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UNCLAS SECTION 01 OF 03 COLOMBO 000503 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS, EEB/CBA, AND EEB/ESC/IEC 
STATE PASS USTR FOR V KADER AND USTDA FOR J NAGY 
COMMERCE FOR JONATHAN STONE AND EROL YESIN 
 
E.O 12958: N/A 
TAGS: EINV ENRG PREL CE IR CH
SUBJECT: SRI LANKA: IRAN REFINERY OFFER GOING AHEAD, BUT IN WHOSE 
INTEREST? 
 
REF: A. 2007 COLOMBO 1707  B. COLOMBO 431  C. 2007 COLOMBO 1050 
 
¶1. (SBU) Summary and comment: Iran's offer of concessionary 
financing for a major expansion of Sri Lanka's sole oil refinery was 
firmed up with the late April visit of President Ahmadinejad to Sri 
Lanka.  Iran has promised to lend Sri Lanka 70% of the estimated 
$1.2 billion project cost, at a concessionary interest rate of 
roughly 5-6%, with a five year grace period followed by a ten-year 
repayment period.  Iran will select a contractor for the work, to be 
agreed by Sri Lanka.  The estimated cost of the refinery has grown 
significantly from the $700-800 million that the American firms had 
calculated; this large "fudge factor" may be the best explanation 
for why Iran is so generously offering financing for the project.  A 
second reason may be the potential for Sri Lanka to sell to Iran 
some of the refined oil it produces, presumably at a friendly rate. 
With the head of the state-owned Ceylon Petroleum Corporation now 
eager to do the Iran deal, there is now little prospect for U.S. 
firms Global Energy and ENGlobal to end up with the work.  Yet, like 
other big infrastructure project plans in Sri Lanka, there remains a 
high probability of this one never actually getting built.  The saga 
also demonstrates Sri Lanka's continued poor transparency related to 
government procurement -- an agenda issue in upcoming U.S.-Sri Lanka 
Trade and Investment Framework Agreement (TIFA) talks.  End summary 
and comment. 
 
IRAN TO LEND GENEROUSLY FOR NEW REFINERY 
---------------------------------------- 
 
¶2. (SBU) Ceylon Petroleum Corporation (CPC) Chairman Asantha de Mel 
told Econoff that, despite his earlier doubts (ref A), it appears 
Iran will actually finance an expansion and upgrade of Sri Lanka's 
sole oil refinery at Sapugaskanda outside Colombo.  De Mel said 
that, during the April 28-29 visit of Iranian President Ahmadinejad 
(ref B), Iran delivered a pre-feasibility study for the proposed 
refinery work and the two countries agreed to the following general 
terms for the deal: 
 
-- Iran to finance 70% of the estimated $1.2 billion project cost. 
 
-- Concessionary interest rate of roughly 5-6%, with a five-year 
grace period followed by a ten-year repayment period. 
 
-- National Iranian Oil Refining and Distribution Company (NIORDC) 
to select contractor; Sri Lanka to have right to approve Iran's 
selection. 
 
-- Construction to take approximately 3.5 years. 
 
-- Expansion to double the output from 50,000 to 100,000 barrels per 
day capacity. 
 
-- Refinery to be capable of processing all forms of crude, 
including heavy. 
 
-- Refinery output to be roughly 40% heavy fuel oil; the remainder a 
mix of diesel, gasoline, and liquid natural gas. 
 
-- The project would qualify under Board of Investment regulations 
for a twenty year tax holiday. 
 
-- Sri Lanka's Treasury would give Iran a loan guarantee. 
 
¶3. (SBU) CPC Chairman De Mel explained that Sri Lanka, which had had 
no luck generating financing to expand the refinery on its own, 
could hardly turn down Iran's concessionary loan offer.  He said 
that the new refinery would eliminate Sri Lanka's need to import 
refined oil products, saving the country about $750 million dollars 
a year.  He calculated that Sri Lanka could use these savings to 
prepay the loan "in 2 1/2 years."  (It was unclear if he meant, 
presumably, after the five-year grace period.)  He emphasized that 
Sri Lanka would not be limited to buying only Iranian light crude as 
an input because the improved facility would be capable of refining 
all grades up to heavy crude.  He noted that its output of heavy 
 
COLOMBO 00000503  002 OF 003 
 
 
fuel oil could be used in the country's thermal power generating 
plants.  He expected that total production would exceed domestic 
demand, making it possible to export some refined oil products. 
 
¶4. (SBU) As to why Iran was eager to finance a refinery in Sri Lanka 
when its own domestic refining capacity was insufficient, de Mel 
said he had asked the Iranians the same question.  They had replied 
that it made more sense for Iran to invest in expanding domestic oil 
production capacity, since its profits on production are higher than 
its potential savings from increased domestic refining.  For this 
reason, Iran would be interested, de Mel expected, in purchasing 
refined oil from Sri Lanka. 
 
CPC STILL WILL NEED $360 MILLION OR MORE 
---------------------------------------- 
 
¶5. (SBU) The 70/30 funding split means that Sri Lanka will have to 
pay approximately $360 million for its share of the refinery 
construction cost.  De Mel told EconOff that he expects the refinery 
could ultimately cost not $1.2 but $1.4 billion due to escalating 
construction costs.  If so, Sri Lanka's cost would rise to $560 
million.  De Mel asked if U.S. banks might be interested in lending 
that money.  EconOff replied that U.S. banks would probably be wary 
of, if not outright prohibited from, a deal which so closely 
involved Iran. 
 
