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Ecuador: In a hurry to mend the past

After a decade marred by corruption and legal disputes, Ecuador’s reformist government wants a more investment-friendly exploration regime

The new order started in August with the completion of the merger of the mining and energy ministries into the hydrocarbons ministry, following years of scandal and wholesale sackings. Over the next few months the revamped ministry will start handing out licences under new profit-sharing contracts.

The merger was forced by the minority, left-wing government of president Lenín Moreno who seems intent on cleaning out endemic corruption in state-owned oil and gas companies and encouraging stable leadership.

In July, for example, PetroEcuador gained its ninth chief executive in 41 months with the appointment of Marcelo Proaño in place of Carlos Tejada who resigned "for personal reasons" after less than a year in the job. With an average tenure of roughly four-and-a-half months in the past three-and-a-half years, the top job at PetroEcuador is a revolving door.

The organisation has been in turmoil for years. According to newspaper reports, Tejada left after dismissing no fewer than 100 financial, accounting and administrative employees who were under investigation at the time. At the last count, three of PetroEcuador's former chief executives were serving prison sentences, while a fourth fled the country while under investigation.

After such a disastrous decade, the situation can only improve. As lawyer Alberto Peña Moscoso of Ecuador law firm Expertise Advisor points out in a report released in mid-2018, "the ministry is committed to recovering the time lost by Ecuador [in attracting] direct private investment in oil exploration, exploitation and refining".

Henceforth, rather than work with mainly state-owned oil and gas companies as it has done in the past, the new ministry has pledged to work through a formal tender process based on free competition among bidders. The government hopes that production and profit-sharing contracts will boost private investment in a stalled oil sector. Under the new terms, producers will be paid in oil, which can then be exported or sold to Ecuador's three refineries.

Industry veteran

The man in the hot seat is Carlos Pérez-García, the new hydrocarbons minister. Appointed in May last year, he's an industry veteran who held a series of positions with Schlumberger and Halliburton. He has outlined a simple ambition: "Our goal is to attract investment and also look for an increase in production and reserves in the future," he said at a conference earlier this year. One of the minister's first tasks was to persuade Opec to give Ecuador a reprieve from the production limits on the grounds that crude output is currently about 515,000 barrels a day, which is below the country's needs.

Pérez-García is running a list of projects that, he hopes, will attract the much-needed private capital. They comprise a hefty increase in production from the controversial ITT Block 43 bordering the environmentally sensitive Yasuni National Park; the expansion of a number of smaller fields that will require a relatively modest overall investment of $800m; a new high-conversion refinery in Manabíi, the capital of Portoviejo; and the further development of the offshore Amistad gasfield located within Block 6 in the Gulf of Guayaquil.

Ecuador certainly needs a new refinery. The total capacity of the three existing ones is 175,000 b/d, way short of demand which can hit more than 237,000 b/d. Hence Ecuador is a net importer of petroleum products.

Environmental opposition

The flagship project, ITT Block 43, could run into trouble with environmental groups. There's a powerful lobby fighting the issue of a license that would open up the Ishpingo oilfield, part of the ITT block, and permit drilling deeper in the Yasuni National Park. The government has plans for the drilling by state-owned Petroamazonas of nearly 300 wells and the construction of nine platforms in the southern-most section of Block 43, overlapping a so-called "untouchable zone".

But in a mid-2018 referendum, 67.5% of voters opposed any extension of the zone, threatening the future of the Ishpingo project. Drilling was expected to start in mid-2018 but has now been postponed.

In late 2018, Ecuador's story in oil and gas remains one of unfulfilled potential.

The problem for the hydrocarbons ministry is that the ITT wells are Ecuador's biggest producer, delivering around 70,000 b/d. The new oil and gas plan calls for Ishpingo to add another 30,000 b/d. By 2022, the three fields in Block 43 are slated to have about 650 wells producing 300,000 b/d.

