VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #2808/01 3552011
ZNR UUUUU ZZH
R 212011Z DEC 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 6827
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE USD FAS WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RHMFIUU/HQ USSOUTHCOM MIAMI FL
RUEHAC/AMEMBASSY ASUNCION 5816
RUEHMN/AMEMBASSY MONTEVIDEO 6032
RUEHSG/AMEMBASSY SANTIAGO 0022
RUEHBR/AMEMBASSY BRASILIA 5671
RUEHSG/AMEMBASSY SANTIAGO 0023
RUEHLP/AMEMBASSY LA PAZ DEC SAO PAULO 3071
RUEHRI/AMCONSUL RIO DE JANEIRO 2081

UNCLAS BUENOS AIRES 002808 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
EB/ESC/IEC FOR SGALLOGLY, MMCMANUS,JIZZO 
WHA FOR WHA/BSC AND WHA/EPSC 
E FOR THOMAS PIERCE 
PASS NSC FOR JOSE CARDENAS 
PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE 
PASS USTR FOR SUE CRONIN AND MARY SULLIVAN 
TREASURY FOR ALICE FAIBISHENKO 
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER 
US SOUTHCOM FOR POLAD 
 
E.O. 12958: N/A 
TAGS: ENRG EPET ECON ETRD AR
SUBJECT: AMBASSADOR HOSTS ELECTRICITY, GAS SECTOR U.S. INVESTOR 
ROUNDTABLE 
 
Ref:  (A) Buenos Aires 2598 
      (B) Buenos Aires 2594 
      (C) Buenos Aires 2683 
 
------- 
Summary 
------- 
 
¶1. (SBU) Country managers of U.S. players in Argentina's electricity 
and natural gas sectors met with Ambassador to review constraints 
imposed by GoA regulations, uncertain natural gas supplies for 
generation, and frozen retail electricity and gas tariffs. 
Participants representing AES, CMS, Duke, Eton Park and E-On 
detailed company-specific stories about how GoA regulations and 
price controls imposed after the 2001 economic crisis had impacted 
their operations and strategic approach to the Argentine energy 
market.  They complained about unmet GoA contractual obligations 
(including late capacity payments electricity generators) and unmet 
GoA promises (including delays of promised 2006 tariff review until 
after October 2007 elections). 
 
¶2. (SBU) All participants agreed that electricity and gas regulatory 
authorities established during Argentina's 1990s privatization 
process were no longer independent.  They saw little in the way of 
long term vision in the GoA's energy policy mix, but rather a short 
term focus on maintaining below market consumer prices in this 
pre-election year.  They doubted that the GoA would - as it has 
promised - move to a less regulated electricity and gas pricing 
model by 2008.  Finally, most participants argued that, while they 
could adapt their operating and investment strategies to a 
suboptimal but stable policy mix, the GoA's penchant for changing 
the rules of the energy sector game preemptively and without 
consultation made it difficult for them to justify investments in 
expanded energy capacity the Argentine market needs.  Participants 
accepted Ambassador's offer to set up a roundtable meeting with 
Planning Minister De Vido to offer a forum for the GoA to address 
these issues.  END SUMMARY. 
 
--------------------------------------------- --------- 
Complaints: Politicized Regulation, Lack of GoA Vision 
--------------------------------------------- --------- 
 
¶3. (SBU) In the second in a series of sector-specific roundtables 
with U.S. investors (the first was held with upstream and downstream 
hydrocarbon investors - see Ref A), Amb met December 13 with 
representatives of U.S. electricity generation, transmission, and 
distribution as well as natural gas pipeline and distribution 
players.  Attendees included AES Country Manger Eduardo Dutrey; CMS 
CEO Bernardo Velar de Irigoyen; Duke Energy Country Manager 
Guillermo Fiad; E-On USA Country Manager Enrique Flaiban; and Eton 
Park consultant Federico Ravazzani.  Participants reviewed operating 
constraints imposed by the GoA's energy sector regulations, 
uncertain natural gas supplies for generation, frozen retail 
electricity and gas tariffs and discussed how these have affected 
their business strategy and investment decisions. 
 
¶4. (SBU) Participants detailed company-specific stories about how 
GoA regulations and price controls imposed following the 2001 
economic crisis, had impacted their profitability, operational 
viability and strategic approach to the Argentine energy market. 
Hydro and thermal electricity generators (AES, CMS and Duke) 
complained of GoA electricity pricing formulas for spot market sales 
that are roughly 65% below regulated rates charged by generators in 
neighboring countries.  Generators explained that these rates 
covered only their variable costs and characterized the GoA's 
below-market pricing formulas as broadly populist, inefficient 
(insofar as they subsidize users who can afford to pay more) and as 
"indirect expropriation" of generator investments.  Further, they 
 
 
 
noted that the GoA's regulated wholesaler CAMMESA has only made 
payments to them for spot electricity sales through July. 
 
