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Ecuador Oil: Reduced Investments

Private foreign investment in Ecuador's oil sector is likely to fall as a result of new laws for the sector, experts say.

Inter-American Dialogue 

Ecuador enacted a law on July 26 aimed at increasing state control over the oil sector that would permit the government to end the contracts of non-complying companies. Foreign firms invested in the sector have 120 days to accept the government's terms, which involve giving up profit-sharing deals to become service providers in exchange for a flat fee. Will the companies accept the terms? What alternatives do foreign companies invested in Ecuador have? How might legal cases play out in arbitration? What are the broader and longer-term implications for Ecuador that will result from the new hydrocarbon law?

Héctor A. Paz y Miño, president of Tecnie Oil & Energy in Quito and president of the energy committee at AmCham Ecuador: The government's average take on net oil income in Ecuador has increased from about 60 percent to 70 percent or higher with the passing of Law 42 in April of 2006 and close to 80 percent as a result of contract renegotiations imposed by the Correa administration after October 2007. The latest reforms to the Hydrocarbons Law passed in July are officially predicated on reclaiming national sovereignty over the country's nonrenewable oil resources. It now mandates existing oil participation contracts to be converted to service-type contracts, whereby 100 percent of the crude produced in a given area shall remain state property. In exchange, the contractor is to receive a negotiated inflation-adjusted service fee for its exploration and/or production services. The fee is supposed to reimburse operational and investment amortization expenses plus a 'reasonable margin.' The investment risk, however, remains 100 percent with the contractor, without the benefit of oil price upsides. Whether the companies will accept this new contract will depend largely on their risk perception and on each individual contract's economics regarding unamortized investment, time remaining to the contract expiration date, company booking of oil reserves and geopolitical perspectives. In order of priority, it would seem reasonable to expect the companies to first try negotiating a reasonable fee; should that fail, they may return the area in exchange for a compensation payment provided for in the law; or eventually, take the international arbitration route. The reforms seem more aligned to a case of diminishing returns; they respond to political rhetoric rather than promoting urgently needed new risk investment to curb the country's rapidly declining oil production base.

Judd Kessler, partner at Porter, Wright, Morris & Arthur in Washington: As an active arbitrator, I can comment only on some of the legal issues raised by this situation. Unless the government makes a surprisingly generous offer to the companies, which does not seem likely, companies which have made commitments under carefully negotiated international contracts are not likely to simply give them up in new negotiations or sit by quietly to see them unilaterally modified or canceled. For them, the question will be whether and how, as a practical matter, to make good on what they see as their legal rights. It is certain that the lights are already burning late at some of the world's finest and most expensive law firms because this situation has numerous complications. Ecuador withdrew from ICSID effective Jan. 7, 2010. In addition, many of the petroleum agreements were negotiated against the background of specific protections provided by some of Ecuador's 26 bilateral investment treaties which were then in place. Many of these treaties have since been renounced by the Ecuadorean government. Can a BIT simply be renounced, without consequences, when investors have acted in reliance on the protections contained in them? And suppose that a company were to prevail, how would it go about attempting to enforce the rulings of an arbitrator or a court? Company counsel will find challenges aplenty in seeking to surmount these and other obstacles. Without making any prediction as to the outcome of any specific dispute, my guess is that Ecuador will be in the news as a respondent in arbitrations or court proceedings for years to come.

César Coronel Jones, founding partner at Coronel & Pérez in Guayaquil, Ecuador: The response will most likely be mixed. Some companies will agree and accept the new scheme, while others will prefer to negotiate for fair compensation, as provided on the last transitory disposition of the recently enacted law. The determining factor will probably be how much a company's investments have been amortized. Those companies whose contracts are set to expire soon or the cost of whose investments has already been amortized will find it more appealing to agree to the new model and extend their presence and activities in Ecuador. There are two main alternatives for companies that do not want to accept the new terms. One alternative is to negotiate with the government regarding the amount and terms of payment of compensation for the anticipated termination of their current contracts. The other alternative is to file international arbitration claims invoking the bilateral investment treaties (BITs) entered into between Ecuador and the home countries of the investors. In arbitration, the investors would probably invoke breaches of fair and equitable treatment or will allege expropriation of contractual rights. The BITs typically provide standards for fair and equitable treatment for foreign investors and investments, as well as fair, full and timely compensation in case of expropriation. Though it is difficult to predict now how things will play out in the future, it would not be unreasonable to believe that most large private companies from the United States and Europe will think twice now before coming to Ecuador to carry out important, high-tech investments. We will probably see an influx of state or mixed-type investors from countries like Venezuela, China and other countries whose governments sympathize with the current Ecuadorean government.

Manuel Gomez, assistant professor of law at Florida International University: The recently enacted amendment to the Hydrocarbons Law and the Domestic Tax Regime Law has helped the government of Ecuador move forward in its persistent effort to take control over the country's oil and gas production. One of the most important changes introduced by this amendment will be the replacement of the current oil exploitation-sharing agreements with a service contract model. Under this new scheme, multinational oil companies will only be entitled to a pre-established production fee instead of a share in the oil and gas produced, and the government will thus remain the sole owner of all hydrocarbons exploited in its soil. The new law will not only have an impact on future agreements but also on those currently in force between Petroecuador and several private companies including, Sociedad Internacional Petrolera (Chile's ENAP), Repsol YPF Ecuador, Overseas Petroleum and Investment Corporation, CRS Resources (Ecuador) LDC, Murphy Ecuador Oil Company and Escuela Superior Politecnica del Litoral, ESPOL. Depending on their size, companies have either 120 or 180 days to accept the modified terms of their contracts or the agreements will be terminated and their investments liquidated at a 'fair' price determined by the secretary of hydrocarbons. The government has instructed the attorney general's office to draft the new agreements and has appointed a negotiating team formed by representatives of the Non Renewable Resources Ministry, the Internal Revenue Service and the Secretary of the Peoples. It is too early to predict whether the companies will accept the government's proposed change of terms to their contracts, or the termination and subsequent liquidation of their investments at a price determined unilaterally by the Ecuadorean government. There is also the possibility of private investors bringing legal claims in domestic courts or through international arbitration, in those cases where arbitration was contractually agreed upon."

Wilson Pástor, Ecuador's minister for nonrenewable natural resources: The negotiating process has begun, so after the conversations with oil companies have concluded, we will know if they have accepted the terms that the government has proposed. We expect to reach greements in good faith with all the companies. We have also received a number of notices of interest to initiate this process, including ones favorable to the new service model. Oil companies' purposes are to invest, discover reserves and increase production, and they were invited to Ecuador for all of those reasons—not just to make profits. Currently they are investing, but only a small portion of the profits they receive. The oil companies that have invested in Ecuador can either continue negotiating to reach agreement on new contracts, or they will have the right to have their contracts liquidated at a fair price. It is hoped that these reforms do not lead to arbitration. However, the attorney general's office is prepared for domestic and international arbitration.As a result of the new hydrocarbons law, new investments and a reversal of declining production at oil fields are expected. Other objectives are more exploration and improved recuperation. Bids for areas in Ecuador's southeastern Amazon region will also be opened. The new hydrocarbons law is a major change as oil contracts will become service provider contracts and the government will take sovereignty over oil. In areas of oil exploration and exploitation, this is a major advance for institutional reform.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter. 


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