RESOURCE NATIONALISM IN ALGERIA ON THE RISE

C O N F I D E N T I A L SECTION 01 OF 04 ALGIERS 001694 SIPDIS SIPDIS PASS TO EEB/ESC/IEC/EPC GLENN GRIFFIN E.O. 12958: DECL: 11/22/2017 TAGS: ENRG EPET PGOV ECON EINV AG SUBJECT: RESOURCE NATIONALISM IN ALGERIA ON THE RISE REF: A. SECSTATE 150999 ¶B. ALGIERS 708 ¶C. ALGIERS 628 ALGIERS 00001694 001.2 OF 004 Classified By: Deputy Chief of Mission Thomas F. Daughton; reasons 1.4(b) and (d). ¶1. (C) SUMMARY: Algerian official behavior since 2005, in terms of the country's hydrocarbons law, tax systems, contracting policies and customs enforcement, strongly suggests a growing sentiment of resource nationalism. Government actions indicate a conscious effort to gain greater control of hydrocarbon resources and a greater share of the revenues associated with those resources. Outdated economic policies and a centralized, bureaucratic and paranoid decision-making process also contribute to stagnation in real economic expansion and frustration among private stakeholders. As a result, some major American companies in the oil and gas industry are seriously rethinking their investments, which could leave Algeria with an expanded stake in its natural resources but a lessened capacity to exploit those resources. END SUMMARY. GOA TAKES GREATER CONTROL OF HYDROCARBON RESOURCES -------------- -------------- ¶2. (C) We have previously reported Algerian government efforts to expand national control over the country's hydrocarbon deposits (refs B, C). Minister of Energy Chakib Khelil told the Ambassador in May 2007 that the government had made a political decision to slow the country's development of petroleum resources in an effort to leave natural resources in the ground for future generations to exploit. He also said the government wished to recoup what it considered to have been "unfair gains" made by foreign partners in Algeria's oil projects in recent years (ref B). A 2005 hydrocarbons law reformulated ownership interests in Algeria's oil and gas deposits such that the state itself, and not even its own oil company, is the sole owner of hydrocarbons found within Algerian territory. According to KPMG's 2007 Hydrocarbons Guide for Algeria, "(the law) is unambiguous: investors are forbidden from ever claiming ownership of the deposit that they discovered." WINDFALL PROFITS TAX... -------------- ¶3. (C) The most prevalent example of Algeria's attempt to "secure a larger share of the revenue" (ref A) from its hydrocarbons sector was the implementation in 2007 of a windfall profits tax. This was a brazen move to take a greater share of revenues gained from the soaring price of oil. The law allows the government to set a special tax rate for oil and gas production when market prices exceed certain benchmark prices. So far, the tax has been assessed only against oil producers, and has been applied at a rate of 50 percent of all revenues when oil surpasses $30 per barrel (ref C). Because most contracts negotiated within the last ten years have included profit caps for private producers, the impact of the tax fell most heavily on a few international producers who entered the Algerian market during its dark years of civil strife and terrorism that began in the late 1980s and early 1990s. American company Anadarko, noted for having been willing to map, explore and drill for oil in Algeria even in the worst years, now has half of its liftings taken by the Algerian government as payment of the windfall profits tax, at a sum total of $450 million per year. Dick Holmes, President of Anadarko Algeria, told the Ambassador on November 6 that the net value profit on the company's Algerian assets has decreased from USD 10 billion to USD two billion as a result of the tax. After failed attempts to nullify the tax and to negotiate a more reasonable tax rate, Anadarko has chosen to seek redress under the conciliation and arbitration clauses in its contract with Algeria's national hydrocarbons company Sonatrach. ...AND OUTRIGHT BULLYING -------------- ALGIERS 00001694 002.2 OF 004 ¶4. (C) Other international oil companies affected by the windfall profits tax have negotiated settlements rather than challenge the GOA. According to Dick Holmes, Anadarko partner ENI of Italy acquiesced to the tax after the Algerians indicated they might not renew several of ENI's concessions. Holmes described this as a new hardball negotiating tactic for the government, as well as an attempt to extract a greater share of a pipeline project to Italy. Italy imports almost a trillion cubic feet of natural gas from Algeria per year, and ENI found itself forced to accept a significant windfall profits tax to avoid an interruption in Italy's gas supply. LUMP SUM CONTRACT TERMS -------------- ¶5. (C) American company Bechtel, another long-term player in Algeria, has recently found itself priced out of the Algerian oil and gas construction market by the government's inflexible contracting terms, which foist the risk of rising construction prices upon the companies that contract with Sonatrach. Bechtel told us that the government insists on "lump sum" contracting for its large construction projects. Under a lump sum contract, a prime contractor like Bechtel agrees to complete a project for a specified contract price inclusive of all survey, goods, equipment and labor costs. Bechtel tells us that when it wins a contract in most other markets, the company acquires goods and services on behalf of the contracting government agency, passing those costs directly to the agency. Bechtel then charges a negotiated service fee for its management of the project. Under the Algerian lump sum contract, rising parts and labor costs over the life-cycle of a large project become the liability of the contractor, which can recoup no more than the total price offered at the outset. Furthermore, over the last several years the Algerians have been awarding construction contracts solely on the basis of the lowest bid, and generally Bechtel cannot beat the low prices offered by some up-and-coming firms from the Arab Gulf states. ¶6. (C) Accordingly, Bechtel tells us it will likely not bid on the large El Merck project, for several reasons: it would