GAS TRANSPORTER OF THE SOUTH INC 20-F 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2004
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number: 1-13.396
TRANSPORTADORA DE GAS DEL SUR S.A.
(Exact name of Registrant as specified in its charter)
GAS TRANSPORTER OF THE SOUTH
(Translation of Registrants name into English)
(Jurisdiction of incorporation or organization)
Don Bosco 3672
C1206ABF Buenos Aires
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the Annual Report:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark which financial statement item the registrant has elected to follow.
TABLE OF CONTENTS:
PRESENTATION OF FINANCIAL AND OTHER INFORMATION
We maintain our financial books and records and prepare and publish our audited consolidated financial statements (our Financial Statements) in Argentine pesos in conformity with generally accepted accounting principles in Argentina (Argentine GAAP), subject to certain specific requirements of the Comisión Nacional de Valores (the Argentine National Securities Commission, or CNV) that may deviate from Argentine GAAP. In this annual report on Form 20-F (Annual Report), references to pesos or Ps. are to Argentine pesos, and references to U.S. dollars, dollars or US$ are to United States dollars. A billion is a thousand million. References to m3 are to cubic meters, to MMm3 are to millions of cubic meters, to MMm3/d are to millions of cubic meters per day and to Bm3 are to billions of cubic meters. References to cf are to cubic feet, to MMcf are to millions of cubic feet, to Bcf are to billions of cubic feet, to d are to day and to HP are to horsepower.
Our Financial Statements for the years ended December 31, 2004, 2003, 2002 and 2001 have been audited by Price Waterhouse & Co S.R.L. (member firm of PricewaterhouseCoopers), Buenos Aires, Argentina (Price), independent auditors. Our Financial Statements for the year ended December 31, 2000, were audited by Pistrelli Díaz y Asociados, Member Firm of Arthur Andersen (Pistrelli), independent accountants. Pistrelli was engaged as our independent financial auditing firm until they were replaced by Price in March 2002. Arthur Andersen ceased practicing before the United States Securities and Exchange Commission (SEC) on August 31, 2002. Prices audit report dated June 17, 2005 covering our Financial Statements as of December 31, 2004 and 2003 and for the three years in the period then ended is included in this Annual Report.
The reports of our independent auditors to our Financial Statements for the years ended December 31, 2003 and 2002 contained, among others, a modification due to: (i) our failure to meet our payment obligations under our outstanding indebtedness and the breach of certain other covenants there under, which resulted in our outstanding indebtedness being reclassified as short-term debt, (ii) the negative impact of the deterioration of the Argentine economy and the Argentine governments adoption of various economy measures, including the violation of the contractually-agreed License terms, and (iii) substantial doubt about our ability to continue as a going concern as a consequence of the uncertainty as to our ability to restructure such outstanding indebtedness and the terms and conditions of any such restructured indebtedness. As mentioned in Note 6 to our Financial Statements included elsewhere in this Annual Report, we restructured substantially all of our outstanding indebtedness on December 15, 2004. Consequently, Prices report on our financial statements as of and for the year ended December 31, 2004, contains no such modification.
Argentine GAAP and the specific requirements of the CNV that govern the preparation and presentation of our Financial Statements differ in certain significant respects from generally accepted accounting principles in the United States of America (US GAAP). Such differences involve methods of measuring the amounts shown in our Financial Statements, as well as additional disclosures required by US GAAP and Regulation S-X of the SEC. Note 12 to our Financial Statements contains a description of the principal differences between Argentine GAAP and US GAAP, as they relate to us, and a reconciliation of net income (loss) and total shareholders equity, in each case from Argentine GAAP to US GAAP.
Our Financial Statements were prepared in constant Argentine pesos, recognizing the overall effects of inflation up to August 31, 1995 when it was discontinued by a decree of the Executive Branch (Executive Branch) and a resolution of the CNV. Effective January 1, 2002, inflation accounting was reintroduced as part of Argentine GAAP by Resolution No. 3/2002 issued by the Professional Council in Economic Sciences of the Autonomous City of Buenos Aires (CPCECABA) and General Resolution No. 415 of the CNV, in view of the resumption of significant inflation in Argentina. However, in view of the relative monetary stability in Argentina during 2003, on March 25, 2003, the Executive Branch, through Decree No. 664/01, suspended the application of inflation accounting for periods ending after such date, and the CNV issued General Resolution No. 441 suspending inflation accounting effective March 1, 2003. If we had applied inflation accounting for the period from March 1 to September 30, 2003: (i) net assets as of December 31, 2004 would have decreased by Ps. 73 million, (ii) net income for the year ended December 31, 2003 would have decreased by Ps. 36 million, and (iii) the impact on the result for the year ended December 31, 2004 would not be material. Amounts as of and for the year ended December 31, 2002 presented in our Financial Statements were restated, for comparative purposes, to constant pesos, as of February 28, 2003 in accordance with CNV General Resolution No. 441. The conversion factor used to restate this information for comparative purposes was 1.0074.
Under Argentine GAAP, our Financial Statements are to be restated for the effects of inflation as of September 30, 2003. In addition, Argentine GAAP requires the recognition of deferred income tax assets and liabilities on a discounted basis. As indicated in Notes 2.c) and 2.h) to our Financial Statements as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002, we have discontinued the restatement of our Financial Statements into constant currency as from March 1, 2003, not September 30, 2003, and have recorded deferred income tax assets and liabilities on a non-discounted basis, following the provisions of the regulations issued by the CNV.
Accordingly, Price, has issued a qualified report on our Financial Statements as of December 31, 2004 and 2003 and for the three years in the period then ended, stating that the application of the CNV regulations mentioned in the preceding two paragraphs represents a departure from Argentine GAAP.
Unless otherwise specified, all exchange rate information contained in this Annual Report has been derived from information published by Banco de la Nación Argentina S.A. (Banco de la Nación).
Certain amounts shown in this Annual Report are subject to rounding. Accordingly, figures shown as totals in certain tables may not be an exact arithmetic aggregate of the other figures in such table.
References to we, us and our mean Transportadora de Gas del Sur S.A. (TGS) and its consolidated subsidiary, Telcosur S.A. (Telcosur).
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Annual Report, including information incorporated by reference herein, may constitute forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements can be identified by the use of forward-looking terminology such as may, will, will likely result, intend, projection, should, believe, expect, anticipate, estimate, continue, plan or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other forward-looking information. Forward-looking statements are subject to various risks and uncertainties. When considering forward-looking statements, you should keep in mind the factors described in the Item 3. Key InformationRisk Factors and other cautionary statements appearing in Item 5. Operating and Financial Review and Prospects. Item 3. Key InformationRisk Factors and other statements describe circumstances that could cause results to differ materially from those contained in any forward-looking statement.
Forward-looking statements include but are not limited to the following:
changes in general economic, business, political or other conditions in Argentina;
estimates relating to future tariffs and prices for our transportation services and future prices for our non-regulated business;
statements relating to the prices of our natural gas liquids (NGL) business and estimates of future volumes associated with our NGL business;
statements regarding expected future political developments in Argentina and expected future developments regarding our license to provide gas transportation services through the exclusive use of the southern gas transportation system in Argentine (the License), the renegotiation process at the Unit for Renegotiation and Assessment of Utilities Contracts (UNIREN), regulatory actions by Ente Nacional Regulador del Gas (ENARGAS) and any other governmental authorities that may affect us and our business;
estimates relating to future revenues, including those from gas transportation contracts;
statements and estimates regarding future pipeline expansion and the cost of, or return to us from, any such expansion;
statements concerning the future impact of the creation of the Electronic Gas Market (MEG); and
estimates of our future level of capital expenditures, including those required by ENARGAS and other governmental authorities.
The following important factors could cause actual results to differ materially from any results projected, forecasted, estimated or budgeted by us in our forward-looking statements:
risks and uncertainties resulting from any non-compliance by us with the covenants contained in our newly restructured debt instruments;
risks and uncertainties related to changes in the peso-U.S. dollar exchange rate and the Argentine domestic inflation rate, which can materially adversely affect our revenues, expenses and reported financial results;
risks and uncertainties associated with our non-regulated business, including those related to international and local prices of NGL, taxes and other restrictions imposed on NGL exports, our ability to renegotiate our agreements with customers and possible increased regulation of the NGL industry in the future by the Argentine government;
risks and uncertainties resulting from government regulations that affect our business and financial condition or results of operations, such as the prohibition on tariff increases, restrictions on payments abroad and exchange controls and risks and uncertainties resulting from the prospect of additional government regulation or other governmental involvement in our business;
developments in litigation;
changes to or revocation of our License;
risks associated with the collection of receivables in light of the difficult economic environment in Argentina;
risks and uncertainties associated with unscheduled and unexpected expenditures for the repair and maintenance of our fixed or capital assets or expenditures required or otherwise mandated or initiated by ENARGAS or other governmental authorities for the expansion of our pipeline system or other purposes;
risks and uncertainties relating to the energy crisis in Argentina, including the risk that we may effectively be forced to make investments or take other actions that may not be as commercially attractive as other actions;
risks and uncertainties impacting us as a whole, including changes in general economic conditions, changes in laws and regulations to which we are subject, including tax, environmental and employment laws and regulations, and the cost and effects of legal and administrative claims and proceedings against us; and
the factors discussed in Item 3. Key InformationRisk Factors below.
Our actual results may differ materially from the results anticipated in these forward-looking statements because such statements, by their nature, involve estimates, assumptions and uncertainties. The forward-looking statements contained in this Annual Report speak only as of the date of this Annual Report, and we do not undertake any obligation to update any forward-looking statement or other information to reflect events or circumstances occurring after the date of this Annual Report or to reflect the occurrence of unanticipated events.
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Selected Financial Data
The following selected consolidated financial data is derived from our Financial Statements as of and for the years ended December 31, 2004, 2003 and 2002, and our Financial Statements as of and for the years ended December 31, 2002, 2001 and 2000, restated in constant pesos as of February 28, 2003. This information should be read in conjunction with and is qualified in its entirety by reference to our Financial Statements, including the independent auditors reports thereon and the notes related thereto, and the discussion in Presentation of Financial and Other Information and Item 5. Operating and Financial Review and Prospects included elsewhere in this Annual Report.
For important information relating to our Financial Statements including information relating to the preparation and presentation of the audited consolidated financial statements and the following selected financial data, see Presentation of Financial and Other Information above.
A summary of the dividends paid during the five most recent years is set forth below:
Stated in constant pesos as of February 28, 2003.
Stated in U.S. dollars as of the payment date. See Exchange Rates for information on the exchange rates used in this Annual Report.
The payments were made on February 29, 2000 and August 8, 2000.
The payments were made on March 12, 2001 and August 21, 2001.
Dividends may be lawfully declared and paid only out of our retained earnings reflected in our annual financial statements and approved by a shareholders meeting as described below. As a consequence of the Argentine economic crisis that began in December 2001, which had a material adverse effect on our economic and financial position, we have not paid dividends since 2001. Our debt instruments currently limit our ability to declare and pay dividends. See Item 10. Additional informationMaterial contractsNew Debt Obligations.
Our Board of Directors may declare interim dividends, in which case the members of the Board of Directors and of the Statutory Audit Committee are jointly and severally liable for such distribution, if such declaration is not in accordance with the Commercial Companies Law and our By-laws.
Our Board of Directors regularly submits our Financial Statements for the preceding fiscal year, together with reports thereon by the Statutory Audit Committee, to the shareholders at the annual ordinary shareholders meeting for approval. According to Argentine law, this ordinary shareholders meeting must be held to approve the financial statements and determine the allocation of our net income for such year. Under the Commercial Companies Law in Argentina, the shareholders are required to allocate a legal reserve equal to 5% of each fiscal year net income, provided that there is no unappropriated retained deficit. In such case, 5% should be calculated on any excess of the net income over the unappropriated retained deficit. This appropriation is legally required until such reserve equals 20% of the sum of (i) Common stock nominal value plus (ii) Cumulative inflation adjustment to common stock, as shown on our Consolidated Statement of Changes in Shareholders Equity. If the legal reserve falls below the 20% required amount, dividends may not be paid until the legal reserve has been restored to at least the required 20% threshold. The amount represented by the legal reserve is not available for distribution as dividends. Under our By-laws, after the allocation to the legal reserve has been made, an amount will be allocated to pay dividends on preferred stock, if any, and an amount equal to 0.25% of the net income for the year will be allocated to pay the participation in earnings of employee profit-sharing certificates. The remainder of the retained earnings for the year may be distributed as dividends on common stock or retained as a voluntary reserve, as determined at the shareholders meeting. Dividends must be paid within 30 days of their declaration. For information on dividend taxation, see Item 10. Additional InformationTaxationArgentine Taxes.
Exchange Rate Information
Fluctuations in the exchange rate between pesos and U.S. dollars would affect the U.S. dollar equivalent of the peso price of our Class B Shares on the Buenos Aires Stock Exchange (BASE) and, as a result, would likely affect the market price of our ADS. In addition, such fluctuations will affect the dollar equivalent of peso amounts reported in this Annual Report. Currency fluctuations would also affect the U.S. dollar amounts received by holders of American Depositary Receipts (ADRs) on conversion by the Depositary of cash dividends paid in pesos on the underlying Class B Shares.
Beginning in April 1991, under the Convertibility Law No. 23,928 (the Convertibility Law), the Central Bank was required to buy or sell U.S. dollars to any person at a rate of one peso per U.S. dollar. On January 11, 2002, the Central Bank ended a banking holiday that it had imposed on December 21, 2001. Subsequently, the Argentine government amended the Convertibility Law, allowing the exchange rate to float freely for the first time since April 1991. Heightened demand for scarce U.S. dollars caused the peso to trade well above the one-to-one parity prevailing under the Convertibility Law. As a result, the Central Bank intervened on several occasions by selling U.S. dollars in order to lower the exchange rate. The Central Banks ability to support the peso by selling U.S. dollars depends, however, on its limited U.S. dollar reserves; the value of the peso has continued to fluctuate significantly. In response to high demand for U.S. dollars in Argentina and the scarcity of U.S. dollars to meet that demand, the Argentine government imposed several temporary freezes, or holidays, and imposed other restrictions on exchange transactions since the Convertibility Law was repealed. For additional information regarding factors affecting the value of the peso, see Risks FactorsRisks Relating to Argentina below. On February 8, 2002, Executive Order No. 260/02 was issued, providing that beginning February 11, 2002, a single free exchange market would channel all foreign currency exchange transactions, to be made at the rates agreed between the parties, pursuant to Central Bank requirements.
The following table sets forth, for the periods indicated, high, low, average and period-end exchange rates between the peso and the U.S. dollar, as reported by Banco de la Nación. The Federal Reserve Bank of New York does not publish a noon buying rate for the peso. The average rate is calculated by using the average of Banco de la Nación reported exchange rates on each day during the relevant monthly period and on the last day of each month during the relevant annual period.
The Argentine Central Bank imposed a banking holiday from December 21, 2001 to January 11, 2002, during which time there was no official exchange rate between the peso and U.S. dollar.
For your convenience and except as we specify otherwise, this Annual Report contains translations of peso-denominated amounts to U.S. dollars at the reported exchange rate on December 31 of each fiscal year. These translations should not be construed as representations that the amounts actually represent such U.S. dollar amounts or could be or have been converted into U.S. dollars at the rates indicated or at any other rates. On June 23, 2005, the reported exchange rate was Ps. 2.8720=U.S.$1.00.
Our results of operations and financial condition are highly susceptible to changes in the peso-U.S. dollar exchange rate because our primary assets and revenues are peso-denominated while substantially all of our liabilities and capital expenditures are U.S. dollar-denominated.
Capitalization and Indebtedness
Reasons for the Offer and Use of Proceeds
You should carefully consider the following risks and uncertainties, and any other information appearing elsewhere in this Annual Report. The risks and uncertainties described below are intended to highlight risks and uncertainties that are specific to us. Additional risks and uncertainties, including those generally affecting Argentina and the industry in which we operate, risks and uncertainties that we currently consider immaterial or risks and uncertainties generally applicable to similar companies in Argentina may also impair our business, results of operations, the value of our securities, and our ability to meet our financial obligations.
The information in this Risk Factors section includes forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of numerous factors, including those described in Cautionary Statement Regarding Forward-Looking Statements above.
Risks Relating to Argentina
We are a sociedad anónima and nearly all of our operations and assets are located in Argentina. A significant portion of our revenues are generated in Argentina and, consequently, are peso-denominated. Conversely, substantially all of our indebtedness is U.S. dollar-denominated. Accordingly, our financial condition and results of operations depend to a significant extent on economic, regulatory and political conditions prevailing in Argentina and on the exchange rate between the peso and the U.S. dollar. As detailed below, in the past several years the Argentine economy has experienced a severe recession as well as a political crisis, and the abandonment of U.S. dollar-peso parity has led to significant devaluation of the peso against major international currencies. These conditions have and may continue to significantly affect our financial condition and results of operations and may impair our ability to make payments of principal and/or interest on our financial indebtedness.
Potential future devaluation of the peso creates uncertainty as to Argentinas economic future and is likely to materially adversely affect our results of operations and financial condition and our ability to service our debt obligations.
The Public Emergency Law No. 25,561 (the Public Emergency Law) ended more than a decade of uninterrupted U.S. dollar-peso parity under the Convertibility Law and eliminated the requirement that the Central Bank back the peso with reserves in gold and foreign currency at least equal to Argentinas outstanding peso monetary base. All throughout 2002, the peso-dollar exchange rate fluctuated significantly and, consequently, the Central Bank intervened on several occasions by selling U.S. dollars in order to lower such exchange rate. However, the policies adopted and the actions taken by the Argentine government may not be able to control the value of the peso. Although during 2003 and 2004 the peso-U.S. dollar exchange rate has remained relatively stable, it is impossible to predict future fluctuations in the exchange rate and how they could affect our results of operations and financial condition (see Exchange Rate Information above). Moreover, we cannot predict or anticipate whether, and to what extent, the Argentine government will further modify its monetary policy and, if so, what impact any of those changes could have on the value of the peso. The devaluation of the peso and the uncertainty surrounding its future value relative to the U.S. dollar and other currencies place the Argentine economy at risk for further deteriorations.
Because substantially all of our indebtedness is U.S. dollar-denominated, further devaluation of the peso will negatively affect our revenues expressed in U.S. dollars while increasing the relative cost, in peso terms, of expenses and other financial obligations denominated in foreign currencies, thereby decreasing our cash-generating ability and materially adversely affecting our liquidity and our ability to service our debt.
At December 31, 2004, our total consolidated U.S. dollar-denominated indebtedness, excluding accrued and unpaid interest, was the equivalent of US$909.5 million.
Substantial inflation has occurred following the repeal of the Convertibility Law and in the future it may continue, which may materially adversely affect our results of operations and financial condition.
Argentina experienced significant inflation from December 2001 through January 31, 2003, with cumulative changes in the Consumer Price Index (CPI) of 42.8% and in the Wholesale Price Index (WPI) of 118.9%. This level of inflation reflected both the effect of the peso devaluation on production costs as well as a substantial modification of relative prices, partially offset by the elimination of public utility rate (tariff or rate) adjustments and the large drop in demand resulting from the severe recession. Inflation slowed in 2003, with the CPI increasing by 3.7% and the WPI increasing by 2.0% for the year. Further, during 2004, the CPI increased by 6.1% and the WPI increased by 7.9%. Additionally, for the first quarter 2005, CPI increased by 4.0% and the WPI increased by 2.0%. This reduction in the relative level of inflation reflects the appreciation of the peso against the U.S. dollar, the increased demand for domestic currency and the distortion of relative prices due to the elimination of public service tariff adjustments.
Notwithstanding this continued stabilization, the Argentine economic and social situation have quickly deteriorated in the past, and may quickly deteriorate in the future, and we cannot assure you that the Argentine economy will continue to grow.
Argentinas history of hyperinflation prior to the adoption in 1991 of the Convertibility Law raises serious doubts as to the ability of the Argentine government to maintain a strict monetary and fiscal policy to control inflation. In the past, inflation materially undermined the Argentine economy and the ability of the Argentine government to create conditions that permitted growth for companies operating in Argentina. The unpredictability of Argentinas inflation rate makes it impossible for us to foresee how our results of operations and financial condition may be affected in the future by inflation. Because a significant portion of our revenues are peso-denominated, unless our tariffs increase at a rate at least equal to the rate of inflation, any further increase in the rate of inflation will result in a relative decrease in our revenues, which would have a material adverse effect on our business, results of operations and financial condition.
Argentinas ability to stimulate sustained economic growth, appease social unrest and repay its debt may depend on external financial assistance, which has been limited and may continue to be limited in the future.
Due to the failure of Argentina to meet budgetary targets, including those for the fourth quarter of 2001, on December 5, 2001, the International Monetary Fund (IMF) suspended disbursements under its lending arrangements with Argentina. On December 23, 2001, interim President Rodriguez Saa declared the suspension of debt payments on approximately US$65.4 billion of Argentinas approximately US$144.5 billion of sovereign debt, as of December 31, 2001. As a result of these events, international rating agencies downgraded the rating of Argentinas sovereign debt to default status.
On January 24, 2003, the IMF approved an eight-month US$3 billion Stand-by Credit Facility that was designed to provide transitional financial support to Argentina through the period ending August 31, 2003. This arrangement replaced Argentinas prior arrangements with the IMF. In September 2003, after the expiration of this transitional agreement, a long-term agreement was executed for the 2003-2006 period, which agreement postponed the maturity date of certain amounts of its debt and established a series of quantitative and qualitative conditions to be met by the Argentine government during the 2003-2004 period. These conditions included, among other things, the renegotiation of the public debt that is currently in default status, implementation of tax reforms and the adjustment of utility rates. Under the agreement, the status of these conditions is reviewed every three months. The first and second reviews were completed in January 2004 and March 2004, respectively.
In August 2004, the IMF announced the suspension of the third review and postponed disbursements to Argentina, in order to evaluate the implementation by the Argentine government of the pending structural reforms related to public utility contracts and the progress made in the renegotiation of the Argentine sovereign debt.
Also in August 2004, the Argentine government announced the suspension of negotiations with the IMF until December 31, 2004, in order to focus efforts on the restructuring of its defaulted sovereign debt. On September 17, 2004 the IMF granted Argentina a one-year grace period in the repayment of an amount of principal of approximately US$1,100 million, initially scheduled to mature between September 20, 2004 and January 17, 2005.
On November 1, 2004, the Argentine government filed with the SEC (and later with the securities commissions of Italy, Germany and Luxembourg) the terms of the new public debt securities to be issued in order to restructure the defaulted debt. Sovereign debt in default totaled approximately US$100 billion, comprised of principal and unpaid interest accrued before December 31, 2001. The new securities offered in connection with the exchange offer will be denominated in U.S. dollars, euros, Japanese yens and Argentine pesos (indexed by CER). On December 9, 2004, Executive Decree No. 1735/04 was issued, approving the debt restructuring under the terms and conditions set forth in the offering circular supplement attached to such Decree, and approving the terms and conditions of the new securities to be delivered in exchange for the eligible securities.
On January 14, 2005, the Argentine government officially launched the debt restructuring process and, on March 18, 2005, officially announced that 76.15% of bondholders had accepted the offer. The new bonds were to be issued in April 2005.
On February 10, 2005, the Argentine Executive Branch enacted Law No. 26,017, which prohibits the Argentine government from reopening the exchange offer. This law essentially eliminates the ability of the Argentine government from entering into separate negotiations with hold-outs that did not participate in the exchange offer process.
Several legal actions were filed in the U.S., Italy and Germany by bondholders who did not accept the Argentine governments offer, which delayed settlement of the exchange offer. On March 21, 2005, a U.S. District Court judge for the Southern District of New York issued several ex parte orders seeking to attach certain bonds with a face value of US$7 billion that had been tendered by bondholders participating in the debt exchange, effectively preventing the scheduled settlement by Argentina and its exchange offer. A week later, the judge decided to vacate the orders, but upon request of the plaintiffs, agreed to stay the vacatur pending plaintiffs appeal to the 2nd U.S. Circuit Court of Appeals. On May 13, 2005, the Court of Appeals affirmed the order of the District Court vacating the restraining order and the order of pre-judgment attachment and on May 23, 2005, the District Court vacated its stay.
On June 2, 2005, the Argentine government issued the new bonds and paid overdue interests accrued from December 2003, as the final stage of the exchange for the Argentine governments debt restructuring. For this reason, Standard & Poors Rating Services rose the short and long term sovereign qualification of Argentina from SD to B-.
Despite this positive outcome, it is unclear what additional measures the plaintiffs will pursue. In addition, it is unclear how the IMF will react to the Argentine governments treatment of holdouts under Law No. 26,017. Further claims against the Argentine government could result in a reduction in funding sources and investment capital, which could have a significant effect on the Argentine governments capacity to implement reforms and reinstate sustainable economic growth, all of which could adversely affect us. Moreover, there can be no assurance that the Argentine government will not default on its obligations under the new bonds, if issued, in the future. In addition, the Argentine government must continue to honor principal and interest payments to credit agencies including the IMF and World Bank without subsequent new loans in order to avoid a default vis-à-vis such agencies. All such events could also impair Argentinas capacity to maintain the current economic recovery and could result in a recession, higher inflation, unemployment and social discontent.
Although the Argentine financial system appears to be recovering, there is still a risk of future collapse.
In recent years, the Argentine financial system has been characterized by extreme volatility. In the past, the Argentine government has restricted bank withdrawals and required the conversion of U.S. dollar-denominated deposits into pesos (pesification). However, these measures have led to a significant decrease in commercial and financial activities, diminished spending and greatly increased social unrest, resulting in widespread public protests against financial institutions.
Recently, a large number of cases brought in Argentine courts have challenged the constitutionality of pesification pursuant to the Public Emergency Law and have demanded the return of deposits in dollars or in pesos at the prevailing exchange rate at the time of payment. In at least one case, the Argentine Supreme Court (the Supreme Court) has struck down the mandatory conversion into pesos of U.S. dollar deposits. On March 5, 2003, the Supreme Court held the Argentine governments conversion of U.S. dollar-denominated deposits into pesos unconstitutional in the case of deposits of the province of San Luis with Banco de la Nación. On October 26, 2004, however, the Supreme Court upheld the constitutionality of the pesification in a separate case brought by a private depositor against the financial institution where the deposit was held. Notwithstanding this decision, the constitutionality of pesification continues to be challenged by private depositors and the inconsistency of the decisions by the Supreme Court creates uncertainty for the Argentine banking system as a whole and raises the possibility that a large number of depositors may seek to withdraw all of their deposits and convert them into dollars in the future. If this happens, a liquidity crisis would occur and the Argentine government may be required to provide additional financial assistance to banks. This, in turn, would add to the countrys outstanding debt and is viewed with concern by holders of Argentinas currently outstanding bonds. If the Argentine government is not able to provide this assistance and withdrawals from banks become significant, one or more banks or even the entire Argentine financial system could collapse. Funds withdrawn from Argentine banks or the Argentine financial system generally may flow to foreign markets which could adversely affect exchange and inflation rates and cause additional volatility in the Argentine financial system.
While the Argentine financial system is recovering, it continues to be fragile. The systems failure would have a material adverse effect on our prospects for economic recovery and stability. Even short of failure, the crisis in Argentina and its financial sector has materially adversely affected us and will likely continue to adversely affect our ability to borrow funds (including the establishment of lines of credit), requiring us to continue to rely on internally generated funds to sustain our operations. We would be materially adversely affected if the Argentine financial system were to collapse or deteriorate.
The Central Bank has imposed restrictions on the transfer of funds outside of Argentina in the past and may do so in the future, which could prevent us from making payments on our foreign currency-denominated debt.
Since the amendment of the Convertibility Law in December 2001, the Argentine government has imposed several temporary restrictions on the transfer of U.S. dollars outside of Argentina. Prior to January 2003, we were required to obtain the prior approval of the Central Bank before we could transfer U.S. dollars outside Argentina to make payments of principal on our debt obligations. Although current regulations do not require prior Central Bank approval for payment of either principal or interest that is due and payable under our indebtedness, the Central Bank may reinstate transfer of funds restrictions at any time. In such case, we cannot assure you that the Central Bank will approve the transfer of funds outside Argentina for payments required under the terms of our foreign currency-denominated indebtedness. In addition, there may be a significant delay before payments required under the terms of our foreign currency-denominated indebtedness may be made.
The Argentine financial market and economy may be adversely affected by the deterioration of other emerging markets.
A significant decline in the economic growth of any of Argentinas major trading partners, such as Brazil and Chile, could have a material impact on Argentinas balance of trade and adversely affect Argentinas economic growth. Brazil is Argentinas largest export market. A decline in Brazilian demand for imports could have a material adverse effect on Argentine exports and Argentinas economic growth. In addition, because international investors reactions to the events occurring in one emerging market country sometimes appear to demonstrate a contagious effect in which an entire region or class of investment is disfavored by international investors, Argentina could be adversely affected by negative economic or financial developments in other emerging market countries. For example, the crisis which occurred in certain Asian countries in mid-1997, the debt moratorium in Russia in 1998, and the Real devaluation in Brazil at the beginning of 1999 had a negative impact on financial markets worldwide, particularly in emerging countries. Consequently, the Argentine financial markets may be adversely affected by the deterioration of other emerging markets.
Because the Argentine standards for corporate disclosure and accounting differ from those of the United States, information about us may not be as detailed or comprehensive as that of non-Argentine companies, including that of companies in the United States.
We are subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (Exchange Act). However, the periodic disclosure required of foreign issuers under the Exchange Act is more limited than the periodic disclosure required of companies in the United States. Furthermore, there is a lower level of regulation of the Argentine securities markets and of the activities of investors in such markets as compared with the securities markets in the United States and certain other developed countries. In addition, regulations governing the Argentine securities market are not as extensive as those in effect in the United States and some other major world markets. We prepare our Financial Statements in accordance with Argentine GAAP and the regulations of the CNV, which differ in certain significant respects from US GAAP. See Note 12 to our Financial Statements for a description of the material differences between Argentine GAAP and US GAAP as they relate to us and for an estimate of the impact of those differences on net income (loss) for the year and our shareholders equity.
Risks Relating to Our Business
Because we receive a significant portion of our net revenues from public service contracts that are no longer subject to indexing, our net revenues, and liquidity, have been harmed as a result of inflation and the devaluation of the peso.