As for the smaller blocks, they will be developed under service contracts with Petroamazonas. That leaves Amistad, which produces 39m cubic feet a day of natural gas from six active wells. Ecuador's only gasfield, it will be put up for auction when enabling legislation is passed.

Arbitration defeats

Ecuador hasn't quite wiped the slate clean yet. The country has been mired in legal battles in international jurisdictions after riding roughshod over oil and gas contracts. And it has comprehensively lost them.

As lawyers Claudio Salas and Nicolás Costábile of WilmerHale point out in a comprehensive paper released late August about energy arbitration in Latin America: "Like Venezuela, Ecuador has faced a number of investment treaty claims in recent years due to measures affecting investors in the energy sector."

The claims started in 2006 with the sharp rise in the price of crude when Ecuador passed a law that imposed a 50% windfall profit tax, later raised to 99%, on investors' extraordinary income. Simultaneously, the government "forced the renegotiation of several production-sharing contracts into service contracts, terminating those where the state and private oil companies couldn't reach an agreement, and subsequently seizing various oilfields between 2009 and 2010".

The matters ended up in the International Centre for Settlement of Investment Disputes (ICSID). Two of the companies affected, Burlington Resources and Perenco Ecuador, brought parallel ICSID claims. While the Burlington tribunal found that windfall profit tax didn't amount to an expropriation on the grounds that "taxation is an essential prerogative of State sovereignty", it did find that the physical takeover of two blocks "was a complete and direct expropriation of Burlington's investment".

The tribunal awarded Burlington $379m, and the parties settled the case for $337m.

“The ministry is committed to recovering the time lost by Ecuador [in attracting] direct private investment” Alberto Peña Moscoso

Perenco also comprehensively won its case. Although the tribunal concluded the taxation in itself didn't amount to an indirect expropriation, it ruled that that raising the tax to 99% constituted a breach of contract. In an implicit warning to high-handed government action in oil and gas contracts, it found that 99% "unilaterally converted the participation contracts into de facto service contracts, while the state developed a new model of such contracts which it demanded the contractor to sign".

The tribunal also said Ecuador's declaration that the contracts had expired amounted to an expropriation of Perenco's contractual rights. Negotiations continue on the size of the compensation, three years after the tribunal issued an award on liability.

Ecuador's biggest defeat came in 2012, with a $1.76bn award to Occidental over a broadly similar case. The government had seized the company's investment as an "administrative sanction", an action the tribunal ruled as "disproportionate and tantamount to expropriation". Compensation was recently agreed at $980m.

Ecuador's most recent defeat came in 2018 when a claim filed with the UN Commission on International Trade Law by a subsidiary of Petrobras, Cayman International Exploration and Teikoku Oil ended in a $515m award against the government and PetroEcuador. The case followed the nationalisation of two Amazon projects.

In late 2018, Ecuador's story in oil and gas remains one of unfulfilled potential. According to official statistics, accumulated production of oil since 1950 is just shy of 6.9bn barrels. Proven reserves are estimated at 1.7bn, while total PPP reserves total 4.4bn. On top of these, contingent resources stand at around 1.46bn and prospective resources at 4.8bn.

Industry consultants expect production to grow substantially in late 2018, but the main question remains: how will foreign, private investors judge the new regime? This will depend on the eradication of what Expertise law firm describes as "the perception of complexity and lack of transparency in oil transactions and contracts".

And, it should be said, corruption. As Expertise adds: "Along these lines, specific codes of conduct that attack corruption and seek its elimination will be implemented."

So far, no new contract appears to have been signed, but there's plenty of promise, with a total of 68 expressions of interest filed by 25 private companies for the oil and gas fields. According to newspapers' reports, Russia's Zarubezhneft has thrown its hat into the ring, while Canada's Frontera Energy has had talks with the hydrocarbons ministry about developing gas deposits.

As Expertise points out, Ecuador's extrication from conflicts with foreign oil and gas companies has been costly, but could mark the start of a new era. 

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