EXIT HUNT: YEMEN MOVES TO NATIONALIZE OIL

C O N F I D E N T I A L SECTION 01 OF 03 SANAA 003185

SIPDIS

E.O. 12958: DECL: 10/31/2015
TAGS: PGOV PREL ECON EINV EPET YM ENERGY ECON COM
SUBJECT: EXIT HUNT: YEMEN MOVES TO NATIONALIZE OIL
PRODUCTION IN BLOCK 18

REF: SANAA 1511

Classified By: DCM Nabeel Khoury for reasons 1.4 (b) and (d).


1. (C) Summary: On October 17, Yemen's Cabinet announced
that it would not renew Hunt's contract for oil production in
Block 18, and would instead award it to the Yemeni-owned
Safer Company. Hunt intends to sue the ROYG for violation of
contract, and will likely announce legal action to coincide
with President Saleh's November visit to Washington. Safer
is rumored to be an alliance of Yemen's major business
families, and will hold a 25 percent share. The ROYG will
hold the remaining 75 percent, and is encouraging Hunt local
employees to stay with the new government-owned venture.
Hunt continues to seek a compromise solution, and there is
some possibility that Saleh will look to deal while in
Washington. High oil prices, however, and the promise of
large personal profits for those involved, make such a
resolution unlikely. End summary.

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It's Official: Hunt Loses Block 18
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2. (C) The Cabinet announced on October 17 that the ROYG
would award drilling rights in Block 18 to the locally owned
Safer Petroleum Exploration Company. Hunt Oil has operated
in Block 18 for 20 years under a production sharing agreement
(PSA),but that agreement will expire on November 15. Block
18 has been one of Yemen's highest producing oil fields, with
an average yield of approximately 80,000 barrels per day of
crude, and Hunt currently produces approximately 30 percent
of Yemen's oil. Hunt was seeking a five-year extension for
the block, which was approved by the Ministry of Oil but
blocked by Parliament in May 2005. (Reftel) The Cabinet's
announcement appears to close the door on any last-minute
deal between the ROYG and the American company.


3. (C) Ambassador met October 23 with Hunt Vice President and
General Manager, Wendell Caviness, and the company's chief
negotiator, Bill Lewis. The executives presented Ambassador
with a written request to include the Block 18 issue in the
agenda during President Saleh's upcoming visit to Washington.
Lewis made clear that Hunt remains open to negotiation, yet
the ROYG has made no indication that it is interested. If
there is no change in the coming week, Lewis said Hunt would
pursue arbitration in international court for approximately
USD 450 million, charging breach of contract. General
Counsel Dennis Grindinger told Econoff that Hunt and Exxon
executives (partners in Block 18) are meeting October 31 to
decide the timing of the lawsuit, which will they will either
announce immediately before or after Saleh's meeting with
President Bush. Lewis also shared that Hunt planned to launch
a simultaneous media campaign against the ROYG in the
American and international press.

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"The Government is Taking Over"
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4. (C) Hunt officials say the message from ROYG officials,
including Presidential Advisor Abdulkarim al-Iryani, is
clear: "The Government is taking over Block 18." The
official Yemeni press has reported that Safer will have full
legal authority to operate and develop the block. According
to Caviness, however, Safer will hold only a 25 percent
working interest in Block 18, while the ROYG will hold the
remaining 75 percent. The ROYG has assured Hunt's local
employees that their jobs will be guaranteed after the
transition, and has appealed to the patriotic duty of Yemeni
citizens to discourage them from resigning. When Prime
Minister Bajammal appeared before Parliament in September,
however, he admitted that the ROYG had done nothing to
prepare for the transition.

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Who Stands to Benefit?
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5. (C) There is little information available as to who owns
Safer, a company that has existed only on paper since 1998.
The ROYG proposed at that time that Safer take over Block 18
after the expiration of Hunt's five-year extension, during
which time Hunt would help improve the local company's
capacity. Tarik al-Haidary, an executive in the Al-Ahmar
Group, told Econoff that Safer is essentially an umbrella
company for all of Yemen's leading investors, including the
Ahmar family, the Hayel Saeeds and others. By joining
together, said Haidary, the stakeholders made a strong case
to Parliament and the ROYG that the transfer of Block 18 to
Safer was in the national interest. Hunt director Caviness
added that at USD 1.5 billion annual revenue from the block,
it wasn't hard to convince Saleh that it was in the ROYG's
interest to nationalize.