All of our net revenues from our gas transportation segment are attributable to public service contracts, which are subject to government regulation. We entered into these public service contracts primarily with natural gas distribution companies in connection with the privatization of Gas del Estado S.E. (GdE). Prior to the passage of the Public Emergency Law, the tariffs we are permitted to charge under these public service contracts permitted indexation, based on semi-annual changes in the U.S. Producer Price Index (PPI), and adjustments every five years, based on the efficiency of, and investments in, our gas transportation operations. The Public Emergency Law, however, eliminated tariff indexation.
In accordance with the Public Emergency Law, in January 2002, public service tariffs were converted into pesos and fixed at an exchange rate of Ps. l.00=US$l.00 even as the peso was allowed to devalue against the U.S. dollar. Future gas transportation regulated tariffs may not be increased or, if increased, may not be increased to a rate that we believe is high enough to adequately compensate us. As a result, our net revenues from our gas transportation segment have been and may continue to be materially adversely affected.
Since the commencement of the Public Emergency Law, we have been successful at generating a large portion of our revenue from our NGL business. However, this business depends is affected in large part by fluctuations in foreign currency, competition, the level of export taxes and the levels of NGL prices, which are things over which we have no control. We cannot assure you that in the future we will be able to sustain current levels of revenue from the sale of NGL. If revenues from our NGL business were to decrease, and our tariffs were not adequately increased, our financial condition and results of operation would be materially adversely effected.
Enron Corp., the parent corporation of certain of the principal shareholders of Compañía de Inversiones de Energía S.A. (CIESA), our controlling shareholder, has filed a claim with the International Centre for the Settlement of Investment Disputes (ICSID) against the Government of Argentina under the Bilateral Investment Treaty between the United States and Argentina. We understand that the claim argues that the pesification of tariffs and other unilateral changes to our regulatory structure effected by the Public Emergency Law and related laws and decrees, violates the requirement of fair and equitable treatment under the treaty. A number of similar claims have been filed by shareholders of public service companies in Argentina under bilateral investment treaties. One such case, involving a US shareholder, has been decided in favor of the shareholder, although media reports indicate that the Argentine government intends to contest the award. The outcome of the ICSID proceeding is unclear. It is possible, however, that the continued pursuit of such claim by Enron could adversely affect the timing and/or terms of any renegotiated tariff structure applicable to our gas transportation activities.
The proposal of UNIREN for the renegotiation of our License requires us, and our shareholders, to abandon any claim or lawsuit we or they may have against the Argentine government resulting from the effects of the Public Emergency Law applicable to the License and the PPI tariff adjustments which were not applied in 2000 and 2001. Additionally, we are required to hold Argentine government harmless from any claim or lawsuit filed by any of our shareholders or any compensation in favor of such shareholders and reimburse the Argentine government for any amount paid by it to our shareholders in connection with any such claim or lawsuit.
Our results of operations may be harmed because our public service contracts with the Argentine government are subject to renegotiation.
The Public Emergency Law authorizes the Argentine government to renegotiate public service contracts, tariffs and licenses with public utility companies on its own initiative, using the following criteria:
the impact of the rates on the competitiveness of the economy and on income distribution;
the quality of the services and the investment programs contractually provided for in the service contract;
the interests of users, as well as service access conditions;
the operational safety of the systems concerned; and
the profitability of a company.
Since the enactment of the Public Emergency Law, there has not been significant progress in respect to the renegotiation of our public service contracts. In July 2003, UNIREN was created, under the joint jurisdiction of the Ministries of Economy, Production, Federal Planning, Public Investment and Utilities. Little progress has been made to date in the renegotiation process with UNIREN. We cannot at this time provide any assurances with regard to the terms or the timing of any renegotiation of our License or the tariffs for our public service contracts. The deadline for the renegotiation of the public works and utilities contracts has been extended until December 31, 2005, pursuant to Law No. 25,972.
If our public service contracts are renegotiated, the new terms of such contracts may be less favorable than the current terms of these public service contracts. If the public service contracts are renegotiated on less favorable terms than our current tariffs provide, our results of operations and financial condition will be materially adversely affected. Even if our public service contracts are renegotiated on more favorable terms, those terms nonetheless may be insufficient to avoid a material adverse affect on our results of operations and financial condition. See Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessRegulatory FrameworkAdjustment of Rates below for more information.
Our results of operations may be harmed if the Argentine courts prevent the implementation of tariff adjustments.
The Public Emergency Law eliminated tariff indexation and adjustments. On January 23, 2003, however, the Argentine government issued Emergency Decree No. 120/03, which established that the Argentine government may provide for interim tariff increases or adjustments until the completion of the renegotiation of public service contracts and licenses process required under the Public Emergency Law. On January 29, 2003, the Argentine government issued Decree No. 146/03, which established a temporary tariff adjustment for the provision of energy and gas services. However, this measure has been challenged in the Argentine courts and suspended by an injunction, on the grounds that the Natural Gas Act (Article 46 of Law No. 24,076), which regulates the transportation and distribution of natural gas, requires that a public hearing and formal contract renegotiations be held with respect to tariff rate increases and absent such measures, an increase cannot be sanctioned by government fiat.
We can provide no assurance that we will be able to obtain another adjustment in the future. Further, our results of operations will be harmed to the extent that the Argentine courts continue to suspend proceedings initiated to permit tariff adjustments in our favor.
Our business may be affected by the recent creation of the MEG or future regulations by the Federal Energy Bureau.
The Executive Branch, through Decree No. 180/04 issued on February 16, 2004, among other measures, established the creation of MEG with the purpose of improving the transparency of financial and operating performance, the coordination of daily transactions in both the gas spot and the transportation and distribution secondary markets along with producing efficient prices through offer and demand free interaction. To that end, all firm transportation capacity not allocated for the following day must be marketed through the MEG and the proceeds from that capacity sale will be used in accordance with the Secretaría de Energías (the Federal Energy Bureau) requirements. Non-allocated capacity includes remaining capacity not used in any of the transportation systems or pipelines. This requirement may have a material impact on non-firm transportation revenues, which for the year ended December 31, 2004 amounted to approximately Ps. 26.7 million. For a description of our gas transportation business, see Item 4. Our Information.Business OverviewGas Transportation Regulated Business below.
There can be no assurance that the future requirements imposed by the Federal Energy Bureau will not have a material adverse effect on our results of operations and financial condition.
Our business is dependent on our being able to maintain our License, which is subject to revocation under some circumstances.
We are licensed to provide gas transportation services through the exclusive use of the southern gas transportation system in Argentina. The Executive Branch may revoke our License in certain circumstances based on the recommendation of ENARGAS, the governmental body charged with the regulation of the transportation, distribution, marketing and storage of natural gas. Reasons for which our License may be revoked include:
repeated failure to comply with the obligations of our License and failure to remedy a significant breach of an obligation in accordance with specified procedures;
total or partial interruption of service for reasons attributable to us that affects transportation capacity during the periods stipulated in our License;
sale, assignment or transfer of our essential assets or the placing of encumbrances thereon without ENARGASs prior authorization, unless such encumbrances serve to finance extensions and improvements to the gas pipeline system;
our bankruptcy, dissolution or liquidation;
ceasing and abandoning the provision of the licensed service, attempting to assign or unilaterally transfer our License in full or in part without the prior authorization of ENARGAS, or giving up our License, other than in the cases permitted therein; and
delegation of the functions granted in such contract without the prior authorization of ENARGAS, or the termination of such agreement without regulatory approval of a new contract.
If our License were revoked, we would be required to cease providing gas transportation services. The impact of a loss of our License on our business, financial condition and results of operations would be material and adverse. In addition, certain changes to our License could result in an Event of Default under our outstanding debt instruments. See Item 10. Additional InformationMaterial ContractsNew Debt ObligationsEvents of Default.
We are subject to a tax inquiry regarding our ability to claim a tax exemption with respect to certain of our cancelled indebtedness, and we may be subject to additional Argentine taxes with respect to certain of our restructured indebtedness, in which case our ability to make payments on our restructured indebtedness may be impaired.
The Administración Federal de Ingresos Públicos (the Argentine Internal Revenue Service or AFIP) has made several inquiries concerning certain of our indebtedness that was cancelled in connection with the exchange offer. In respect of such indebtedness, the AFIP has made inquiries into whether the offering of such Negotiable Obligations met the requirements established in Section 36 of the Negotiable Obligations Law necessary in order to receive the tax exemptions set forth in Section 36 of the Negotiable Obligations Law.
If the AFIP determines that we are not entitled to the benefits of tax exemptions with respect to such indebtedness (and such determination is upheld by the relevant court if we appeal any such determination), the Negotiable Obligations Law provides that we will be responsible for the payment of the tax that would otherwise have been due from the holders of such indebtedness, in addition to interest and fines that may be imposed on us. The amounts of such taxes, interest and fines could have a material adverse effect on our liquidity and results operations.
In February 2005, the CNV has determined that US$178 million in aggegate principal amount of notes issued in connection with the settlement of our exchange offer in respect of our existing OPIC Notes (the OPIC Notes) did not fulfil the necessary requirements for being entitled to the benefits of the tax exemption provided by the Negotiable Obligations Law. Therefore, we cannot assure you that the New Notes issued in respect of the OPIC Notes will be entitled to the benefits of the tax exemption provided by the Negotiable Obligations Law if CNV challenges the availability of the tax exemption. If that is the case, we might be responsible for the payment of the tax, which rate could range between 18% and 54% (depending on the residency country of the holders) applicable to each interest payment. On February 18, 2005, we filed an appeal with the CNV, alleging sufficient grounds to support the tax exemption in respect of the aforementioned New Notes. As of the date of the issuance of this Annual Report, the CNV has not responded to our appeal.
The affirmative and restrictive covenants in our restructured indebtedness could adversely restrict our financial and operating flexibility and subject us to other risks.
Our restructured indebtedness contains numerous affirmative and restrictive covenants that limit our ability to, among other things:
make capital expenditures;
enter into transactions with shareholders and affiliates;
incur additional debt;
pay dividends, acquire shares of stock and make payments on subordinated debt;
create liens; or
consolidate, merge or sell substantially all of our assets.
These restrictions may limit our ability to operate our businesses and may prohibit or limit our ability to enhance our operations or take advantage of potential business opportunities as they arise. The breach of any of these covenants by us or the failure by us to meet any of these conditions could result in a default under any or all of such indebtedness. Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions and the renegotiation of public works and licenses process. In addition, if we are unable to generate sufficient cash flow from operations, we may be required to refinance outstanding debt or to obtain additional financing. We cannot assure you that a refinancing would be possible or that any additional financing would be obtained on acceptable terms.
Our creditors may not be able to enforce their claims against us in Argentina.
We are a stock corporation with limited liability, or sociedad anónima, organized under the laws of Argentina. Substantially all or a substantial portion of our assets are located in Argentina.
Under Argentine law, foreign judgments are enforced provided that the requirements of Articles 517 through 519 of the Federal Code of Civil and Commercial Procedure are met. Foreign judgments cannot violate principles of public policy of Argentine law, as determined by Argentine courts. It is possible that an Argentine court would deem the enforcement of foreign judgments ordering us to make a payment in a foreign currency outside of Argentina to be contrary to Argentine public policy if at that time there are legal restrictions prohibiting Argentine debtors from transferring foreign currency outside of Argentina.
Under Argentine law, attachment prior to execution and attachment in aid of execution will not be ordered by an Argentine court with respect to property located in Argentina and determined by such courts to be utilized for the provision of essential public services. A significant portion of our assets may be considered by Argentine courts to be dedicated to the provision of an essential public service. If an Argentine court were to make such determination with respect to any of our assets, unless the Argentine government ordered the release of such assets, such assets would not be subject to attachment, execution or other legal process as long as such determination stands and the ability of any of our creditors to realize a judgment against such assets may be adversely affected.
In order to mitigate the energy crisis, the Argentine government has initiated new strategies, measures and programs with respect to the gas transportation industry, including the expansion of our pipeline, which could materially adversely affect our business, results of operations and financial condition.
Recently, the gas industry has experienced a sharp increase in natural gas demand as a consequence of: (i) the recovery of certain industries in the Argentine economy, (ii) the devaluation of the peso and the pesification of transportation and distribution tariffs and the elimination of both tariff and wellhead gas price adjustments, making this fuel relatively inexpensive for consumers as compared to other types of fuel the prices of which are affected by inflation, and (iii) lower hydroelectric generation due to a decrease in Argentine rainfall. However, notwithstanding this increase in demand, these conditions have severely and negatively impacted the profitability of companies providing services relating to the production, transportation and distribution of natural gas.
Specifically, distribution companies have been prohibited from passing through price increases to consumers. Producers of natural gas, therefore, have been limited, if not unable, to implement wellhead gas price adjustments since 2002 until May 2004, which has caused such producers to suffer a sharp decline in their rate of return on investment activities. As a result, natural gas producers have limited their investments in exploration and production of natural gas. Likewise, the elimination of tariff adjustments for transportation companies has caused transportation companies to suffer a decrease in their profitability and, therefore, such companies have limited their investments in pipeline expansion activities. These events have contributed to the energy crisis in the natural gas industry in Argentina, where demand is expected to significantly exceed available capacity.
In light of these events, the Argentine government has decided to initiate a number of strategies, measures and programs aimed at mitigating the energy crisis and supporting the recovery of the Argentine economy generally. With respect to the natural gas industry, these strategies, measures and programs include, among others, the expansion of our pipeline.
In June of 2004, we submitted a proposal to the Federal Energy Bureau upon its request for a project for a 2.9 MMm3/d (102.4 MMcf/d) expansion of the San Martín pipeline transportation capacity. The estimated total amount of such project is approximately US$351 million, including value added tax (VAT) and expenses. We are required to make capital expenditures on our transportation system, totaling approximately US$40 million including VAT and expenses, in connection with the project. Although we do not expect our contribution to the expansion to significantly exceed the amounts specified above, we cannot ensure you that the government will not implement additional strategies to mitigate the energy crisis that would involve our participation. As of the date of this Annual Report, the Argentine government has requested that we provide an estimate of the amount of investments that would be required to expand the transportation capacity of the pipelines that service the Austral and Neuquén Basins. On June 17, 2005, the Federal Energy Bureau issued the Resolution No. 608/05, which requires our participation in the expansion investment for 2006 and states that our investment will not be less than the net discounted value of the future cash flows to be generated by the expansion, calculated at current tariffs. The transportation capacity expansion as well as the discount rate will be determined at a later date. Moreover, the resolution establishes that the Federal Energy Bureau will agree with us prior to implementing any mechanism that would result in the increase of our investment in this new expansion. We will follow up with Federal Energy Bureau on the extent of this resolution. Any new or modified strategies could materially adversely affect our business, results of operations and financial condition.
Also, in 2004, the Executive Branch issued Decree No. 181/04 directing the Federal Energy Bureau to establish a system of priority pursuant to which power stations and gas distribution companies could receive natural gas in priority to other users, even those with firm transportation contracts. On March 23, 2005 we received a notice from the Federal Energy Bureau that provides that from time to time, as necessary, it can make request us to interrupt transportation service to our customers in order to service power stations and gas distribution companies and that ENARGAS will set the priority of transportation in such cases. Although to date our business has not been materially adversely affected by interruption requests, we can not assure you that in the future our business and results of operations will not be adversely affected by such requests.
Increases in export taxes on, a decrease in international prices of or other regulation of NGL may materially adversely affect our results of operations and financial condition.
As a result of the deterioration of our gas transportation segment, operations relating to NGL production and commercialization represented a larger portion of our total net revenues during 2004 and 2003, as compared to previous years. For the year ended December 31, 2004, net revenues relating to NGL production and commercialization represented approximately 51% of total net revenues, as compared to 48% for the same period in 2003. This increase is primarily due to higher international prices for NGL, to which Argentine domestic prices of NGL are tied, and production volume increases. Any decline in international prices for NGL, which have fluctuated significantly over the last ten years, may materially adversely affect our results of operations and financial condition.
In addition, effective March 1, 2002, the Argentine government imposed a 5% export tax on NGL exports, which tax was increased 20% effective May 2004. Any further changes in this tax rate may materially adversely affect our results of operations and financial condition.
Finally, under the current regulatory regime producers of NGL are obliged to ensure that demand in the domestic Argentine market is met, a requirement that may lead us to sell NGL into the domestic market in preference to the export market where prevailing prices are likely to be higher. In addition, while there currently is no formal regulation of domestic prices for NGL, the current regulatory regime may impose a limit in practice on the prices we are able to realize for our domestic NGL sales, and such limit is likely to be below the prices we realize on our export sales.
CIESA, as principal shareholder, exercises significant control over matters affecting us.
Our controlling shareholder is CIESA, which together with Petrobras Energía S.A. (Petrobras Energía) and Enron, hold approximately 70% of our common stock. The shares of CIESA are currently held 50% by Petrobras Energía and one of its subsidiaries and 50% by certain subsidiaries of Enron. The remaining ownership of our capital stock is held by local and foreign investors.
As CIESA controls us, it is in position to direct the management of us, to control the election of a majority of the Board of Directors, to determine our dividend policy and other policies of and to generally determine the outcome of any matter put to a vote of our shareholders. Pursuant to the procedures established by the Argentine Government under which CIESA made its investment in us, there are restrictions on the ability of CIESA to reduce its shareholding in us below 51% of the share capital.
We have engaged in and will continue to engage in transactions with the shareholders of CIESA and their affiliates. However, the interests of these shareholders and affiliates may not be aligned, or may conflict, with our interests.
Item 4. Our Information
Our History and Development
We commenced commercial operations on December 29, 1992, as the largest company created in connection with the privatization of GdE, the Argentine state-owned gas company at the time, whose integrated operations included gas transportation and distribution. GdE was divided into ten companies: two transportation companies and eight distribution companies. We are a sociedad anónima, incorporated with limited liability under Argentine law, whose registered offices are located at Don Bosco 3672, 5th Floor, Buenos Aires (C1206ABF), Argentina, and our telephone number is (54 11) 4865-9050/60/70/80 and our web address is www.tgs.com.ar.
We are currently the largest transporter of natural gas in Argentina, delivering approximately 61% of the countrys total gas consumption through 7,419 km (4,610 miles) of pipeline with a current firm contracted capacity of 65.4 MMm3/d (approximately 2.3 Bcf/d). Substantially all of our capacity is subscribed for under firm long-term transportation contracts. We are also the largest processor of natural gas and one of the largest marketers of natural gas liquids NGL in Argentina. We also operate the General Cerri gas processing complex and the associated Galván loading and storage facility in Bahía Blanca in the Buenos Aires Province (the Cerri Complex) where NGL are separated from gas transported through our pipeline system and stored for delivery.
We hold a License that is currently scheduled to expire in 2027, extendible for an additional ten-year period at the option of us if certain conditions are met, giving us the exclusive right to operate the existing southern Argentine gas transportation pipeline system. Our system connects major gas fields in southern and western Argentina with distributors of gas, as well as large consumers of gas in those regions and in the greater Buenos Aires area, the principal population center of Argentina.
Our controlling shareholder is CIESA, which together with Petrobras Energía and one of its subsidiaries and certain subsidiaries of Enron, hold approximately 70% of our common stock. The shares of CIESA are currently held 50% by Petrobras Energía and one of its subsidiaries and 50% by certain subsidiaries of Enron. The remaining ownership of our capital stock is held by local and foreign investors.
In connection with Enrons bankruptcy, on April 16, 2004, the shareholders of CIESA entered into Master Settlement and Mutual Release Agreement (the Settlement Agreement)providing for, among other things, the transfer, in two stages, of certain shares of our capital stock and the shares of capital stock issued by CIESA. In the first stage: (i) the Enron subsidiaries will transfer 40% of the outstanding share capital of CIESA held by them to a trust or to an alternative entity; and (ii) Petrobras Energía and its subsidiary will transfer our Class B shares they hold (which represent approximately 7.35% of our outstanding share capital) to such Enron subsidiaries. In the second stage, the Enron subsidiaries will transfer their remaining outstanding share capital of CIESA to the trust or the alternative entity, mentioned above, subject to the simultaneous transfer of our Class B shares held by CIESA (which represent approximately 4.3% of our outstanding shares) to the Enron subsidiaries. The Settlement Agreement provides that the trustee of the trust (who will be an independent professional trustee) or the alternative entity would exercise voting control with respect to CIESA shares that are transferred to the trust or the alternative entity and will have power to appoint directors of CIESA. The stated purpose of the trust or the alternative entity as set forth in the Settlement Agreement is to make the property of the trust or alternative entity available for transfer to the creditors of CIESA in connection with the restructuring of CIESAs indebtedness.
In May 2004, the bankruptcy court having jurisdiction over the bankruptcy of Enron approved the Settlement Agreement. In addition, the transfers referred to above are subject to several conditions, one of which is the approval from ENARGAS.
With the prior approval of ENARGAS, on July 15, 2004, Enron Pipeline Company Argentina S.A. (EPCA) assigned its technical assistance agreement with us to Petrobras Energía, whereby Petrobras Energía now functions as our technical operator. During the last three fiscal years, our aggregate capital expenditures amounted to approximately Ps. 245.3 million. Such capital expenditures include Ps. 112.5 million related to our gas transportation system expansions, Ps. 84.9 million related to improvements to our gas transportation system, Ps. 27.0 million related to NGL production and commercialization activities and Ps. 20.9 million related to other services and activities. Information relating to the size and financing of future investments is included in Item 5. Operating and Financial Review and Prospects.
Our major achievement, during 2004, was the successful restructuring of our financial indebtedness in December, as a result of which we replaced defaulted debt with new debt obligations with significantly longer maturities, more closely aligning our repayment obligations with our expected cash flows.
Our Future Strategy
During 2004, we conducted our business within an improved Argentine macroeconomic environment which resulted in an 8% increase of the gross domestic product. The increased prices of Argentine commodities throughout most of 2004, benefited not only the country but also us. However, we believe that the sustainability of this macroeconomic improvement depends on future investment in Argentina and on the resolution of certain key issues which remain yet unsolved and are vital to provide stable and transparent market rules, necessary to foster adequate levels of investments.
However, we still face significant challenges, such as the unresolved issue of the adjustment of tariffs and the redefinition of the gas transportation regulatory framework, which still remains unsettled after three years since the enactment of the Public Emergency Law. We expect that the renegotiation process of utilities and public works contracts will establish new methodologies for the assessment of tariff increases and new mechanisms for their periodic review so as to ensure that long-term investments will be able to be made by the private utilities and that the utilities will be able to receive a return thereon.
In light of the positive achievements described above and the improvement in the macroeconomic circumstances in Argentina, we intend to focus on pursuing and achieving the following goals and objectives:
renegotiating our License and, in particular, the terms and conditions relating to our tariffs and future tariff adjustments. A renegotiation of our License, and the licenses held by similar companies, is essential to support our continued ability to render our gas transportation services and our long-term growth and the growth of the energy industry generally. If this were to occur, we would be in a better position to commence the expansion of our gas transportation system and to maintain and improve the safety and reliability of our gas transportation system;
for the non-regulated business, the consolidation and enhancement of our NGL production and commercialization segment. As for our other services, we aim to develop synergism with other business segments and to explore new business opportunities both in the local and regional markets;
the adoption of corporate governance practices in line with international best practices; and
a style of management that favors communication and teamwork, fostered by the corporate values of the people that work in our organization.
If we achieve these goals and objectives, we believe that our short-term and long-term viability and our prospects for future growth and development will be significantly enhanced, allowing us to play a substantial role in the Argentine economic recovery.
GAS TRANSPORTATION REGULATED BUSINESS
As a transporter of natural gas, we receive gas owned by a shipper, typically a gas distributor, at one or more intake points on our pipeline system for transportation in the pipeline and delivery to the shipper at specified delivery points along the pipeline system. Under applicable law and our License, we are not permitted to buy or sell natural gas except for our own consumption and to operate the pipeline system. See Regulatory Framework below for more information.
Our pipeline system connects major gas fields in southern and western Argentina with distributors of gas in those areas, and the greater Buenos Aires area. Transportadora de Gas del Norte S.A. (TGN), the only other natural gas transportation operating company that supplies the Argentine market, holds a similar license with respect to the northern pipeline system, which also provides gas transportation services to the greater Buenos Aires area.
Gas transportation services accounted for approximately 44%, 47%, 57% and 78% of our total net revenues in 2004, 2003, 2002 and 2001, respectively. In 2004, approximately 72% of our average daily gas deliveries were made under long-term firm transportation contracts entered into with four gas distribution companies that also were formed upon the privatization of GdE and with consumers of natural gas. (See Customers and Marketing below). Firm transportation contracts are those under which capacity is reserved and paid for regardless of actual usage by the customer. All of our firm contracted capacity is currently subscribed for at the maximum tariffs allowed by ENARGAS. Substantially all of our remaining gas deliveries were made under interruptible transportation contracts entered into, in most cases, with the same four gas distribution companies and Repsol-YPF. Interruptible contracts provide for the transportation of gas subject to available pipeline capacity. During 2004, the amount of net revenues derived from firm transportation contracts was approximately Ps. 407.6 million, representing 94% of the total net revenues for the gas transportation segment.
Customers and Marketing
Our principal service area is the greater Buenos Aires area in central-eastern Argentina. We also serve the more rural provinces of western and southern Argentina. Our service area contains approximately 4.8 million end-users, including approximately 3.3 million in the greater Buenos Aires area. Direct service to residential, commercial, industrial and electric power generation end-users is mostly provided by four gas distribution companies in the area, all of which are connected to our pipeline system: MetroGas S.A. (MetroGas), Gas Natural BAN S.A. (BAN), Camuzzi Gas Pampeana S.A. (Pampeana) and Camuzzi Gas del Sur S.A. (Sur). These distribution companies serve in the aggregate approximately 69% of the distribution market in Argentina. The other five distribution companies are located in and serve northern Argentina and are not connected directly to our pipeline system.
The table below contains certain information for 2004, as it relates to the distribution companies that are connected to our pipeline system:
Also connected to the TGN system.
The firm average contracted capacity for our four largest distribution customers, and for all other customers, as a group, at December 31, 2004, 2003 and 2002, together with the corresponding net revenues derived from firm gas transportation services during such years and the net revenues derived from interruptible services during such years, are set forth below:
Step-down Rights. Within the scope of the open bidding conducted during 1998 and 1999 (see Pipeline OperationsPipeline Expansions below), ENARGAS required us to grant all shippers of natural gas step-down rights, which permitted the shippers to reduce some of their committed capacity. Such rights could be exercised if, as a result of the open bidding, new shippers of natural gas subscribed for firm transportation capacity in the zones corresponding to the zones for which step-down rights are being exercised by the original shipper (from the intake to the delivery point) and provided we did not suffer any economic harm. ENARGASs intention was to promote a more efficient use of the pipeline system, avoiding over-subscribed capacity at levels above market demands. ENARGAS requested that we apply this framework to all future open biddings.
If a customer of the distribution company that waived its step-down rights enters into a firm transportation agreement, either directly or indirectly, with us (a by-pass), then the distribution company will have the right to reduce its firm transportation commitment with us up to the amount that is subject to the by-pass arrangement.
Pipeline Deliveries. The following table sets forth our average daily firm and interruptible transportation deliveries for 2004, 2003 and 2002:
Since privatization of the pipeline system, we have succeeded in increasing peak-day delivery capability, as reflected in the pipelines increase in average three-day peak deliveries, from 42.9 MMm3/d (1.5 Bcf/d) in 1991, as measured by GdE (no statistical data is available for 1992), to 69.8 MMm3/d (2.5 Bcf/d) in 2004, representing an increase of 63%.
Pipeline Expansions. As a result of increased availability, we have conducted several open biddings designed to provide all potential shippers with the opportunity to secure additional firm transportation capacity.
From 1994 to 2001, we increased our transportation capacity by approximately 19.6 MMm3/d with an investment of US$423 million. Such investments in the General San Martín, Neuba I, Neuba II and Cordillerano pipelines included (i) the construction of loops for 781 km (485.3 miles), and (ii) an increase of 121,200 HP through the construction of compressor stations, the expansion of the compressing capacity of existing compressor stations and the addition of a new turbine-driven compressor.
Additionally, in 2001, we and Dinarel S.A. (Dinarel) (a company owned by Pan American Energy S.A., Wintershall Energy S.A. and British Gas S.A.) created Gas Link S.A (Link) and entered into an agreement to jointly construct, operate and maintain an approximately 40 km (24.9 miles) gas pipeline that connects our pipeline system to a newly constructed pipeline. This new pipeline was the result of a bidding process sponsored by the Uruguayan government to construct a pipeline to Uruguay with an original capacity of approximately 2.5 MMm3/d (88.3 MMcf/d), to provide gas mainly to two central power generators and to the city of Montevideo. This pipeline capacity, designed to supply the potential Uruguay market demand, which was estimated to be approximately 5.5 MMm3/d (194.2 MMcf/d), could be expanded to 18.5 MMm3/d (653.3 MMcf/d) to cover the demand in the south of Brazil. The link pipeline has an initial transportation capacity of approximately 1 MMm3/d (35.3 MMcf/d), with an associated investment of approximately US$ 20 million, and commenced operations in May 2002.
During 2003 and 2002, we did not make any pipeline expansions, so as to reduce operating costs and capital expenditures and preserve cash flow during the Argentine economic crisis.
In 2003, we entered an agreement with a consortium of gas producers in the Austral basin, constituted by Total Austral S.A., Panamerican Sur S.R.L. and Wintershall Energía S.A. (the Consortium) with the purpose of providing Argentine natural gas to the Methanex company, a leader in methanol production, located in Chile. Under such agreement, in 2004, we constructed a compressor plant of 12,700 HP along the General San Martín pipeline, and through an affiliate, Emprendimientos de Gas del Sur S.A. (EGS), built a pipeline about 6 km (3.7 miles) long and with 1 MMm3/d (35.3 MMcf/d) of initial capacity (with a 1.2 MMm3/d or 42.4 MMcf/d expansion foreseen by the year 2009), which links our main pipeline system to the Chilean border. The financing of the project consisted of advance payments from the Consortium on account of future services. The pipeline was completed in late 2004 and is currently in service.
In February 2004, we reached an agreement with UNIREN and Sur, under which we invested Ps. 17.0 million in a pipeline expansion. The project consisted of the construction of approximately 51 km (32.7 miles) of looping pipeline that is connected to the Cordillerano pipeline. Our investment in this project reduced our liability to GdE in respect of a claim filed by GdE in 1996. See Item 8. Financial InformationConsolidated Statements and Other Financial InformationLegal and Regulatory Proceedings.
