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C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000134 
 
SIPDIS 
 
SIPDIS 
NOFORN 
 
STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, EB/CBA, AND WHA/CEN 
STATE FOR D, E, P, AND WHA 
STATE FOR S/ES-O MMILLER AND MSANDELANDS 
TREASURY FOR AFAIBISHENKO 
STATE PASS AID FOR LAC/CAM 
NSC FOR DAN FISK 
COMMERCE FOR MSELIGMAN AND WBASTIAN 
STATE PASS USTR FOR AMALITO 
 
E.O. 12958: DECL: 01/21/2017 
TAGS: EPET ENRG PREL BBSR NI VE HO
SUBJECT: HONDURAN GOVERNMENT DIALOGUE WITH OIL INDUSTRY 
CONSTRUCTIVE BUT INCONCLUSIVE 
 
REF: REF: TEGU 0098 AND PREVIOUS 
 
Classified By: AMB Charles Ford for reasons 1.4 (b,d) 
 
¶1. (C/NF) Summary:  The January 18 talks in Salvador between 
oil industry representatives and a GOH delegation led by 
Minister Counselor for Legal Affairs Enrique Flores Lanza 
reportedly made significant progress.  The GOH put two 
alternatives on the table and the affected oil companies have 
undertaken to respond constructively to those proposals by 
January 23.  The GOH agreed to the talks when a rigorous GOH 
analysis suggested the new state-run import scheme would not 
save Honduras any money, while incurring significant legal 
risks and sending a strong anti-investment message.  Industry 
concerns over inventory "confiscation" were reportedly 
resolved at the table, and talks now center on USD 0.01 to 
0.02 per gallon margin reductions each on imports and 
handling costs.  Post considers it highly significant that 
Flores Lanza has reportedly been convinced of the poor 
risk/reward ratio of continuing to pursue a strategy of 
nationalizing imports.  If accurate, this would be one of the 
most important defections of this year-long process, and 
could open the way to a breakthrough in the talks. The 
proposed negotiated solution is not optimal, but it might be 
the best obtainable under the circumstances, and it avoids 
several far-worse alternatives. End summary. 
 
¶2. (C/NF) On January 19, EconChief had an extended meeting 
with Presidential advisor on fuels Arturo Corrales, who 
presented his statistical analysis of the current offers and 
a comprehensive review of the current state of negotiations 
with the international oil companies (IOCs).  On the 
ConocoPhillips offer, Corrales noted that the final version 
of that offer contained two significant changes:  the 
inclusion of a hefty price premium for product delivered to 
the southern port of San Lorenzo, and a clause making the new 
offer a package deal rather than a la carte.  The 
consequence, Corrales said, was an "unbalanced offer" in 
which a low-ball headline price for super unleaded gasoline 
delivered to the Atlantic ports was compensated by higher 
prices for other products and other ports.  Modeling this 
offer using empirical data from 2004 through 2006, Corrales 
determined that the Conoco offer would have cost Honduras USD 
3.43 million more in imports in 2004, and saved it USD 2.9 
million in 2005 and USD 6.2 million in 2006.  The net savings 
overall, he says, is therefore only USD 2 million per year on 
average, on a total import bill of more than USD 650 million 
(that is, less that 0.3 percent savings).  Given the numerous 
assumptions implicit in his model, Corrales dismisses this as 
"within the statistical margin of error" and therefore is 
confident in saying that overall the new deal would not 
really save Honduras any money at all. 
 