¶5. (SBU) Electricity distributor AES noted that it was only 
partially allowed to implement industrial and wholesale end-user 
tariff rate increases negotiated with the GoA and that a full tariff 
review for one of its distributors promised by the GoA in 2006 had 
been delayed until after October 2007 elections as a matter of 
"political expediency."  Gas transportation company CMS called 
favorable an ICSID ruling directing the GoA to pay it $130 million 
in compensation for contractual breaches in CMS' investment in one 
of the national gas pipelines.  However, CMS complained that the 
GoA's ongoing diversion of gas supplies to the domestic market had 
forced it to default on contacted natural gas sales to Chile.  Gas 
distribution company E-On complained that retail gas tariffs it is 
able to charge Argentine end consumers are roughly 10 times lower 
than rates normally charged in Brazil and Chile and argued that the 
GoA was "not respecting the contractual rules of the game" by 
failing to approve the pass through of increased costs to consumers. 
 
 
¶6. (SBU)  All participants agreed that independent electricity and 
gas regulatory authorities established during Argentina's 1990s 
privatization process had long since been subordinated to the 
post-crisis political process and were no longer independent.  They 
saw little in the way of long term vision in the GoA's energy policy 
mix, but rather a short term focus on maintaining below market 
consumer prices in this pre-election year.  They doubted that the 
GoA would - as it has promised - move to a substantially less 
regulated electricity and gas pricing model by 2008.  Finally, 
participants argued that, while they could adapt their operating and 
investment strategies to a suboptimal but stable policy mix, the 
GoA's penchant for changing the rules of the energy sector game 
preemptively and without consultation made it difficult for them to 
justify to their Boards of Directors investments in expanded 
capacity that the Argentine market needs. 
 
¶7. (SBU) Ambassador noted that Planning Minister De Vido had earlier 
offered to co-host sector-specific roundtables with the Ambassador 
to address U.S. investor concerns.  Participants agreed that such a 
roundtable would offer a forum for the GoA to address broad 
regulatory inconsistencies and asked the Ambassador to request a 
meeting in January. 
 
------------------------------ 
Argentina's Electricity Sector 
------------------------------ 
 
¶8. (SBU) Argentina has the third-largest power market in Latin 
America, relying mostly on hydropower and natural gas-fired thermal 
plants for most of its electricity supply.  With approximately 28 
gigawatts of installed generation capacity, 61% of Argentina's 
electricity production capacity is fossil fuel-based (primarily 
natural gas) and 35% is hydroelectric.  Subsidized domestic demand 
has raised generating capacity utilization to internationally 
accepted limits, and experts are projecting power shortages this 
austral summer. 
 
¶9. (SBU) Following the 2001/2002 economic crisis, the GoA pessified 
capacity payments to generators, reducing them to roughly 40% of 
their earlier dollar value, and changed the structure of electricity 
spot pricing so as to make investments in generation, particularly 
in marginal capacity, much less attractive.  These interventions 
resulted in an electricity sector pricing mechanism for the 
wholesale generation market that provides few incentives for new 
greenfield investment.  Private electricity sector players charge 
that, over the last four years, the GoA has undermined the 
electricity sector by freezing energy prices, manipulating the 
 
 
 
methodology used to set market prices, and effectively confiscating 
funds owed to private companies.  The GoA has committed to 
"normalize" electricity sector tariffs by 2008. 
 
¶10. (SBU) FONINVENMEM (Fondo de Inversiones en Mercado Electrico 
Mayorista:) With voluntary private investment in new electricity 
generating capacity limited by GoA price controls and investor 
concerns over rapid GoA shifts in sector regulation, the GoA created 
a fiduciary fund, FONINVENMEM, to "encourage" new investment in two 
new 800 MW combined cycle plants in Buenos Aires and Santa Fe 
provinces.  The plants will cost $1.2 billion, of which $450 million 
is being funded by the swap of outstanding CAMMESA (the GoA's 
regulated electricity wholesaler) debt to generators into 
FONIMVENMEM equity.  The GoA has stated that the remaining $750 
million will be funded via a 3-4% surcharge on medium and large 
electricity users over the next 5 years, via private pension fund 
financing and via new investors. 
 