In June 2004, we submitted to the Federal Energy Bureau a project for the expansion of the General San Martín pipeline transportation capacity of approximately 2.9 MMm3/d (102.4 MMcf/d). On November 3, 2004, we entered into a letter of intent (the Letter of Intent) with the Ministry of Economy and Production, the Ministry of Federal Planning and Public Service (MPFIPyS), the Federal Energy Bureau, Nación Fideicomisos S.A. (Nación Fideicomisos), Banco de la Nación Petrobras Energía and Petróleo Brasileiro S.A. (Petrobras), among others, which was approved by the Argentine government by Resolution MPFIPyS No. 185/04, outlining an agreement of the general terms of the pipeline expansion project. In accordance with the structure specified in the trust agreement (the Trust Agreement), dated as of November 10, 2004, among us, the Federal Energy Bureau, Nación Fideicomisos (the trustee of the Gas Trust), Banco de la Nación, Petrobras Energía and Petrobras, among others, a trust was created (the Fideicomiso de Gas or Gas Trust) for the purpose of implementing the expansion project, which will be funded in two tranches: (i) the first one, through private contributions made by Brazils National Development Bank (BNDES), Banco de la Nación, Petrobras Energía, Petrobras and other gas producers, and (ii) will be followed by a second tranche funded by the issuance of up to Ps. 3 billion in principal amount of securities to the public, a portion of the proceeds from which will be used to reimburse the initial private contributors (other than us). The estimated total investment required for the expansion project is approximately US$351 million (including VAT and expenses), approximately US$40 million of which shall be provided by us through capital expenditures on our transportation system. We are the project manager for the expansion project (as well as being the trustor of the Gas Trust) and will receive a fee equal to 1% of the final amount of investment based on the execution of the projects works. In addition, we will operate the assets and render the maintenance services. Our investment of approximately US$40 million is to be recovered over time by the payment to us of 80% of the gas transportation revenues obtained from the additional transportation capacity, based on our current tariff rate (but not to the extent of any increased rate that may apply in the future), which we expect will represent annual revenues of approximately Ps. 23 million (for more information see Item 10. Additional InformationMaterial ContractsGas Trust).
This project involves the construction of approximately 509 km (316 miles) of pipeline and a 30,000 HP compression capacity increase through the construction of a compressor plant, the addition of a new turbocompressor at Cerri and the revamping of some of our existing compressor units. As of the date of this Annual Report, all of the additional capacity is expected to be on line by August 30, 2005. This additional transportation capacity was fully subscribed under firm transportation contracts in an open bidding conducted by us in June 2004. The term of these new contracts is for approximately 16 years. Substantially all the capacity was subscribed for by gas distribution companies.
As of the date of the issuance of this Annual Report, we maintain an escrow of US$24 million in favor of the pipe supplier in connection with the San Martín expansion project, as a condition to preserve the price and delivery terms of the bid submitted by the supplier to the Gas Trust. The supplier will reimburse this amount to us once it receives payment from the Gas Trust, the timing of which depends principally on the Gas Trust obtaining a loan from a foreign bank.
System Improvements. During the five-year period ended December 31, 1997 and as a part of the five-year mandatory investment program required under our License, we made capital expenditures in the aggregate amount of approximately US$ 172 million to improve the safety and reliability of our pipeline system. These investments included approximately US$ 34 million for internal and external inspection of approximately 10,000 km (6,217 miles) including a first and, in some cases, a second inspection of our main pipelines. The inspections were performed using the leading technology for detecting pipeline flaws, such as metal loss, out-of-round condition and manufacturing or welding defects and their magnitude and precise location. We used the information resulting from the inspection program to establish a maintenance and repair schedule. Based on the results of the inspections, we replaced approximately 304 km (189 miles) of pipelines on our Neuba I, Loop Sur and San Martín pipelines without any significant impact on service, at a cost of approximately US$ 111 million, including repair costs. In addition, we invested approximately US$ 27 million in other mandatory investments designed to improve the safety and reliability of the system. During the initial five-year period we also made capital expenditures of approximately US$ 54 million in addition to those required under our License. These investments were directed towards the pipeline compression facilities and the enhancement of overall pipeline system safety and reliability.
In 2004, 2003 and 2002, we made capital expenditures in the amount of approximately Ps. 26.4 million to continue the enhancement of the pipeline systems safety and reliability. We operate our pipelines in accordance with the Argentine gas transmission safety regulations, which are substantially similar to U.S. federal regulations. We believe that, based on the pipeline inspection reports we have received to date and the pipeline repairs and/or replacements being made to the General San Martín and Neuba I pipelines, the current operation of the pipeline system poses no significant safety risks. Since the commencement of our operations in late 1992, we have implemented measures to ensure that the service would not be interrupted in any relevant consumption center; for this reason in the last five years we had not had significant ruptures in our systems pipeline.
As the Neuba I suffered ruptures in 1998 and 1999, caused by the fissures which were produced by the Stress Corrosion Cracking (SCC), we made, in 2000 and 2001, hydrostatic tests on some critical tranches of that pipeline. As a consequence of these tests, we replaced approximately 1.2 km of pipeline and carried out a recoating program.
The hydrostatic tests imply the interruption of the gas transportation service for approximately one month. Currently, this is impracticable due the high gas transportation demand. Therefore, in 2004, we contacted a Russian company, an internal inspection service supplier, which offered us an internal inspection tool that permits the detection of the SCC without requiring the interruption of the gas transportation service. In March 2005, we made an internal inspection on some pipeline tranches by using this new technology and, currently, we are assessing the effectiveness of this tool.
System Automation. We have improved system automation through a three-part program that includes installation of an Electronic Flow Measurement (EFM) system, implementation of remote controls at compressor stations and end devices, such as valves, and implementation of dynamic system simulation. The EFM system has been installed at custody transfer points along the system and the data is transmitted to the gas control center in Buenos Aires. The EFM system controls almost all the gas transported along the pipeline, allowing us to monitor the flow and pressure of gas along the pipeline in real time. The information provided by the EFM system and the remote compressor controls provide data to the system simulation. The system simulation, in turn, analyzes the data and assists in optimizing the volume of gas transported through the system. We believe that the improved system automation ensures greater control over gas flow and improves our ability to deliver gas more effectively, to provide precise information to customers as to the movement of the gas, to minimize fuel usage and to generally enhance the quality and reliability of the services we provide. Currently, we remotely operate 14 of our 28 compressor stations.
Technical Assistance Agreement. As part of its bid to purchase a 70% interest in us from the Argentine government, CIESA was required to have an investor-company with experience in natural gas transmission that would serve as our technical operator. In late 1992, we entered into the Technical Assistance Agreement with EPCA, an indirect, majority-owned subsidiary of Enron. The term of the Technical Assistance Agreement was for eight years from December 28, 1992, renewable automatically upon expiration for additional eight-year periods. The Settlement Agreement, mentioned in Our History and DevelopmentGeneral, includes a term which provides for the assignment of the Technical Assistance Agreement to Petrobras Energía. This assignment, which was approved by ENARGAS in June 2004, was carried out on July 15, 2004. As from that date, Petrobras Energía is our technical operator and in charge of providing services related to, among others, the operation and maintenance of the gas transportation system and related facilities and equipment, to ensure that the performance of the system is in conformity with international gas transportation industry standards and in compliance with certain Argentine environmental standards.
The Technical Assistance Agreement sets out the services to be provided by Petrobras Energía to us, at the request of our Chief Executive Officer (CEO), in return for payment of an annual technical assistance fee equal to the greater of (i) Ps. 3 million or (ii) 7% of the amount obtained after subtracting Ps. 3 million from net income before financial income (expense) and holding gains (losses) and income taxes. The services to be provided by Petrobras Energía to us under the Technical Assistance Agreement include assisting us in the following matters to the extent that they arise in the ordinary course of business: (i) replacement, repair and renovation of facilities and equipment to ensure that the performance of the system is in accordance with international gas transportation industry standards; (ii) preparation of performance evaluations, operating cost analyses, construction assessments and advice related to budget control; (iii) advice regarding safety, reliability and efficiency of system operation and gas industry services; (iv) advice regarding compliance with applicable laws and regulations relating to safety and health, pollution and environmental protection of the system; (v) routine and preventive maintenance of the system; (vi) staff training; (vii) design and implementation of the procedures necessary to accomplish the aforesaid services; and (viii) design and implementation of a management information and inspection system for all major aspects of natural gas transportation and NGL production. The amounts payable under the Technical Assistance Agreement are also limited by the terms of our debt instruments. See Item 10. Additional InformationMaterial ContractsNew Debt ObligationsCovenants.
The Argentine Natural Gas Industry
Historical Background. Prior to the privatization of GdE, the Argentine natural gas industry was effectively controlled by the Argentine Government. In addition, prior to its privatization, Repsol-YPF or its predecessors held exclusive rights over the development and production of all new hydrocarbon reserves in Argentina.
In 1992, the Natural Gas Act and Decree Nos. 1,189/92 and 1,738/92 of the Executive Branch were passed providing for the privatization of GdE. The Natural Gas Act and the related decrees provided for, among other things, the transfer of substantially all of the assets of GdE to two transportation companies and eight distribution companies. The transportation assets were divided into two systems on a broadly geographical basis, the northern and southern trunk pipeline systems, designed to give both systems access to gas sources and to main centers of demand, including the greater Buenos Aires area. As a result of the division, our transportation system is connected to the two distribution systems serving the greater Buenos Aires area, one serving Buenos Aires Province (excluding the greater Buenos Aires area) and one serving southern Argentina. TGN is connected to five distribution systems serving northern Argentina. TGN is also connected to the distribution systems serving the greater Buenos Aires area and, to a limited extent, the distribution system serving Buenos Aires Province (excluding the greater Buenos Aires area). In the two instances where we are directly connected to a distribution system with TGN, we are the principal supplier of gas transportation services.
The Natural Gas Act and the related decrees granted each privatized gas transportation company a license to operate the transferred assets, established a regulatory framework for the privatized industry based on open, non-discriminatory access, and created ENARGAS to regulate the transportation, distribution, marketing and storage of natural gas. The Natural Gas Act also provided for the regulation of wellhead gas prices in Argentina for an interim period. Prior to deregulation, the regulated price was set at US$0.97/million British thermal units (MMBtu) at the wellhead, which had been the regulated price since 1991. Pursuant to Decree No. 2,731/93, gas prices were deregulated as of January 1, 1994. Since deregulation until 2001, average prices rose by approximately 67%.
On February 13, 2004, the Executive Branch signed two decrees related to the natural gas market in order to secure the adoption of measures to normalize the supply of natural gas. The Executive Branch, through Decree No. 180/04, established the creation of the MEG with the purpose of improving the transparency of financial and operating performance, the coordination of daily transactions both of the gas spot market and the transportation and distribution secondary markets along with the shaping of efficient prices through offer and demand free interaction. To that purpose, all firm transportation capacity non-allocated for the following day shall be marketed through the MEG and the proceeds from that capacity sale will be used at the discretion of the Federal Energy Bureau. Non-allocated capacity includes remaining capacity not used in any of the transportation systems or pipelines. This implies that we are bound to offer daily non-allocated capacity that complies with this condition in the MEG, which might have a material impact on our interruptible transportation revenues.
In spite of the devaluation of the peso, from early 2002 to May 2004, wellhead gas prices remained unchanged. This was the indirect consequence of the government prohibition on distribution companies passing through any price increase implemented by the producers, which made it impossible for producers to implement any increase in the wellhead gas price. In May 2004, both producers and the Argentine government agreed on: (i) graded price increases in several stages only for power plants, compressed natural gas (CNG) for vehicles, industries and retail in which consumption surpasses 9,000 m3/month; and (ii) free market prices since August 1, 2005 and January 1, 2007, for the above mentioned end-consumers and those users whose consumption is lower than 9,000 m3/month, respectively. The last agreed increase will be effective in July 2005, and the aggregate agreed increases will range from 105% to 180%, depending on the gas basin.
According to Decree No. 181/04, the Federal Energy Bureau has the power to make agreements with natural gas producers to establish natural gas price adjustments associated with the services rendered by distribution companies. In addition, the Federal Energy Bureau may agree with producers on mechanisms to protect new direct consumers who start purchasing natural gas directly from producers previously connected to the distribution companies system. This price adjustment must contemplate a scheme of tariff segmentation created by the above-mentioned Decree that considers the possibilities to afford this adjustment to different kinds of end-consumers.
Demand for Natural Gas. Natural gas consumption in Argentina has almost quadrupled from approximately 9.3 Bm3 (328 Bcf) in 1980 to 33.5 Bm3 (1,182.2 Bcf) in 2004, representing a compound annual rate of growth in consumption of approximately 5.5%. According to recent projections, local demand for natural gas is expected to increase at an average annual rate of 3% through the year 2015 principally due to expected increase in the thermoelectric power generation, growth in residential and industrial demand and increases in the consumption of CNG for vehicles. In addition, natural gas has experienced a significant increase in market share in Argentina in recent years to approximately 48% of total national energy consumption in 2004, which is greater than the comparable percentage for worldwide energy consumption. Despite the relatively high market share for natural gas in Argentina when compared with other countries, additional market opportunities for natural gas exist in Argentina. For example, according to the Federal Energy Bureau, approximately half of residential households currently have no access to natural gas.
The table below sets forth the consumption of natural gas in Argentina by class of user, stated as a percentage of total consumption, for the periods indicated.
A sharp increase in natural gas demand started as a result of the devaluation of the peso in early 2002. Natural gas became, by far, the cheapest fuel due to the pesification of transportation and distribution tariffs and the lack of adjustments of both these tariffs and wellhead gas prices. As a consequence, gas has been substituted for other fuels at a high level, including the increase of the use of CNG for vehicles. Likewise, the rising demand for gas was also based on the recovery of certain industrial segments of the Argentine economy and the shortage of rain in Argentina, which contributed to lower hydroelectric generation and, consequently, to a higher demand for electricity from thermoelectric power plants.
As the distribution companies have been prohibited from passing through price increases to consumers, producers of natural gas, therefore, have been limited, if not unable, to implement wellhead gas price adjustments since 2002, which has caused such producers to suffer a sharp decline in their rate of return on investment activities. As a result, producers of natural gas have limited their investments in exploration and production of natural gas.
The Argentine government has decided to play a decisive role in the industry through a set of measures to address the combination of the rising demand and lower investments in exploration, production, transportation and distribution of natural gas. The goal of the measures set forth below is to reduce the impact of the energy crisis on the recovering Argentine economy:
creation of Energía Argentina S.A. (ENARSA) for the purposes of restoring the levels of reserves, production and supply of natural gas and meeting the infrastructure needs of the gas transportation and electricity industries. The controlling shareholder will be the Argentine government and a portion of the common stock will be sold to private investors;
approval of graded price increases of natural gas at wellhead;
the establishment of a framework for the constitution of trust fund vehicles to finance gas pipeline expansions;
creation of the MEG to improve the transparency and efficiency of daily operations through the free interaction of the offer and demand of natural gas;
creation of the Program for the Rationalization of Energy intended to stimulate savings of gas and electricity to generate surplus to be applied to industrial activities;
the decision to import natural gas from Bolivia, electricity from Brazil and fuel oil from Venezuela -the latter as an alternative fuel to natural gas - and to reduce natural gas exports to Chile; and
the completion of the expansion works in Yacyretá Hydroelectric Plant and Atucha I Nuclear Power Plant.
The lack of progress in the renegotiation of utility companies services contracts, in part, prevented natural gas licensees from making investments to expand pipeline capacity that are necessary to meet increasing demand in the industry. To address this issue, the Argentine government promoted the creation of financial trust funds, such as the Gas Trust, as vehicles to facilitate those investments. Although this alternative investment structure may prove successful at addressing demand problems in the few years, management believes that it does not seem feasible as a solution for financing infrastructure investments in the long-term, because trust-sponsored expansions of the pipeline system are likely to be designed to permit investors in the trust to recover their investments in the short term. As a result, this structure requires significant tariff increases that are borne by a relatively small number of parties (e.g., large industrial companies, power plants, CNG suppliers and other important commercial companies). Management believes that the capacity of these groups of customers to absorb tariff increases is limited.
The financing approach taken over the last decade by privatized companies not only resulted in a significant increase of gas transportation capacity and distribution in the gas transportation systems but also the introduction of new technologies and the development of optimal operative maintenance conditions of the systems. The excellent maintenance conditions that were developed have enabled the privatized companies to continue delivering quality in gas transportation and distribution services and respond to a growing demand, despite the inability of such companies to make additional capital investments in the systems during the recent Argentine economic crisis. However, the deterioration of the tariff regime and abrogation of the adjustment mechanism specified in the private companies licenses has turned Argentina into the Latin American country with the lowest cost in gas, rendering it unfeasible for companies to raise capital sufficient to implement the expansion projects necessary to address high gas demand growth rates (7.7% in 2004).
In response to the Argentine governments initiative to create trust funds to finance system expansions, in June 2004, we submitted to the Federal Energy Bureau an expansion project for the General San Martín pipeline involving a capacity increase of approximately 2.9 MMm3/d (102.4 MMcf/d). The project will require the construction of approximately 509 km (316.3 miles) of pipeline and a compression capacity increase of 30,000 HP through the construction of a compressor plant and the renovation of certain compressor units. The expansion is anticipated to be completed in the third quarter of 2005. See Item 10. Additional Information. Material Contracts.
Additionally, on May 6, 2005, the Executive Branch issued Decree No. 465/05 that instructs the MPFIPyS to develop, through the Federal Energy Bureau, a course of action to expand the gas transportation system capacity in 2006. These expansions shall be financed by trust funds organized by the Federal Energy Bureau following Decree No. 180/04. The Federal Energy Bureau has requested us to estimate the amount of investments that would be necessary to expand transportation capacity from 1 up to 5 MMm3/d in each of the pipelines which transport gas from the Austral and Neuquén Basins.
On June 17, 2005, the Federal Energy Bureau issued the Resolution No. 608/05, which requires our participation in the expansion investment for 2006 and states that our investment will not be less than the net discounted value of the future cash flows to be generated by the expansion, calculated at current tariffs. The transportation capacity expansion as well as the discount rate will be determined at a later date. Moreover, the resolution establishes that the Federal Energy Bureau will agree with us prior to implementing any mechanism that would result in the increase of our investment in this new expansion. We will follow up with Federal Energy Bureau on the extent of this resolution.
Gas Supply. For the most part, Argentinas gas reserves were discovered as a consequence of exploration for oil reserves. There are 19 known sedimentary basins in the country, ten of which are located entirely onshore, six of which are combined onshore/offshore and three of which are entirely offshore. Production is concentrated in five basins: Noroeste in northern Argentina, Neuquén and Cuyo in central Argentina, and Golfo San Jorge and Austral in southern Argentina. Approximately 70% of the gas transported by our system in 2004 originated in the Neuquén basin with the remainder coming primarily from the Austral basin. Our pipeline system is connected to the Neuquén, Austral and Golfo San Jorge basins. We are not connected to the Cuyo or Noroeste basins.
Set forth in the table below is the location of the principal gas producing basins by province, their proved natural gas reserves estimated as of December 2003, production in 2003 and the calculated reserve life for each basin:
Estimated as of December 31, 2003. There are numerous uncertainties inherent in estimating quantities of proved reserves. The accuracy of any reserve estimate is a function of the quality of available data and engineering and geological interpretation and judgment. Results of drilling, testing and production after the date of the estimate may require substantial upward or downward revisions. Accordingly, the reserve estimates could be materially different from the quantity of gas that ultimately will be recovered.
Reserve figures do not include significant reserves located in certain Bolivian basins to which TGN is connected.
Weighted average reserve life for all basins, at 2003 production levels.
Source: Federal Energy Bureau
Neuquén Basin. The largest of the gas basins and the major source of gas supply for our system is the Neuquén basin, located in west central Argentina. The TGN system also accesses the Neuquén basin. Of the transported gas coming from the Neuquén Basin approximately 67% was transported by us and approximately 33% by TGN for the year ended December 31, 2004.
Austral and Golfo San Jorge Basins. Natural gas provided by these basins, located in the southern region of Argentina, was transported mainly by us (Sur also transports gas through regional pipelines). In the Austral basin, exploration has centered in and around the basins existing gas fields and on other fields located offshore. The Golfo San Jorge basin is primarily an oil-producing basin.
Industry Structure. The Natural Gas Act, together with Decree No. 1,738/92, other regulatory decrees, El Pliego de Bases y Condiciones para la Privatizacion de Gas del Estado S.E. (the Pliego), the transfer agreements and the licenses of the newly privatized companies establish the legal framework for the transportation and distribution of gas in Argentina Law No. 17,319 (the Hydrocarbons Law) regulates the midstream gas industry, under a competitive and partially deregulated system. The Public Emergency Law and related laws and regulations have had the practical effect of significantly altering the regulatory regime under which we operated until 2002. See Item 3. Key InformationRisk FactorsRisks Relating to Our BusinessBecause we receive a significant portion of our net revenues from public service contracts that are no longer subject to indexing, our net revenues, and liquidity, have been harmed as a result of inflation and the devaluation of the peso.
Natural gas transportation and distribution companies operate in an open access, non-discriminatory environment under which producers and certain third parties, including distributors, are entitled to equal and open access to the transportation pipelines and distribution system in accordance with the Natural Gas Act, applicable regulations and the licenses of the privatized companies. In addition, a regime of concessions under the Hydrocarbons Law is available to holders of exploitation concessions to transport their own gas production.
The Natural Gas Act prohibits gas transportation companies from also being merchants in natural gas. Also, (i) gas producers, storage companies, distributors, and consumers who contract directly with producers may not own a controlling interest (as defined in the Natural Gas Act) in a transportation company, (ii) gas producers, storage companies and transporters may not own a controlling interest in a distribution company, and (iii) merchants in natural gas may not own a controlling interest in a transportation or distribution company.
Contracts between affiliated companies engaged in different stages in the natural gas industry must be approved by ENARGAS. ENARGAS may reject these contracts if it determines that they were not entered into on an arms-length basis.
ENARGAS, which was established by the Natural Gas Act, is an autonomous entity responsible for enforcing the provisions of the Natural Gas Act, applicable regulations and the licenses of the privatized companies. ENARGAS is governed by a board of directors composed of five full-time directors who are appointed by the Executive Branch subject to confirmation by the Congress. ENARGAS, which operates within the purview of the Ministry of Economy and Public Works and Services, has broad authority to regulate the operations of the transportation and distribution companies, including the ability to set rates. ENARGAS has its own budget which must be included in the Argentine National Budget and submitted to Congress for approval. ENARGAS is funded principally by annual control and inspection fees that are levied on regulated entities in an amount equal to the approved budget, net of collected penalties, allocated proportionately to each regulated entity based on their respective gross regulated revenues, excluding natural gas purchase and transportation costs in the case of distribution companies. ENARGAS also collects the fines imposed for violations of the Natural Gas Act on each companys license.
Most of the electrical power stations do not have firm gas supply agreements and, as a result of the gas shortage in Argentina, they have increasingly used alternative fuel which is more expensive than natural gas. In 2004, the Executive Branch issued Decree No. 181/04, directing the Federal Energy Bureau to establish a system of priority pursuant to which power stations and gas distribution companies could receive natural gas in priority to other users, even those with firm transportation contracts. On April 21, 2004, the MPFIPyS issued Resolution No. 208/04 that memorialized an agreement between the Federal Energy Bureau and gas producers to give effect to this new system.
On March 23, 2005, we received a notice from the Federal Energy Bureau that provides that, in the event there is insufficient gas available in the market to supply power stations, they can require us to interrupt transportation services to our firm capacity customers in order to give priority to gas distribution companies and power plants that have not entered into firm transportation. In any such case, ENARGAS will set the priority of transportation.
Under these circumstances and according to the responsibilities granted to us in the License, if ENARGAS asks us to interrupt firm transportation contracts, we will be exposed to possible claims from, among others, our customers. Therefore, we have requested that in connection with these new procedures, ENARGAS submit to us in writing instructions for any such firm transportation service interruption request. However, if ENARGAS does not accept our petition and we do not comply with ENARGAS instructions, if any (in order to avoid future claims from our customers), Resolution No. 208/04 will require us to pay the price difference between natural gas and alternative fuel used by power stations, in order to offset the loss resulting from our failure to comply with the instructions.
Our License. Our License authorizes us to provide the public service of gas transportation through the exclusive utilization of the southern gas transportation system. Our License does not grant us an exclusive right to transport gas in a specified geographical area and licenses may be granted to others for the provision of gas transportation services in the same geographical area. TGN operates the northern gas transportation system under a license containing substantially similar terms to those described below and elsewhere herein.
Our License has been granted for an original term of 35 years beginning on December 29, 1992. However, the Natural Gas Act provides that we may apply to ENARGAS for a renewal of our License for an additional ten-year term. ENARGAS is required at that time to evaluate our performance and make a recommendation to the Executive Branch. If ENARGAS determines that we are in substantial compliance with all our obligations arising under the Natural Gas Act, related regulations and our License, the renewal must be granted by the Executive Branch. ENARGAS would have the burden of proving that we had not complied with the obligations described above and, therefore, should not be granted a renewal. At the end of the 35-year or 45-year term, as the case may be, the Natural Gas Act requires that a new competitive auction be held for the license, in which we would have the option, if we have complied substantially with our obligations described above, to match the best bid offered to the Argentine government by any third party. To the extent that we were found not to have complied with the obligations described above or chose not to seek renewal of our License, we would be entitled to certain specified compensation. See Certain Restrictions with Respect to Essential Assets below.
Our License also specifies certain other rights and obligations of us relating to the services we provide. These include:
operating and safety standards;
terms of service, including general service conditions such as specifications regarding the quality of gas transported, major equipment requirements, invoicing and payment procedures, imbalances and penalties, and guidelines for dispatch management;
contract requirements, including the basis for the provision of service, e.g., firm or interruptible;
mandatory capital investments to be made over the first five-year of the license term; and
applicable rates based on the type of transportation service and the area serviced.
The mandatory five-year investment plan for the years 1993-1997, which was approved by ENARGAS in 1999, required us to invest in its natural gas pipeline system a total of US$153 million representing US$ 30.6 million per year beginning in 1993. This mandatory investment plan was related to the operational capability and public safety of the pipeline system and included, among other things, cathodic protection, internal inspection and pipeline replacement and coating.
Our License establishes a system of penalties in the event of a breach by us of our obligations thereunder, including warnings, fines and revocation of our License. These penalties may be assessed by ENARGAS based, among other considerations, upon the severity of the breach or its effect on the public interest. Fines of up to Ps. 500,000 may be levied for persistent breaches. Revocation of our License may only be declared by the Executive Branch upon the recommendation of ENARGAS. Our License specifies several grounds for revocation, including the following:
repeated failure to comply with the obligations of our License and failure to remedy a significant breach of an obligation in accordance with specified procedures;
total or partial interruption of the service for reasons attributable to us, affecting completely or partially transportation capacity during the periods stipulated in our License;
sale, assignment or transfer of our essential assets or otherwise encumbering them, without ENARGASs prior authorization, unless such encumbrances serve to finance extensions and improvements to the gas pipeline system;
bankruptcy, dissolution or liquidation of us; and
ceasing and abandoning the provision of the licensed service, attempting to assign or unilaterally transfer our License in full or in part without the prior authorization of ENARGAS, or giving up our License, other than in the cases permitted therein.
Our License also prohibits us from assuming debt of CIESA, or from granting credit to, creating security interests in favor of, or granting any other benefit to, creditors of CIESA.
Generally, our License may not be amended without our consent. As part of the renegotiation process under the Public Emergency Law, however, the terms of our License may be changed or our License may be revoked. In addition, ENARGAS may alter the terms of service annexed to our License. If any such alteration were to have an economic effect on us, ENARGAS could modify our rates to compensate for such effect or we could request a change in the applicable rates.
Regulation of Transportation RatesActual Rates. The gas transportation rates established under each transportation companys license must be calculated in U.S. dollars and converted into pesos at the time of billing pursuant to the terms of such license. However, the Public Emergency Law eliminated tariff indexing covenants based on U.S. dollar exchange rate fluctuations and established a conversion rate of one peso equal to one U.S. dollar for tariffs.
The transportation rate for firm transportation services consists of a capacity reservation charge and is expressed as a maximum monthly charge based on the cubic meters per day of reserved transportation capacity. The rate for interruptible transportation service, which is expressed as a minimum (from which no discounts are permitted) and a maximum rate per 1,000 m3 of natural gas transported, is equivalent to the unit rate of the reservation charge for the firm service based on a load factor of 100%. For both firm and interruptible transportation services, customers are obligated to provide a natural gas in-kind allowance, expressed as a maximum percentage of gas received, equivalent to the gas consumed or lost in rendering the transportation service. The rates for all services reflect the rate zone(s) traversed from the point of receipt to the point of delivery.
The table below sets out our firm and interruptible rates by pipeline and zones, in effect as of the date of this Annual Report (which have not changed since January 1, 2000):
Monthly charge for every cubic meter per day of reserved transportation capacity.
Minimum charge equal to the unit rate of the firm reservation charge at a 100% load factor.
Maximum percentage of total transported gas which customers are required to replace in-kind to make up for gas used by us for compressor fuel or losses in rendering transportation services.
Source: ENARGAS Resolution No. 2,496/02 (gross receipts tax is not included in such transportation rates)
Adjustment of Rates. Under our License, we may be permitted to adjust rates semi-annually to reflect changes in PPI and every five years in accordance with efficiency and investment factors to be determined by ENARGAS and, subject to ENARGASs approval, from time to time to reflect cost variations resulting from changes in the tax regulations (other than income tax) applicable to us, and for objective, justifiable and non-recurring circumstances. However our ability to make these adjustments has been suspended by the Argentine government as part of the Public Emergency Law.
The Natural Gas Act requires that in formulating the rules that apply to the setting of future rates, ENARGAS must provide the transportation companies with (i) an opportunity to collect revenues sufficient to recover all proper operating costs reasonably applicable to service, taxes and depreciation, and (ii) a reasonable rate of return, determined in relation to the rate of return of businesses having comparable risk, and shall take into account the degree of efficiency achieved and the performance of the company in providing the service. No assurances can be given that the rules to be promulgated by ENARGAS will result in rates that will enable us to achieve specific earnings levels in the future.