¶3. (C/NF) Corrales presented this analysis to Minister of the 
Presidency Yani Rosenthal on Tuesday, January 16 and a 
convinced Rosenthal urged the President to consider these 
results.  President Zelaya sent the lead GOH official on the 
fuel issue, Minister Flores Lanza, to receive the same 
briefing and report back.  After several hours of detailed 
review, Flores Lanza reported to the President that Corrales 
was correct. Following the extensive discussions with 
Ambassador earlier that day, Lanza's conclusion reportedly 
convinced Zelaya to dispatch Corrales and Flores Lanza to 
Salvador for talks with the IOCs.  According to Corrales, 
Flores Lanza -- long one of the staunchest supporters of this 
poorly-planned scheme to nationalize fuel imports -- was 
persuaded by the evidence and has now switched his position 
to one of seeking an accommodation with the IOCs, as long as 
such a deal delivers the needed political victory for the 
President. 
 
¶4. (C/NF) In the meantime, the GOH is no longer convinced 
that an exclusive contract with ConocoPhillips makes sense. 
The GOH's own analysis reveals that savings will be 
 
TEGUCIGALP 00000134  002 OF 004 
 
 
negligible, and Zelaya has expressed concerns about the 
reliability of a partner with no investment on the ground in 
Honduras.  Post has made it clear that ConocoPhillips is a 
first-class company, and that we have no doubts it would 
fully honor its contract, if signed.  However, to avoid the 
possibility of lawsuits from other companies or breaches of 
international treaties, any GOH contract with ConocoPhillips 
should not infringe upon the rights of existing investors. 
Given the potential legal conflicts with existing investors 
(as vividly demonstrated last week by the GOH's announced 
intention to take over privately-owned fuel storage 
facilities), the GOH appears to be considering carefully 
whether the meager (or zero) savings from an exclusive 
contract with ConocoPhillips is worth the negative political 
consequences a state takeover of the sector would entail. 
 
¶5. (C/NF) In Salvador, in a series of separate meetings on 
January 18, Corrales delivered his presentation to each 
company and initiated a negotiation based on technical and 
financial factors, while also reminding the companies of the 
political context.  Flores Lanza was reportedly calmly 
supportive and incisive, and offered the companies two 
options:  buy their fuel imports from Conoco and maintain all 
their other downstream operations; or present the GOH with 
alternatives to the current plan that deliver similar or 
greater savings than the bid solicitation would deliver. 
According to press remarks, Shell is considering the first 
option, while Texaco and Esso told EconChief that they prefer 
the second. 
 
¶6. (C/NF) Corrales said he would grade the companies' degree 
of constructive engagement in these talks as:  Texaco A , 
Shell B , and Esso D.  Texaco and Shell each brought senior 
officials, listened politely, asked probing questions, 
admitted their role in perpetuating this problem, and agreed 
to consider the GOH offer and propose a compromise by 
Tuesday.  Texaco representatives told EconChief on January 18 
that the talks were more open than previous meetings had 
been, and that both sides seemed genuinely engaged.  Esso, on 
the other hand, was represented by a public relations person, 
and reportedly opened their meeting by literally banging on 
the table and demanding a USD 0.10 per gallon immediate price 
increase.  Despite such provocations, Corrales and Lanza 
remained focused and continued talks for several more hours. 
At EconChief's urging, Esso's Country Manager said on January 
21 that he was going to contact Flores Lanza to reaffirm that 
while talks got off to a rocky start, Esso remains optimistic 
and seeks a mutually acceptable outcome. 
 
¶7. (C/NF) The talks, while quite technical, basically focused 
on three elements:  financial losses on inventories caused by 
the sudden change in sales prices; changes to the import 
pricing formula; and the proposed "onshore" price 
adjustments.  The first issue, initially presented as a 
potential deal-breaker and likely impetus for legal suits 
over "confiscation," was essentially resolved at the 
negotiating table "in about three minutes," according to 
Corrales. Of the eight lempira price reduction that affected 
inventories, he explained, about six came from changes in the 
international price or changes to the Honduran price 
calculations by shifting from a 22 day rolling average to a 
10 day rolling average (thus bringing forward last week's 
sharp drop in international prices). These are largely price 
adjustments that would have occurred anyway over the next 10 
days (when the next inventory deliveries were to be made). 
Thus, the financial losses on inventories to the importers 
are limited to 10 days of losses, which Corrales estimated at 
about USD 150,000 per company.  (On January 21, Esso told 
EconChief it estimated these losses at approximately USD 
200,000.)  Corrales dismissed this as a minor issue made to 
seem major for bargaining purposes.  Such a relatively small 
loss, he said, could be recovered by the companies by 
slightly tweaking the pump prices over the coming weeks. 
Corrales told EconChief (and Esso later confirmed) that this 
 
