VZCZCXYZ0005
PP RUEHWEB

DE RUEHSN #0317/01 0932221
ZNR UUUAA ZZH
P 032221Z APR 09
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC PRIORITY 0939
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
RHEBAAA/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY

UNCLAS SAN SALVADOR 000317 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ENRG EPET EINV ES
SUBJECT: ELECTRICITY SUBSIDIES END BUT PROBLEMS CONTINUE 
 
REF: 08 SAN SALVADOR 1403 
 
¶1.  SUMMARY: The GOES announced on March 23 that electricity 
subsidies will be discontinued.  This change is expected to 
raise energy costs by 60% for industrial and 30% for 
residential customers.  Industry groups have criticized the 
government's failure to honor an agreement to phase out the 
subsidy and they warn of inflationary effects.  Though 
generally supporting the change, energy firms say their 
liquidity problems will continue and additional measures will 
be needed to put the industry on more stable footing.  They 
are pressing for quarterly electricity rate adjustments to 
reduce their financing needs.  Energy companies are reaching 
out to President-elect Funes' transition teams to raise these 
concerns and discuss a planned transition to long-term energy 
contracts under a cost-based dispatch system.  END SUMMARY. 
 
ELECTRICITY SUBSIDY ENDS 
------------------------ 
 
¶2.  Presidential Chief of Staff Eduardo Ayala Grimaldi 
announced on March 23 that electricity subsidies will be 
ended due to lack of funding.  His statement signals that the 
electricity regulator, SIGET, will allow electricity rates to 
rise at the next biannual "tariff reset" on April 12, when 
SIGET must either schedule subsidy payments or adjust rates 
to reflect average energy costs during the previous six-month 
period.  Distribution companies had already stopped applying 
electricity subsidies after February 11 because the 
government failed to pay $15.7 million per month subsidy 
bills for March-April.  However, since the GOES committed to 
paying the January subsidy bill only on February 9 (after 
companies had been applying unsubsidized energy rates for 
nearly a month), the change to full energy tariffs was masked 
by the reimbursement of January subsidies to customers on 
their February-March bills. 
 
¶3. Distribution companies estimate that the elimination of 
subsidies will raise average electricity rates by 30% for 
residential customers and 50% for industry.  Several business 
groups criticized the government,s failure to honor an 
agreement to gradually eliminate the subsidy for commercial 
users in three phases, and some warned that rising energy 
costs will have inflationary effects.  When industry groups 
protested a decision in July 2008 to remove energy subsidies 
for industry, the GOES agreed to phase out the subsidies in 
three stages in August 2008, April 2009 and October 2009. 
 
¶4.  Electricity companies project that the April subsidy bill 
(for the period October 2008-March 2009) will rise to $98.2 
million, higher than the $94.6 million March-October 2008 
bill that the GOES has failed to pay off.  Since the GOES 
will not pay this amount, electricity companies will raise 
their rates to recover the subsidy over the next six months. 
Generation companies note that savings from declining fuel 
prices have been offset by a 70% increase in prices by the 
state-owned generator Comision Ejecutiva Hidroelectrica del 
Rio Lempa(CEL) for hydroelectric and geothermal energy from 
71$ per MWH in November 2007 to 120$ per MWH one year later. 
CEL was forced to raise its wholesale energy prices to 
compensate for credits it issued to cover the subsidy, but it 
lowered its average price to 88$ in March after the subsidy 
was lifted. 
 
LIQUIDITY PROBLEMS CONTINUE 
--------------------------- 
 
¶5. With distribution companies unable to pay their March 
power bill in full by the March 24 due date, the GOES 
extended the payment deadline for $17 million (roughly 30% of 
their monthly energy bill) to April 6, but required firms to 
pay interest (at a 14% annual rate) on late payments.  The 
companies point out that their liquidity problems have been 
largely caused by the government policy to adjust rates only 
every 6 months.  Even with the subsidy ended, El Salvador's 
price stabilization scheme only allows distribution companies 
to collect $66 per MWH for current consumption, while the 
difference between this price and the real energy cost is 
deferred to the next semester.  With wholesale energy prices 
projected to average roughly $139 per MWH for the current 
six-month period (October 2008-March 2009), the accumulation 
of deferred payments is likely to surpass $200 million, 
including taxes, or more than half of the total energy bill. 
With CEL's prices now reduced, average energy prices fell to 
$117 in March and should remain lower during the next 
semester. 
 
¶6. Energy companies also note that the GOES does not pay 
interest or penalties for its own late payments, including a 
$5 million monthly subsidy payment for low-income customers 
who use less than 99 kilowatt-hours per month. The 
government's postponement of this payment from March 20 to 
March 31 also contributed to distributors' bill payment 
problems. 
 
¶7. Distribution companies (led by U.S.-based AES) warn that, 
in the short term, the end of subsidies may worsen their 
existing cash-flow problems since bill collections will take 
longer than lump-sum subsidy payments from CEL.  Companies 
note that Salvadoran law requires a 60-day grace period 
before they can disconnect customers for delinquent bills. 
With industrial power rates rising sharply during an economic 
downturn, managers are concerned that collection problems may 
increase. 
 