The rate-setting methodology contemplated by the Natural Gas Act and our License is the price-cap with periodic review model. Under this model, rates may be adjusted by an efficiency and an investment factor. Based upon this regulatory approach, those rates should provide a reasonable return and that the benefit of increased efficiency should be shared by the consumer and the transporter. The inclusion of an efficiency factor results in a decrease in rates as the transporter lowers costs through increased efficiency. Notwithstanding this, the inclusion of the efficiency factor in the pricing system provides the transporter with an incentive to cut costs because the price is established in advance for the period up to the next five-year revision, and does not discount for efficiencies made during the period. The adjustment to account for efficiencies is proposed by ENARGAS based on specific plans for efficiency improvements, taking into account both the expected cost savings and the investment required for the implementation of such plans.
The inclusion of the investment factor in the formula specified in our License is intended to permit an increase in the rates at the time of their adjustment to compensate us for certain investments to be made during the relevant five-year period. The investments contemplated by the investment factor are those designed to improve the efficiency, safety or reliability of the system and to expand the system, and may either be required by ENARGAS to be made or may initially be proposed to be undertaken by us. In exceptional cases, we may also petition ENARGAS at any time for a rate adjustment relating to proposed investments to expand system capacity when the resulting costs cannot be recovered with the existing rate.
If we do not agree on the efficiency or investment factors established by ENARGAS, or on the terms of the investment program established by ENARGAS, the factors established by ENARGAS will be applied but we may seek administrative or judicial review.
ENARGAS is responsible for determining the rates that are to be effective during each succeeding five-year period following the initial five-year period ended December 1997. In 1996, ENARGAS set the weighted average cost of capital to be used for the determination of the efficiency and investment factors at 11.3% per annum, net of future inflation. As a result of the first general rate review process which ended in December 1997, our transportation rates suffered an up front one-time decrease of 6.5% effective January 1, 1998, based on the application of the efficiency factor, representing a decrease of approximately Ps. 52 million in 1998 net revenues. In connection with the investment factor, ENARGAS approved the application of periodic increases through January 2002 to our tariffs resulting in a total weighted average of 2.6% as of that date to compensate us for approximately US$70 million in investments. These investments principally include the modifications to the Buenos Aires high-pressure ring, the expansion of the Cordillerano pipeline in western Argentina, and enhancements to the General San Martín pipeline in preparation for future expansions.
Since January 1, 2000, adjustments to tariffs to reflect PPI variations were suspended, first through an agreement with the Executive Branch and later by a court decision arising from a lawsuit started to determine the illegality of tariff adjustment through indexes. In light of this situation, we continued recording the higher incomes derived from semi-annual PPI increases until December 31, 2001. However, since the approval of the Public Emergency Law, we deemed that tariff adjustment to reflect PPIwhich was legitimate according to the regulatory framework agreed upon in the privatizationhad turned out unlikely, as the possibility of its recovery was subject to future events beyond our control. Therefore, in 2001, we recorded a loss of Ps. 126.7 million related to the deferral of semi-annual PPI adjustments accrued during 2000 and 2001, and, since 2002, we have discontinued such accrual. This does not mean that we waive the rights and the actions we are entitled to under the regulatory framework. We intend to continue to maintain and exercise such rights and actions in every available legal and administrative venue, including the renegotiation process under the Public Emergency Law.
As mentioned above, tariff adjustments contemplated within the regulatory framework are no longer effective since the approval of the Public Emergency Law in early 2002, which among other provisions eliminated tariff indexing increases based on U.S. dollar exchange rate fluctuations, foreign price indexes or any other indexing procedure and established a conversion rate of one peso to one U.S. dollar for tariffs. The Public Emergency Law also granted the Executive Branch power to renegotiate contracts entered into with private utility companies, pursuant to the framework included in the Public Emergency Law. However, since early 2002 and up to the date of this Annual Report no resolution has been reached in the renegotiation of our contractsnor have tariffs been readjustedin spite of several attempts by the Executive Branch to grant partial tariff increases. These tariff increases were suspended by court decisions on legal actions filed by consumer organizations and the Ombudsman, on the grounds that tariff increases were illegal until the contract renegotiation process was completed.
In July 2003, UNIREN was created under the joint jurisdiction of the Ministries of Economy, Production, Federal Planning, Public Investment and Utilities. This unit, which is the successor of the former Committee for the Renegotiations of Public Services and Works Contracts, will conduct the renegotiation process of contracts related to utilities and public works, and is empowered to reach total or partial agreements with the licensees and submit proposals regulating the transitory adjustment of tariffs and prices, among other things. No progress was made in the renegotiation process until December 2003, when we discussed preliminary documents with UNIREN, including (i) the renegotiation guidelines, which determined the preparation of an agenda and a schedule for its discussion, (ii) a draft agenda which was outlined in order to deal with main issues such as costs, investments programs and financing, rates of return and tariffs, etc. and (iii) a schedule, which settled for the renegotiation of the regulatory framework.
In July 2004, UNIREN submitted to us a proposal for the adjustment of the contractual terms and conditions of our License, which provides for, among other things, a tariff increase of 10% effective as from January 2005, an overall tariff review to become effective beginning 2007 and requires our abandonment and the abandonment of our shareholders of any claim or lawsuit resulting from the effects of the Public Emergency Law on our License prior to the effectiveness of a renegotiation of our License, as well a requirement that we hold the Argentine government harmless from any claim or lawsuit filed by our shareholders or reimburse the Argentine government for any amount paid by it to our shareholders in connection with any such claim or lawsuit.
As this proposal differed from discussions we previously had with UNIREN, we rejected it choosing instead to seek to reach an overall agreement with UNIREN by the end of 2004 (in line with what had been originally outlined by UNIREN in the Preliminary Renegotiation Guidelines) and to carry out the process of obtaining approval from the National Congress during the first semester of 2005.
On March 10, 2005, UNIREN called for a public hearing, which was held on April 27, 2005, to discuss its proposal presented in July 2004. During the hearing, UNIREN reaffirmed its offer of a 10% tariff increase and proposal to continue the process of the overall tariff revision, so that the resulting tariff adjustments will come into effect during 2006. Regarding the abandonment of claims against the Argentine government resulting from the Public Emergency Law, UNIREN outlined a first stage that included the postponement of the potential claims by us and our shareholders, prior to a renegotiation of our License, to be followed by the abandonment of any such claims by us or our shareholders to any claim or lawsuit, and our agreement to hold harmless the Argentine government. We informed UNIREN that, regarding the original proposal, it is imperative to negotiate an overall agreement of our License and, since some points of the UNIREN proposal required improvement, we expressed our willingness to continue discussing it.
In June 2005, we received a new proposal from UNIREN which is in line with the previous one, but now includes, apart from a 10% increase, a new tariff as from August 1, 2006 resulting from an overall tariff revision. It also establishes, as an additional condition, our abandonment and that of any of our shareholders, from any future claim or lawsuit regarding the PPI tariff adjustments which were not applied in 2000 and 2001.
According to the UNIRENs new proposal, if we accept it and, after the renegotiation of our License, the abandonment any claim or lawsuit in connection with the effects of the Public Emergency Law is not carried out, our License can be revoked without any compensation.
The deadline for the renegotiation of the public works and utilities contracts has been extended to December, 31 2005, pursuant to Law No. 25,972.
Certain Restrictions with Respect to Essential Assets. A substantial portion of the assets transferred by GdE were defined in our License as essential to the performance of the licensed service. Pursuant to our License, we are required to segregate and maintain the essential assets, together with any future improvements thereon, in accordance with certain standards defined in our License.
We may not for any reason dispose of, encumber, lease, sublease or lend essential assets for purposes other than the provision of the licensed service without ENARGASs prior authorization. Any extensions or improvements that we may make to the gas pipeline system may only be encumbered to secure loans that have a term of more than one year to finance such extensions or improvements.
Upon expiration of our License, we will be required to transfer to the Argentine government or its designee, the essential assets specified in our License as of the expiration date, free of any debt, encumbrance or attachment, receiving compensation equal to the lower of the following two amounts:
the net book value of the essential assets determined on the basis of the price paid by CIESA for shares of our common stock plus the original cost of subsequent investments carried in U.S. dollars in each case adjusted by the PPI, net of accumulated depreciation in accordance with the calculation rules to be determined by ENARGAS; or
the net proceeds of a new competitive bidding.
Under Argentine law, an Argentine court would not permit the enforcement of a judgment on any of our property located in Argentina which is determined by the courts to provide essential public services. This may adversely affect the ability of a creditor to realize a judgment against our assets.
Under a transfer agreement we entered into in connection with the privatization of GdE (the Transfer Agreement), liabilities for damages caused by or arising from the GdE assets are allocated to either GdE or us depending whether any such damage arose or arises from the operation of the assets prior to or following the commencement of our operations (Takeover Date). Also, pursuant to the Transfer Agreement, we are responsible for any defects in title to such assets, although any such defects are not expected to be material. The Transfer Agreement further provided that GdE was responsible for five years until December 1997, for the registration of easements related to the system which were not properly recorded and for the payment to property owners of any royalties or fees in respect thereof. Since 1998, we have been responsible for properly recording any remaining easement agreements and for making payments of royalties or fees related to such easements. See Item 8. Financial Information.
Our gas transportation business faces only limited direct competition. Although there are no regulatory limitations on entry into the business of providing gas transportation services in Argentina, the construction of a competing pipeline system would require substantial capital investment and the approval of ENARGAS. Moreover, as a practical matter, a direct competitor would have to enter into agreements with distribution companies or end-users to transport a sufficient quantity of gas to justify the capital investment. In view of our current firm transportation contracts with our distribution company customers, and the other characteristics of the markets in which we operate, management believes that it would be very difficult for a new entrant to the transportation market to pose a significant competitive threat to us, at least in the short to intermediate term. In the longer term, the ability of new entrants to successfully penetrate our market would depend on a favorable regulatory climate, an increasing and unsatisfied demand for gas by end-users, and sufficient investment in downstream facilities to accommodate increased delivery capacity from the transportation systems.
On a day-to-day basis, we compete with TGN, to a limited extent, for interruptible transportation services and from time-to-time for new firm transportation service made available as a result of expansion projects being undertaken by each of the two companies for service to the distribution companies to which both we and TGN are either directly or indirectly connected (Pampeana, MetroGas and BAN). We compete directly with TGN for the transportation of gas from the Neuquén basin to the greater Buenos Aires area. The following chart shows the contracted firm capacity by Pampeana, Metrogas and BAN from the Neuquén basin with us and TGN in MMm3/d:
ENARGAS has issued rules establishing a methodology to govern the brokering of excess capacity among the distribution companies and other transporters of natural gas, which has been effective since 1997. The system is administered by us and TGN. To the extent that such capacity brokerage results in more efficient use of contracted firm capacity, the demand for interruptible transportation services by our and TGNs customers could decrease.
Gas transportation companies should not be directly affected by changes in gas prices resulting from deregulation, since they neither buy nor sell gas commercially. However, competition in gas markets may affect both us and TGN to the extent that the gas basins which they service suffer from a loss of demand as a result of price competition with gas from other basins. This may affect the volume of gas transported from particular gas producing regions.
The cost of gas relative to competing fuels may also affect the demand for transportation services in the long term. The delivery cost of gas to end-users in Argentina, based on energy content, is currently significantly lower than other alternative fuels, except for hydroelectric power.
Additionally, this situation will be affected by the creation of the MEG, which by Decree requires that all firm transportation capacity not allocated for the following day, must be marketed through the MEG and the proceeds from that capacity sale must be used in accordance with the Federal Energy Bureaus requirements. For further information, see Item 4. Business Overview. Gas Transportation. Regulated Business. The Argentine Natural Gas Industry.
NGL PRODUCTION AND COMMERCIALIZATIONNON-REGULATED BUSINESS
NGL production and commercialization activities are not subject to regulation by ENARGAS.
Our NGL production and commercialization activities are conducted at our Cerri Complex which is located near the city of Bahía Blanca. In the Cerri Complex, ethane, propane, butane and natural gasoline are extracted from the natural gas, which arrives from three main pipelines from the Neuquén and Austral gas basins. The owners of the extracted NGL are required to make in-kind deliveries of additional gas to replace their attributable share of the natural gas shrinkage, fuel and losses associated with the extraction of liquids from the gas. We operate three different kind of NGL-related business:
NGL production and commercialization by our own account: In this business, the NGL products obtained at Cerri belong to us. We make in-kind deliveries of additional gas to replace thermal units consumed in the NGL production process and agree with the natural gas distributors on the payment of richness contribution incentives in order to maximize the NGL production in the Cerri Complex.
NGL production and commercialization on behalf of third parties: In this business, we process the natural gas and commercialize the NGL products and, in exchange, we collect a percent commission on the sale price.
NGL production on behalf of third parties: In this business, we process the natural gas and deliver the NGL products to the gas producers who pay us a U.S. dollar-fixed commission per ton or a percentage on US$ average sale price.
We sell our production of propane and butane to marketers and refineries in the local market and part of the production is exported to Petrobras International Finance Company (PIFCO), a subsidiary of Petrobras, at the international reference price, commonly referred to as the Mont Belvieu price, less a discount. In the domestic market, we set prices in order to maintain the parity in U.S. dollar terms with the prices received for propane and butane exports. The commercialization of natural gasoline is made to PIFCO at the international reference price, less a discount, while ethane is sold to PBB Polisur S.A. (PBB) at agreed fix prices. This business segment also comprises storage and dispatch by truck and subsequent shipment of the NGL extracted at the Cerri Complex in facilities located in Puerto Galván. Propane, butane and natural gasoline are transported via two eight-inch pipelines to the loading terminal at Puerto Galván. Ethane is piped via an eight-inch pipeline to the PBB olefins plant, which is the sole outlet for ethane from the Cerri Complex. The Cerri Complex extracts ethane only when it can be accepted at PBB. Otherwise, any ethane extracted is reinjected into the pipeline.
As a consequence of the adverse change in the regulated gas transportation segment, our results of operations are now significantly more dependent on the results of the NGL business. The significant increase in the NGL segment is due to higher prices in the foreign market, an increase in the production volume and our ability in the domestic market to charge unregulated prices that are priced at parity with export prices.
NGL production and commercialization net revenues accounted for approximately 51%, 48% and 37% of net revenues in 2004, 2003 and 2002, respectively.
The annual sales for the Cerri Complex for 2004, 2003 and 2002 in short tons were as follows:
As a result of agreements entered into with gas producers in Neuquén, during 2002 we were able to increase the richness of the gas stream arriving to the Cerri Complex for processing. Consequently, we were able to return NGL production volumes to levels that existed prior to the start up of the competitive processing complex, owned by Compañía MEGA S.A. (MEGA), at the beginning of 2001.
The economic crisis during 2002 provided a growth opportunity for this business segment because in 2004, 34%, which represented approximately 372,984 short tons, of total NGL production was exported, enabling us to benefit from the peso devaluation. Additionally, local market prices increased in order to maintain parity with export prices. The combination of such factors led to an increase in revenues and a greater percentage of our total revenues coming from NGL sales.
In addition, our management anticipates that future expansions on the pipeline system will provide new opportunities in the NGL production and commercialization business and lead to related increases in revenues from our gas transportation and NGL production and commercialization businesses.
However, we are currently undergoing a reduction in natural gas production that has caused, or may cause in the future, a decrease in NGL production in the Cerri Complex. This critical situation is a consequence of a significant rise in the demand for natural gas, as natural gas became the most inexpensive fuel because prices have not been adjusted for more than two years (from early 2002 to mid-2004). Consequently, gas producers did not undertake exploration activities and existing natural gas reserves have been diminished considerably. To address this situation, the Argentine government and the gas producers agreed to graded increases in natural gas prices in 2004, and, in 2005, the Argentine government has granted tax benefits for oil and gas exploration investments. While these measures are expected to help, it is unlikely that the positive effects will be seen for two or three years, which is the minimum time required for oil and gas exploration investments to result in actual gas production activities. However, there exist many doubts that these measures taken by the Argentine government will encourage producers to make the necessary investments needed to increase production and satisfy the expected natural gas demand.
In March 2005, the Congress enacted Law No. 26,020, requiring propane and butane producers to ensure that demand in the domestic Argentine market is met, a requirement that may lead us to sell NGL into the domestic market in preference to the export market where prevailing prices are likely to be higher. In addition, while there currently is no formal regulation of domestic prices for NGL, the current regulatory regime may impose a limit in practice on the prices we are able to realize for our domestic NGL sales, and such limit is likely to be below the net prices we realize on our export sales. However, the market for NGL domestic demand is predominantly comprised of residential consumers located is remote locations outside the natural gas network that require natural gas to cover their basic needs and, historically, this market has been, and is expected to remain, relatively static.
Repsol-YPF, together with Petrobras Energía and Dow Chemical, created MEGA, which, at the end of 2000, finished building and started the operation of a gas processing plant with a capacity of approximately 36 MMm³/d (1.3 Bcf/d), located in the Province of Neuquén. Any resulting lower production associated with gas with lower liquids content arriving at the Cerri Complex, as well as any other project that eventually may be developed midstream of the Cerri Complex, might adversely affect our revenues from NGL production and commercialization services. To minimize the revenue impact of any project developed midstream of the Cerri Complex, during 2000 and 2001, we signed agreements with gas producers and distributor customers to maximize the richness of the gas to be processed at the Cerri Complex in order to have the availability of the associated liquids.
OTHER SERVICESNON-REGULATED BUSINESS
Our other services are mostly comprised of midstream activities and telecommunication services. Our midstream activities consist of gas treatment at the wellhead, which include the separation and removal of impurities such as water, carbon dioxide and sulfur from the natural gas stream. Small diameter pipes from the wellheads form a network, or gathering system, carrying the gas stream to larger pipelines where field compression is sometimes needed to inject the gas into our large diameter gas pipelines. In addition, we also provide services related to pipeline construction, inspection and maintenance.
In 2004, in spite of the severe restrictions on our ability to obtain financing, we were able to participate in some projects through innovative contractual arrangements. In December 2004, we completed a project where we rendered engineering, construction and assembly services to a 3.9 MMm3/d (137.7 mcf/d) compressor plant, denominated El Chourrón, owned by Pampeana, which receives gas delivered by us through the General San Martín Pipeline and transmits it to the Tandil-Mar de Plata Pipeline and the Coastal Pipeline. We also entered an agreement with Pampeana to provide operational and maintenance services for the plant.
We will continue searching for new projects, both in the local and the regional markets, to allow us to sustain growth in this segment, capitalizing upon synergies with our other businesses.
Telcosur (Telecommunications System)
We own 99.98% of Telcosur, a telecommunications company formed in September 1998 for the purpose of providing value-added and data transportation services through the use of our existing telecommunications infrastructure (which was installed for purposes relating to our gas transportation system).
During 2001, we completed a capacity expansion project of our telecommunication system, by investing US$ 26 million in a starting up modern microwave digital system with synchronous digital hierarchy (or SDH) technology.
In 2004, the economic recovery trend continued to benefit the country and specifically the telecommunications industry, driven mainly from the sudden upsurge of cellular phone lines and internet bandwidth for corporate and residential services. Telcosur took advantage of these circumstances to consolidate its business relations with major operators that constitute part of its clients portfolio, adding important companies and Chilean operators by the celebration of long-term agreements denominated in U.S. dollars. Additionally, Telcosur strengthened ties with major operators of the oil segment, diversifying its services, in an attempt to increase the commercialization of its remaining capacity.
The following is a summary diagram of our material subsidiaries and affiliates as of the date of this Annual Report, including information about ownership and location:
(1) Incorporated in Argentina
(2) Incorporated in Uruguay
The following table sets forth certain information, with respect to each shareholder known to us to own more than five percent of our common stock:
As of December 31, 2004, approximately 21.5% of the securities held by the public were held in the form of ADRs. At such date, a total of 10,086,808 ADRs, representing 50,434,040 Class B shares, were held by approximately 40 holders of record. Because certain of these ADRs are held by nominees, the number of record holders may not be representative of the number of beneficial owners.
Property, Plant and Equipment
The principal components of the pipeline system we operate are as follows:
Pipelines. The 7,419 km (4,610 miles) natural gas transportation system that we own and operate consists primarily of large diameter, high pressure pipelines intended for the transportation of large volumes of gas at a pressure of approximately 60-70 kg/cm2. Line valves are installed on the pipeline at regular intervals, permitting sections of the pipeline to be isolated for maintenance and repair work. Gas flow regulating and measurement facilities are also located at various points on the system to regulate gas pressures and volumes. In addition, a cathodic protection system has been installed to protect the pipeline from corrosion and significantly reduce metal loss. All of the pipelines are located underground or underwater.
Maintenance bases. Maintenance bases are located adjacent to the gas pipeline system in order to maintain the pipeline and related surface facilities and to handle any emergency situations which may arise. Personnel at these bases periodically examine the pipelines to verify their condition and inspect and lubricate pipeline valves. Personnel at the bases also carry out a cathodic protection system to ensure that adequate anti-corrosion systems are in place and functioning properly. They also maintain and verify the accuracy of measurement instruments to ensure that these are functioning within appropriate industry standards and in accordance with the specifications contained in our service regulations. We have determined that we can more effectively maintain the pipeline at a lower cost by outsourcing non-critical maintenance functions and reducing the number of maintenance bases. We have reduced the number of maintenance bases from 11 to 8. In addition, we have consolidated the operations of some maintenance bases with those of the compressor plants.
Compressor plants. Compressor plants along the pipelines recompress the gas volumes transported in order to restore pressure to optimal operational levels, thereby ensuring maximum use of capacity as well as efficient and safe delivery. Compressor plants are spaced along the pipelines at various points (between 100 and 200 km) depending upon certain technical characteristics of the pipelines and the required pressure for transport. Compressor plants include turbine-driven compressors or motor-driven compressors which use natural gas as fuel, together with electric power generators to supply the complementary electrical equipment (control and measurement devices, pumping, lighting, communications equipment, etc.).
We transport gas through four major pipeline segments: General San Martín, Neuba I, Neuba II and Loop Sur, as well as several smaller gas pipelines. Information with respect to certain aspects of our main gas pipelines as of December 31, 2004, is set out in the table below:
Includes 398 km (247 miles) of transfer pipelines throughout the pipeline system, as well as the Cordillerano pipeline, with a length of 313 km (194 miles).
General San Martín. This pipeline was built in three stages, completed in 1965, 1973 and 1978, and transports gas from the extreme southern portion of Argentina to the greater Buenos Aires area in east-central Argentina. It originates in San Sebastián (Tierra del Fuego), passes through the Straits of Magellan and the Provinces of Santa Cruz, Chubut, Río Negro and Buenos Aires (including the Cerri Complex located near the city of Bahía Blanca in central Argentina), and terminates at the high pressure transmission ring around the city of Buenos Aires. The pipeline receives natural gas from the Austral basin in the extreme south at Tierra del Fuego, from the same basin further north at El Cóndor and Cerro Redondo, in the Province of Santa Cruz and from the San Jorge basin in northern Santa Cruz and southern Chubut provinces. The pipeline serves principally the districts and cities of Buenos Aires, La Plata, Mar del Plata, Bahía Blanca and Comodoro Rivadavia. In addition, we are in the process of expanding the General San Martín. See Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessPipeline OperationsPipeline Expansions for more information.
Neuba I (Sierra Barrosa-Bahía Blanca). Neuba I was built in 1970 and is one of our two main pipelines serving our principal source of gas supply, the Neuquén basin. The pipeline originates in west-central Argentina at Sierra Barrosa (Province of Neuquén), passes through the provinces of Río Negro, La Pampa and Buenos Aires, and terminates at the Cerri Complex. This pipeline transports the gas received from the Neuquén basin, particularly from the Sierra Barrosa, Charco Bayo, El Medanito, Fernández Oro, Lindero Atravesado, Centenario, Río Neuquén and Loma de la Lata gas fields. The gas delivered from Neuba I is subsequently compressed and injected into the Loop Sur and the General San Martín pipelines for transportation north to the greater Buenos Aires area.
Loop Sur. This gas pipeline was built in 1972 as an extension of Neuba I and runs parallel to a portion of the General San Martín gas pipeline. Located in the province of Buenos Aires, it transports gas from the terminus of Neuba I at the Cerri Complex at Bahía Blanca and terminates at the high pressure transmission ring around Buenos Aires, which we also operate. The gas delivered by this gas pipeline constitutes a portion of the gas supply for the greater Buenos Aires area. Loop Sur is also connected to the TGN system and allows us to deliver gas to or receive gas from TGN. Such transfers occur occasionally during periods of high demand for gas.
Neuba II. Our newest pipeline, Neuba II, was built in 1988 and is our other pipeline serving the Neuquén basin. Neuba II begins at Repsol-YPFs Loma de la Lata gas treatment plant in the western portion of the basin and runs through the provinces of Neuquén, Río Negro, La Pampa and Buenos Aires (through the Cerri Complex), up to its terminal station located at Ezeiza just outside of Buenos Aires. Neuba II is a principal source of gas for the Federal District and the greater Buenos Aires area.
Other Pipelines. Our other pipelines include the Cordillerano pipeline, built in 1984, which receives gas from the Neuquén Basin and supplies it mainly to three tourist centers in southern Argentina. In addition, we operate other minor pipelines, the high pressure transmission ring around Buenos Aires, the Chelforó-Conesa pipeline and other pipelines known as gas transfer pipelines.
Information regarding gas transportation system expansion is included in Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessPipeline OperationsPipeline Expansions.
Cathodic Protection System
Currently, we operate more than 200 cathodic protection devices, which are located along our main pipelines. The objective of this system is to mitigate the corrosion process on the pipes surface. The corrosion process causes metal loss, which, depending on the severity of the damage, may cause pipeline ruptures. Cathodic protection equipment includes thermic, turbine-driven, motor-driven or even solar electric generators in locations where no electric lines are available. The system also includes an impressed current-deep anode, which facilitates circulation of electricity through the circuit formed by the generator, the anode itself, the pipe and the land.
Gas Control System
Located at our Buenos Aires headquarters, the gas control system controls scheduled gas injections and deliveries and allows us to follow gas flows in real time. Data is received from compressor stations by phone and automatically from remote terminal units (RTUs) installed in the receipt and delivery points equipped with the EFM system. The information is normally collected by the Supervisory Control and Data Acquisition (SCADA) system (which has an ad-hoc database that is updated every 30 seconds on average) and is then consolidated into other databases. In order to control gas injection and deliveries, we have developed a software system called Solicitud, Programación, Asignación y Control (SPAC), which, among other things, allows us to control actual volumes and projected future injections to determine producer deviations. As part of this system, we operate meteorological equipment and receive daily weather information from various sources, which is used for the purpose of forecasting gas demand.
Shipped and delivered gas is measured through primary field facilities that are connected with RTUs. Such RTUs transmit the data to the Buenos Aires headquarters. This data is utilized to prepare reports for clients, shippers, producers and ENARGAS. Energy balances are also prepared in order to control our system efficiency.
NGL production and commercialization
Our NGL production and commercialization activities are conducted at our Cerri Complex. It is located near the city of Bahía Blanca and is connected to each of our main pipelines. The Cerri Complex consists of an ethane extraction plant to recover ethane, propane, butane and natural gasoline, together with a lean oil absorption plant to recover propane, butane and gasoline. The facility also includes compression, power generation and storage facilities. The Cerri Complex processing capacity is approximately 43 MMm3/d (1,519 MMcf/d).
As part of the Cerri Complex, we also maintain at Puerto Galván a storage and loading facility for the natural gas liquids extracted at the Cerri Complex. The Cerri Complex, including the Puerto Galván facility, is currently capable of storing 60,450 short tons. In 1998, we completed the expansion of the processing and storage facilities of the Cerri Complex. For a more detailed description of the expansion, see Business OverviewNGL Production And CommercializationNon-Regulated Business above.
As part of this business segment, we provide services relating to natural gas including treatment, gathering and gas compression, which are rendered at five treatment plants located in the gas fields with a total capacity of 11.7 MMm3/d. The following chart shows summary information regarding the treatment plants capacity:
Additionally, we render our gas compression service by three gas compression plants with a total capacity of 32,160 HP. The following chart shows summary information regarding the gas compression plants capacity:
In 1998, we completed the construction of a modern and flexible telecommunication system of digital terrestrial microwave network with a length of more than 4,600 km (2,858 miles). This fifth generation system runs parallel to our main pipelines, from the southernmost province of Tierra del Fuego and Neuquén in the west, to the Companys headquarters in Buenos Aires. The system is controlled from Telcosurs headquarters and has a capacity of 252 megabytes per second.
We believe that our current operations are in substantial compliance with applicable laws and regulations relating to the protection of the environment. Our environmental policy is designed to comply with Argentine laws relating to hazardous waste and air quality. Under these laws, the principal hazardous substances we generate consist of discarded casing oil and those parts of the compressor station entry filters that are soaked in hydrocarbons.
Throughout 1995, we completed a study of all the emissions we produced, including gaseous, liquid and solid emissions, with the objective of implementing a policy of reducing and treating hazardous substances. Following the completion of the study, our drainage collection systems were redesigned in order to direct them to a single storage tank and incinerators for the hazardous substances were installed in several geographic areas of the transportation system.
Since then, we have steadily consolidated our policy in connection with environmental affairs, which in October 1998 helped us obtain the certification of our environmental management system, in accordance with the international standards ISO 14001.
In 2001, we adopted a global management system policy in an effort to increase our customers satisfaction. The policy focuses on continuous improvement efforts and our commitment to comply with the provisions contained in the current legislation and procedures that we establish through annual goals and objectives.
The main foundation of this policy lies in our personnel, the quality, innovation and value of our products and services as well as a management system in line with international standards.
In 2004, investments in environmental measures included updates to our gas measurement equipment to improve the quality of the services rendered as well as commencement of projects to minimize environmental changes in accordance with our commitment to preserve the environment. The first stage, started in 2004, consisted of: elimination of gas combustion emissions in Cerri Complex; reduction of methane venting produced by compression plant shutdowns; reduction of the impact of liquid effluents; avoidance of soil pollution; waste reduction; disposing in sanitary landfills of all the asbestos waste buried in the fields in the province of Buenos Aires; and the restructuring of the anti-fire network in the Cerri Complex.
In December 2004, we obtained the re-certifications of the international standards ISO 9001 and 14001. Recertifying ISO 9001 and 14001 international standards involves maintenance auditings performed every six months by the same certification body that carried out the initial certification. This body revises and controls the compliance with the requirements of those standards and verifies the commitment to continuous improvement and compliance with the annual objectives and goals.
We have established an environmental and industrial safety investment plan for the period of 2005-2007 with a budget of approximately US$ 11.7 million.