TEGUCIGALP 00000134  003 OF 004 
 
 
arrangement was accepted in principle by both sides at the 
bargaining table, thus removing the inventories issue as an 
obstacle to a settlement. 
 
¶8. (C/NF) The second issue under discussion is the import 
price, which is currently based on Platt's Gulf Posting 
prices with slight adjustments.  The new proposal eliminates 
the adjustments, and instead offers a fixed premium based on 
product and delivery port.  The net change according to the 
GOH is close to zero, proving that current import prices are 
basically "fair" and that price gouging is not taking place. 
Esso argues that the new formula will cost it an additional 
USD 0.035 per gallon (a figure not supported by the 
spreadsheets produced by Corrales).  Corrales replies that 
the net impact is very sensitive to the weights applied (such 
as product mix and delivery port) as well as to the specific 
premium given in each case.  He is confident Esso's alleged 
loss could be minimized or eliminated by massaging the 
weights in the revised formula.  Esso has agreed to consider 
this offer carefully and produce a proposal. 
 
¶9. (C/NF) The third issue under discussion is the array of 
non-standard "onshore" costs, including a credit for leakage, 
a guaranteed margin for the importer, inspection costs, and 
others.  These fees and costs currently total USD 0.113 per 
gallon, but the GOH calculates that they should be reduced to 
between USD 0.05 and 0.06 per gallon.  This reduction would 
include shifting a portion (about USD 0.004 per gallon) of 
late fees to the importers in recognition that some demurrage 
is the fault of the companies, whereas currently 100 percent 
is attributed to the GOH.  It also proposes equally sharing 
the costs for product inspections (about USD 0.0015 per 
gallon), since those inspections benefit both the companies 
and the GOH equally.  The largest reduction would be the 
elimination of the guaranteed profit margin for importers 
(USD 0.045), which was inserted into the formula by Honduran 
oil importer DIPPSA to make it more competitive with the 
IOCs.  All participants reportedly agree that fee is not 
justifiable, and Esso even objected to it as "unethical" in a 
letter to the GOH several years ago when the fee was first 
imposed.  (Comment: DIPPSA's former owner Jose Lamas likely 
saw the writing on the wall last year and realized that 
without this guaranteed margin enhancement DIPPSA would be 
worth far less to a buyer and might even fail.  He therefore 
sold it promptly to Henry Arevalo, who then sold 50 percent 
to IOC Trafigura.  The loss of this margin likely negatively 
impacts DIPPSA earnings and therefore valuation.  We can't 
imagine Trafigura will be pleased to learn it has bought into 
a depreciating asset.  End Comment.) 
 
¶10. (C/NF) As a result of the Salvador talks, this 
negotiation -- which only a week ago threatened arrests, 
confiscations, and lawsuits -- is now focused instead on a 
USD 0.02 margin reduction on imports and a USD 0.01 to 0.02 
margin reduction on fees.  The GOH will attempt to resolve 
the former using formula weights, and the latter will be 
negotiated.  In exchange for this deal, the companies would 
remain in the country doing business, would not have to 
contemplate a mutually assured destruction policy of 
international lawsuits, and would win what they have most 
sought:  a reform to the current unsustainable pricing 
formula and a broader liberalization of the sector.  This 
liberalization would be codified in a GOH document with 
specific steps and milestones, beginning January 2008. 
 