GOAL: CPC TO NOT LOSE MONEY LIKE IT IS NOW 
------------------------------------------ 
 
¶6. (SBU) De Mel reiterated his vision that the Ceylon Petroleum 
Corporation would operate at a profit with the expanded refining 
capacity.  The ability to refine and sell all of Sri Lanka's fuel 
demand would make the CPC profitable for the first time, he 
anticipated. He explained that, despite the government allowing CPC 
to raise retail fuel prices periodically in 2007, the state 
enterprise is currently operating at a loss of about 30 Rupees 
($0.28) per liter of fuel it sells, due to the increased price it is 
paying for crude.  He expected to be able to reduce this loss by 
raising retail prices again in May or June; however, the government 
has been telling local media that it does not intend to permit a 
price rise in the near future. 
 
US FIRMS GLOBAL ENERGY AND ENGLOBAL ON SIDELINES... 
--------------------------------------------- ------ 
 
¶7. (SBU) CPC's progress with Iran on the proposed deal leaves 
would-be U.S. investors Global Energy & Industrial Operations (GEIO) 
and ENGlobal farther than ever from securing the right to expand and 
upgrade the Sapugaskanda refinery as private investors (refs A and 
C).  Iran's undertaking the feasibility study for the project -- 
"for free," according to de Mel -- also means the CPC will not 
proceed with the feasibility study contract it had planned to award 
to ENGlobal last fall. 
 
...HOLDING THEIR NOSES 
---------------------- 
 
¶8. (SBU) The two companies' reactions to the Iran-Sri Lanka plans 
were similar: both noted numerous ways in which the deal was likely 
to be bad for Sri Lanka.  Most significant is that it will probably 
waste a lot of public money, by having Sri Lanka overpay for an 
inferior product.  Noting that the project cost has grown from 
around $700 million to $1.2 (or even $1.4) billion, ENGlobal's Sri 
Lankan representative told EconOff, "this stinks to high heaven." 
Global Energy's principal described CPC Chairman de Mel as "an 
operator" with no knowledge of the oil industry.  (Note: de Mel is a 
marriage relative of President Rajapaksa and was formerly in the 
garment industry before the president appointed him to be CPC 
chairman.) 
 
¶9. (SBU) The GEIO and ENGlobal reps also feared the project could 
fail to fully utilize the still-valuable asset of the existing 
refinery.  Worst, they said, would be if the new refinery was built 
 
COLOMBO 00000503  003 OF 003 
 
 
using technology incompatible with the old refinery.  This would 
create operating complexities and increase operations and 
maintenance costs.  They noted that the existing refinery uses 
proprietary technology of American firm UOP.  Noting that UOP is 
blocked by US sanctions from selling its technology to Iran, they 
speculated that Iran or its contractor would likely use competing, 
incompatible, technology by French firm Axens. They also noted that 
a worldwide backlog of orders for new refineries meant that Sri 
Lanka's project would probably end up on a waitlist running three to 
five years. 
 
ACCOUNTABILITY MISSING AS UNIONS SPLIT, 
EXPERIENCED MANAGER SIDELINED 
--------------------------------------- 
 
¶10. (SBU) The ENGlobal rep added that the government and CPC 
management would normally have a hard time pushing an overpriced, 
technically inappropriate project past the enterprise's strong and 
influential unions.  However, the recent split in the leadership of 
the Marxist JVP party had led to a split along the same lines in the 
powerful JVP union within the CPC, which resulted in the union being 
unable to threaten serious labor action to block the plan.  He also 
noted that the CPC had recently skipped over appointment of its most 
experienced engineer to the position of overall manager of the 
Sapugaskanda refinery.  He believed that the CPC and the government 
were rushing forward on the Iran deal while the unions and refinery 
management were weak. 
 
POSSIBLE CHINA LOAN AND CONSTRUCTION ROLE? 
------------------------------------------- 
 
¶11. (SBU) The engineer passed over for refinery manager is suing the 
CPC in a "fundamental rights" case to try to gain the post he would 
have been entitled to based on normal seniority promotion practices. 
 The ENGlobal rep repeated to EconOff the engineer's prediction for 
how the Iran project might go forward: noting that Sri Lanka will 
likely have difficulty coming up with the $360 million or more for 
its share of the project, he expects Sri Lanka to turn to China to 
lend it that amount, in exchange for the refinery construction 
contract going to a Chinese firm. 
 
COMMENT: SHOULD HAVE GONE WITH GLOBAL ENERGY 
-------------------------------------------- 
 
¶12. (SBU) The $360-560 million that Sri Lanka will have to borrow 
for its share of the Iran-financed project equals half or more of 
the entire estimated $700-800 million that Global Energy and 
ENGlobal say the project should cost.  Given that the Ceylon 
Petroleum Corp's perennial losses prevented it from getting bank 
financing in the past, it seems unlikely to be able to raise the 
money on the open market now.  This makes the idea of a 
supplementary loan from China look plausible.  So too do the 
politics of the entire Iran-Sri Lanka aid relationship, with Iran 
and China both being vocal about giving Sri Lanka "unconditional" 
aid. 
 
¶13. (SBU) Ultimately, however, we would be surprised if the Iran 
refinery project materializes.  It will likely falter on the 
combination of the long waitlist for refinery construction, the 
large amounts of money that Iran and Sri Lanka would have to invest, 
and an eventual effort by the unions, the opposition, or the courts 
to block it.  This has been the case for other high profile 
infrastructure projects that have languished for decades amidst 
charges of politicization and corruption.  We think a time will come 
when Sri Lanka will wish it had never abrogated its 2004 MOU with 
Global Energy.  If that plan had gone forward, Global Energy would 
now probably be nearing the end of construction on a state-of-the 
art refinery using compatible UOP technology and fully private 
financing that would not have cost Sri Lanka a cent.  Washington 
agencies may wish to keep this case in mind when discussing 
government procurement with Sri Lanka in upcoming Trade and 
Investment Framework Agreement (TIFA) talks. 
MOORE