We maintain insurance, subject to deductibles, against third-party liability, against business interruption and against damage to our pipeline assets that pass under rivers or other bodies of water and the Straits of Magellan, which we believe is consistent with standards for international natural gas transportation companies. The terms of the policies related to the regulated assets have been approved by ENARGAS. In addition, we have obtained insurance coverage for our directors and officers.
Item 5. Operating and Financial Review and Prospects
We are an Argentine company who commenced our commercial operations on December 29, 1992. We are currently the largest transporter of natural gas in Argentina, delivering approximately 61% of the countrys total gas consumption through 7,419 km (4,610 miles) of pipeline. with a current firm contracted capacity of 65.4 MMm3/d (approximately 2.3 Bcf/d). Substantially all of our gas transportation capacity is subscribed for under firm long-term transportation contracts. Gas transportation activities are regulated by ENARGAS. We are also the largest processor of natural gas and one of the largest marketers of NGL in Argentina, operating the Cerri Complex and the associated Galván loading and storage facility in Bahía Blanca in the Buenos Aires Province where NGL are separated from gas transported through our pipeline system and stored for delivery. We also provide other services, which include midstream and telecommunications activities. Midstream activities consist of gas treatment at the wellhead which include the separation and removal of impurities such as water, carbon dioxide and sulfur from the natural gas stream and gas compression. In addition, we also provide services related to pipeline construction, inspection and maintenance by ourselves and by our affiliates Link, Transporte y Servicios de Gas en Uruguay S.A. (TGU) and EGS. Telecommunication services are rendered by Telcosur a 99.98%-owned subsidiary. Telcosur provides services to leading telecommunications operators and corporate customers.
Since the onset of the severe economic crisis in Argentina, which began in late 2001, our revenue composition has changed significantly, mainly as a consequence of (i) the substantial devaluation of the peso as compared to the U.S. dollar, (ii) high inflation that occurred in 2002 and (iii) the suspension of adjustments of the regulated tariff for the transportation of natural gas pursuant to the Public Emergency Law enacted on January, 6, 2002. In 2002, the peso was devalued against the U.S. dollar by 237.0% and Argentina experienced a cumulative rise in the CPI of 40.7% and in the WPI of 118.2% from December 2001 through December 2002. During 2003, the peso appreciated by 13.1%, the CPI increased by 3.7% and the WPI increased by 2.0%. In 2004, the peso depreciated against the US dollar by 1.7%, the CPI rose 6.1% and the WPI rose 7.9%.
Source: Argentine National Institute of Statistics and Census or INDEC, Banco de la Nación
Laws and regulations currently governing the Argentine economy may continue to change in the future and these changes may adversely affect our business, financial condition or results of operations. For more information, see Item 3. Key InformationRisk Factors. Our Financial Statements do not include any adjustments or reclassifications that might result from the outcome of the uncertain economic and political environment in Argentina.
The most important factors affecting our results of operations were the following:
Pesification of our tariffs:
According to the original regulatory framework existing at the time of our privatization in 1992 our regulated tariffs were U.S. dollar-based. The Public Emergency Law eliminated U.S. dollar-based tariffs and converted into pesos at a one-to-one exchange rate.
Suspension of tariff adjustment:
Under our License, we may be permitted to adjust rates semi-annually to reflect changes in PPI and every five years in accordance with efficiency and investment factors to be determined by ENARGAS and, subject to ENARGASs approval, from time to time to reflect cost variations resulting from changes in the tax regulations (other than income tax) applicable to us, and for objective, justifiable and non-recurring circumstances. However, our ability to make these adjustments has been suspended by the Argentine government as part of the Public Emergency Law.
Devaluation of the peso:
The Public Emergency Law eliminated the U.S. dollar-peso parity. The devaluation has had a material adverse impact on our results of operations as it was coupled with the pesification and freezing of our tariffs. In addition, almost all of our financial indebtedness is U.S. dollar-denominated. During 2002, we had a foreign exchange loss of Ps. 615.7 million as a consequence of the 237.0% devaluation of the peso against the U.S. dollar, while during 2003 we had a foreign exchange gain of Ps. 30.7 million as a consequence of the 13.1% appreciation of the peso against the U.S. dollar. During 2004, we had a foreign exchange loss of Ps. 26.0 million as a consequence of the 1.7% devaluation of the peso against the U.S. dollar.
In response to the negative events mentioned above, we have taken the following measures with the goals of producing high liquidity and maintaining the high quality of the services we render:
The significant devaluation of the peso that began in early 2002 and the numerous delays in the renegotiation process adversely impacted our financial condition and consequently impeded our ability to service our financial indebtedness. On May 15, 2003, we announced the suspension of all interest and principal payments in respect of our outstanding financial indebtedness and focused our efforts on negotiating the restructuring of such indebtedness with our creditors. On December 15, 2004, we completed the restructuring of substantially all of our outstanding indebtedness by issuing new financial debt obligations in exchange for our outstanding indebtedness that was restructured and entering into amended and restated loan agreements. We expect the payment obligations under our newly-issued and amended and restated financial debt to correspond to our future cash flow generation. However, our new debt obligations contain several restrictive covenants that limit our ability to, among other things, incur additional debt, pay dividends and make capital expenditures. For a further description of the restrictive covenants contained in our new financial debt obligations, refer to Item 10. Additional InformationMaterial ContractsNew Debt Obligations.
According to the Public Emergency Law, the Executive Branch has the authority to renegotiate contracts entered into with private utility companies. In July 2003, UNIREN was created under the joint jurisdiction of the MPFIPyS. This unit conducts the renegotiation process of the contracts related to utilities and public works, and is entitled to reach total or partial agreements with the licensees and submit proposals regulating the transitory adjustment of tariffs and prices, among other things. To date, we have been unable to renegotiate our License with the Argentine government. See Item 4. Business OverviewGas Transportation Regulated BusinessRegulatory FrameworkAdjustment of Rates for more information.
The new deadline for the renegotiation of the public works and utilities contracts has been extended to December, 31 2005, pursuant to Law No. 25,972.
Implemented capital expenditures controls:
Considering the uncertainty surrounding the economic, social and political environment in Argentina, we decided to reduce significantly our capital expenditures for the years ended 2003 and 2002, limiting capital expenditures to those necessary to maintain operational safety and reliability of the pipeline system.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 3. Key InformationSelected Financial Data and our Financial Statements as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002 and the report of our independent auditors, included elsewhere herein. Such financial statements have been prepared in accordance with Argentine GAAP (taking into account CNV regulations). This Operating and Financial Review and Prospects discussion contains forward-looking statements that involve certain risks, uncertainties and assumptions. These forward-looking statements can be identified by the use of forward-looking terminology such as may, will, will likely result, intend, projection, should, believe, expect, anticipate, estimate, continue, plan or other similar words. Our actual results may differ materially from those identified in these forward-looking statements. For more information on forward-looking statements, see Cautionary Statement Regarding Forward-Looking Statements. In addition, for a discussion of important factors, including, but not limited to, the pesification of our tariffs and other factors that could cause actual results to differ materially from the results referred to in the forward-looking statements, see Item 3. Key InformationRisk Factors.
For information relating to the presentation of financial information see Presentation of Financial and Other Information.
Discussion of Results of Operations for the Three Years ended December 31, 2004, 2003 and 2002
The following table presents a summary of our consolidated results of operations for the years ended December 31, 2004 and 2003, stated in pesos, and the increase or decrease and percentage of change between the periods presented:
The following table presents a summary of our consolidated results of operations for the years ended December 31, 2003 and 2002, stated in pesos, and the increase or decrease and percentage change between the periods presented:
According to Resolution No. 441 issued by the CNV, our financial information presented above has been restated to reflect the effects of inflation as of February 28, 2003. Our consolidated financial information for the year ended December 31, 2003 accounts for the effects of inflation for the first two months of the year, during which the cumulative change in the WPI was 0.7%. Our consolidated financial information for the year ended December 31, 2002 accounts for the effects of inflation for the entire fiscal year, reflecting the 118.2% cumulative change in the WPI for the twelve-month period ended December 31, 2002.
For comparative purposes, peso-denominated amounts for the year ended December 31, 2002 have been restated using a conversion factor of 1.0074.
Fiscal Year 2004 Compared to Fiscal Year 2003
Regulated Gas Transportation Segment. Net revenues from the gas transportation segment accounted for approximately 44% and 47% of total net revenues for the years ended December 31, 2004 and 2003, respectively. Substantially all of our gas transportation segment revenues are derived from firm contracts, under which pipeline capacity is reserved and paid for regardless of actual usage by the shipper. We also provide interruptible transportation services subject to available pipeline capacity. Revenues associated with such services comprised 5.4% and 4.4% of our segment revenues in 2004 and 2003, respectively. With respect to our gas transportation segment, we do not face commodity risk because we are not the owner of the gas that is transported through the pipeline.
Net revenues from the gas transportation segment for the year ended December 31, 2004 increased by approximately 2.9%, or Ps. 12.2 million, as compared to the year ended December 31, 2003. This increase was due primarily to additional revenues of Ps. 5.4 million as a result of new firm transportation contracts that came into effect as from May 2004, and an additional Ps. 5.0 million in higher interruptible transportation services revenues generated by a growing demand of natural gas in 2004. Tariffs remained constant in peso terms in 2004.
We had additional firm-contracted capacity of approximately 3.6 MMm3/d (127 MMcf/d) for the year ended December 31, 2004, as compared to the year ended December 31, 2003. Our higher firm-contracted capacity in 2004 was the result of an open bidding process conducted by us in March 2004, and is related to available capacity from our gas pipelines plus additional capacity obtained from enhancements to our pipeline system during the first quarter of 2004. Most of these new contracts became effective as from May 2004. We estimate that annual revenues from these contracts will be approximately Ps. 9 million (based on current tariffs) until fiscal year 2008.
In light of the lack of investment in gas pipeline expansion over the last several years (as a consequence of the pesification of tariffs and the failure to complete the renegotiation of our gas transportation license) and due to rising demand for natural gas from all of the Argentine economy, the Argentine Government, through the Executive Branch Decree No. 180/04 issued in February 2004 and Resolution No. 185/04 issued by the MPFIPyS in April 2004, has established a framework for the establishment of a trust fund that would finance the expansion of the gas transportation system in Argentina (referred to in this Annual Report as the Gas Trust). To that purpose, in June 2004, we submitted to the Federal Energy Bureau upon request a project for the expansion of the San Martín pipeline transportation capacity for approximately 2.9 MMm3/d (102.4 MMcf/d). This project involves the construction of approximately 509 km (316 miles) of pipeline and a 30,000 HP compression capacity increase through the construction of a compressor plant and the revamping of some compressor units. As of the date of this Annual Report, all of the additional capacity is expected to be fully on line by August 30, 2005. This additional transportation capacity was fully subscribed for under firm transportation contracts in an open bidding conducted by us in June 2004. The term of these new contracts is for almost 16 years in most cases and the new contracts were mainly entered into with gas distribution companies. We are required to make capital expenditures on our transportation system, totaling approximately US$40 million, including VAT and expenses, in connection with the project. This investment of approximately US$40 million shall be recovered over time by the payment to us of 80% of the revenues obtained from the additional transportation capacity, based on the current tariff rate (but not to the extent of any increased rate that may apply in the future), which, we expect, will represent annual revenues of approximately Ps. 23 million. See Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessPipeline OperationsPipeline Expansions for more information.
On February 13, 2004, the Executive Branch signed two decrees related to the natural gas market in order to secure the adoption of measures to normalize the supply of natural gas. The Executive Branch, through Decree No. 180/04, established the creation of the MEG with the purpose of improving the transparency of financial and operating performance, the coordination of daily transactions both of the gas spot market and the transportation and distribution secondary markets along with the shaping of efficient prices through offer and demand free interaction. To that purpose, all firm transportation capacity not allocated for the following day shall be marketed through the MEG and the proceeds from that capacity sale will be used at the discretion of the Federal Energy Bureau discretion. Non-allocated capacity includes remaining capacity not used in any of the transportation systems or pipelines. This implies that we are bound to offer daily non-allocated capacity that complies with this condition in the MEG, which might eliminate the interruptible transportation contracts and, as the Federal Energy Bureau will manage the application of the revenues generated by the MEG, there is no assurance that we can collect these revenues. Revenues from the provision of interruptible transportation services were Ps. 23.5 and Ps. 18.6 million for 2004 and 2003, respectively.
We are still in the process of renegotiating our tariffs. See Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessRegulatory FrameworkAdjustment of Rates for more information.
Non-Regulated NGL Production and Commercialization Segment. Net revenues from the NGL production and commercialization segment accounted for approximately 51% and 48% of total net revenues for the years ended December 31, 2004 and 2003, respectively. As a consequence of the adverse effects suffered by our gas transportation segment, our results of operations are now significantly more dependent on the results of the NGL production and commercialization segment. Our NGL production and commercialization activities are conducted at our Cerri Complex which is located near the city of Bahía Blanca.
The annual sales for the Cerri Complex for 2004 and 2003 in short tons were as follows:
Net revenues from the NGL production and commercialization segment increased by Ps. 77.9 million, or approximately 18%, for the year ended December 31, 2004, as compared to the year ended December 31, 2003. This increase was mainly due to a Ps. 76.8 million increase generated by a rise in international prices for NGL products, which corresponded to oil price escalation. Additionally, Ps. 4 million of this increase is due to an increase of approximately 5% of the volume of NGL products sold generated by a higher local market demand.
As a result of insufficient natural gas supply from producers in the first few months of 2005 (who were faced with a higher demand, which was exacerbated by lower hydroelectric energy production) we expect our NGL revenues could fall as much as 15%.
In March 2005, the Congress enacted Law No. 26,020, requiring propane and butane producers to ensure that demand in the domestic Argentine market is met, a requirement that may lead us to sell NGL into the domestic market in preference to the export market where prevailing prices are likely to be higher. In addition, while there currently is no formal regulation of domestic prices for NGL, the current regulatory regime may impose a limit in practice on the prices we are able to realize for our domestic NGL sales, and such limit is likely to be below the prices we realize on our export sales.
Other Services. Net revenues from the other services segment accounted for approximately 5% of total net revenues for each of the years ended December 31, 2004 and 2003. This segment includes midstream and telecommunications services. Midstream services include gas treatment, separation and the removal of impurities from the natural gas stream, and compression services, which are generally rendered to the natural gas producers at wellhead, as well as activities related to construction, operation and maintenance of pipelines and compressor plants. These services are rendered by us or through our affiliates Link, TGU and EGS. Telecommunications services are provided by Telcosur, a 99.98%-owned subsidiary. Telcosur provides services to leading telecommunication operators and corporate customers.
Net revenues from the other services segment increased by Ps. 11.2 million, or approximately 26%, for the year ended December 31, 2004, as compared to the year ended December 31, 2003. This increase was mainly due to: (i) an additional Ps. 5.3 million in revenues received from construction, engineering and assembly services provided to Pampeana in 2004, in connection to the construction of a 3.9 MMm3/d (137.7 mcf/d) compressor plant located in the Buenos Aires Province which receives gas delivered by us through the San Martín Pipeline and transports it to the Tandil-Mar de Plata pipeline and the Coastal pipeline; (ii) an additional Ps. 4.8 million in revenues derived from the provision of midstream services; and (iii) an additional Ps. 3.1 million in revenues derived from the provision of telecommunication services by our subsidiary Telcosur, which reflect a sustainable growth of its sales, and the increase of the CER indexed tariffs.
It is expected that our other services revenues will continue increasing in 2005 as the result of additional telecommunication services expected to be generated in such year.
Costs of Sales
Cost of sales for the year ended December 31, 2004 increased by approximately Ps. 39.1 million, or approximately 9.2%, as compared to the same period in 2003. This increase was primarily the result of: (i) a Ps. 18 million increase in direct costs related to the NGL production and commercialization segment, which was mainly due to increases in the prices of the natural gas and the associated richness; (ii) a Ps. 8.6 million increase of operation and maintenance costs of the gas transportation pipeline system, mainly due to internal inspections that were conducted in 2004; and (iii) a Ps. 2.3 million increase of depreciation and amortization.
Administrative and Selling Expenses
Administrative and selling expenses for the year ended December 31, 2004 increased by approximately Ps. 15.4 million, or approximately 26.3%, as compared to the same period in 2003. This increase was primarily the result of Ps. 14.5 million in higher taxes and contributions caused primarily by increases in May 2004, from 5% to 20%, in the tax rate on propane and butane exports.
Other Expenses, Net
For the year ended December 31, 2004, other expenses, net increased by Ps. 7.3 million, or approximately 28%, as compared to the year ended December 31, 2003. The increase is mostly due to the Ps. 13 million allowance booked in 2004 with respect to a turnover tax claim made by the Buenos Aires Province on our NGL sales billed since 2002. We also registered a loss of Ps. 16.1 million during 2004 (in addition to the Ps. 24 million loss recorded in this line item for the year ended December 31, 2003), in connection with a decision of the Supreme Court in a lawsuit filed by GdE against us, relating to assets transferred at the time of our privatization in 1992. The court-appointed experts assessed the price of the compressor plants at approximately Ps. 13.2 million and, in September 2004, the court of original jurisdiction sentenced us to pay the amount determined by the experts plus VAT, other interest and litigation expenses. Nevertheless, we consider that the amount is excessive and not properly substantiated. Thus, we have appealed the decision. For more information on these lawsuits, see Item 8. Financial InformationConsolidated Statements and Other Financial InformationLegal and Regulatory Proceedings.
On October 21, 2002, the AFIP formalized a claim against us in the amount of Ps. 5.6 million (including interest) related to our failure to make certain contributions to the Argentine Social Security Bureau. As a condition to filing an appeal with the Cámara Federal de Seguridad Social, we were required to deposit Ps. 5.6 million with the AFIP, pending the outcome of the appeal. In December 2004, the Cámara Federal de Seguridad Social what is this in relation to the Social Security Bureau ruled in our favor and instructed the AFIP to reimburse us the amount of our deposit. At December 31, 2004, AFIP had the right to appeal this decision, and accordingly we did not reverse the related accrual as of that date. AFIP did not appeal within the permitted time, and accordingly we reversed the expense of Ps. 5.6 million during the first quarter of 2005. See Note 9.d) to our Financial Statements.
Equity in (Losses) Earnings of Affiliates
Equity in (losses) earnings of affiliates had a negative variation of Ps. 4.6 million for the year ended December 31, 2004, as compared to the year ended December 31, 2003. This negative variation was primarily due to lower earnings on our investment in Link, mainly due to unfavorable exchange rates.
Net financial expense
Net financial expense for the years ended December 31, 2004 and 2003 is as follows:
For the year ended December 31, 2004, we reported a net financial expense of Ps. 260.9 million, as compared to a net financial expense of Ps. 219.8 million for the year ended December 31, 2003. This increase in net financial expense was primarily due to a significant drop in the peso-U.S. dollar exchange rate during the year ended December 31, 2003, from Ps. 3.37 per U.S. dollar to Ps. 2.93 per U.S. dollar. This drop in the exchange rate resulted in a Ps. 30.7 million gain generated by our net monetary liability position in U.S. dollars, which was partially offset by partial reduction of the capitalization of exchange loss, in 2003. Moreover, in 2004, the peso-U.S. dollar exchange rate increased from Ps. 2.93 per U.S. dollar to Ps. 2.979 per U.S. dollar, which generated an exchange loss of Ps. 26 million. This increase in net financial expense was partially offset by the Ps. 33.1 gain generated during the year ended December 31, 2004 due to the restructuring of substantially all of our financial indebtedness, which resulted in the forgiveness of default interest due on our financial indebtedness of Ps. 96.6 million, net of the write-off of the financial intangible assets for Ps. 63.5 million.
Income Tax (Expense) Benefit
For the year ended December 31, 2004, we reported a Ps. 10.6 million income tax expense, which compares to the Ps. 121.5 million income tax benefit we reported for the year ended December 31, 2003. This represents a negative variation of Ps. 132.1 million, which was primarily the result of a Ps. 137 million decrease in deferred tax liabilities in 2003 as a consequence of the partial reduction of the capitalized exchange loss.
Fiscal Year 2003 Compared to Fiscal Year 2002
Regulated Gas Transportation Segment. Net revenues from the gas transportation segment accounted for approximately 47% and 57% of total net revenues for the years ended December 31, 2003 and 2002, respectively, reflecting the deterioration of this segment.
Net revenues from the gas transportation segment for the year ended December 31, 2003 decreased by approximately 21%, or Ps. 110.0 million, as compared to the year ended December 31, 2002. Although contracted capacity remained consistent with the prior year, gas transportation segment revenues decreased primarily due to the lack of tariff adjustment as a consequence of the recurrent delays in the commencement of the renegotiation process and the restatement of 2002 amounts to account for the effects of inflation. Both effects were partially offset by higher revenues of Ps. 4.9 million related to our interruptible transportation services, which resulted from a greater demand for natural gas.
Non-Regulated NGL Production and Commercialization Segment. Net revenues from the NGL production and commercialization segment accounted for approximately 48% and 37% of total net revenues for the years ended December 31, 2003 and 2002, respectively.
Net revenues from the NGL production and commercialization segment increased by Ps. 81.0 million, or approximately 23%, for the year ended December 31, 2003, as compared to the year ended December 31, 2002. This increase was primarily due to: (i) higher international NGL prices, which influenced local prices; (ii) the renegotiation of some processing and marketing agreements that were originally peso-denominated and that are now U.S. dollar-denominated; and (iii) a 4% increase in the volume of NGL sold. These factors were partially offset by the restatement of 2002 amounts to account for the effects of inflation.
The annual sales for the Cerri Complex for 2003 and 2002 in short tons were as follows:
Other Services. Net revenues from the other services segment accounted for approximately 5% and 6% of total net revenues for the years ended December 31, 2003 and 2002, respectively.
Net revenues derived from the other services segment decreased by Ps. 17.7 million, or approximately 30%, for the year ended December 31, 2003, as compared the year ended December 31, 2002. This decrease was primarily due to higher revenues in 2002 derived from construction services rendered to Link, and the restatement of 2002 amounts to account for the effects of inflation. These factors were partially offset by the positive effect of completing a successful renegotiation of the prices and tariffs applicable to our midstream and telecommunications services, which had been affected by devaluation of the peso, and the provision of additional midstream services in 2003 as compared to 2002. In 2003, we successfully completed the renegotiation of outstanding midstream and telecommunications services agreements, which were originally peso-denominated and, consequently, were adversely affected by the large peso devaluation. Through the implementation of the new agreements, we were able to increase our midstream services revenues.
Costs of Sales
Costs of sales for the year ended December 31, 2003 decreased Ps. 8.4 million, or approximately 2%, as compared to the year ended December 31, 2002. The decrease was primarily due to lower depreciation and amortization expense in 2003, as a consequence of the decline in the capitalization of exchange loss due to the stabilization of the peso relative to the U.S. dollar during the period from December 31, 2002 to July 28, 2003, the last date for which exchange loss capitalization was permitted. For more information see Note 2.i) to our Financial Statements, included elsewhere in this Annual Report. Also, the decrease reflects higher pipeline construction costs in 2002 than in 2003, as well as the restatement of 2002 amounts to account for the effects of inflation. This decrease was partially offset by a Ps. 9.5 million increase in operating costs due to higher costs associated with increased NGL production and commercialization.
Administrative and Selling Expenses
Administrative and selling expenses for the year ended December 31, 2003 decreased by Ps. 9.3 million, or approximately 14%, as compared to the year ended December 31, 2002. The decline is largely the result of the restatement of 2002 amounts to account for the effects of inflation, as well as lower depreciation expenses in 2003 and an increase in the allowance for doubtful accounts in 2002 accounted for as a result of delays in the collection of receivables from one transportation customer.
Other Expenses, Net
Other expenses, net for the year ended on December 31, 2003 increased by Ps. 20.3 million, or approximately 333%, as compared to the year ended December 31, 2002 This increase was primarily due to the creation of a Ps. 24.0 reserve in connection with an adverse ruling from the Supreme Court in the lawsuit that GdE filed several years ago regarding the transfer of certain assets to us at the time of our privatization in 1992. For more information on this lawsuit, see Item 8. Financial InformationConsolidated Statements and Other Financial InformationLegal and Regulatory Proceedings.
Equity in Earnings (Losses) of Affiliates
Equity in earnings (losses) of affiliates increased by Ps 8.6 million for the year ended December 31, 2003, as compared to the year ended December 31, 2002, primarily due to higher earnings related to our investment in Link, mainly generated by a positive exchange rate result reported in 2003.
Net financial expense
Net financial expense for the years ended December 31, 2003 and 2002 is as follows:
For the year ended December 31, 2003, we reported a net financial expense of Ps. 219.8 million, as compared to a net financial expense of Ps. 1,071.4 million for the year ended December 31, 2002. This decrease was primarily due to the appreciation of the peso against the U.S. dollar. The appreciation of the peso in 2003 partially mitigates the significant devaluation effect recognized and reported in 2002 when the exchange rate rose from US$ 1.00=Ps. 1.00 to US$1.00= Ps.3.37 as of December 31, 2002, net of the capitalized portion of exchange loss in Property, plant and equipment, net and the recognition of inflation effects on our net monetary liability position during 2002. In addition, the decrease in net financial expense in 2003 reflects a lower interest expense, due to a decline in the average exchange rate in 2003 as compared to 2002 and the restatement of 2002 amounts to account for the effects of inflation.
Income Tax (Expense) Benefit
For the year December 31, 2003, we reported a Ps. 121.5 million income tax benefit. This amount includes the income tax expense as determined by applying the statutory tax rate on the historical pre-tax income. The income tax expense thus determined was more than offset by the combination of: (i) a reduction of the deferred tax liability due to a decrease in the capitalization of exchange loss in Property, plant and equipment, net and (ii) the reduction of the tax loss carry-forward allowance. This income tax benefit compares to the Ps. 37.8 million income tax benefit reported for the year ended December 31, 2002, which was primarily due to a significant tax loss carry-forward generated by the devaluation effect coupled with the deferral over a five-year period of the exchange loss as permitted by the Public Emergency Law and Decree No. 2,568/02. Both effects were partially offset by a deferred tax liability resulting from the capitalization of exchange loss.
Differences between Argentine GAAP and US GAAP
Our Financial Statements and the information shown in this section have been prepared in accordance with Argentine GAAP, which differs in certain significant respects from US GAAP. Such differences involve methods of measuring the amounts shown in the financial statements, as well as additional disclosures required by US GAAP and Regulation S-X promulgated by the SEC. The following is a list of the principal differences, other than with regard to inflation accounting, between Argentine GAAP and US GAAP, as they relate to us, that affected the reported amounts under Argentine GAAP of our total shareholders equity as of December 31, 2004 and 2003 and net income (loss) for the years ended December 31, 2004, 2003 and 2002:
the capitalization of interest costs;
the capitalization of exchange differences arising from the devaluation of the Argentine peso under Argentine GAAP, which are treated as expenses under US GAAP;
the accounting for derivatives and hedging activities;
the deferral of certain pre-operating and organizational expenses under Argentine GAAP, which are expensed as incurred under US GAAP;
the accounting for income taxes;
the accounting for the effects of our debt restructuring;
the impact of US GAAP adjustments on equity investees;
the accounting for vacation expenses; and
the present-value accounting of certain assets and liabilities.
Note 12 to our Financial Statements, included elsewhere in this Annual Report, provides a description of the main differences between Argentine GAAP and US GAAP as they relate to us and a reconciliation to US GAAP of shareholders equity at December 31, 2004 and 2003 and net income (loss) for the years ended December 31, 2004, 2003 and 2002. Net income (loss) under Argentine GAAP for the years ended December 31, 2004, 2003 and 2002 was approximately Ps. 147.9 million, Ps. 286.2 million and Ps. (608.4) million, respectively, as compared to approximately Ps. 151.6 million, Ps. 597.7 million and Ps. (355.9) million, respectively, under US GAAP. Shareholders equity under Argentine GAAP as of December 31, 2004 and 2003 was Ps. 2,206.6 million and Ps. 2,058.7 million, respectively, as compared to approximately Ps. 1,257.4 million and Ps. 1,104.0 million, respectively, under US GAAP.
New Accounting Pronouncements under Argentine GAAP
In February 2003, the CPCECABA approved Technical Resolutions (TR) No. 21 Equity method- consolidation of financial statements- information to be disclosed on related companies through its Resolution M.D. No. 5/2003. TR No. 21 and its amendments became effective for public companies for fiscal years starting as from April 1, 2003. Although the CNV determined that this resolution will be effective for public companies for fiscal years starting as from April 1, 2004, early application is permitted and accordingly, we have applied TR No. 21 effective fiscal year 2004.
The application of this new accounting standard has not had an impact on our net income and shareholders equity for the year ended December 31, 2004.
New Accounting Pronouncements under US GAAP
The following is a summary of recent changes in US GAAP. We do not believe any of these changes will have a material impact on US GAAP reconciliation of our reported financial results:
Statement of Financial Accounting Standard (SFAS) No. 151 Accounting for Inventory Costs
In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory Costs, an amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4. This Statement clarifies the accounting for abnormal amounts of idle facility expense freight, handling costs and wasted material (spoilage), requiring that those items be recognized as current-period charges. In addition, this Statement requires the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of production facilities. This Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 will not have a material impact on our Financial Statements.
SFAS No. 153 Exchanges of Non-monetary Assets
In December 2004, the FASB issued SFAS No. 153 Exchanges of Non monetary Assetsan amendment of APB Opinion No. 29. This statement amended Opinion No. 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this Statement are effective for non monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We estimate that the adoption of SFAS No. 153 will not impact on our Financial Statements.
Critical Accounting Policies and Estimates
In connection with the preparation of our Financial Statements included in this Annual Report, we have relied on variables and assumptions derived from historical experience and various other factors that we deemed reasonable and relevant. Although we review these variables and assumptions in the ordinary course of our business, the presentation of our financial condition and results of operations often requires management to make judgments regarding the effects of matters that are inherently uncertain. Actual results may differ from those estimated as a result of these different variables and assumptions. We have described each of the following critical accounting policies and estimates in order to provide an understanding about how our management forms judgments and views with respect to such policies and estimates, as well as the sensitivity of such policies and estimates:
impairment of long-lived assets;
provision for allowances and contingencies; and
income taxes deferred tax assets and credit on assets tax.