INDUSTRY WANTS QUARTERLY RATE ADJUSTMENTS 
----------------------------------------- 
 
¶8. Energy companies want the GOES to change from semi-annual 
to quarterly "tariff resets" to alleviate cash-flow problems 
caused by the time-lag in rate adjustments.  The industry has 
hired a consulting firm to study how to implement this 
transition and estimate the cost.  Companies estimate that 
the GOES and/or customers will need to pay roughly $100 
million to shift to quarterly tariff adjustments.  This 
amount represents three months of delayed payments that 
energy companies would need to recover. 
 
INDUSTRY CONCERNED OVER TRANSITION TO LONG-TERM CONTRACTS 
--------------------------------------------- ------------ 
 
¶9. Energy companies have also raised several concerns over 
the planned transition of El Salvador,s energy market to a 
cost-based dispatch system with long-term energy contracts. 
In a March 20 meeting with the Charge, distribution company 
managers requested Mission support to help the GOES ensure a 
competitive process for soliciting long-term contracts with a 
level playing field for different energy sources.  They are 
concerned that a recently launched solicitation for a 320 MW 
long-term contract favors thermal generators and fails to 
realistically address current financial constraints.  While 
the GOES is seeking technical assistance in addressing these 
concerns, energy firms are not confident that regulators will 
address these financial issues. 
 
¶10. Generation companies are also pressing for open bidding 
on capacity payments, the component of long-term energy 
contracts intended to reduce investment risks by guaranteeing 
payments for installed capacity, before the transition to 
cost-based pricing begins in January 2010. One manager told 
Econoff earlier that the capacity payment issue was "the next 
fight" (after the subsidy issue) as generators consider this 
a critical policy to ensure future investment.  The companies 
have criticized the government for setting fixed capacity 
payment of only $6 per kwh based on investment costs for gas 
turbines, the cheapest generator which is not used in El 
Salvador.  They argue that this amount is far too low to 
ensure the recovery of their investments. 
 
¶11. The GOES counters that capacity payments are intended to 
only partially reduce investment risks, but companies can 
prepare their bids for variable costs to include recovery of 
additional investment costs.  They say that investment costs 
for a gas turbine were used, following a Chilean model, 
because these turbines have the highest variable cost, so the 
low fixed capacity payment allows all energy sources to 
compete on a level playing-field. 
 
INDUSTRY PLANS OUTREACH TO TRANSITION TEAMS 
------------------------------------------- 
 
¶12. During a March 24 AmCham Energy Committee meeting, energy 
companies discussed efforts to raise their concerns with 
members of President-elect Funes' transition team.  Several 
members expressed cautious optimism that Funes' team will 
consult with the energy industry and listen to their 
concerns.  They noted he has supported positive moves to 
focus subsidies and he appears to be assigning pragmatic 
advisors to handle energy policy.  Industry leaders have 
already met with several of Funes' economic advisors, 
including economist Alex Segovia and FMLN legislator Blanca 
Coto, who is expected to play a leading role on energy 
issues.  Members noted that Coto is seen as an FMLN moderate 
who has made comments sympathetic to the private sector. 
 
¶13. In an earlier meeting with Econoff, Axel Soderberg, an 
informal FMLN energy advisor and Vice-Rector of Universidad 
Centro-Americana (UCA), predicted the FMLN would strengthen 
the leadership role of the national energy commission and 
mandate increased renewable energy production.  After a 
series of seven meetings with FMLN legislators and advisors 
to discuss energy policy, Soderberg said they moderated their 
more radical proposals and accepted the need for private 
sector involvement in the electricity sector. 
 
COMMENT 
-------- 
 
¶14. The elimination of electricity subsidies is a big step 
towards more sustainable energy policies, but additional 
policy reforms will be needed.  The effects of the subsidy 
will be seen in suddenly higher energy prices and continuing 
liquidity problems.  In the short-term, it is unlikely that 
the GOES will shift to quarterly payments in the April tariff 
reset, but industry will press for this change to be made at 
the October 2009 tariff reset.  The early outreach by 
electricity companies to the Funes transition team reflects a 
rapid shift in the business community from aggressive support 
for ARENA during the campaign to pragmatic engagement with 
Funes and his transition team. 
 
¶15. The current government and incoming administration knew 
that the unsustainable electricity subsidies would have to be 
addressed.  In light of their electoral loss, the Saca 
administration no longer feels obligated to keep President 
Saca,s promise not to raise electricity rates prior to June 
¶2009.  This saves the Funes administration from having to 
take this unpopular step. 
 
¶16.  While the abrupt elimination of the subsidy will take a 
large toll, especially at a time of general economic 
distress, it was a necessary action.  The next step will be 
to ensure that a realistic basis is used for the future 
cost-based pricing mechanism that has already been delayed 
for several years.  Once that is accomplished and when 
economic conditions improve, El Salvador and the private 
sector will be ready to move forward with currently postponed 
new electricity generation projects that will be needed to 
meet rising electricity demand when the economy starts to 
grow again. 
BLAU