¶11. (SBU) Post has been working closely with the World Bank 
to identify resources to support the GOH's announced 
intention to move over the medium term towards a liberalized 
fuels market.  The World Bank has already done a study of the 
Honduran fuels market and has identified an expert who could 
come to Honduras to advise the GOH on next steps.  This would 
fit with Zelaya's professed intent (as confirmed to 
Ambassador) to establish a firm timeline with concrete steps 
towards such a market opening, which the GOH prefers to call 
 
TEGUCIGALP 00000134  004 OF 004 
 
 
"competitiveness" instead of "liberalization."  In a January 
18 meeting at the World Bank, Minister of the Presidency 
Rosenthal was presented this option by World Bank officials. 
Rosenthal, who is no longer the lead official on the fuels 
topic, took the offer on board and promised to get back to 
World Bank staffers in "a couple of weeks." 
 
¶12. (C/NF) Comment: Post considers it highly significant that 
Flores Lanza has reportedly been convinced of the poor 
risk/reward ratio of continuing to pursue a strategy of 
nationalizing imports.  His continued support has been one of 
the primary reasons for President Zelaya's reluctance to 
follow his own instincts to abandon this scheme and instead 
seek lower prices through a market-based reform.  In his 
public remarks just prior to the Salvador meetings, Minister 
Flores Lanza had again begun referring to the GOH seeking a 
legal way to compel Texaco to allow use of its storage 
facilities.  Lanza had made similar comments on January 13, 
raising the spectre of expropriation (as reported by Post on 
January 14).  Since that time, the GOH has told Post that no 
expropriation is being invoked, but rather a pre-existing 
clause in the GOH contract with DIPPSA (which the GOH argues 
also covers Esso's joint venture storage facility with 
DIPPSA).  Because no such clause exists in Texaco's contract, 
any GOH move to take over those facilities would have 
required some other legal justification.  If a deal were 
struck with the IOCs, this plan to seize storage facilities 
would likely be abandoned as unnecessary and 
counterproductive.  If Flores Lanza has finally accepted the 
need for a negotiated exit strategy, this would be perhaps 
the most important defection of this entire process, and 
could open the way to a breakthrough in the talks. 
 
¶13. (C/NF) Comment continued: We are also very pleased to see 
that the mutual suspicion between Flores Lanza and Corrales 
appears to have lessened, as Flores Lanza reportedly now 
accepts both that the numbers are persuasive and that 
Corrales is not a mouthpiece for the IOCs.  According to 
Corrales, Flores Lanza was favorably impressed that Corrales 
was just as demanding with the IOCs in the El Salvador talks 
as he had been with the GOH over the previous weeks.  Both 
Corrales' objective mathematical analysis and Flores Lanza's 
influence with the President will be needed for any 
negotiated settlement to be accepted by the GOH. 
 
¶14. (C/NF) Comment continued: The proposed negotiated 
solution is not optimal, but it might be the best obtainable 
under the circumstances, and it avoids several far-worse 
alternatives.  The status quo is neither politically 
sustainable nor financially justifiable.  A short-term win 
for Zelaya in exchange for a medium-term overhaul of the 
sector serves the interests of investors and the GOH alike. 
To IOC grumbling about these margin reductions, the GOH 
responds that this will only be a USD 0.01 to 0.02 and only 
last for one year, whereas the IOCs benefited from the padded 
USD 0.045 margin adjustment for several years.  Finally, Esso 
(and presumably the other IOCs as well) understands that if 
it refuses to negotiate flexibly and creatively, and in the 
end is nevertheless forced to accept a GOH takeover of the 
fuel import sector, its credibility will be damaged in the 
eyes of all governments in the region.  With an increasingly 
populist wind blowing throughout the region, this would be an 
invitation to similar moves by other governments elsewhere in 
the hemisphere.  A negotiated solution that champions 
market-based reforms, on the other hand, would send a 
positive message to consumers throughout the region while 
defending the long-term enlightened interest of the IOCs. 
End Comment. 
 
Ford 
FORD