Impairment of Long-Lived Assets
Argentine GAAP and US GAAP require that the carrying value of assets be evaluated for impairment against its recoverable value which for a long lived asset is generally defined as its economic use value. We believe that the accounting estimate related to asset impairment is a critical accounting estimate because it requires our management to: (1) periodically evaluate the carrying value of our long-lived assets for impairment, (2) make estimates about future revenues and costs over the life of our long-lived assets and (3) assess the impact of how and to what extent an impairment could be material to our financial position, as well as our results of operations. Management estimates about future revenues require significant judgment because actual revenues have fluctuated in the past and may continue to do so especially due to the pending tariff renegotiation.
In estimating future revenues, we mainly use our projected cash flow that may affect the carrying value of our long-lived assets. With respect to projected cash flow, we have made certain estimates relating to the tariff adjustments we expect to be made in the future. However, due to the uncertainties surrounding the tariff renegotiation process (discussed above in OverviewInflation and inflation accountingTariff renegotiation), these estimates are highly uncertain and there is a substantial risk that these estimates could prove to be materially inaccurate. Accordingly, we can give no assurance that the projected cash flow, based on these estimates, will be realized in the future and, consequently, whether the recoverable value of our fixed assets will exceed their respective net carrying values.
We consider the carrying value of a long-lived asset to be impaired when the expected cash flow, undiscounted and without interest, from such asset is separately identifiable and less than its carrying value. In that event, a loss would be recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset.
Provision for Allowances and Contingencies
We provide for losses relating to trade receivable accounts. The allowance for losses is based on managements evaluation of various factors, including the credit risk of customers, historical trends and other information. While management uses the most current information available to make its evaluations, future adjustments to the allowance may be necessary if future economic conditions differ substantially from the estimated economic conditions used in making these evaluations. Management considers all events and transactions that it believes are relevant to our business and believes it has made reasonable estimates.
We have certain contingent liabilities with respect to legal and regulatory proceedings. For more information, see Item 8. Financial InformationConsolidated Statements and Other Financial InformationLegal and Regulatory Proceedings. We accrue liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments as of the time the accruals are made, estimates of the outcomes of these matters and our lawyers experience in contesting, litigating and settling other matters. As the scope of the liabilities becomes better defined, there may be changes in estimates of future costs, which could have a material effect on our financial condition and results of operations.
Income TaxesDeferred tax assets and tax credits
As of December 31, 2004 and 2003, we had significant deferred tax assets that were generated principally by the devaluation of the peso. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become recoverable.
Due to the economic crisis affecting Argentina, all working days between December 21, 2001 and January 11, 2002 were declared exchange holidays by the Argentine government. On January 11, 2002, when the exchange market first opened, the exchange rate was Ps. 1.4 per US$ 1 (buying rate) and Ps. 1.6 per US$ 1 (selling rate). As per Argentine Income Tax Law, the net exchange loss arising from the devaluation of the Argentine peso after comparing the exchange rate in force at December 20, 2001 (Ps. 1 = US$ 1) vis-à-vis the exchange rate in force at January 11, 2002 (Ps. 1.4 = US$1) is to be considered deductible for income tax purposes at a rate of 20% per year commencing in fiscal year 2002. As a result of the application of this requirement, we maintain a deferred tax asset amounting to Ps. 58.0 million and Ps. 87.0 million at December 31, 2004 and 2003, respectively.
As of December 31, 2004 and 2003, based on current financial information, we are uncertain that we will recover our entire tax loss carry-forward through future taxable income. Consequently, our management has recorded a valuation allowance of Ps. 245.9 million and Ps. 334.3 million as of December 31, 2004 and 2003, respectively.
We are required to periodically evaluate the recoverability of deferred tax assets. This evaluation is made based on internal projections, which are routinely updated to reflect more recent trends in our results of operations.
We have also recorded an asset of Ps. 57.7 million as of December 31, 2004 for the value of our tax credit related to asset tax. In the opinion of management, it is more likely than not that we will utilize such asset against future income tax charges within the next ten years, and, as a result, no valuation allowance was recognized.
For more information, see Item 18. Financial Statements Notes 2.k) and 2.l).
Liquidity and Capital Resources
Due to the severe financial crisis in Argentina and our resulting default under our financial indebtedness, we have had no access to external sources of financing or the capital markets generally since the 2002 economic crisis in Argentina. Prior to the 2002 economic crisis in Argentina, we relied on internally generated funds, supplemented by third-party financings and access to capital markets through our several global medium-term note programs for debt issuances in order to finance our operations. For more information, see Item 18. Financial StatementsNote 6. Since the crisis, we have had to rely only on internally generated funds to satisfy our payment obligations.
However, our ability to generate funds internally suffered severely from the pesification of our tariffs, resulting in lower revenues from our gas transportation segment and the devaluation of the peso resulting in, in relative U.S. dollar terms, lower revenues and a substantial increase in our indebtedness. The impact of these events and conditions on our financial condition caused us to breach financial and certain other covenants contained in several of our significant debt obligations, thereby causing defaults to occur under those debt obligations. In turn, those defaults caused cross-defaults to occur under substantially all of our other debt obligations. Also, as a result of these conditions, internally generated cash was not sufficient to service our debt and satisfy significant principal payment obligations due in 2003. Therefore, on February 24, 2003, we launched a proposal aimed at restructuring substantially all of our outstanding indebtedness; however, we failed to obtain the level of consent that was necessary under Argentine law to implement the proposal. In May 2003, we withdrew our initial restructuring proposal and announced that we would suspend principal and interest payments on all of our financial debt obligations
On October 1, 2004, we announced a new debt restructuring proposal, in the form of an exchange offer, which was accepted by creditors holding 99.76% of the principal amount of our debt that we sought to restructure. Accordingly, on December 15, 2004, we concluded the restructuring process of our outstanding indebtedness. The restructuring proposal consisted in (i) a cash payment in satisfaction of past due interest on such debt obligations, (ii) a cash payment in respect of 11% of the principal amount of such debt obligations, and (iii) the issuance of new debt obligations (or, in the case of some debt obligations, the amendment and restatement of such debt obligations) in respect of the remaining 89% of the principal amount of such debt obligations. In connection with the restructuring we also settled Ps. 27.0 million of peso-denominated debt, and since the closing of the restructuring on December 15, 2004, we have settled an additional US$ 2.2 million of additional principal amount of unrestructured indebtedness.
The renegotiation enabled us to reduce the interest rates of our indebtedness and align amortization payments with our anticipated cash flow. Consequently, a predetermined step-up interest rate (to avoid risk of future international interest rate rises) was agreed to in our new debt obligations, which will allow us to make lower interest payments during the first years following issuance, when the total amount of the new debt obligations is higher. Also, we are hopeful that the step-up increase in the capital amortization schedule (see Future Capital Requirements) will allow us to reduce financial pressure in the short-term and thus enable us to focus on the growth of our business, which was affected by the crisis.
As the result of the debt restructuring process and our new debt profile, our liquidity ratio (current assets to current liabilities) improved significantly, from 0.24x as of December 31, 2003 to 1.72x as of December 31, 2004.
A potential future devaluation of the peso, additional capital expenditures required by the Argentine government or a significant decrease of NGL prices could harm our cash-generating ability and materially adversely affect our liquidity and our ability to service our debt.
Our primary sources and uses of cash during the years ended December 31, 2004, 2003 and 2002, are shown in the table below:
Cash flows provided by operating activities
Cash flows provided by operating activities for the year ended December 31, 2004 decreased by approximately Ps. 411.3 million, or approximately 78%, as compared to the year ended December 31, 2003. This decrease was primarily the result of our suspension of interest payments on our debt commencing in May 2003, which led to an unusually high amount of cash and cash equivalents at December 31, 2003, and our payment in 2004 of Ps. 370.3 million in accrued interest on our debt in connection with our restructuring discussed above.
Cash flows provided by operating activities for the year ended December 31, 2003 increased by approximately Ps. 286.4 million, or approximately 119%, as compared to the year ended December 31, 2002. This increase reflects the suspension of interest payments on our financial debt obligations, as from May 2003.
Cash flows used in investing activities
Cash flows used in investing activities for the year ended December 31, 2004 increased by approximately Ps. 36.5 million, or approximately 59%, as compared to the year ended December 31, 2003, primarily due to the higher capital expenditures during 2004.
Cash flows used in investing activities for the year ended December 31, 2003 decreased by approximately Ps. 35.2 million, or approximately 36%, as compared to the year ended December 31, 2002, primarily due to the suspension of an expansion project as a consequence of the Argentine economic crisis in 2002. As from May 2003, the investing activities were limited to essential maintenance capital expenditures.
Cash flows (used in) provided by financing activities
Cash flows used in financing activities for the year ended December 31, 2004 were Ps. 354.7 million, as compared to Ps. 2.0 million in cash flows provided by financing activities for the year ended December 31, 2003. This increase in cash flows used in financing activities was primarily the result of our suspension of principal payments on our debt commencing May 2003 and our payment in 2004 of Ps. 362.7 million in outstanding principal on our previously existing debt obligations in connection with our restructuring discussed above.
Cash flows provided by financing activities for the year ended December 31, 2003 were Ps. 2.0 million, as compared to Ps. 62.6 million in cash flows used in financing activities for the year ended December 31, 2002. This change reflects advance payments received in 2003 from certain customers for services to be provided in the future and our suspension of principal and interest payments due under our financial debt obligations on May 2003.
Description of indebtedness
In December 2004, we concluded the process of restructuring substantially all of our outstanding indebtedness. Our restructuring proposal, which was accepted by creditors holding 99.76% of the principal amount of our debt, consisted of the exchange of our existing debt obligations for a combination of cash and either newly-issued notes (the New Notes) or, in the case of the loans with the Inter-American Development Bank (IDB), entering into amended and restated loan agreements with new terms (the Amended Loans).
Holders of our outstanding debt who consented to the restructuring proposal received a cash payment consisting of (i) the repayment of 11% of the principal amount of such debt obligations and (ii) a payment in respect of past due interest owing on such debt obligations. Such payment in respect of past due interest was made in settlement of all claims for accrued and unpaid interest on such debt obligations, including default interest.
Accordingly, on December 15, 2004, we issued six series of new notes in an aggregate principal amount of US$614,295,095 pursuant to our Global Program, which provides for the issuance of up to a maximum principal amount of US$800 million in notes. We also entered into amended loans with IDB on December 15, 2004 having an aggregate principal amount of US$290,140,000. Accordingly, as of December 15, 2004, our total U.S. dollar-denominated debt consisted of US$904,435,095 in new notes and amended loans (referred to collectively as the New Debt Obligations) and US$2,393,000 in pre-existing debt obligations that were not tendered in our restructuring. As of the date of the issuance of this Annual Report, we have made two amortization payments on our new debt obligations in an aggregate amount of US$ 10,581,891 on each of March 15, 2005 and June 15, 2005; on June 15, 2005, we also made a payment of an early cash surplus amortization amount of US$28,068,000. In addition, we repaid US$2,194,000 of our remaining pre-existing debt obligations. Accordingly, the aggregate principal amount of our total U.S. dollar-denominated debt as of the date of this Annual Report is US$855,203,313 in new debt obligations and US$199,000 in pre-existing debt obligations.
We are subject to several restrictive covenants under our new debt obligations that limit our ability to obtain additional financing, including limitations on our ability to incur additional indebtedness and limitations on our ability to create liens on our property, assets or revenues. Since our new debt obligations amortize, we have quarterly obligations to repay principal on such debt. Also, the new debt obligations contain a mandatory cash surplus amortization provision, pursuant to which we are required to use cash on hand (net of certain adjustments), at least annually and more frequently at our option, to accelerate payments of principal under the amortization schedule for our new debt obligations. We are also subject to other restrictive covenants that impact our use of cash on hand, such as limitations on our ability to pay dividends to our shareholders, limitations on our ability to make capital expenditures, limitations on our ability to sell our assets, and limitations on our ability to make investments. See Item 10. Additional InformationMaterial ContractsNew Debt Obligations for a detailed discussion of the terms of our new debt obligations, including the interest rates, amortization terms and material covenants applicable to such indebtedness.
Future Capital Requirements
Details of our currently projected capital expenditures for the 2005-2007 period, in millions of U.S. dollars, are set forth in the following table:
Considering the current uncertainty surrounding the tariff renegotiation and the capital expenditure restrictions contained in our new debt obligations, we intend to limit our capital expenditures to those necessary to maintain operational safety and the reliability of the pipeline system. Nevertheless, we are continuously exploring new business opportunities both in the local and regional markets. Also, as noted above, the Argentine Government has created a Gas Trust to finance the expansion of the San Martín pipeline and we are required by agreement to invest approximately US$33 million (excluding VAT), US$ 21.1 million of which we are investing in 2005 and the remainder of which was invested in 2004. For more information, see Item 10. Additional InformationMaterial ContractsGas Trust.
As of the date of the issuance of this Annual Report, we maintain an escrow of US$24 million in favor of the pipe supplier in connection with the San Martín expansion project, as a condition to preserve the price and delivery terms of the bid submitted by the supplier to the Gas Trust. The supplier will reimburse this amount to us once it receives payment from the Gas Trust, the timing of which depends principally on the Gas Trust obtaining a loan from a foreign bank.
The following table represents a summary of our contractual obligations as of December 31, 2004:
(1) As described above in Cash Flow ItemsDescription of indebtedness our new debt obligations include the provision for accelerated amortization, which was not considered for purposes of this table.
Almost all of the debt obligation amounts set forth above are U.S. dollar-denominated and, therefore, principal and accrued interest included in the amounts presented have been converted to peso amounts using the selling exchange rate of US$1=Ps. 2.979 as of December 31, 2004. Actual foreign currency debt payments may significantly differ from these estimates due to exchange rate fluctuations.
Currency and Exchange Rates
Our primary market risk exposure is associated with changes in the foreign currency exchange rates since our debt obligations are denominated in U.S. dollars and the measures taken by the Argentine government since the repeal of the Convertibility Law and the pesification of our regulated tariffs. However, with respect to our NGL production and commercialization segment, our revenues are mainly denominated in US dollars.
Additionally we do not consider interest rates as a market risk exposure, since our debt does not bear market interest rates.
Our financial debt obligations denominated in foreign currency as of December 31, 2004, amounted to US$913.3 million (Ps. 2,720.9 million). As of December 31, 2004, we also had the equivalent of US$10.2 million (Ps. 30.5 million) of trade and other payables denominated in foreign currencies. Finally, US$171.7 million (Ps. 504.7 million) of our receivables, investments and cash and banks are denominated in foreign currency. Therefore, net position in US$ amounted to 751.8 million as of December 31, 2004.
Derivative financial instruments
Interest rate caps
We had outstanding interest rate cap agreements with major financial institutions to manage the impact of the floating interest rate changes on the privately placed U$S 200 million note issued pursuant to the year 2000 EMTN Program. Premiums paid by us in respect of the interest rate cap agreements amounted to US$ 2.9 million. During the year ended December 31, 2003, the agreements did not generate results due to the fact that LIBOR remained below an annual rate of 5.25%. Based on the expected future levels of LIBOR, we decided that the derivative was no longer necessary to cover the associated risk and consequently the difference between the unamortized portion of the premium paid at inception and its fair value (included in Other Current Receivables) was charged to expense during fiscal year 2003. Such difference amounted to Ps. 3.5 million and was included within Write off of intangible assets included in Net financial results, see Note 2.p) to our Financial Statements.
In 1998, we entered into two treasury interest rate lock agreements with a notional amount of US$ 200 million associated with the IDB loan issued in April 1999, pursuant to which we locked in the rate on the US Treasury Bond at a cost between 5.66% and 5.89% per year. We settled one of the agreements in February 1999 for an amount of US$ 100 million and the other for US$ 100 million paid in two installments in March and April 1999. In settlement of these agreements, we made payments totaling US$ 11 million in March and April 1999. The settlement cost of these agreements had been recorded as Intangible assets and was amortized over the term of the loan agreement as of December 15, 2004, the date on which we entered into the amended loan agreements. The net book value at December 15, 2004, which was Ps. 8.3 million, was charged to expense.
Research and Development, Patents and Licenses, etc.
See Discussion of Results of Operations for the Three Years ended December 31, 2004, 2003 and 2002 and Item 8Financial Information. Legal and regulatory Proceedings.
Off-balance sheet arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, in each case, the disclosure of which would be material to investors. See Liquidity and Capital ResourcesDerivative Financial Instruments and Note 6 to our Financial Statements regarding our use of derivative financial instruments.
Tabular disclosure of contractual obligations
See Future Capital Requirements for tabular disclosure of our know contractual obligations.
Directors, Senior Management and Employees
Directors and Senior Management
General. Management of our business is vested in the Board of Directors. Our By-laws provide for a Board of Directors consisting of nine Directors and nine Alternate Directors. In the absence of one or more Directors, Alternate Directors will attend meetings of the Board of Directors. Directors and Alternate Directors are elected at an ordinary meeting of shareholders to serve one- to three-year renewable terms, as decided by the shareholders.
Under our By-laws and Argentine law, the Board of Directors is required to meet at least once every three months. A majority of the members of the Board constitutes a quorum, and resolutions must be adopted by a majority of the Directors present. In the case of a tie, the Chairman or the person replacing him at a particular meeting is entitled to cast the deciding vote.
In the Annual Shareholders Meeting held on April 2, 2004, the number of Directors on our Board was increased by two members to nine from seven. Additionally, the shareholders decided at that meeting that upon motion by the Chairman, our Board of Directors meetings may now be held by video or telephone conference.
The current Board of Directors was elected by our shareholders at the Annual Shareholders Meeting held on March 31, 2005 for a one-year term.
The Shareholders Agreements contain provisions governing the voting of our shares held by CIESA, the election of the members of our Board of Directors and certain other matters. For more information see Item 7. Major Shareholders and Related Party Transactions. Shareholders Agreements.
Duties and Liabilities of Directors. Under Argentine law, Directors have the obligation to perform their duties with the loyalty and the diligence of a prudent business person. Directors are jointly and severally liable to us, shareholders and third parties for the improper performance of their duties, for violating the law, our By-laws or regulations, if any, and for any damage caused by fraud, abuse of authority or gross negligence. Under Argentine law, specific duties may be assigned to a Director by our By-laws or regulations or by a resolution of a Shareholders Meeting. In such cases, a Directors liability will be determined with reference to the performance of such duties, provided that certain recording requirements are met. Moreover, under Argentine law, Directors are prohibited from engaging in activities in competition with us without express shareholder authorization. Certain transactions between us and Directors are subject to ratification procedures established by Argentine law.
A Director will not be liable if, notwithstanding his presence at the meeting at which a resolution was adopted or his knowledge of such resolution, a written record exists of his opposition thereto and he reports his opposition to the Statutory Audit Committee before any complaint against him or her is brought before the Board, the Statutory Audit Committee, a Shareholder Meeting, competent governmental agency or the courts. Shareholder approval of a Directors performance terminates any liability of a Director vis-à-vis us, provided that shareholders representing at least 5% of our capital stock do not object and that such liability does not result from a violation of the law or our By-laws or regulations.
Causes of action against Directors may be initiated by us upon a majority vote of shareholders. If a cause of action has not been initiated within three months of a shareholders resolution approving its initiation, any shareholder may initiate the action on behalf of and for our account.
At the Annual Shareholders Meeting held on March 6, 1996, our shareholders approved the acquisition of civil liability insurance coverage for directors, syndics and officers. Such coverage is common practice among public companies who seek protection against shareholders and other parties claims.
Three of the members of our Board of Directors are independent as defined in Section 301 of the Sarbanes Oxley Act and Resolution No. 368 of the CNV. All three are also members of our Audit Committee. The remainder of the members of the Board of Directors are not independent. Under the independence requirements a director is not independent if any of the following apply:
the director is also a director of a controlling shareholder or any other entity controlled by or related to a controlling shareholder of the issuer;
the director is also a director of another entity, any of whose shareholders is also a shareholder of the issuer or its controlling entity or any other entity controlled by or related to the latter;
the director provides, or belongs to a professional corporation or association which provides, professional services to or receives any form of remuneration or fees from the issuer or its controlling entity or any other entity controlled by or related to the latter; and
the director provides, or belongs to a professional corporation or association that provides professional services to or receives any form of remuneration or fees from another entity, any of whose shareholders is also a shareholder of the issuer or its controlling entity or any other entity controlled by or related to the latter.
The following table sets out the current membership of our Board of Directors, their respective positions on the Board and the year they were appointed to such position. Except for Kalil George Wassaf, Miguel Mendoza, James Monroe and Kevin Michael Altit, all members live in Argentina.
Additional information regarding the occupation and employment background of each of our regular Directors is set forth below:
Mr. Rafael Fernández Morandé obtained a Civil Engineering in Industry degree from Universidad Católica de Chile. Before joining Petrobras Energía, he worked at Chilgener S.A. from 1989 to 1992, at Central Puerto S.A. from 1992 to 1995 and at Guacolda S.A. from 1995 to 1997. In 1998, he joined Petrobras Energía. He is also a member of the Board of Directors of Distrilec S.A., Petrobras Energía, Edesur S.A., Citelec S.A., Transener S.A., Transba S.A., CIESA, Petrobras Energía Participaciones S.A., and Compañía Mega S.A.
Mr. Eduardo Ojea Quintana received a law degree from the Universidad del Museo Social Argentino. He worked with Petrobras Energía from 1972 to 1992. At the beginning of our operations, he served as Director of Legal, Regulatory and Public Affairs until 1998. From 1998 until June 21, 2004, he served as our CEO. He is member of the Board of Directors of Telcosur, TGU, CIESA, EPCA, EGS and Enron Argentina CIESA Holding S.A. He is also a manager of Enron Inversiones de Energía S.C.A. and of Enron Inversiones de Gas S.R.L.
Mr. Jorge Casagrande graduated from the University of Buenos Aires as a Certified Public Accountant. He previously worked at Massalin Particulares and Price. He joined Petrobras Energía in 1992. Mr. Casagrande is currently the Planning and Control Corporate Manager of Electricity and Gas Business of Petrobras Energía. He is also a member of the Board of Directors of Distrilec S.A., Edesur S.A., Citelec S.A., Transener S.A., Transba S.A., CIESA, Telcosur, EGS and Compañía Mega S.A.
Mr. Kalil George Wasaff graduated from the University of Texas as a Certified Public Accountant. Before joining Enron Corp. in 1986, he worked in El Paso Natural Gas Company and Transwestern Pipeline. From 1993 to 1998 he worked for us, where he acted as Vice Chairman and CEO during the period 1995-1998. Currently, he is Managing Vice President of Corporate Services of Enron Corp.
Mr. César Días Ramos obtained a degree in Mechanical Engineering from the Universidad de Federal Fluminense and holds a Master in Business Administration. Currently he is also a member of the Board of Directors of Compañía Mega S.A. and CIESA.
Mr. Miguel Mendoza graduated from Universidad Católica Andres Bello of Venezuela with a Juris Doctor degree and has received a Master in International Law, Trade and Finance from Tulane Law School, New Orleans, Louisiana USA. Before joining Enron Corp. in 1999, he worked at Adams & Reese in New Orleans as an associate, and at Torres Plaz & Araujo in Caracas, Venezuela, as a partner. He is also Assistant General Counsel in the Enron Corp. Legal Department.
Mr. Víctor Díaz Bobillo obtained a law degree from the University of Buenos Aires. He is currently a partner of the Diaz Bobillo, Richard & Sigwald law firm in Buenos Aires. He is also a member of the Board of Directors of Argforus S.A., Riviera Center S.A., Laborum.com S.A. and Graham Packaging Argentina S.A.
Ms. Carolina Sigwald obtained a law degree from the University of Buenos Aires. She worked at the law firm of Chadbourne and Parke LLP in New York from 1996 to 1997 and at the Corporación Interamericana de Inversiones in Washington D.C. from 1997 to1998. Currently she is partner of the Diaz Bobillo, Richard & Sigwald law firm in Buenos Aires. She is also a member of the Board of Directors of Supertap S.A. and Heidrick & Struggles S.A.
Mr. Oscar Marano graduated from the University of Buenos Aires as a Certified Public Accountant and Bachelor of Administration. He has worked in Edenor S.A., Astra S.A., Compañía Financiera Eugenio Diez S.A., Eugenio Diez S.A. and EDF Branch Americas. He is also working as independent consultant.
Executive Officers. The following is a list of our executive officers as of the date of issuance of this Annual Report, their respective positions with us and the year they were appointed to such position:
The present principal occupations and employment history of each of our executive officers are set forth below:
Mr. Pablo Alejandro Ferrero received an engineering degree from the Universidad Católica Argentina and obtained a Master in Business Administration at the University of Washington. He joined Petrobras Energía in 1991 and in 1993 he joined us as Transportation and Business Development Manager and from 1997 to 1998 he was Marketing and Tariffs Vice President. In 1998 he returned to Petrobras Energía as the manager of Gas and Oil Commercialization and Transportation, and in 2001 he became the Vice President of Planning and Business Development, which position he held until June 21, 2004, when he became our CEO. He is Chairman of the Board of Directors of Telcosur.
Mr. Jorge García received an accounting degree from the University of Buenos Aires. Mr. García worked for the following companies within Petrobras Energía Group: Central Costanera S.A. during 1992, Petroquímica Argentina S.A. from 1987 to 1991 and Petrobras Energía from 1980 to 1986. He was our Chief Financial Officer from 1992 to September 1998, and currently is the Marketing Vice President. He is Vice Chairman of the Board of Directors of Link and TGU.
Mr. Eduardo Pawluszek received an accounting degree from the University of Buenos Aires and a Master Degree in Finance and Capital Markets from the Escuela Superior de Economía y Administración de Empresas (ESEADE). He worked for Royal Bank of Canadá from 1988 to 1999. Prior to that, he worked for other financial institutions in Argentina. He started to work with us in 1999 as Financial & Investor Relations Manager. He has been our Chief Financial Officer since April 2005.
Mr. Jorge Bonetto received an electromechanical engineering degree from the Universidad de Córdoba and a Masters degree in Business Administration from the Escuela de Dirección y Negocios de la Universidad Austral (IAE). Before joining us, he worked for Petroquímica Argentina S.A., Petroquímica Cuyo S.A. and Corcemar S.A. He has served as our Operations Vice President since May 2000.
Mr. Daniel Perrone received a mechanical engineering degree from the Universidad Tecnológica Nacional. He previously worked for Cometarsa S.A., Matoil S.A., Servoil S.A., Bridas S.A.P.I.C. and TransCanada International. Since the end of 1999, he has been our Vice President of Regulatory and Institutional Affairs since August 2001.
Mr. Cristian Dougall received a law degree from the University of Buenos Aires. From 1973 to 1993, he worked in the law firm of Dougall & Emery in Buenos Aires. He joined us in 1993. He was Legal and Regulatory Affairs Manager from March 1998 to November 1999. He is currently the Legal Affairs Department Manager.
Mr. Juan Martín Encina received a law degree from the University of Buenos Aires and a Master in Human Resources Direction from the Universidad de Ciencias Empresariales y Sociales (UCES). From 2000 through 2004, he worked as Human Resources Manager of the Gas & Energy Division and Centralized Functions at Petrobras Energía, leading projects in Argentina, Ecuador and Brazil. He joined us in September 2004 as Manager of the Human Resources Department.
Mr. Alejandro Basso received an accounting degree from the University of Buenos Aires. He was associated with Petrobras Energía from 1987 to 1992 and with Quitral-Co from 1992 to 1994. From 1994 to 1998, he acted as Planning and Corporative Control Manager. He has been Planning Department Manager since September 1998 and Planning and Control Department Manager since June 2002. He is member of the Board of Directors of TGU.
Mr. Oscar Sardi received a mechanical engineering degree from the Universidad Tecnológica Nacional and he attended a IAEs General Management Program. He was associated with GdE from 1983 to 1992 and with us since 1992. He has been Services Department Manager since April 2005.
Mr. Florentino Tobares obtained the degree of Electromechanical Engineer and post-graduate course in Hygiene and Occupational Safety from the Universidad Tecnológica Nacional. He has worked with us since 2000 as Safety, Environmental and Quality Manager. He previously worked for PASA S.A., Empresa Petroquímica Cuyo, U.C.A.S.A. and YPF S.E.
Indemnification of Officers and Directors. Under the Shareholders Agreements, CIESA is required to cause us to: (i) limit the liability of each of our officers and directors for all actions or omissions of such officers and directors, excluding actions or omissions involving bad faith or willful misconduct and (ii) enter into agreements obligating CIESA to defend, indemnify and hold harmless each of our officers and directors from and against all liabilities, losses, and other expenses incurred by each such officer or director in connection with a pending, threatened or completed civil, criminal, administrative or other proceeding, or any investigation that could lead to such a proceeding, by reason of the fact that such officer or director is or was one of our officers or directors, excluding actions or omissions involving bad faith or willful misconduct.
The aggregate remuneration paid or accrued by us during 2004 to all directors and executive officers was approximately Ps. 5.8 million. We do not provide pension, retirement or similar benefits for directors and officers.
The compensation of our executive officers is through a program of variable compensation. Agreed-upon objectives are established, either for particular individuals or for our business sectors, whereas and through the variable compensation program, a portion of our executive officers compensation is determined based on their own performance and our performance.
Pursuant to the provisions of the Regime Concerning Transparency in Public Offerings approved by Decree No. 677/01, and further complemented by Resolution Nos. 400/02 and 402/02 issued by the CNV; Argentine public companies must have an audit committee composed of three or more members of the board of directors.
On May 26, 2003, our Board of Directors approved and adopted the Model Charter of the Audit Committee, to comply with Resolution No. 402/02 of the CNV, which mandated that as of May 28, 2003, Argentine public companies must have an audit committee charter in place. In addition, that resolution required all Argentine public companies to establish their audit committee no later than May 28, 2004.
Consequently, and in compliance with the above resolutions, at the shareholders ordinary and extraordinary meeting held on April 2, 2004, we approved an amendment to our By-laws adding a provision related to the structure and operation of the Audit Committee.
As provided by the Audit Committee Charter, our Audit Committee is comprised of three regular directors. All members are independent according to the regulations in force issued by the SEC and the CNV. The committee members are named by simple majority vote of the Board of Directors, in the first meeting after the Board members are appointed, and their term continues until their successors are named by the Board of Directors. The Audit Committee adopts its own internal regulations, and creates an action plan for each fiscal year. At the Board of Directors meeting held on March 31, 2005, Oscar Marano, Victor Díaz Bobillo and Carolina Sigwald were appointed as regular independent members of the Board of Directors and members of the Audit Committee.
