VZCZCXYZ0034
PP RUEHWEB

DE RUEHSN #2383/01 3451920
ZNR UUUAA ZZH
P 111920Z DEC 07
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC PRIORITY 8705
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC

UNCLAS SAN SALVADOR 002383 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ENRG EINV EPET ES
SUBJECT: HIGH OIL PRICES RAISE EL SALVADOR'S ENERGY SUBSIDY 
 
¶1.  SUMMARY: A freeze on El Salvador's electricity rates is 
exhausting the capacity of the state-run renewable energy sources to 
subsidize more expensive oil-fueled electricity and may increase 
public debt in 2008.  Despite high oil prices, the GOES has 
maintained electricity rates since June 2006 and it recently 
promised no rate hikes through the 2009 elections.  The GOES may 
need to borrow up to $50-60 million to cover a projected 2008 
shortfall in a subsidy fund for the electricity sector. 
Distribution companies have protested recent cuts in distribution 
rates and are exploring their legal options.  Pressure to control 
prices may delay regulatory reforms needed to stimulate investment 
in new generation capacity.  The political expediency to avoid 
unpopular rate hikes is causing the GOES to postpone the day of 
reckoning when electricity rates will need to reflect generation 
costs. END SUMMARY 
 
RISING ENERGY COSTS EXHAUSTING SUBSIDY FUND 
------------------------------------------- 
 
¶2. In a national address on December 3 to announce a series of 
popular measures in the "Alliance for the Family", President Saca 
promised not to increase electricity rates through the end of his 
term (June 2009).  This follows an October decision to avoid a rate 
increase despite rising generation costs due to high oil prices.  To 
avoid a rate hike, the GOES approved a $42 million subsidy by the 
state-owned Hydroelectric Executive Commission of Rio Lempa (or CEL 
by its Spanish acronym) to a "compensation fund" that helps to pay 
higher generation costs of oil-based power producers.  CEL Executive 
Director Irving Tochez told Econoff that CEL was only able to pay 
$30 million it had budgeted for the compensation fund but offered a 
$12 million credit to power distributors to cover the remaining 
subsidy cost.  In addition to the compensation fund, the GOES pays 
$35-40 million per year to subsidize electricity for low-income 
customers that consume 99 or less kilowatt hours per month. 
 
¶3. According to Tochez, annual compensation fund costs may rise to 
nearly $100 million in 2008 if current oil prices and market trends 
continue.  He estimated that CEL can only cover $40-50 million of 
this cost, so the GOES will be looking for a way to fund the 
remainder.  He suggested three possible measures to reduce subsidy 
costs: (1) making distributors pay $10 million in transmission costs 
currently shouldered by the GOES; (2) limiting who can receive the 
subsidy for the first 99 kwh of consumption; and (3) making the 
water company (ANDA) pay the full cost for its electricity. 
(Comment: Each of these measures would likely be controversial and 
together they would not be enough to cover the projected shortfall 
in the compensation fund.  End comment.) 
 
¶4. The subsidy has increased as rising oil prices have raised power 
costs for oil-fueled thermal generators that provided 44% of El 
Salvador's electricity production in 2006.  Hydroelectric plants 
accounted for 31% of production while geothermal plants provided 25% 
of production, but the actual energy mix varies seasonally with 
hydroelectric production typically ranging from 55% of total 
production during the rainy season to 25% during the peak dry 
season.  When hydroelectric capacity declines during the 
November-April dry season, oil-fueled generators make up the 
difference, providng up to 50% of monthly production. As oil prices 
have exceeded $90 per barrel in 2007, the energy regulator, SIGET, 
reports that oil-fueled electricity costs have risen to roughly 
twice the cost of renewable energy. 
 
DISTRIBUTION RATES CUT 
---------------------- 
 
¶5. While electricity rates are frozen, SIGET has moved to cut 
distribution charges which represent roughly 30% of consumers' 
electricity bills.  On December 4, SIGET announced a new 
distribution rate schedule for the next five years that it says will 
reduce distribution rates by 18%.  Distributors say the new rate 
schedule will reduce their income by 30% and threaten their 
financial viability.  The regional manager of one distributor told 
Econoffs the new rates will push distribution companies into 
"survival mode" resulting in probable layoffs and possible reduction 
in service quality.  Distributors offered a 9-10% reduction, but 
were rebuffed.  In addition, the distribution companies assert that 
by focusing on the distribution tariff, which makes up only 30% of 
the total cost of electricity, the GOES is not getting to the root 
of the problem, the high costs of fossil fuels that constitute the 
majority of electricity costs.  The companies are also looking for 
ways to contest the new tariffs, but they have noted that the law 
gives SIGET considerable discretion in regulating rates. 
 
