US embassy cable - 04MADRID763

UNCLAS SECTION 01 OF 05 MADRID 000763 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ENRG, BTIO, EPET, SP 
SUBJECT: OPPORTUNITIES IN SPAIN'S GROWING ENERGY MARKET 
 
REF: 2003 MADRID 1079 
 
1.  SUMMARY:  Since joining the EU in 1986, Spain has 
experienced dramatic industrialization and economic 
development.  Along with development, energy consumption has 
skyrocketed and shows no sign of abating.  These developments 
bring challenges for a country that is now emitting 
greenhouse gasses more than its Kyoto commitments permit, and 
exceeding EU pollution emissions limits.  Spain has an 
ambitious but likely untenable plan for meeting the EU 
requirement to supply 12 percent of its energy needs through 
renewables by 2010, and will increasingly rely on natural gas 
imports as a relatively clean and inexpensive energy source. 
There are opportunities for US business to enter the Spanish 
energy market in such areas as gas, combined cycle generation 
and renewables, although experience to date suggests it may 
be advantageous to start small and learn the ropes, meet 
niche market demand, or enter into joint ventures with local 
companies rather than go it alone.  END SUMMARY. 
 
2.  Spain's economy continues to be one of the most dynamic 
in the European Union, growing an average of 3.5 percent over 
the past six years.  Spain's demand for energy has grown even 
faster at an average rate of 4.5 percent per year between 
1998 and 2002, with electrical demand increasing at a 
particularly rapid rate of 6 percent per year.  Growth in 
total energy demand is expected continue at 3.5 percent 
annually over the next decade.  Spain is attempting to 
increase capacity to meet current and future demand through a 
combination of sources, including new natural gas pipelines 
from Africa and construction of combined-cycle electric 
generation facilities, while attempting to mitigate emissions 
increases through significant investment in alternative 
energy sources, especially wind power. 
 
Following is an overview of the energy market and suggestions 
for U.S. companies wishing to take advantage of significant 
opportunities. 
 
ENERGY LIBERALIZATION AHEAD OF SCHEDULE 
 
3.  Spain is implementing deregulation faster than most other 
EU countries.  Spain has adopted legislation to allow 
third-party access to the power network, and scheduled full 
liberalization of the energy market through various phases by 
2013.  So far, the primary benefit of liberalization is 
consumer choice among energy providers.  To date, price-based 
competition has been minimal. 
 
4.  Under a June 2000 law, Spain commenced separation of 
transmission, generation and distribution functions, and 
opened the energy grid to other suppliers several years 
before EU initiatives began forcing changes.  The oil, 
natural gas, and electricity markets have been key 
liberalization targets during the Aznar administration.  In 
the petroleum market, former government-owned Repsol was 
privatized in 1997 and is now Repsol-YPF (following a merger 
with Argentine company YPF).  It has reduced ownership from 
62% to around 26% in Compania Logistica de Hidrocarburos 
(CLH), the petroleum distribution company.  In natural gas, 
the market for industrial customers was partially opened in 
2000, and in 2002 the dominant conglomerate, Gas Natural 
Group, reduced its interest from 100% to 35% in the 
distribution company, Enegas.  Spain's largest electricity 
utility, Endesa, was privatized in June 1998.  Customers may 
now select their electricity supplier, and Spain has recently 
signed a pact with Portugal to form a single power market. 
As liberalization continues, and competitive forces 
strengthen in the energy sector, US business may find a 
myriad of opportunities for penetrating the Spanish energy 
market. 
 
NATURAL GAS 
 
5.  By 2010, the International Energy Association (IEA) 
anticipates that over 24 percent of Spain's electricity will 
be generated from natural gas.  This is up from 9.2 percent 
in 1999, and only one percent in 1990.  In 2003, natural gas 
accounted for 14% of the energy consumed in Spain.  In real 
terms, natural gas consumption is skyrocketing, with around 
1.7 million tons of oil equivalent (Mtoe) used in 1985, 10 
Mtoe in 1999, and 13.5 Mtoe expected for 2010. 
 
6.  Although virtually all natural gas must be imported, its 
increased use may enable Spain to reduce its greenhouse gas 
emissions.  Spain has historically imported its natural gas 
from Algeria and Norway.  Libya has also been an important 
source.  Nigeria and Trinidad & Tobago are becoming major 
suppliers. 
 