The Committees mandatory periodic duties are to:
supervise the internal control and accounting systems as well as the reliability of the latter and all the financial information and other significant issues that are to be submitted to the SEC, CNV and BASE in compliance with the applicable disclosure policies;
supervise the application of information policies regarding our risk management;
ensure that the market is informed about those operations in which there might be some conflict of interests with the members of the Board of Directors, controlling shareholders or other parties as defined by the applicable regulations;
express its view on the reasonableness of compensation proposals and stock option plans for directors and officers submitted by the Board of Directors;
express its view as to compliance with laws and regulations and the reasonableness of the conditions of an issuance of shares (or convertible securities), in the case of a capital increase excluding or limiting preferential rights;
verify compliance with the Code of Conduct;
issue a well-founded opinion on whether the terms and conditions of relevant transactions with related parties are according to market practice, within five calendar days from the receipt of a petition issued by the Board of Directors, and any other time in which exists or might exist conflict of interests;
prepare an annual performance plan for the fiscal year and notify the Board of Directors and the Statutory Audit Committee within 60 days from the beginning of the period;
fulfill all the obligations stated in our By-laws, and the laws and regulations applicable to us;
express its view on the Board of Directors proposals appointing (or rejecting) the external auditors to be hired and monitor the auditors independence.
Also, regarding the internal and external auditors, the Committee shall:
review their plans; and
evaluate their performance, and give an opinion on their performance when issuing the annual financial statements. When evaluating the external auditors performance, the Committee shall:
analyze the different services rendered by the external auditors and their independence, according to TR No. 7 of the Argentine Federation, any other related regulations issued by professional councils and those regulations set by Resolution No. 400/02, section 4 and Chapter 18, section 18 of the CNV rules;
report the fees payable separately as follows: (i) fees for external audit and other related services meant to provide reliability to third parties (e.g., special reports about internal controls, shareholding prospectus, certifications and special reports requested by regulators, etc.); and (ii) fees related to other special services different from those mentioned above, such as those associated with design and implementation of systems, laws and regulations, financial issues, etc.; and
verify the independence of the external auditors in accordance with internal policies.
The mandatory occasional duties the Committee must perform are those duties contained in the regulatory framework, such as:
give a prior assessment, within five days from notification, that shall be used by the CNV to require us to designate an external auditor as requested by minority shareholders, as long as they represent at least 5% of our common stock (in those cases in which the minority shareholders rights might be affected), in order to carry out one or more specific revisions. The charges of such revisions shall be paid by the petitioning shareholders (Decree No. 677/01 section 14 article e; Regulation No. 400/02 section 4; and Chapter 3 section 23 of the CNV rules);
provide a well-founded assessment about an acquiring tender offer in case of withdrawing the public offering if we would cease to be a public company or our stock cease to be traded. (Decree No. 677, section 32; Resolution No. 401/02, sections 25 and 27);
issue a report supporting a Board of Directors resolution to buy back our shares (Decree No. 677/01 section 68 article b; Resolution No. 400/02, section 4; and Chapter 3 article 11 of the CNV rules).
Once a year, the Audit Committee shall prepare a plan for the fiscal year to be submitted to the Board of Directors and to the Statutory Audit Committee. The Directors, members of the Statutory Audit Committee, managers and external auditors shall, when requested by the Audit Committee, attend its meetings, provide the Audit Committee with information and otherwise assist the Audit Committee in the performance of its functions. In order to better perform its functions, the Audit Committee may seek the advice of legal counsel and other independent professionals at our expense, pursuant to a budget approved by shareholders. The Audit Committee shall have access to the information and documents it may deem necessary to perform its duties.
According to CNV rules, at least once a year and upon the filing of the annual financial statements, the Audit Committee shall issue a report to the shareholders, addressing how the Committee performed its duties and the results of its work.
The aggregate remuneration paid by us in respect of the year ended 2004 to the members of the Audit Committee was approximately Ps. 0.13 million. We do not provide pension, retirement or similar benefits for any member of the Audit Committee.
Statutory Audit Committee. The Statutory Audit Committee is our monitoring body as stipulated in article No. 284 of the Commercial Companies Law. Our By-laws provide for a Statutory Audit Committee consisting of three members (Syndics) and three alternate members (Alternate Syndics). In accordance with our By-laws, two Syndics and the respective Alternate Syndics are elected by a majority vote of the holders of our Class A Shares. The remaining Syndic and corresponding Alternate Syndic are elected by the majority vote of the remaining holders of our common stock. Each member of the Statutory Audit Committee is elected at the Annual Ordinary Shareholders Meeting and serves for a one-year renewable term. Members of the Statutory Audit Committee must be lawyers or accountants qualified under Argentine law and, for the accountants, TR No. 15. Our directors, officers and employees may not be members of the Statutory Audit Committee. Our By-laws require the Statutory Audit Committee to hold meetings at least once per month.
The primary responsibilities of the Statutory Audit Committee consists of monitoring our managements compliance with the Commercial Companies Law, our By-laws and the shareholders resolutions, and without prejudice to the role of external auditors, reporting to the shareholders at the Annual Ordinary Shareholders Meeting regarding the reasonableness of our financial information. Furthermore, the members of the Statutory Audit Committee are entitled to: (i) attend Board of Directors and Shareholder Meetings, (ii) call Extraordinary Shareholders Meetings when deemed necessary and Ordinary Shareholders meetings when the Board of Directors fails to do so, and (iii) investigate written inquires initiated by shareholders. The Statutory Audit Committee does not control our operations or evaluate managements decisions, which are the exclusive responsibility of the Board of Directors.
The aggregate remuneration paid or accrued by us during 2004 to the members of the Statutory Audit Committee was approximately Ps. 0.054 million. We do not provide pension, retirement or similar benefits for syndics and alternate syndics.
The current members of the Statutory Audit Committee, each of whom was appointed at the Annual Shareholders Meeting held on March 31, 2005, the year they were initially appointed to the Statutory Audit Committee and the year their term expires, are as follows:
The present principal occupations and employment history of our Syndics are set forth below:
Mr. Mariano Pablo González obtained a law degree from the Universidad de Belgrano and a Master in Law from the Columbia University School of Law of New York. He has worked as an attorney in the Argentine Securities and Exchange Commission from 1993 to 1994; as foreign associate at Milbank, Tweed, Hadley & McCloy from 1994 to 1995; as a foreign lawyer at Linklaters & Paines from 1996 to 1997, as a senior associate of Marval, O'Farrell & Mairal from 1997 to 1998, as a partner of Estudio Beccar Varela from 1998 to 2005 and currently serves as a partner of González & Ferraro Mila. He is also a member of the Board of Directors of EPCA, Enron Argentina CIESA Holding S.A. and a syndic of CIESA.
Mr. Carlos Dionisio M. Ariosa obtained his law degree from the Universidad Católica Argentina. He was previously associated with the Federal Judicial Branch, the Central Bank and Maciel, Norman & Asociados. Since 1998, he has been working for Petrobras Energía and currently serves as Legal Affairs Manager of Energy & Gas.
Mr. Enrique Prini Estebecorena obtained his law degree from the University of Buenos Aires in 1987. He obtained a Master in Law & Finance from Universidad del CEMA. He has been a member of the American Bar Association since 1992, a member of the Stakeholder Council of the UN Global Reporting Initiative since 2002, a founder member of the Gas Industry Lawyers Association since 1998 and Chair of the Honorary Council of Legal Affairs of the Business Corporation Chamber since 1997. He serves as a Manager of Legal Affairs of Petrobras Energía. He is also a syndic of CIESA and Telcosur.
Corporate Governance Practices; New York Stock Exchange Requirements
Our corporate governance practices are governed by applicable Argentine law (particularly, the Commercial Companies Law No. 19,550, as amended), Decree No. 677/01, the standards of the CNV and our By-laws. We have securities that are registered with the SEC and listed on the New York Stock Exchange (the NYSE) and, consequently, we are subject to the rules and regulations of the NYSE.
On November 4, 2003, the NYSE established new corporate governance standards (NYSE standards) that are applicable to NYSE-listed companies, including non-U.S. companies. Under these standards, non-U.S. companies are permitted, in general, to follow their home country corporate governance practices in lieu of most of the new NYSE corporate governance requirements (the NYSE Sections) codified in Section 303A of the NYSEs Listed Company Manual. However, non-U.S. companies must comply with NYSE Sections 303A.06, 303A.11 and 303A.12(b) and (c) Non-US companies must be in compliance with Section 303A.06 prior to July 31, 2005. Section 303A.11 requires that non-US companies disclose any significant ways in which their corporate governance practices differ from those followed by U.S. companies under NYSE listing standards. Specifically, a non-U.S. company is required to provide a brief, general summary of the significant differences by means of (i) the companys website (in English) and/or (ii) the companys annual report distributed to its investors in the United States.
Pursuant to the requirements of Section 303A.11, the following table summarizes the significant differences between our corporate governance standards and those required of U.S. companies in accordance with the NYSE Sections:
As of December 31, 2004, we employed 745 employees located in seven provinces of the country (Buenos Aires, La Pampa, Río Negro, Chubut, Neuquén, Santa Cruz and Tierra del Fuego) and in the City of Buenos Aires.
The following table sets out the number of employees according to department as of December 31, 2004, 2003 and 2002:
The number of employees increased almost 18% from December 31, 2002 to December 31, 2004 due to: (i) in 2003, we insourced the Cerri Complex maintenance service, (ii) as of December 2004, we have hired temporary employees for the San Martín pipeline expansion and (iii) we recruited new employees in order to replace those employees who are to be retired in the short term.
Under Argentine law, in the event of an unfair dissmisal of an employee, the employer is required to pay the terminated employee severance, the amount of which is regulated by the Argentine Labor Agreement Act (Section 245). The severance payment is calculated by counting one wage for each year of employment. However, this act also stipulates limit to the severance payment, which only affects employees who earn high wages.
However, the Public Emergency Law established an increase in severance payments, that currently amounts to 80%, and empowered the Executive Branch to modify such percentage.
Moreover, the Supreme Court ruled unconstitutional the limit of severance payments, when this limit results in a loss of more than 33% for a terminated employee in respect to the amount calculated if the limit had not been applied.
Also, there has been a significant change regarding occupational accidents. The federal court has ruled unconstitutional the Law of Occupational Hazard Prevention and extended the responsibility of such accidents to the consigner of the outsourced works when a contractors worker is injured during the execution of the works.
In reference to the obligations of the contractors workers and third party service providers regarding social security, wage payment, compulsory insurance, etc., there exist case law records that hold the consigner responsible for the contractors non-complied obligations, even if the outsourced service is not part of the consigners usual business.
As for the Collective Labor Law, conflicts between employers and labor unions have increased lately. Even though these kind of conflicts have not involved us yet, other companies in the same industry have suffered strikes and conflicts with labor organizations. Despite this hostile framework and the demands of the unions, we renewed and/or are in process of renewing or endorsing the new Collective Bargaining Agreements with the corresponding labor unions.
Currently, approximately 11% of our workforce is affiliated with a national union, the Federación Argentina de Trabajadores de la Industria del Gas Natural y Afines (the Federation) and with a regional union.
The total amount of our Class B Shares held by our directors and executive officers as of February 28, 2005 is 49,957.
Our directors and executive officers, individually and together, hold less than 1% of our Class B Shares.
Item 7. Major Shareholders and Related Party Transactions
Our controlling shareholder is CIESA, which together with Petrobras Energía and one of its subsidiaries and certain subsidiaries of Enron, hold approximately 70.5% of our common stock. The remaining 29.5% of our common stock is currently held by local and foreign investors.
CIESA is owned 50% by Petrobras Energía and one of its subsidiaries and 50% by certain Enron subsidiaries and has the ability to direct our management, to control the election of the majority of the Board of Directors, to determine our dividend policy and other policies and to determine the outcome of any matter put to a vote of our shareholders. CIESA may freely dispose of its Class B shares in us and may transfer or sell any of our Class A Shares under certain conditions and with ENARGAS approval. See Future Changes in CIESA Shareholding.
The following table sets forth certain information, with respect to each shareholder known to us to own more than five percent of our common stock.
Pursuant to the Pliego and our debt agreement, CIESA may not reduce its shareholding in us below 51% of our share capital.
As of December 31, 2004, approximately 21.5% of the securities held by the public were held in the form of ADRs. At such date, a total of 10,086,808 ADRs, representing 50,434,040 Class B shares, were held by approximately 40 holders of record. Because certain of these ADRs are held by nominees, the number of record holders may not be representative of the number of beneficial owners.
Transfers of CIESA and Our Shares. The original holders of the common stock of CIESA entered into two shareholders agreements (the Shareholders Agreements) for the purpose of governing certain matters relating to their participation in CIESA and in us. Petrobras Energía and Enron Argentina continue to be parties to these agreements. The Shareholders Agreements provide certain rights of first refusal and tag-along or co-sale rights in the event of a proposed transfer of CIESA shares. The Shareholders Agreements further provide that any CIESA shareholder must offer to sell to the other shareholders all of its shares of CIESA common stock in the event of a change in control of such shareholder or in certain events of bankruptcy, insolvency or liquidation.
Under the Shareholders Agreements, the sale or transfer of any of our shares held by CIESA requires the approval of an absolute majority of the directors of CIESA, except that the sale or transfer of our shares such that CIESA would own less than 51% of our voting common stock requires the unanimous vote of the CIESA directors. Such a transaction would also require previous ENARGAS approval.
Election of Our Directors and Officers; Voting. The Shareholders Agreements also contain provisions governing the voting of our shares held by CIESA, the election of the members of our Board of Directors and Statutory Audit Committee, the appointment of certain officers and certain other matters.
Our Board of Directors consists of nine Directors (see Item 6. Directors, Senior Management and EmployeesDirectors and Senior Management). Under the Shareholders Agreements, each CIESA shareholder (so long as it retains at least a 15% interest in CIESA) is entitled to direct the appointment of one of our Directors (the Core Directors). If CIESA has the ability to elect our additional Directors, such additional Directors will be designated by the shareholders of CIESA on a rotating basis. Our shares held by CIESA are required under the Shareholders Agreements to be voted unanimously for the nominees of the CIESA shareholders.
The following actions by us require approval by a majority of the Core Directors: (i) certain sales of assets other than in the ordinary course of business; (ii) adoption of our annual financial plan and certain significant modifications thereto; (iii) certain borrowings, capital expenditures and operating expenses in excess of the amounts approved in the annual financial plan; (iv) appointment of officers other than the CEO; (v) certain capital expenditures not approved in our annual financial plan; (vi) salary and compensation policies; (vii) amendments to the Technical Assistance Agreement; (viii) decisions relating to certain legal claims by or against us; (ix) certain decisions relating to tax planning; and (x) granting of certain guarantees, indemnities or similar security arrangements other than in the ordinary course of business and not approved in our annual financial plan. Our policies regarding public communication and government relations must be approved unanimously by the Core Directors. Under the Shareholders Agreements a deadlock among the Core Directors with respect to any decision is considered a no-vote.
The Shareholders Agreements further provide that no CIESA shareholder shall compete with us in the open access gas transportation business in Argentina or have a preferential position in doing business with us.
Under the Shareholders Agreements, Petrobras Energía is entitled to direct the appointment (and removal) of the Chairman of our Board of Directors, and EPCA is entitled to direct the election (and removal) of the Vice Chairman of our Board of Directors and the appointment of the CEO. However, our current CEO was appointment by Petrobras Energía with EPCAs consent. The CEO has the authority to direct our day-to-day operations, subject to provisions of the Shareholders Agreements requiring approval by specified proportions of the Core Directors or of all of our Directors appointed by CIESA. Also, our shares held by CIESA are required under the Shareholders Agreements to be voted unanimously for the nominees of CIESA shareholders on all occasions on which such shares are voted for the election of the first, second and third Syndics (and their alternates), respectively.
Actions Requiring Special Shareholder Approval. The Shareholders Agreements provide that all of our shares held by CIESA will be voted in favor of the following actions only if approved by all the directors of CIESA: (i) mergers or sale of all or substantially all of our assets; (ii) engaging in any business other than the gas transportation business in Argentina; (iii) declaration of dividends in amounts not consistent with the policy set forth in the Shareholders Agreements; and (iv) amendment to our By-laws. In addition, approval by a majority of the directors of CIESA is required for the favorable vote of our shares held by CIESA with respect to the issuance of any additional shares.
Future Changes in CIESA Shareholding. On April 16, 2004, the shareholders of CIESA entered into a Settlement Agreement providing for, among other things, the transfer, in two stages, of certain shares of our capital stock and the shares of capital stock issued by CIESA. In the first stage: (i) the Enron subsidiaries will transfer 40% of the outstanding share capital of CIESA held by them to a trust or to an alternative entity; and (ii) the Petrobras subsidiaries will transfer our Class B Shares they hold (which represent approximately 7.35% of our outstanding share capital) to such Enron subsidiaries. In the second stage, the Enron subsidiaries will transfer their remaining outstanding share capital of CIESA to the trust or the alternative entity, subject to the simultaneous transfer of our Class B Shares held by CIESA (which represent approximately 4.3% of our outstanding shares) to the Enron subsidiaries. The Settlement Agreement provides that the trustee of the trust or the alternative entity would exercise voting control with respect to CIESA shares that are transferred to the trust or the alternative entity and will have power to appoint directors of CIESA.
CIESAs Shareholders Agreement will be terminated and replaced by a new Shareholders Agreement addressing the ownership change following consummation of the first stage. At no time will the Petrobras parties hold, directly or indirectly, more than their current 50% shareholding in CIESA or hold a controlling interest in CIESA.
The Settlement Agreement also provides that the Petrobras parties and their respective affiliates and the Enron parties and their respective affiliates will each grant the other releases from any and all claims under or arising from or in connection with certain agreements entered into by such parties in connection with their investment in CIESA and in us and certain other related documents. Such releases will not be given by, but will be extend to, Transwestern Pipeline Company, a member of the Enron Economic Group (as defined in the Settlement Agreement).
In May 2004, the bankruptcy court having jurisdiction over the bankruptcy of Enron approved the Settlement Agreement. In addition, the transfers referred to above are subject to several conditions, one of which is the approval from ENARGAS.
Tender Offer Regime. According to Decree No. 677/01, issued by the Executive Branch, public companies shall be included in the Tender Offer Regime, starting from the date of the shareholders meeting approving the companys inclusion in the regime or automatically upon the first shareholders meeting held twelve months subsequent to the enforcement of the CNV resolution regulating the matter, issued in March 2003. The Decree also provides that if a public company is not willing to be included in such regime, it must incorporate an article to its By-laws stating the following: Company not Subject to the Tender Offer Regime. Such resolution must be adopted not later than in the shareholders meeting mentioned above. As our shareholders decided not to adhere to this regime, in the shareholders meeting held on April 2, 2004, our shareholders approved an amendment to our By-laws to incorporate the exclusion expressly.
Related Party Transactions
Our principal transaction with a related party is our arrangement under the Technical Assistance Agreement under which payments are made to Petrobras Energía, in its capacity as our technical operator. The term of the Technical Assistance Agreement entered into with EPCA was for eight years from December 28, 1992, renewable automatically upon expiration for additional eight-year periods. The Settlement Agreement mentioned in Item 4. Our InformationOur History and DevelopmentGeneral includes a term which provided for the assignment of the Technical Assistance Agreement to Petrobras Energía. This transfer, which was approved by ENARGAS in June 2004, was carried out on July 15, 2004. As from that date, Petrobras Energía has been in charge of providing services related to, among others, the operation and maintenance of the gas transportation system and related facilities and equipment, to ensure that the performance of the system is in conformity with international standards and in compliance with certain environmental standards. For these services, we pay a monthly fee based on the higher of: a percentage of certain defined income of us or a specified fixed annual amount.
In connection with the San Martín pipeline expansion project, on November 3, 2004 we entered into the Letter of Intent and on November 10, 2004 we entered into the Trust Agreement, both of which Petrobras and Petrobras Energía are also parties. See Item 4. Our InformationBusiness Overview-Pipeline Operations for more information.
The detail of significant outstanding balances for transactions with related parties as of December 31, 2004, 2003 and 2002 is as follows:
Year ended December 31, 2004
(1) Includes NGL sales made on behalf of third parties, from which we withhold fees for production and commercialization.
Year ended December 31, 2003
(1) Includes NGL sales made on behalf of third parties, from which we withhold fees for production and commercialization.
Year ended December 31, 2002
(1) Includes NGL sales made on behalf of third parties, from which we withhold fees for production and commercialization.
Interests of Experts and Counsel
Item 8. Financial Information
Consolidated Statements and Other Financial Information
Our Financial Statements, which are set forth in the Index to financial statements in Item 18, are filed as part of this Annual Report.
In 2004, our export revenues from our NGL production and commercialization segment were Ps. 264.8 million and represented 27% of our total net revenues. Additionally, the total volume of sales from NGL was 1,088,940 short tons, and the volume of sales from NGL exports was 372,984 short tons. These volumes also include sales made on account of third parties.
Our NGL revenues are based on spot prices. We sell NGL for export at the international reference price for propane and butane, commonly referred to as the Mont Belvieu price, less a discount. In the domestic market, we set prices in a manner designed to maintain, to the extent possible, parity in U.S. dollar terms with the prices received for our NGL exports. Consequently, our NGL business is exposed to risk in changes in prices of NGL in Mont Belvieu.
Effective May 2004, the Argentine government increased the export tax on NGL exports from 5% to 20%. Future changes in this tax rate may have a material adverse effect on our results of operations and financial condition.
Legal and Regulatory Proceedings
In April 1996, GdE filed a legal action against us for Ps. 23 million, which is the amount GdE claims as a reimbursement for the cost of construction of two compressor plants currently in operation on our pipeline. We denied the claim on the grounds that we acquired these compressor plants as part of our overall purchase of the pipeline assets in the 1992 privatization. At the end of February 2000, an initial judgment was rendered upholding GdEs claim for Ps. 23 million plus interest (calculated at the passive rate set by the Argentine Central Bank Circular No. 14,290 from the date GdE paid the above-mentioned purchase orders) and litigation expenses. In August 2001, the Chamber of Appeals partially confirmed the initial judgment and ordered us to pay the fair value of such plants based on an expert assessment to be performed. We have recorded such plants as Property, plant and equipment, net, valued at Ps. 4.3 million based on the replacement cost of similar compressor equipment. The Chamber of Appeals deferred the payment of the litigation expenses until the compressor plants fair value resulting from the expert assessment could be determined. In October 2001, we filed an ordinary and extraordinary appeal before the Supreme Court of Justice (SCJ). In August 2003, the SCJ sustained GdEs claim and ordered us to pay the fair market price of the compressor plants at the date on which they were added to our assets (such price to be determined by a court appointed expert) plus interest and litigation expenses. The court-appointed experts assessed the price of the compressor plants at approximately Ps. 13.2 million. In September 2004, the court of original jurisdiction ordered us to pay the amount determined by the experts plus VAT, interest and litigation expenses. As of December 31, 2004, we recorded a provision of Ps. 60 million, which was estimated considering the amount determined by the judge. Nevertheless, we consider that amount to be excessive and not properly substantiated. Thus, we have appealed the decision and are expecting to obtain a favorable resolution.
On January 14, 2004, we signed an agreement with UNIREN pursuant to which we will carry out the expansion of the Cordillerano Pipeline. The cost of the expansion will be taken as a payment on account of the final amount to be paid as a consequence of the outcome of the lawsuit described above. Therefore, the cost of the works was recorded under Other Liabilities, offsetting the provision mentioned in the last paragraph. The Argentine government owns such assets and granted their right of use to us, since we will have to operate and maintain such assets until expiration of the License. On July 29, 2004, the Executive Branch, through Decree No. 959/04, ratified the agreement with UNIREN.
As of the date of this Annual Report, GdE, directly or through ENARGAS, has failed to properly register easements relating to the transferred pipeline system and to make related payments to property owners of such required easements in accordance with the Transfer Agreement . In order for us to fulfill our capital expenditures program related to the system integrity and public safety required by our License, we have entered into easement agreements with certain landowners and paid related amounts. Consequently, we filed a claim against GdE to recover such amounts paid.
On October 7, 1996, the Executive Branch, through Decree No. 1,136/96, created a contribution fund (the Easement Contribution Fund), as specified in our License, to assume GdEs obligations for paying easements and any other compensation to land owners for a five-year period, beginning with the privatization and ending on December 28, 1997. ENARGAS manages the fund, which is financed by a special charge included in the transportation rates and paid to ENARGAS. We have filed against GdE and ENARGAS an administrative claim requesting reimbursement for the amounts we paid in connection with easements related to facilities existing prior to December 28, 1992. In December 1997, ENARGAS declared that it would allow the reimbursement of the useful expenses, as determined by the Argentine government, derived from easements. As of December 31, 2004 we recorded approximately Ps. 4.2 million in the account Other non-current receivables. We expect to fully recover the amounts paid, based on our rights under our License.
In June 2004, the ENARGAS fined us Ps. 1.9 million (including interest) in connection with the delayed payment to the Easement Contribution Fund. Although a provision was recorded for the amount, we have filed an appeal against this penalty.
In February 2005, the CNV has determined that US$ 178 million in aggegate principal amount of notes issued in connection with the settlement of our exchange offer in respect of our existing OPIC Notes did not fulfil the necessary requirements for being entitled to the benefits of the tax exemption provided by the Negotiable Obligations Law. If that is the case, we might be responsible for the payment of the tax, which rate could range between 18% and 54% (depending on the residency country of the holders) applicable to each interest payment. On February 18, 2005, we filed an appeal with the CNV, alleging sufficient grounds to support the tax exemption in respect of the aforementioned New Notes. As of the date of the issuance of this Annual Report, the CNV has not responded to our appeal.
We are party to certain claims brought by the Tax Bureau of the province of Río Negro pursuing the collection of stamp taxes which, according to the tax claim, would be applicable over gas transportation contracts and services offer letters between us and our shippers. The amount claimed totals Ps. 438 million (including fines and interest calculated at the date of each claim).
We filed administrative appeals before the Tax Bureau of Río Negro. Afterwards, we filed a declaratory action before the SCJ, requesting the court to rule on the legitimacy of the Tax Bureaus claims. The SCJ granted injunctions to prevent the provinces from attempting to collect the aforementioned taxes until a final ruling is issued on the subject. At the date of this Annual Report, the Tax Bureau of Río Negro has rejected our appeals. We are now awaiting a final ruling from the SCJ.
Our management does not believe that our transportation contracts and offers are subject to the provincial stamp taxes mentioned above. Management believes that if the contracts were subject to these taxes, this circumstance should be considered as a change in the interpretation of the tax law, and its impact should be reflected in a tariff adjustment according to relevant regulations which permit such processes. ENARGAS has stated that the claims for stamp tax lack merit and are therefore unlawful.
Similar claims were filed by the Tax Bureaus of the provinces of Santa Cruz, Chubut, La Pampa and Neuquén. Additionally, there is also a stamp tax claim from the Tax Bureau of Neuquén related to the Share Transfer Contract subscribed in the privatization of GdE and the Technical Assistance Agreement.
In April 2004, the SCJ declared inadmissible the province of Santa Cruzs tax claims. This decision by the SCJ sets a material judicial precedent for the resolution of the remaining claims.
On June 7, 2004, the Provincial Executive Branch of Neuquén issued Decrees No. 1,133/04 and 1,134/04 which upheld the appeals filed by us in connection with the contracts transferred by GdE and the Technical Assistance Agreement, making void the provincial Tax Bureaus claims in those cases. Both Decrees were presented in the legal files of the proceedings and a final decision by the SCJ is still pending.
In July 2004, the Tax Bureau of the Province of Chubut withdrew its administrative motions through Resolution No. 198/04, in view of the SCJ pronouncement. This resolution was ratified on August 20, 2004, through Resolution No.143/04 of the Ministry of Economy and Credit of the province of Chubut, which granted the appeals filed by us.
In May 2005, the tax Bureau of the province of La Pampa withdrew its administrative motion through Resolution No. 1,065/05 in view -among others- the SCJ pronouncement.
On October 21, 2002, the AFIP formalized a claim against us through a liability assessment of Ps. 5.6 million (including interest) related to our failure to make certain contributions to the Registro Nacional de Seguridad Social (the Argentine Social Security Bureau) for personnel that the AFIP considered fully employed by us. In order to be able to file an appeal before the AFIP, the Company had to deposit the amount claimed (recorded under Other current receivables), which will be reimbursed to us if we receive a favorable ruling. In December 2004, the Cámara Federal de Seguridad Social ruled in our favor, instructing the AFIP to reimburse the deposited amount to us. At that date, AFIP had the right to appeal this decision, and accordingly we did not reverse the related accrual as of December 31, 2004. AFIP did not appeal within the permitted time and accordingly we booked the reversal of the allowance in Other incomes, net during the first quarter of 2005.
In the framework of the Tax Agreement subscribed by the National Government and the Provinces in 1993, and as from the enactment of provincial Law No. 11,490, NGL sales benefited from the turnover tax exemption in the province of Buenos Aires. In September 2003, the Tax Bureau of the province of Buenos Aires, by overruling Resolution No. 4,560/03, denied the exemption and requested the payment of the tax related to revenues accrued as from the year 2002. In October 2003, we filed an administrative appeal before the Tax Court of the province of Buenos Aires, the resolution of which, as of the date of this Annual Report, is still pending. In November 2004, we were served notice of the commencement of a liability assessment process. As of December 31, 2004, we recorded a provision of Ps. 13 million in connection with this issue.
As discussed above under Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessRegulatory Framework, we are involved in the process of renegotiating our public service contracts with UNIREN.
In addition to the matters discussed above, we are a party to certain lawsuits and administrative proceedings arising in the ordinary course of business. Although no assurances can be given, we believe there are meritorious defenses, which will be asserted vigorously to challenge all claims and that possible liabilities from these claims will not have a material adverse effect on our consolidated financial position or results of operations.
Dividend Distribution Policy
Our dividend distribution policy consists of maintaining a dividend level that assures our credit quality and allows the partial reinvestment of earnings, considering growth projects that we may develop. Our debt instruments currently limit our ability to declare and pay dividends. See Item 10. Additional informationMaterial contracts.
No undisclosed significant change has occurred since the date of our Financial Statements.
