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Wednesday, October 17, 2007

Ecuador Oil: More Trouble Ahead

Latin Business Chronicle, 16 October, 2007

President Correa's oil policies will result in more disputes with foreign companies and reduced oil production, experts predict.


Ecuadorian president Rafael Correa, inspired by policies in Venezuela, is aggressively attacking foreign oil companies in a gamble that likely will lead to further falls in oil output from Latin America's fifth-largest oil producing country. Foreign oil companies account for half of Ecuador's oil production, while state oil company Petroecuador continues to be plagued by mismanagement and a heavy debt burden.

"The changes implemented by the Correa administration will constrain the ability of Ecuador to lure foreign investors into the country," Bear Stearns analyst Alberto Bernal said in commentary Friday.


The new policies will also lead to more formal disputes, risk consultancy Exclusive Analysis warns. "President Correa's moves to increase state control over the oil industry will likely lead to more litigation with multinationals," Exclusive Analysis said in a commentary late last week.

The latest hike comes after the then-government of president Alfredo Palacio raised the government's share from 30 to 50 percent in April last year. Several oil companies are still in arrears on those hikes, the government says. All in all, they owe $317 million, which they have to pay the next two weeks - October 31 - or face sanctions, officials warned yesterday.

Spanish oil giant Repsol YPF, French-based Perenco and Chinese-owned Andes Petroleum are among the companies that are in arrears, the government claims. Amazingly enough it also mentioned U.S.-based Occidental Petroleum, which left Ecuador last year after being forced to do so in a move that caused the U.S. government to stop free trade talks with Ecuador.

The latest action follows last week's decree that the state's share of oil revenues above set benchmarks would increase from 50 percent to 99 percent. Those that disagreed, he said, would face contracts with a 100 percent government share of windfall profits. Venezuela's government will advise Ecuador on the negotiations for new contracts, Correa said Saturday.

That measure will affect some 15 contracts signed since 1996. Most of these were due to expire in 2012, according to Exclusive Analysis. They include Brazil's state-owned Petrobras (Latin America's largest company) in addition to Repsol YPF, City Oriente, Perenco and Andes Petroleum.

"President Correa’s decision to increase the tax on extraordinary oil income of the private-sector oil fields ... implies an almost complete fiscalization of the extra income that oil companies are receiving for taking the risk of investing in this country," Bernal says. "The government’s aggressive stance suggests that the Correa administration intends to force oil companies to migrate from participation contracts into service contracts, as in the case of Venezuela."

Meanwhile, Ecuador also has pending disputes with Chevron, Occidental Petroleum and City Oriente.


Ecuador last year produced an average of 545,000 barrels per day, a 0.7 percent increase from 2005, according to the latest BP Statistical Review of World Energy. In the first quarter this year, however, it fell to 501,056 barrels per day, according to U.S.-based consultancy Global Insight.

And if Ecuador follows the lead from Venezuela, it will likely see even stronger declines. Venezuela's production averaged 2.8 million bpd last year, a 3.9 percent decline from 2005. In 1998 - the last year before Chavez became president - it was 3.5 million bpd, according to BP. That means the daily average has fallen 18.9 percent during the Chavez administration, according to a Latin Business Chronicle analysis of the BP data.

In the same period, Brazil's oil production has grown 80.4 percent. Even Mexico, which has suffered from well-publicized problems in production, increased its production by 5.3 percent in the 1998-2006 period, according to the Latin Business Chronicle analysis.

"Unlike Venezuela, Correa's growing political clout is not matched by the state's market leverage," Exclusive Analysis points out.

While the Ecuadorian government should get an additional oil windfall next year - amounting to $700–900 million (depending on the international price of oil) - the royalty hike will deter more foreign investment in the key oil sector, Bernal warns.

The measure also contradicts the purpose of a recent trip to New York by Economy Minister Mauricio Davalos, the analyst argues. "In typical Ecuadorian fashion, however, the president decided to squander the goodwill achieved—and the money spent by Ecuador’s taxpayers in paying for the minister’s business trip—by “kicking the table” with the international investors interested in developing the oil industry in Ecuador," Bernal observed.

Correa also plans all oil contracts to be on a service provider basis, which means foreign oil companies would receive a fixed fee instead of the current deals that allow them to retain a share of the oil extracted, Exclusive Analysis points out.


Chevron, a former partner of Petroecuador, says the state company illegally sold oil on the international market at below market prices and last year filed a $750 million claim against the state company at the International Court of Justice in Hague. That dispute comes on top of a lawsuit filed by Ecuadorian citizens against Chevron for alleged contamination of the Amazon. Chevron last week filed a claim at a superior Ecuador court to dismiss the $6 billion lawsuit, alleging an unfair process (see Chevron: Ecuador Tests Flawed). Among other things, the lawsuit uses a 1999 law that cannot be used retroactively, according to Charles James, Chevron's general counsel. The company has now asked a panel of distinguished jurists to observe the case, company officials said at a press briefing in Miami last week.

Both Occidental and City Oriente have claims pending at the World Bank's International Center for Settlement of Investment Disputes (ICSID). Occidental Petroleum filed a claim against Ecuador after its operations were expropriated in May 2006. Oxy was the top foreign investor in Ecuador at the time and had invested more than $1 billion in the Andean country. That case is still pending a decision by the ICSID.

Meanwhile, City Oriente's ICSID case is a dispute over last year's royalty rate hike. However, Correa has said he won't allow any ICSID arbitration of Ecuador oil disputes. And his government even launched its own $30 million lawsuit against the City Oriente, Exclusive Analysis points out.

"Ecuador expects an increase in international litigation, as evidenced by Correa's instruction his foreign minister to inform the ...ICSID body that Ecuador would no longer accept it as a mediator in oil cases," Exclusive Analysis says.

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