have to spend nearly $4.5 million in survey costs just to prepare its bid, which cannot be recouped if the bid is not accepted; it has no confidence of winning the bid against other companies with histories of low-balling their bids; and even if it were to win, the cost of goods and labor would be certain to increase over the four years or more of the project, which Bechtel would not recoup under the Algerian lump sum contract, leaving it with marginal profits at best. A Bechtel VP told us in early November that Sonatrach was pushing hard for the company to bid on El Merck, in part because of promises Sonatrach had made to the Algerian political leadership about the expected number of bidders. Bechtel responded, the VP said, by saying they would be willing to bid if Sonatrach underwrote the survey costs. EXCESSIVE CUSTOMS FINES -------------- ¶7. (C) Bechtel and U.S. company Nabors Drilling both are facing excessive fines imposed by Algerian customs for bureaucratic mistakes associated with the temporary importation of equipment. The rules for temporary imports are onerous, requiring customs service approval before an item can be moved from one project to another. Companies face pressure from several fronts in this regard. First, a piece of equipment that entered Algeria without tariffs must be exported back out of the country within 90 days of the completion of the work for which the equipment was designated. A piece of equipment may be transferred to another site upon application and customs approval, but that approval process frequently takes more than the 90 days allowed under the temporary import rule. Further, subcontractors need to be able to quickly move equipment from one project to another in order to maintain their various contract timelines, and the typical three- to six-month delay in customs approval interferes with the business necessity of ALGIERS 00001694 003.2 OF 004 these contracts. ¶8. (C) On the advice of their customs agents, both companies eventually adopted the common practice of applying for customs transfer approval after already moving a piece of temporary equipment to a new site. Today, each company faces penalties mounting into millions of dollars based on the original value of the equipment, rather than the standard penalty for faulty application filing of roughly $80 per transaction (in each case, there would be over 100 transactions at stake, and each company is willing to pay such a fine). Both companies have faced myriad hurdles negotiating the customs bureaucracy -- with the Ambassador's assistance in the case of Bechtel -- but even meetings with the customs agency chief has not resolved the issues that originated from a field office in the oil patch. CLOSED DOOR POLICIES -------------- ¶9. (C) Algerian bureaucracy also poses significant challenges to companies doing business in hydrocarbons and other natural resources. Major oil companies continue to report problems gaining access to decision-makers at the Ministry of Energy and at Sonatrach (ref B). Anadarko's Dick Holmes told us that his company's decision to seek conciliation and arbitration on the windfall tax stemmed in part from the government's refusal to negotiate. Indeed, he said, Anadarko could not even find anyone who admitted the authority to negotiate. In September, Energy Minister Khelil told Anadarko CEO James Hackett that he could not talk about the tax issue because his ministry could not interfere with the sanctity of Sonatrach contracts. Meanwhile, Sonatrach executives told Hackett that they could do nothing regarding the tax because the parastatal could take no action that would have a negative impact on the nation's revenues. More recently Khelil has been seen as outright hostile toward corporate executives, often refusing meetings unless a very specific topic that cannot be handled by the bureaucracy is identified in advance (ref B). PULLING UP STAKES -------------- ¶10. (C) These problems and their impact on the profit margins of private companies are causing major players in the industry to rethink their investments and their very presence in Algeria. Both Anadarko and Bechtel have told us that they are not bidding on any new oil and gas projects in the near future. In fact, Bechtel faces a watershed decision in Algeria at the conclusion of its current outstanding project. If it does not win a contract for a mining project for which it is currently considering a bid, Bechtel will have no remaining stake in Algeria, and may pull out by mid-2008. The company has no plans to replace the VP who currently acts as de facto country manager in Algeria when he leaves at the close of the company's current gas refinery project (slated for the end of 2007). Dick Holmes of Anadarko told the Ambassador that his company is likewise considering pulling out of the el-Merck project, risking legal action by Sonatrach that Holmes is confident his company would win. If that happens, and depending on the outcome if the arbitration over the windfall profit tax, Anadarko could also be in a position to leave Algeria altogether before the end of 2008. COMMENT -------------- ¶11. (C) Algerian behavior in the last year suggests officials believe that, with oil at $98 a barrel and Europe in constant need of gas, they can buy their way out of almost any problem and can take this opportunity to increase the country's stake in its own natural resources. Yet recent history has shown that the rush by the Algerian government and its parastatals to greet low bidders on major contracts -- even at the cost of alienating U.S. and other major foreign players -- has produced projects that face crippling delays, cost over-runs, and even deadly accidents. If major U.S. firms do decide to avoid new projects in Algeria, we would expect the challenges ALGIERS 00001694 004.2 OF 004 to resource exploitation here to increase. Decision-making on major contracts appears to be driven from the very top in a highly centralized and hierarchical manner. Accordingly, any USG effort to influence the trends noted here will have to be made at the upper levels of the Algerian government, through direct contact with ministers and the presidency. FORD