¶11. (SBU) Generators' share of FONINVENMEM investment is roughly 
based on their share of domestic generating capacity, though the 
GoA's participation formula favors both higher margin hydroelectric 
producers and those generators who sell onto the spot market rather 
than through long term supply contracts.  Of U.S. generation 
players, AES holds 20% and Duke 5%.  France's Total (which announced 
the sale of its Argentine generating assets to a local group and to 
Merrill Lynch) holds 28%, Spain's Endessa 23%, and Petrobras 10%. 
In exchange for this investment, the GoA has committed to (1) have 
the GoA's regulated wholesale distributor, CAMESA, sign a power 
purchase agreement to guaranty the profitability of the two new 
plants; (2) secure dedicated gas supplies for the new plants; and 
(3) eventually transition to a free market in energy after the two 
new plants are on line. 
 
¶12. (SBU) Electricity Generators Collections from CAMMESA:   U.S. 
electricity generators project continued difficulty collecting full 
payment from the GoA/CAMMESA for 2007 power sales.   These concerns 
are based on the growing CAMMESA deficit due to the mismatch between 
regulated prices and power production costs.  According to a report 
prepared by CAMMESA, a cash deficit of about US$ 580 million is 
expected for the November 2006 - March 2007 period. As of November 
2006, only payments owed for July 2006 had been paid in full, 
leaving August, September and October unpaid. 
 
¶13. (SBU)  ICSID Arbitration Claims:  Numerous electricity sector 
players in Argentina have filed ICSID claims seeking compensation 
for some combination of (1) the GoA's pre-crisis de-linking of power 
tariffs from the U.S. PPI; and (2) post-emergency law pesification 
of generation capacity cost and variable cost payments by regulated 
wholesaler CAMMESA.  Pre-crisis capacity payments to generators were 
roughly US$10 /MW while current payments total ARP 12/MW. 
 
-------------------------------------------- 
AES: Electricity Generation and Distribution 
-------------------------------------------- 
¶14. (U) With over $1 billion invested since 1993 and over 1,600 
employees, AES operates 6 hydro and gas-fired power plants in Salta, 
San Juan, Neuquin and Buenos Aires provinces with the capacity to 
produce 2.8 GW, 12% of Argentina's total installed capacity.  AES is 
the third largest private generator, behind ENDESA (Spain) and 
TotalFina/Elf (France).  AES also owns three distribution companies, 
EDELAP, EDEN and EDES, all in the province of Buenos Aires that 
provide energy to more than 750,000 customers. 
 
¶15. (SBU) AES holds a $60 million in the two new FONIMVENMEM 
generation plants.  AES filed an ICSID claim in 2002 seeking 
compensation for the GoA's post-emergency law pesification of 
capacity and variable cost payments to generators and the 
pesification and freezing of end-user electricity fees paid to 
 
 
 
distributors.  In August 2005, AES agreed to suspend this ICSID suit 
in exchange for a GoA promise to permit a tariff increases in 
distributor AES' EDELAP electricity rates for rural industrial and 
commercial (but not politically sensitive residential) clients and 
to follow-on with a February 2006 full renegotiation of EDELAP's 
rate base.  According to AES country manager Dutrey, the GoA 
ultimately allowed only a partial implementation of this agreed rate 
increase and the promised February 2006 rate base renegotiation was 
postponed until after October 2007 elections. 
 
------------------------------------------- 
CMS: Electricity Generation & Gas Pipelines 
------------------------------------------- 
 
¶16. (U) CMS entered the Argentine market in 1993 in electricity 
generation, gas transportation and trading services.  Its assets 
include three power plants totaling 2000 MW installed capacity, CMS 
Ensneada, Centrales Termicas Mendoza and Hidroelectrica El Chocon, 
as well as stakes in three gas pipelines, Transportadora de Gas del 
Norte (TGN) , Transportador de Gas del Mercosur and the Atacama gas 
pipeline from Salta province to Chile. 
 
¶17. (SBU) In July 2001, CMS filed an ICSID case regarding its 
investment in TGN, one of the two privatized Argentine gas 
transportation companies, charging that the GoA violated US BIT 
obligations via its unilateral modification of the legal and 
regulatory framework governing TGN including the pre-crisis 
de-linking of gas tariffs from the U.S. PPI and the post-emergency 
law pesification and freezing of natural gas pipeline tariffs. In 
May 2005, an ICSID tribunal found in favor of CMS and awarded the 
company damages of approximately US$ 150 million.  This was the 
first final award issued of the xx claims pending.  The GoA has 
filed an appeal to nullify the ruling and the Foreign Ministry has 
since publicly pledged to respect final ICSID rulings after the 
appeals process has been completed. 
 