Item 9. The Offer and Listing
Offer and Listing Details
Trading of Our Shares. Prior to May 5, 1994, there was no public market for our shares or ADSs. On May 5, 1994, we established a Rule 144A American Depositary Receipt (Rule 144A ADR) facility and a Regulation S American Depositary Receipt (Regulation S ADR) facility, each with Citibank, N.A., as Depositary. On that date, the Argentine Government, as selling shareholder, made an international offering of 195,000,000 Class B shares. A portion of the Class B shares was offered in the form of Rule 144A ADRs in the United States pursuant to Rule 144A under the Securities Act and in the form of Regulation S ADRs outside the United States and Argentina, pursuant to Regulation S under the Securities Act.
In November 1994, we completed an exchange offer (the Exchange Offer), whereby we offered existing Rule 144A ADR holders registered ADRs in exchange for their restricted Rule 144A ADRs. Except for the absence of resale restrictions, the terms of the registered ADRs received in the Exchange Offer were substantially identical to the terms of the restricted Rule 144A ADRs tendered. We have terminated our Rule 144A ADR facility. Each ADR represents five Class B shares.
The table below shows the high and low market prices of the Class B Shares on the BASE, stated in historical Argentine pesos and of the ADRs on the NYSE, stated in U.S. dollars, for each of the last five fiscal years.
The table below shows the high and low market prices of the Class B Shares on the BASE, stated in historical Argentine pesos and of the ADRs in the NYSE, stated in U.S. dollars, for each full quarterly period within the two most recent fiscal years.
The table below shows the high and low market prices of the Class B Shares on the BASE, stated in historical Argentine pesos and of the ADRs in the NYSE, stated in U.S. dollars, for each full monthly period within the six most recent months.
Plan of Distribution
The Argentine Securities Market. In Argentina, the oldest and largest exchange is the BASE, founded in 1854 and on which the majority of equity trades in Argentina are executed. As of December 31, 2004, the market capitalization of shares of the 107 companies (excluding mutual funds) listed on the BASE was approximately Ps. 689,990 million. At the end of December 2004, the top 10 listed securities represented 94.42% of the total. Trading in securities listed on an exchange is conducted through the Mercado de Valores (Stock Market) affiliated with such exchange.
Securities may also be listed and traded through over-the-counter market brokers who must be linked to an electronic reporting system. The activities of such brokers are controlled and regulated by the Mercado Abierto Electrónico S.A. (the MAE), an electronic over-the-counter market reporting system that functions independently from the Mercado de Valores de Buenos Aires S.A. (the Buenos Aires Stock Market) and the BASE. Under an agreement between the BASE and the MAE, trading in equity and equity-related securities is conducted exclusively on the BASE and trading in corporate debt securities is conducted on both the BASE and the MAE. Trading in Argentine government securities, which are not covered by the agreement, may be conducted on either or both of the BASE and the MAE. The agreement does not extend to other Argentine exchanges.
Changes to the legal framework of securities trading have been introduced permitting issuance and trading of new, non-bank financial products in the Argentine capital markets, including commercial paper, new types of corporate bonds and futures and options. The Argentine government deregulated brokerage fees and eliminated transfer taxes and stamp taxes on securities transactions in November 1991.
The Buenos Aires Stock Market. The Buenos Aires Stock Market, which is affiliated with the BASE, is the largest stock market in Argentina. The Buenos Aires Stock Market is a corporation whose 250 shares are owned by a number of members who are the only individuals and entities authorized to trade in the securities listed on the BASE. Trading on the BASE is conducted by open outcry and a computer-based negotiation system called SINAC from 11:00 A.M. to 6:00 P.M. each business day. The BASE also operates an electronic continuous market system from 11:00 A.M. to 6:00 P.M. each business day, on which privately-arranged trades are registered and made public. To control price volatility, the Buenos Aires Stock Market operates a system that restricts dealing in shares of any issuer when changes in the price of such issuers shares varies 15% from the previous closing price, unless trading at the top price.
Investors in the Argentine securities market are primarily individuals, companies and institutional investors consisting of a limited number of mutual funds. Certain information regarding the Argentine equities market is set forth in the table below.
Source: Data published by the Buenos Aires Stock Market.
Expenses of the Issue
Item 10. Additional Information
Memorandum and Articles of Association
Information contained in Item 14 of our Registration Statement on Form F-1 (Registration No. 33-85178) is hereby incorporated by reference.
New Debt Obligations
On December 15, 2004, in connection with our debt restructuring, we issued six series of new notes in an aggregate principal amount of US$614,295,095 pursuant to our Global Program, which provides for the issuance of up to a maximum principal amount of US$800 million in notes. The creation of the Global Program was approved by the ordinary Shareholders Meeting held on April 2, 2004 and authorized by the CNV, the Bolsa de Comercio de Buenos Aires (BCBA) and MAE. On December 15, 2004, we also entered into amended and restated loan agreements with IDB having an aggregate principal amount of US$290,140,000 in connection with our debt restructuring.
These six series of new notes and amended and restated loan agreements (referred to collectively as the new debt obligations) can be categorized as three separate tranches, with the new debt obligations within each tranche containing identical interest payment terms and amortization terms. The Series A Variable Fixed Rates Notes due December 2010, the Series A-P Variable Fixed Rates Notes due December 2010 and the Tranche A Loans are referred to collectively as the Tranche A debt obligations. The Series B-A Variable Fixed Rate Notes due December 2013, the Series B-A-P Variable Fixed Rate Notes due December 2013 and the Tranche B-A Loans are referred to collectively as the Tranche B-A debt obligations. The Series B-B Variable Fixed Rate Notes due December 2013 and the Series B-B-P Variable Fixed Rate Notes due December 2013 are referred to collectively as the Tranche B-B debt obligations.
Tranche A Debt Obligations
On December 15, 2004, we issued US$470,306,281 in principal amount of Tranche A debt obligations, which represents 52% of the total principal amount of our new debt obligations. The scheduled maturity date of each of the Tranche A debt obligations is December 15, 2010. The Tranche A debt obligations accrue interest at a variable fixed rate, ranging from an annual rate of 5.3% for the first year to 7.5% in the sixth year. Principal on the Tranche A debt obligations is amortized over the six-year term of such debt obligations, with amortization payments commencing on March 15, 2005. Interest and principal on the Tranche A debt obligations is payable on a quarterly basis. The Tranche A debt obligations include a provision that provides for acceleration of the amortization schedule of such debt obligations if the level of our adjusted cash surplus (as defined in the new debt obligations) for an applicable year or portion of such year exceeds a specified level. See Early Cash Surplus Amortization below for more information regarding this provision.
Tranche B-A Debt Obligations
On December 15, 2004, we also issued US$409,044,874 in principal amount of Tranche B-A debt obligations, which represents approximately 45% of the principal amount of our new debt obligations. The maturity date of each of the Tranche B-A debt obligations is December 15, 2013. The Tranche B-A debt obligations accrue interest at a base variable fixed rate ranging from an annual rate of 7% for the first year to 10% in the ninth year. In addition, commencing December 15, 2006, the Tranche B-A debt obligations may also accrue additional interest at an incremental annual interest rate ranging from 0.75% to 2%, subject to, if applicable, the level of our consolidated adjusted EBITDA (as defined in the new debt obligations) for each applicable fiscal year. The Tranche B-A debt obligations are also amortizing, but amortization payments do not commence until March 15, 2011. Interest and, commencing March 15, 2011, principal on the Tranche B-A debt obligations is payable on a quarterly basis. The Tranche B-A debt obligations include a provision that provides for acceleration of the amortization schedule of such debt obligations if the level of our adjusted cash surplus for an applicable year or portion of such year exceeds a specified level; however, this provision will not apply to the Tranche B-A debt obligations until such time as the Tranche A debt obligations are no longer outstanding. See Early Cash Surplus Amortization below for more information regarding this provision.
Tranche B-B Debt Obligations
On December 15, 2004, we also issued US$25,083,940 in principal amount of Tranche B-B debt obligations, which represents approximately 3% of the principal amount of our new debt obligations. The maturity date of each of the Tranche B-B debt obligations is December 15, 2013. The Tranche B-B debt obligations accrue interest at a base variable fixed rate ranging from an annual rate of 7% for the first year to 10% in the ninth year. In addition, commencing December 15, 2006, the Tranche B-B debt obligations will also accrue additional interest at an incremental annual rate starting at 0.60% in such year and increasing by 5 basis points (0.05%) annually until such annual rate reaches 0.90% in the ninth year. The Tranche B-B debt obligations are also amortizing, but amortization payments do not commence until March 15, 2011. Interest and, commencing March 15, 2011, principal on the Tranche B-B debt obligations is payable on a quarterly basis. The Tranche B-B debt obligations include a provision that provides for acceleration of the amortization schedule of such debt obligations if the level of our adjusted cash surplus for an applicable year or portion of such year exceeds a specified level; however, this provision will not apply to the Tranche B-B debt obligations until such time as the Tranche A debt obligations are no longer outstanding. See Early Cash Surplus Amortization below for more information regarding this provision.
Early Cash Surplus Amortization
As noted above, the new debt obligations include an accelerated amortization feature, referred to as Early Cash Surplus Amortization, the implementation and amount of which will depend on our consolidated debt ratio (relationship between our consolidated total indebtedness and consolidated adjusted EBITDA (each as defined in the new debt obligations)) for the applicable fiscal period and the amount of our cash surplus for such applicable fiscal period, as adjusted for certain subsequent payments that we make. We are required to determine whether an early cash surplus amortization amount is payable with respect to each fiscal year, or portion thereof, occurring during the period from and including December 15, 2004 to and including December 15, 2010. We will also be required to determine whether an early cash surplus amortization amount is payable for any semi-annual period occurring during the period set forth above with respect to which we make a dividend payment to our shareholders. We may also, in our sole discretion, make a payment of an early cash surplus amortization amount with respect to any fiscal quarter occurring during the period set forth above. Early cash surplus amortization amounts will be calculated and, if applicable, paid to holders of our new debt obligations following the applicable reference period. We expect the payments in respect of a fiscal year-period to generally be made on May 1,, if any such payment is required to be made. Any early cash surplus amortization amounts payable must first be paid in respect of the Tranche A debt obligations, on a pro rata basis, until such debt obligations are no longer outstanding, and next be paid in respect of the Tranche B-A debt obligations and Tranche B-B debt obligations, together, on a pro rata basis, until such debt obligations are no longer outstanding.
We are subject to several restrictive covenants under our new debt obligations (which differ between our amended loans and our new notes, in some respects), which include, among others, the following:
a limitation on our and our subsidiaries ability to enter into transactions with our affiliates;
a limitation on our and our subsidiaries ability to make or commit to make capital expenditures;
a limitation on our and our subsidiaries ability to sell our assets;
a limitation on our and our subsidiaries ability to create liens on our property, assets or revenues;
a limitation on our and our subsidiaries ability to invest in the securities of other companies;
a limitation on our and our subsidiaries ability to enter into a merger, consolidation or similar transaction;
a limitation on our and our subsidiaries ability to change the nature of our business;
a prohibition on our ability to terminate or assign the license granted to us by the Argentine Government to provide gas transportation services through the southern gas pipeline system and a limitation on our ability to consent to certain material amendments, modifications or waivers of such License or to transfer to any person the right to receive the License termination compensation;
a limitation on our and our subsidiaries ability to incur additional indebtedness. Until December 15, 2007, we are permitted to incur only certain specified types of indebtedness, which includes, among others, the incurrence of up to US$25 million in indebtedness for the financing of working capital, the incurrence of debt for the purpose of refinancing the new debt obligations and the incurrence of up to US$10 million in capitalized lease obligations. As from December 15, 2007, we will be permitted to incur any indebtedness if our consolidated debt ratio for the applicable period is equal to or less than 3.50 to 1 for the twelve-month period beginning on such date. This maximum consolidated debt ratio decreases for each subsequent twelve-month period; and
a prohibition on our and our subsidiaries ability to pay dividends and make certain other restricted payments with respect to any fiscal year or fiscal semester unless, among other things, (i) no default exists under our new debt obligations and (ii) our consolidated coverage ratio (that is, the ratio of our consolidated adjusted EBITDA to our consolidated interest expense (each as defined in the new debt obligations)) is at least 2.70 to 1 as of the applicable fiscal year end or fiscal quarter end in 2005, at least 2.75 to 1 as of the applicable fiscal year end or fiscal quarter end in 2006, at least 2.80 to 1 as of the applicable fiscal year end or fiscal quarter end in 2007, at least 2.90 to 1 as of the applicable fiscal year end or fiscal quarter end in 2008 and at least 3.00 to 1 as of the applicable fiscal year end or fiscal quarter end in 2009 or thereafter. Moreover, the aggregate amount of all such dividends and other restricted payments (including certain fees under our Technical Assistance Agreement) with respect to any fiscal year shall not exceed US$10 million with respect to 2004, US$15 million with respect to each of 2005 and 2006, US$20 million with respect to 2007 and US$25 million with respect to 2008 and each fiscal year thereafter.
We must also comply with several affirmative covenants under our new debt obligations (which differ between our amended loans and our new notes, in some respects), including, among others, an obligation to maintain our properties in compliance with specified environmental requirements, an obligation to maintain in full force and effect all required governmental approvals, consents and licenses, and a requirement to ensure that at all times the new debt obligations rank at least pari passu with all of our other unsecured and unsubordinated indebtedness.
Events of Default
The new debt obligations contain the following events of default (which differ between our amended loans and our new notes, in some respects), among others:
default in the payment of principal due after a specified grace period;
default in the payment of interest or other amounts due after a specified grace period;
breach of the covenants contained in the new debt obligations after a specified cure period;
material breach of our representations and warranties contained in the new debt obligations after a specified cure period;
the occurrence of an event of default under our other debt obligations;
the occurrence of certain bankruptcy events;
a creditor takes steps to enforce any mortgage, lien or other security created or assumed by us or one of our subsidiaries exceeding US$10 million;
certain required governmental authorizations are not obtained when required or are rescinded, terminated, lapse or cease to be in full force and effect;
the occurrence of certain material adverse events with respect to our License, such as the revocation or termination of the License;
it becomes unlawful for us to perform or comply with our obligations under the new debt obligations;
a governmental authority condemns, seizes, confiscates or otherwise expropriates or assumes control of all or any substantial part of our or our subsidiaries assets or capital stock; or
a general moratorium or suspension is declared in respect of the payment or performance of all or substantially all of our new debt obligations.
In light of the lack of expansion of the natural gas transportation system over the last years (as a consequence of the pesification of tariffs and the fact that the renegotiation of the License is still pending) and a growing gas demand in certain segments of the Argentine economy, the Argentine Government established - through Executive Branch Decree No. 180/04 and Resolution No. 185/04 issued by the Ministry of Federal Planning, Public Investment and Utilities- the framework for the creation of a trust fund that would finance gas transportation system expansions.
In June 2004, we submitted to the Federal Energy Bureau upon request a project for the expansion of the San Martín pipeline transportation capacity for approximately 2.9 MMm3/d (102.4 MMcf/d). This project involves the construction of approximately 509 km (316 miles) of pipeline and a 30,000 HP compression capacity increase through the construction of a compressor plant and the revamping of some compressor units. As of the date of this Annual Report, all of the additional capacity is expected to be fully on line by August 30, 2005. This additional transportation capacity was fully subscribed under firm transportation contracts in an open bidding conducted by us in June 2004. These new contracts are for almost 16 years and were mainly subscribed by gas distribution companies.
In November 2004, we, MPIFIPyS, the Federal Energy Bureau, Petrobras, Petrobras Energía, Banco de la Nación and Nación Fideicomisos, among others, signed the Letter of Intent agreeing to carry out the expansion. This agreement was ratified by Executive Branch Decree No. 1,658/04.
This Agreement established a suitable framework to put into operation the Gas Trust (which finances most of the expansion) as well as the Global Program for the issuance of debt securities and/or Gas Trust certificates of participation.
In February 2005, ENARGAS along with the Federal Energy Bureau awarded to Odebretch, a Brazilian company, the civil works contract for the expansion. Works are currently on-going. The investment for the expansion amounts to approximately US$351 million (including VAT), of which approximately US$ 40 million will be provided by us.
Our investment will be recovered with 80% of the revenues obtained from the additional transportation capacity, based on current tariffs representing approximately annual revenues for Ps. 23 million. The remaining 20% and a specific tariff charge shall be allocated to the Gas Trust to repay its investment. The tariff charge represents a tariff increase of 81.6%, which will be finally paid by industries, power plants and CNG suppliers which gas transportation supply is made under firm contracts. This tariff charge will be effective until the total amount invested by the Gas Trust is recovered.
Once the Gas Trust investment is repaid, the ownership of the assets resulting from the expansion will be transferred to us for no economic value, as they will not generate future revenues for us. Additionally, those assets will be classified as essential assets (for more information, see Item 4. Our InformationBusiness OverviewGas Transportation Regulated BusinessRegulatory FrameworkCertain restrictions with respect to essential assets), so their sale will be prohibited.
We are the project manager for the expansion project and are required to render the following services: engineering, project works management, project control, supply and administration. We will be paid monthly an amount equal to 1% of the final amount of the investment made by the Gas Trust based on the execution of works. Additionally, we will operate the assets and render the maintenance services.
On June 1, 2005, we, in our capacity as the manager of the San Martín expansion, notified the Federal Energy Bureau of a cost-overrun of US$ 26.1 million for construction-related expenses. According to the Letter of Intent, in the event financing is required to cover higher expansion costs, the parties are required to meet within a time-frame set by the Federal Energy Bureau in order to find some alternative financing to assure the continuity of the expansion works. As of the date of the issuance of this Annual Report, the Federal Energy Bureau has not notified the parties yet of a time-frame for the meeting.
The Argentine foreign exchange market was subject to exchange controls until December 1989. From 1989 to December 3, 2001, there were no foreign exchange controls preventing or restricting the conversion of pesos into dollars.
Since early December 2001, the Argentine authorities implemented a number of monetary and currency exchange control measures that included restrictions on the withdrawal of funds deposited with banks and tight restrictions for making transfers abroad, with the exception of those related to foreign trade and other authorized transactions. These regulations have been changing constantly since they were first promulgated and we cannot predict how long these current regulations will be in effect or whether they will be made stricter.
Pursuant to resolutions issued by the Central Bank seeking a gradual normalization of the local foreign exchange market, effective January 8, 2003, prior authorization from the Central Bank is no longer required to transfer funds abroad for payment to foreign beneficiaries of corporate profits and dividends reported as payable under approved financial statements certified by an independent auditor.
In addition, for the remittance abroad of funds required for principal payments under financial loans, prior Central Bank authorization is no longer required as of May 6, 2003, provided such debts have been disclosed under the Informative Regime of External Debts (Régimen Informativo de Pasivos Externos).
Interest payments on outstanding financial indebtedness no longer require Central Bank approval for their remittance abroad, provided that the transfer abroad in connection with such payments is made not more than 15 days in advance of their stated payment date.
The following is a general summary of certain Argentine and United States federal income tax matters that may be relevant to the ownership and disposition of ADSs or Class B Shares. The summary describes the principal tax consequences of the ownership and disposition of ADSs or Class B Shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a holder of ADSs or Class B Shares.
The summary is based upon tax laws of Argentina and the United States and regulations thereunder as in effect on the date of this Annual Report, which are subject to change. In addition, the summary is based in part on representations of the Depositary and assumes that each obligation provided for in or otherwise contemplated by the Deposit Agreement or any other related document will be performed in accordance with its terms. Holders of ADSs or Class B Shares should consult their own tax advisors as to the United States, Argentine or other tax consequences of the acquisition, ownership and disposition of the ADSs or Class B Shares in their particular circumstances.
Taxation of Dividends. Dividends of our cash, property or capital stock paid or distributed to holders of Class B Shares or ADSs are currently exempt from Argentine withholding or other taxes. However, according to Law No. 25,063, published on December 30, 1998, cash or other type of dividend distribution, exceeding accumulated net income at year end determined as stipulated by tax regulations, will be subject to a 35% withholding tax as a sole and definite payment.
Taxation of Capital Gains. Capital gains derived by non-Argentine residents from the sale, exchange or other disposition of ADSs or Class B Shares are not subject to income tax.
Tax on Personal Property (Individuals). The Argentine Tax authority has recently introduced some amendments to the Personal Property Tax. In accordance with the Law No. 25,585, the personal tax corresponding to the ownership of securities issued by entities domiciled in Argentina, whose direct owners are individuals domiciled in Argentina or abroad and entities domiciled abroad, will be liquidated and deposited by the entity that has issued such securities. The applicable rate is 0.50% on the equity value according to the last financial statements as of each respective fiscal year. The Law presumes that securities whose holders are entities domiciled or located abroad, indirectly belong to individuals domiciled abroad.
We will be responsible to deposit such tax and will have the right to recover such amount from holders, even withholding and/or liquidating such securities which originated such tax payment. Amendment is effective starting fiscal year 2002.
VAT. The sale, exchange or other disposition of ADSs or Class B Shares is not subject to VAT.
Transfer Taxes. The sale, exchange or other disposition of ADSs or Class B Shares is not subject to transfer taxes.
Purchase or Sale of Foreign Currency. There is no tax on the purchase or sale of foreign currency.
Deposit and Withdrawal of Class B Shares in Exchange of ADSs. No Argentine tax is imposed on the deposit or withdrawal of Class B Shares in exchange for ADSs.
Other Taxes. There are no Argentine inheritance or succession taxes applicable to the ownership, transfer or disposition of ADSs or Class B Shares. There are no Argentine stamp, issue, registration or similar taxes or duties payable by holders of ADSs or Class B shares.
Tax Treaties. Argentina has entered into tax treaties with several countries. A tax treaty between Argentina and the United States has been signed but has not yet been ratified and therefore is not currently in effect. It is not clear when, if ever, the treaty will be ratified or enter into effect.
United States Taxes
General. This discussion relating to certain US federal income tax consequences only applies to an investor who holds our ADSs or Class B Shares as capital assets for tax purposes and is not a member of a special class of holders subject to special rules, including: a dealer in securities; a trader in securities that elects to use a mark-to-market method of accounting for his or her securities holdings; a tax-exempt organization; an insurance company, a person liable for alternative minimum tax; a person that actually or constructively owns 10% or more of our voting stock; a person that holds shares or ADSs as part of a hedging or straddle or conversion transaction; or a US holder whose functional currency is not the U.S. dollar. A holder is a US holder if such holder is a beneficial owner of shares or ADSs and such holder is: a citizen or resident of the United States; a domestic corporation; an estate whose income is subject to US federal income tax regardless of its source; or a trust, if a US court can exercise primary supervision over the trusts administration and one or more US persons are authorized to control all substantial decisions of the trust.
Moreover, the effect of any applicable US state or local tax laws is not discussed in this Annual Report.
For US federal income tax purposes, a holder of ADRs evidencing ADSs will be treated as the owner of the underlying shares represented by those ADSs, and exchanges of Class B Shares for ADRs, and ADRs for ordinary shares, will not be subject to US federal income tax.
Taxation of Dividends. Subject to the passive foreign investment company (PFIC) rules discussed below, if a holder is a US holder such holder must include in his or her gross income the gross amount of any dividend (or other distribution, other than certain distributions in redemption of ADSs or Class B shares or distributions of our capital stock or rights to subscribe for our capital stock) paid by us out of our current or accumulated earnings and profits (as determined for US federal income tax purposes). If the holder is a non-corporate US holder, dividends paid to him or her in taxable years before January 1, 2009 that constitute qualified dividend income will be taxable at a maximum tax rate of 15% provided that the shares or ADSs are held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date and meet other holding period requirements. Dividends with respect to the shares or ADSs generally will be qualified dividend income, provided that in the year that the holder receives the dividend, the shares or ADSs are readily tradable on an established securities market in the US. The holder must include dividends in income when he or she receives them, either actually or constructively, in the case of Class B Shares, or when the depositary receives such dividend, in the case of ADSs. The dividend will not be eligible for the dividends-received deduction generally allowed to US corporations in respect of dividends received from other US corporations. Distributions in excess of current and accumulated earnings and profits, as determined for US federal income tax purposes, will be treated as a non-taxable return of capital to the extent of a holders basis in the ADSs or Class B Shares and thereafter as capital gain.
The amount of the dividend distribution that a holder must include in his or her income will be the U.S. dollar value of the Argentine peso payments made, determined at the spot Argentine peso/U.S. dollar rate on the date such dividend distribution is includible in such holders income, regardless of whether the payment is in fact converted into U.S. dollars. Generally, any gain or loss resulting from currency exchange fluctuations during the period from the date a holder includes the dividend payment in income to the date such payment is converted into U.S. dollars will be treated as ordinary income or loss and will not be eligible for the special tax rate applicable to qualified dividend income. Such gain or loss will generally be income or loss from sources within the United States for foreign tax credit limitation purposes.
For foreign tax credit purposes, the dividend will be income from sources outside the United States. Dividends paid in taxable years beginning before January 1, 2007 generally will be passive income or financial services income and dividends paid in taxable years beginning after December 31, 2006 will, depending on your circumstances, be passive or general income, which, in either case, is treated separately from other types of income for purposes of computing the foreign tax credit allowable to a holder. No US foreign tax credit will be allowed to US holders of Class B Shares or ADSs in respect of any personal property or similar tax imposed by Argentina (or any taxing authority thereof or therein). Special rules apply in determining the foreign tax credit limitation with respect to dividends that are subject to the maximum 15% tax rate.
Distributions of additional shares to US holders with respect to their Class B Shares or ADSs that are made as part of a pro rata distribution to all shareholders generally will not be subject to US federal income tax.
Taxation of Capital Gains. Subject to the PFIC rules discussed below, a US holder that sells or otherwise disposes of Class B Shares or ADSs will recognize gain or loss for US federal income tax purposes in an amount equal to the difference between the U.S. dollar value of the amount realized and his or her tax basis (determined in U.S. dollars) in such shares or ADSs. Capital gain of a non-corporate US holder that is recognized on or after May 6, 2003 and before January 1, 2009 is generally taxed at a maximum rate of 15% where the holder has a holding period greater than one year. The gain or loss will generally be income or loss from sources within the US for foreign tax credit limitation purposes.
PFIC Rules. We believe the Class B Shares or ADSs should not be treated as stock of a PFIC for United States federal income tax purposes, but this conclusion is a factual determination that is made annually and thus may be subject to change. The application of the PFIC rules to a corporation such as ours, a substantial portion of whose business is the processing and selling of NGL, is not entirely clear. If we were to be treated as a PFIC, unless a US holder elects to be taxed annually on a mark-to-market basis with respect to the Class B Shares or ADSs, gain realized on the sale or other disposition of the shares or ADSs would in general not be treated as capital gain. Instead, the US holder would be treated as if he had realized such gain and certain excess distributions ratably over the holding period for the shares or ADSs and would be taxed at the highest tax rate in effect for each such year to which the gain was allocated, together with an interest charge in respect of the tax attributable to each such year. In addition, dividends received from us will not be eligible for the special tax rates applicable to qualified dividend income if we are a PFIC either in the taxable year of the distribution or the preceding taxable year, but instead will be taxable at rates applicable to ordinary income.
Dividends and Paying Agents.
Statement by Experts.
Documents on Display
We are subject to the informational requirements of the CNV and the BASE and file reports and other information relating to our business, financial condition and other matters with the CNV and the BASE. You may read such reports, statements and other information, including our publicly-filed financial statements, at the public reference facilities of the CNV and BASE maintained in Buenos Aires. We are also required to file annual and special reports and other information with the SEC. You may read and copy any documents filed by us at the SECs public reference room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our filings with the SEC will also be available to the public at the offices of the NYSE, 11 Wall Street, New York, New York 10005.
We have appointed The Bank of New York to act as depositary for our ADRs. For so long as our ADRs are deposited with the depositary, we will furnish the depositary with our annual reports; and summaries of all notices of general meetings of shareholders and other reports and communications that are made generally available to our shareholders.
The depositary will, as provided in the deposit agreement, arrange for the mailing of summaries in English of such reports and communications to all record holders of our ADRs. Any record holder of ADRs may read such reports, notices, or summaries thereof, and communications at the depositarys office. The depositarys office is located at 111 Wall Street, New York, NY 10043.
Whenever a reference is made in this Annual Report to a contract or other document of ours, please be aware that such reference is not necessarily complete and that you should refer to the exhibits that are a part of the Annual Report for a copy of the contract or other document. You may review a copy of the Annual Report at the SECs public reference room in Washington, D.C.
Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact our consolidated financial position, results of operations or cash flows due to adverse changes in financial market prices and interest rates. We are exposed to market risk in the areas of interest rates and foreign currency exchange. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors. Uncertainties that are either non-financial and non-quantifiable, such as political, economic, tax, other regulatory or credit risks, are not included in the following assessment of our market risks.
Interest Rate Risk
Our exposure to market risk associated with changes in interest rates is limited to our current investments.
We place our cash and current investments in high quality financial institutions in Argentina, United States and Europe. Our policy is to limit exposure with any institution. Our temporary investments primarily consist of money market mutual funds. As of December 31, 2004, current investments amounted to Ps. 325.8 million.
Regarding our debt obligations, as a general matter, we are not exposed to interest rate risks, since all our debt bears fixed rates of interest. However, beginning December 15, 2006, 45% of our debt will bear an upside interest rate which, if required to be paid, can be 0.75%, 1.25% or 2.00% per annum depending on our annual consolidated EBITDA (as defined in our new debt obligations).
Foreign exchange exposure
Our primary market risk exposure is associated with changes in the foreign currency exchange rates since our debt is denominated in U.S. dollars. As of December 31, 2004, our net monetary liability position that is subject to exchange rate fluctuations amounted to US$ 751.8 million.
As discussed herein, the Argentine government has adopted various economic measures, including the repeal of the Convertibility Law and the pesification of our gas transportation revenues. Therefore, our results of operations are very susceptible to changes in the peso/U.S. dollar exchange rate because our revenues are denominated in pesos while substantially all our liabilities are denominated in U.S. dollars.
Sensitivity analysis disclosure to interest rates and exchange rates
In view of the nature of our current investments, an immediate 100 basis points parallel shift change in the interest rate curve would not have a significant impact on the total value of our current investments.
The potential loss in our net monetary liability position held as of December 31, 2004, that would have resulted from a hypothetical, instantaneous and unfavorable 10% change in the currency peso/U.S. dollar exchange rates would have been approximately Ps. 224.0 million.
The following table provides information presented in our reporting currency, Argentine pesos, with respect to our interest rate risk and foreign exchange exposure, including long-term debt. For debt obligations, the table presents principal cash flows and weighted average interest rate by expected maturity dates. The weighed average rates are based on current rates as of December 31, 2004.