DEMAND APPROACHING CAPACITY 
--------------------------- 
 
¶6. As energy costs are subsidized, demand is approaching capacity 
and increasing the possibility of short-term energy shortages during 
the next few years.  CEL President Nicolas Salume had warned in 
August of potential power shortages by April-May 2008 due to high 
demand growth and unusually low rainfall. He estimated that peak 
demand will approach 870 MW during the 2008 dry season, not far from 
the operating capacity of 900 MW (not including 200 MW of "cold" 
capacity - less cost-efficient generators reserved for emergencies). 
 Another member of CEL's board told Econoff that CEL narrowly 
averted a probable dry season energy shortage after heavy 
late-October rains filled reservoirs to increase hydroelectric 
capacity during the dry season.  In the short-term, generation 
capacity has been reduced by the breakdown of a 44 MW geothermal 
plant currently under repair from October 2007 and scheduled to 
return to operation by January 2008. 
 
¶7. In order to meet the projected 6% annual rise in demand 
(currently about 50 MW per year), CEL is pursuing several 
small-scale generation projects.  To meet demand in 2008, CEL is 
working on a 50 MW expansion of its oil-powered generating station 
in Talnique, where an additional 50 MW expansion could follow. 
(Comment: CEL originally planned to exit from fossil fuel generation 
projects, but has since commenced new projects to make up for the 
gap in new private electricity generation. End comment.)  CEL has 
also conducted studies of a 30 MW expansion of its "September 15" 
hydroelectric facility and a 10 MW wind energy project. 
 
¶8. Generation companies are planning several long-term projects to 
expand electricity supply after 2010.  CEL plans to build two 
hydroelectric plants: the 66 MW El Chaparral project scheduled for 
completion in 2011 and the 261 MW Cimarron project currently 
undergoing a feasibility study.  AES recently obtained an 
environmental permit to build a 250 MW coal-fired power plant in La 
Union and plans to begin construction in early 2008.  Another U.S. 
firm, Cutuco Energy, has obtained environmental permits for a large 
Liquified Natural Gas depot and 525 MW generating station also based 
in La Union. However, even if both projects get underway in 2008, 
which is by no means certain, they would not come on-line until at 
least 2010. 
 
REGULATORY REFORMS MAY BE DELAYED 
--------------------------------- 
 
¶9. Delays in conversion to a cost-based pricing model with long term 
contracts may affect long-term investments in new generating 
capacity.  Following the 2003 reform of El Salvador's electricity 
law, the GOES issued Decree 57 in 2006 to implement these reforms. 
Although the conversion to cost-based pricing is currently scheduled 
for January 2008, MINEC's electricity manager, Jorge Rovira, told 
Econoff the GOES is still finalizing details of implementation which 
will likely include a six-month transition period. 
 
¶10. The reforms may increase electricity rate in the short term but 
should encourage long-term investments in larger and more efficient 
energy projects.  U.S.-owned Duke Energy plans to invest $100 
million in a two-year project to convert an existing liquid-fuel 
generator to cheaper coal generation, but Duke's Managing Director 
Julio Torres told Econoff this project is contingent upon the 
regulatory reforms. (Comment: AES, El Salvador's main electricity 
distributor serving 75% of the market, can sell the power it will 
generate to itself, so its coal-fired project does not depend as 
much on regulatory reforms; however, it remains to be seen how 
SIGET's handling of distribution tariffs may affect AES's investment 
decision. End Comment.) 
 
¶11. Regional integration of the power sector is helping to stimulate 
interest in larger and more cost-competitive energy projects. 
According to CEL, a 300 MW regional transmission line may be 
completed by 2009-2010 and regulatory integration has also 
progressed. SIGET noted that El Salvador was the first country to 
ratify a regional accord for the integration of electricity markets 
including provisions to create regional institutions to operate and 
regulate the market. 
 
COMMENT 
------- 
 
¶12.  The GOES will face a challenge to pay the compensation fund in 
April 2008 when it will need to subsidize higher dry-season 
consumption of oil.  Its determination to control energy costs is 
part of a general focus on pocketbook issues aimed at forestalling 
opposition criticism leading up the 2009 elections.  By pursuing the 
short-term political expediency to control energy prices, the GOES 
may damage longer-term interests in reforming the energy sector to 
encourage investment, increase competitiveness and ensure adequate 
energy supply. It is also increasingly possible that in the dry 
season just before the January and March 2009 elections, the energy 
companies could become more vocal in their demands for a rate 
increase after having rates frozen or reduced over the past two 
years.  Worse still, El Salvador might even see energy shortages 
just before the elections.  Neither scenario would bode well for the 
ruling party. 
 
GLAZER