----------------------------------- 
Duke Energy: Electricity Generation 
----------------------------------- 
 
¶18. (SBU) Duke Argentina owns two power generating assets are 
located in Neuquen province:  The Planicie Banderita hydroelectric 
power station produces 479 MW and the Alto Valle gas-fired thermal 
station produces 80 MW.  Duke also conducts licensed trading and 
marketing in the wholesale electric and natural gas markets as of 
late 2000. 
 
¶19. (SBU) In discussions with the GoA, Duke has committed to upgrade 
its Alto Valle gas-fired plant to bring 17 MW of unused capacity on 
line.  In return, Duke has asked the GoA to lock-in scarce natural 
gas supplies for this plant.  Duke has also submitted plans to 
invest roughly $60 million to add 40MW of new generating turbines to 
its Neuquen hydro plant if an appropriate package of federal and 
provincial tax incentives can be negotiated. 
 
----------------------------------- 
Eton Park: Electricity Transmission 
----------------------------------- 
 
¶20. (SBU) Eton Park, a U.S. investment firm managing over US$5.5 
billion, signed in August 2006 a contract with Brazil's Petrobras 
Energia Argentina to purchase its 50% stake in Citilec SA, the 
company that holds a 52.7% majority share in Argentine power 
transporter Transener.  Petrobras's earlier takeover of independent 
Argentine energy group Perez Companc in 2003 was subject by GoA 
anti-trust authorities to Petrobras's sale of Perez Companc's stake 
in Transener.  Transener is the largest electrical power 
transmission company in Argentina.  The formerly state-owned company 
 
 
 
was privatized in 1993 with a 95 year concession and is considered 
to be one of the leading players internationally in long-distance 
power transmission.  It owns the national high-voltage transmission 
network, with over 8,800 kilometers of transmission lines, as well 
as the 5,500 kilometer network of its controlled subsidiary Transba. 
 In addition, Transener's Brazilian division separately operates 
over 2,300 kilometers of 500kV lines.  Transener's combined networks 
are one of the longest 500kV systems in the world, as well as 
extensive 125kV and 250kV lines. Eton Park's purchase is not yet 
finalized. 
 
--------------------------- 
E-On U.S.: Gas Distribution 
--------------------------- 
 
¶21. (SBU) E-On US, a U.S. subsidiary of Germany leading energy 
provider, acquired LG&E Energy in 2001.  Through this purchase, E-On 
now owns interests in three Argentine gas distribution companies: 
Distribuidora de Gas del Centro S.A.; Distribuidora de Gas Cuyana 
S.A.; and Gas Natural BAN S.A. These three gas distribution 
companies in which E.ON US has interests provide 33% of the natural 
gas consumed in Argentina, reaching a customer base of over 2.2 
million. 
 
¶22. (SBU) In late 2001, LG&E filed an ICSID suit against the GoA's 
pre-crisis de-linking of gas tariffs from the U.S. PPI and later 
amended the case to include the GoA's post-crisis pesification and 
freezing of these same tariffs.  In an October 3, 2006, ruling, an 
ICSID tribunal did hold that the GoA violated provisions of the US 
BIT.  However, at the same time, the tribunal exempted the GoA from 
liability for a 17 month December 1 2001 to April 26, 2003 emergency 
"state of necessity" period of the Duhalde presidency.  While 
damages have yet to be calculated by the tribunal, the precedent 
this ruling sets is troubling to many ICSID claimants. 
 
------- 
Comment 
------- 
 
¶23. (SBU) That U.S. electricity and gas sector players see little in 
the way of long term vision in the GoA's energy policy mix is 
consistent with views expressed earlier by U.S. upstream and 
downstream hydrocarbon players (Ref A).  Their doubt that the GoA 
will keep its promise to move a substantially less regulated 
electricity and gas pricing model by 2008 is troubling given the 
manifest need to expand domestic generating capacity to meet 
burgeoning demand.  While the potential for ongoing energy shortages 
and blackouts during the peak summer season has been a media staple 
for some time, most analysts believe the GoA will be able to muddle 
through -- perhaps with some rationing -- until October 2007 
elections.  But the reluctance of electricity sector players to 
invest in new capacity in the face of the GoA's heavy handed energy 
policy mix will eventually force the GoA to consider reforms.  The 
question is when and the only certainty is that substantive reforms 
will not be implemented before October 2007 elections. 
 
WAYNE