7.  The Pedro Duran Farell pipeline connects Algerian natural 
gas supplies with the Iberian Peninsula, passing through 
Morocco and into Spain via the Strait of Gibraltar.  Spain is 
also connected to European supplies through the 
Lacq-Calahorra pipeline that runs from France.  The planned 
MEDGAZ pipeline will link the Algerian supply directly with 
Spain.  MEDGAZ partners include Sonatrach (Algeria's national 
oil company), Spanish companies CEPSA, ENDESA, and Iberdrola, 
BP, TOTAL, and Gaz de France.  With the new pipeline, imports 
from Algeria are projected to supply 60% of Spain's natural 
gas demand, but given the supply diversification strategies 
of the major players, this will actually signify a reduction 
in Algeria's share of the market. 
 
8.  Gas Natural is the leading natural gas conglomerate in 
Spain.  During the first quarter of 2002, Gas Natural 
maintained a 72 percent share of the liberalized gas market 
and gained a 4 percent share of the electricity market. 
 
9.  The US company AES, after years of regulatory delays, is 
constructing a 400 MW combined cycle facility in Cartegena, 
which is estimated to contribute over 500 jobs and more than 
$1 billion to the local economy. 
 
PETROLEUM 
 
10.  Oil plays a vital but decreasing role in Spain.  The IEA 
estimates that by 2010, only 7.6 percent of electricity will 
be generated from oil, down from 11.8 percent in 1999. 
Industrial and residential demand for oil is predicted to 
remain level while demand from the transportation industry 
will continue to grow for several years before leveling off. 
 
11.  The petroleum market is dominated by 
vertically-integrated REPSOL-YPF which provides over 50% of 
Spain's petroleum, although Cepsa and BP have significant 
interests as well.  Almost all oil is imported, with Nigeria, 
Libya, Saudi Arabia and Algeria being primary sources. 
Repsol-YPF also continues to invest heavily overseas.  In the 
last year, Repsol-YPF has announced major new projects in 
Venezuela, Iran and Libya, in addition to its enormous 
investment in Argentina. 
 
NUCLEAR ENERGY 
 
12.  The IEA estimates that by 2010, 24.4 percent of Spain's 
electricity will be generated from nuclear energy.  This is 
down from 28.5 in 1999 and 35.9 in 1990.  Majority or total 
ownership of all nine nuclear facilities is held by large 
Spanish energy companies Union Fenosa, Iberdrola, and Endesa. 
 The plants, built from 1971-1988, have the capacity to 
generate 7,897 megavolts. 
 
13.  A political moratorium on construction of new nuclear 
power plants was established in 1984 under the Socialist 
government, and not challenged by the current center-right 
government.  The government plans to maintain the number of 
licenses until 2012, and will only close individual plants if 
they outlive their usefulness.  However, because of Kyoto 
commitments, some believe the GOS may move towards a new 
program if the incumbent Popular Party carries the March 2004 
general elections.  The opposition PSOE has called for a 
formal nuclear moratorium within five years.  The Spanish 
public is not mobilized against nuclear energy, although 
groups such as Greenpeace have occasionally "tested" NPP 
security measures by trying to breach facilities and have 
protested against alleged safety deficiencies. 
 
COAL 
 
14.  The leading producers of hard coal in Spain are 
state-owned Hunosa and privatized Encasur, while Endesa is 
the leading producer of lignite.  The United States is a 
major exporter of coal to Spain.  The IEA estimates that by 
2010, 14.2 percent of Spain's electricity will be generated 
from coal, down from 36.6 percent in 1999 and 40.1 percent in 
1990.  However, in real terms, coal consumption is expected 
to increase slightly over the next few years, before leveling 
off. 
 
15.  Spain's coal costs far more than current world market 
prices.  A traditionally protected industry, some energy 
experts claim that Spain could save money by eliminating 
subsidies, shutting down the mines, and giving all current 
miners lifelong pensions.  But political factors would make a 
total shutdown difficult.  Coal production has been a 
significant industry in the northern coal-producing regions 
of the country, which are suffering from high unemployment. 
Rather than cutting production drastically and facing 
radically higher unemployment, Spain has initiated a program 
to wean domestic coal mining from subsidies and face world 
market conditions. 
 
HYDRO 
 
16.  According to the IEA, 14.7 percent of Spain's 
electricity will be generated from hydropower by 2010. 
Although it is anticipated that hydropower will produce 50% 
more power in 2010 than in 1999, its proportional share of 
total energy transformation to electricity will increase only 
3.6% largely due to the anticipated stronger increase in 
utilization of natural gas. 
 