6. (C) Caviness speculated that the effective nationalization
of Block 18 would only last a few months, until such time as
Safer inevitably shows a decline in production. At that
point, he suggested, the ROYG will enlist the help of another
international operator and could even sell a substantial
share of the block to the new investor. American-owned
Occidental Petroleum is often mentioned as a potential
partner, as are Premier from Great Britain and Total from
France. Occidental has been maneuvering behind the scenes
for several months, in partnership with Lebanese-based CCC,
to capture a share of Block 18.


7. (C) A limited period of state ownership could shield
Occidental or other international companies from legal action
by Hunt in U.S. courts. It may also allow the ROYG to reach
a more lucrative deal, based on high oil prices, than it
would have received under the Hunt extension. In an October
25 meeting with Ambassador, Saleh said he fully intended to
bring in foreign partners, perhaps even Hunt. (Note: It is
unclear what the terms of such an arrangement would be, and
unlikely that Hunt would accept. End note).

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Hunt Looks for Justice...
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8. (C) Grindinger is confident about Hunt's legal case, which
will be based on sanctity of contract. Hunt maintains that
Parliament had no authority to cancel the extension signed by
the Ministry of Oil. Grindinger also cited a 1997 contract
signed by the ROYG, which stipulates that if Hunt's PSA ever
expired the oil would revert back to the Government. The
contract also specifies, however, that Mareb Upstream
Services (MUS) obtains the liquid natural gas (LNG) rights
and must approve any new operator in Block 18. Hunt is a 30
percent owner in MUS, said Grindinger, and has blocking
rights on any new operator. Grindinger explained that Hunt
bought its share of MUS for specifically this purpose: to
make sure that poor management of oil reserves did not
endanger LNG production in the same area.


9. (C) The case is likely to drag on for several years, said
Caviness, and could have serious consequences for the ROYG if
Hunt is successful. Yemen would be liable for Hunt's losses,
explained Caviness, and if they refused to pay Hunt could
move to garnish their assets anywhere in the world.
Recognizing the seriousness of the situation, the ROYG has
retained the legal services of British firm Clyde and Co.
(Note: British-owned Cable and Wireless actually seized
planes from Yemenia Airlines in London following a similar
dispute with TeleYemen. End note).


10. (C) Caviness was concerned that perhaps the ROYG believes
it can avoid litigation by threatening Hunt's other
investments in Yemen. Hunt continues to operate Block 5,
with average production of 55,000 barrels per day and holds
an 18 percent share in Yemen LNG (YLNG),with a projected
total profit of USD 20 billion over 17 years. Block 18 is
the source of 95 percent of the LNG for the proposed project,
with the remainder coming from Block 5. The Prime Minister
assured Ambassador on July 4 that, "Hunt is not leaving
YLNG!" Should the ROYG attempt to remove the American
company from either Block 5 or LNG, however, Caviness said
Hunt would counter with additional lawsuits.

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...and Hopes Against Hope
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11. (C) President Saleh has yet to approve the Safer deal
officially, indicating that there may still be some room for
a compromise. In previous meetings with Ambassador, Hunt
executives indicated that they would be willing to accept
different ownership configurations, as long as their
percentage of profits is at least 15 percent and they retain
majority representation on the board of directors for five
years. Grindinger said that Hunt will continue to explore
every avenue, noting that the company may look to set up a
meeting between Saleh and CEO Ray Hunt during the President's
visit to the United States.


12. (C) Comment: Nothing is ever final in Yemen and there is
some hope that Saleh may be persuaded to reach a deal with
Hunt during his trip to Washington. Post recommends
discussion of Block 18 within the context of the broader
challenges of corruption and rule of law. American companies
find it impossible to invest in Yemen as they cannot depend
on contract enforcement, tendering guidelines, or legal
protection. Even with such arguments, there is little cause
for optimism. The high price of oil has made the short-term
gains of nationalizing Block 18 too tempting for the ROYG to
pass up. The corruption will be evenly distributed through
the Safer Company, which appears to offer a piece of the pie
to many of Yemen's most influential business families. At
the same time, the ROYG can boast that it is increasing
revenue to meet short-term budget needs, even if production
in Block 18 declines and Yemen's investment climate
deteriorates further. In short, everyone wins -- except Hunt
and the Yemeni people. End comment.
Krajeski