefficient and 
production continues to decline, political elites continue to 
find opportunities for graft and patronage.  They strongly 
support a powerful state role in Petroecuador and are 
unlikely to support a move toward privatization.  Despite a 
growing public recognition of the company's ineptitude, as 
evinced by the recent public outcry when Ecuador's Social 
Security system began investing in Petroecuador, there is an 
absence of political will to cure what afflicts Ecuador's 
wealthiest corporate citizen.  End comment. 
BROWN