17.  Large-scale hydroelectric production is expected to 
decrease from 2.645 Mtoe in 1998 to 2.121 Mtoe in 2010. 
Recouping that loss will be small scale hydro (less than 10 
megawatts (MW)) production growing from 0.482 Mtoe to 0.594 
Mtoe, and 10 to 50 MW hydro facilities contributing 0.542 
Mtoe.  The large hydropower plants are owned by Iberdrola, 
Endesa, Union Fenosa, Hidrocantabrico and Viesgo (affiliated 
with Italy's Enel).  These same companies own many smaller 
facilities as well.  Local engineering and construction 
company consortiums also build and operate small facilities. 
 
RENEWABLES:  WIND AND SOLAR POWER 
18.  Sunny, mountainous Spain is a prime prospect for wind 
and solar power generation.  As technology progresses and 
provides less expensive means of harnessing the power of the 
wind and the sun, Spain may use these power sources to great 
advantage as it seeks to reduce emissions. 
 
19.  Significant financial incentives, primarily sourced 
through EU cohesion funds, have caused most Spanish energy 
companies to develop renewables projects.  With approximately 
$1.5 billion allocated for environmental purposes, the 
central government distributes some funding to the regions 
for projects.  Along with the funds, the regional and local 
governments often provide additional incentives such as tax 
benefits and land donation or discount.  However, when the 
cohesion funds stop in 2007, it remains to be seen how much 
additional development will continue. 
 
WIND ENERGY 
 
20.  Spain is one of the world's largest wind energy 
producers along with the U.S. and Germany.  The land of Don 
Quixote and his windmills has long used wind for power 
generation.  But only recently have large-scale efforts begun 
to exploit this renewable energy source. 
 
21.  At the end of 1998, Spain generated only 800 MW from 
wind.  That almost doubled in 1999, and in 2003 total 
installed wind energy reached 6,202 MW.  Plans call for 
capacity increase to about 9,000 MW by 2010, and Spain is on 
its way to meeting that goal.  Regions with the most 
installed wind power generation are Galicia, Navarra, 
Castilla-La Mancha, Aragon and Asturias. 
 
22.  Some energy companies with interests in primary energy 
sources have also invested in wind generation facilities, 
among them Gamesa (the strongest), Iberdrola and Endesa. 
Additionally, smaller generators have emerged and several 
foreign developers, including American-owned Global 3 (see 
Paragraph 31), have plans to invest in wind power in Spain. 
 
SOLAR ENERGY 
 
23.  Still too expensive to compete with primary energy 
sources and wind power, current cost efficiency has not 
stopped research efforts or government incentives for small 
investment in solar power.  CIEMAT, the energy and 
environmental research arm of the Ministry of Science and 
Technology, has a solar platform research/production facility 
in southeastern Spain in the Desert of Tabernas.  It was 
developed to offer researchers a place where the climatic 
conditions are optimal for researching solar power production 
such as could be used within the sunbelt. 
 
24.  Prosolmed, a group of engineers and economists in the 
orange-growing region of Valencia, has taken advantage of 
some incentives for small-scale production and is trying to 
help city-living small investors get in on the action. 
Prosolmed claims that investors can enjoy a rate of return 
greater than 10%, and has installed 100 small solar panels, 
each occupying 50 square meters.  An article likens this 
venture to earlier Spanish tree plantation investment 
opportunities.  According to the article, a secondary market 
now exists for these plantation interests, suggesting that 
small investment solar opportunities might also be successful 
on Spain. 
 
25.  Solar energy technology still needs to advance and 
become more cost-competitive before it can supply a 
significant portion of the country's renewable energy goals. 
In 2001, Spain collected only 35 ktep (equivalent to 35,000 
tons of oil) of energy generated through solarthermic 
installations, and 2 ktep from photovolcaic installations. 
Spain's goals by 2010 include generation of 336 ktep from 
solarthermic sources, and 19 ktep from photovolcaic 
installations. 
 
ELECTRICAL DISTRIBUTION 
 
26.  Red Elctrica de Espaa (REE) is Spain's electricity 
transmission grid and system operator.  The GOS owns 28.5 
percent of REE, with Endesa, Iberdrola, Union Fenosa and 
Hidrocantabrico each holding 10 percent, Viesgo with 1 
percent, and the remaining 18 percent and 13 percent held by 
institutional investors and small shareholders, respectively. 
 The government fixes electricity rates on an annual basis. 
Only one foreign firm, ESB (of Ireland), currently operates 
within the Spanish electrical distribution industry, in the 
Basque region. 
 
27.  Although deregulation of this market enables consumers 
to shop freely for electricity, suppliers are required to 
sell at rates set by the government.  These mandated rates 
have fallen 35 percent since 1997.  But the lack of price 
competition reduces consumer incentive to change suppliers, 
making it difficult for competition to thrive. 
 
28.  The recently announced integration of the Spanish and 
Portuguese electricity markets into the "Iberian Electricity 
Market" will, per Vice President and Economy Minister Rodrigo 
Rato, form the fourth largest electricity market in Europe in 
terms of power generation capacity, and the second 
full-fledged electricity pool after Scandinavia's Nord pool. 
The new market will allow consumers to choose any electric 
company within the system as a supplier. With this 
integration, utility rates should fall; especially in 
Portugal where the rates are higher than in Spain. 
 
MARKET ENTRY BARRIERS 
 
29.  Spain is a difficult market for the foreign energy 
investor to successfully enter due to lack of transparency in 
bidding and permit processes, as well as the entrenched 
status of the incumbent companies.  Although GOS regulations 
suggest a liberalized market, large Spanish incumbents, many 
of which were state-owned monopolies, still control 
significant market share and have long-established 
relationships with (and the trust of) their regulating 
bodies.  Additionally, the GOS still holds "golden shares" of 
Repsol and Endesa.  These shares give veto power over 
corporate decisions that the GOS believes would affect 
national interest.  Spain's dominant energy companies have 
significant power and sophistication, with Repsol-YPF, 
Iberdrola and Endesa included in the Financial Times 500 List 
of top international companies.  It is not unusual that a new 
market entrant must negotiate for access to its dominant 
competitor's distribution network to get its product to 
market.  Relationships formed in grade school between 
regulators and corporate leaders also seem to play a strong 
role.  (See reftel for more information about Spain's "old 
boys" network.) 
 
30.  When U.S. companies have attempted to enter the Spanish 
market, they have faced significant delays in obtaining 
construction and other types of permits, while the Spanish 
and some other European companies (from countries who have 
permitted Spanish companies to enter their markets) tend to 
receive their permits rapidly.  While some attribute this to 
Spain's tendency to trust its incumbents, others add that 
many foreign companies ineffectually attempt to manage 
Spanish investment from London offices.  Despite 
difficulties, several US companies are making progress, 
including AES (see Paragraph 9) and Global 3. 
 
31.  Global 3 began in Spain in 1997 by building a one 
megawatt plant to learn how to work through Spain's 
labyrinthine permit processes and to prove that they could 
actually become successful on a small scale.  Per one of 
Global 3's owners, the company has vertically integrated and 
owns liquefied natural gas storage facilities and pipelines, 
has developed and operates five power plant projects, and 
continues developing various energy facilities, including 
wind farms.  The company attributes its success to its 
approach:  starting small, learning Spanish methods, 
establishing contacts, and building on experience. 
 
32.  An alternative approach for penetrating the Spanish 
market is filling demand within niche markets.  Chiptec 
Corp., a Vermont manufacturer of high fuel efficiency biomass 
gasification systems, found a Spanish food packing company 
who wanted to convert food waste into energy.  Chiptec sold 
equipment to suit this purpose in an arrangement valued at 
over $1 million, and has continued negotiating for more 
business in Spain.  US companies with products that would 
enable Spanish firms to increase efficiency or produce energy 
in non-traditional ways have a potential market in Spain. 
 
COMMENT: 
33.  The Spanish energy sector is changing in a primarily 
market-driven manner, with natural gas playing a dominant 
role in meeting energy needs and wind power playing a role in 
Spain's efforts to reach 12 percent of energy consumption 
through renewables by 2010.  Predicted strong growth will 
continue to provide opportunities for U.S. companies, not 
only in the traditional energy sectors but also in 
renewables.  Independent entry strategies into the Spanish 
energy market are problematic (but possible) due to permit 
processes and generally unavoidable negotiation with 
incumbent competitors for necessary services.  Importing 
energy to Spain's major energy companies for processing and 
distribution, establishing joint ventures and partnerships 
with Spanish companies, acquiring small-scale on-the-ground 
experience, or selling equipment or technology for less 
typical energy sources such as biomass, are some of the best 
strategies for US companies to successfully enter the Spanish 
energy market.  End Comment. 
ARGYROS