FOREIGN COMPANIES LAMENT IMPEDIMENTS TO

C O N F I D E N T I A L SECTION 01 OF 03 ALGIERS 000628

SIPDIS

SIPDIS

DOE PLEASE PASS TO SECRETARY BODMAN

E.O. 12958: DECL: 05/07/2017
TAGS: ENRG EPET EINV ECON AG
SUBJECT: FOREIGN COMPANIES LAMENT IMPEDIMENTS TO
HYDROCARBON INVESTMENT IN ALGERIA

REF: 06 ALGIERS 01769

Classified By: Deputy Chief of Mission Thomas F. Daughton;
reasons 1.4 (b),(d).


1. (C) SUMMARY: Representatives of foreign oil companies
operating in Algeria are increasingly voicing concern about
the ambiguously worded -- and apparently hastily drafted --
amendments to Algeria's hydrocarbon legislation in effect
since the beginning of the year. Although Sonatrach has
begun taking oil liftings from foreign operators to pay the
new taxes, foreign companies still do not fully understand
how these duties are being calculated. An independent
financial analysis indicated that the new regulations would
negatively impact the bottom line of all foreign energy
companies operating in Algeria, and most profoundly the three
that were the first to develop Algeria's hydrocarbon sector.
One foreign operator told us that according to its analysis,
the new taxes have made Algeria a less profitable operating
environment than Venezuela -- without taking into account the
question of the sanctity of Algerian contracts. Foreign
operators also consider the brain drain and resultant
bureaucratic slowdown caused by the reorganization of
Algeria's energy regulatory agencies as having a deleterious
impact on investment. Others have faulted Algeria's
"baossem" bidding process, which Energy Minister Khelil
implemented following his tenure at the World Bank as a means
to increase transparency, as having contrarily increased
corruption while giving Algeria a shoddy physical
infrastructure likely to stunt the energy sector's long-term
development. End Summary.

NEW LAW'S OPAQUE CALCULATIONS:
LESS PROFITABLE THAN VENEZUELA
--------------


2. (C) Foreign energy companies operating in Algeria are
increasingly voicing concern about the amendments to
Algeria's hydrocarbon legislation that came into effect
earlier this year. Most criticism has centered on the
windfall profits provision, which applies a production tax on
a company's production as soon as oil surpasses USD 30 per
barrel. The 2006 amendments noted that this tax could range
from five to 50 percent, which international oil companies
(IOCs) presumed would be applied on a graduated basis and
apply only to revenues over the USD 30 threshold. However,
the initial correspondence that the IOCs have received from
the Algerian government suggests that the tax is instead a
flat 50-percent assessment. One company representative
equated this system to the old stamp tax regime that once
existed on real estate in the U.K. In other words, once the
price of oil passes from USD 29.99 to USD 30.00, the
extraordinary profits tax kicks in and the 50-percent
production tax takes effect. It appears to apply then to all
revenues, rather than just those above the threshold,
although the exact formulas remain unclear. Various energy
companies we spoke to claimed not to fully understand how
these duties are being calculated; they commented that the
texts were ambiguously written and apparently hastily
prepared. Nonetheless, Anadarko Petroleum told us that
Sonatrach has begun taking its liftings -- which Anadarko
claims to own under contract -- to pay the new taxes, which
are retroactive as of August 2006.


3. (C) An independent financial analysis prepared by a
British energy consultancy and shared with us in private
indicates that all foreign companies operating in Algeria
would be adversely impacted by these new duties. Since most
contracts signed in Algeria since the 1990s have
profit-limiting provisions, the study estimates that this
change is likely to have the most profound impact on a few
contracts -- currently belonging to Anadarko Petroleum
(U.S.),ENI (Italy),and Maersk (Denmark) -- that were signed
early in Algeria's hydrocarbon development in the late 1980s
(reftel). These affected contracts of those three firms
could lose between a third and almost half of their value.
The study predicted that the value of other IOCs' investment,
in comparison, would drop between 3 and 21 percent, resulting
in a net drop of 23 percent, or USD 6.9 billion.

UNCERTAINTY OF CONTRACTS
--------------


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4. (C) Foreign energy operators have stressed that Algeria's
cavalier attitude to contracts has had just as negative
impact on the opportunities for future investment as the new
taxes have, albeit one that's harder to quantify. One
Halliburton executive based in the oil producing center of
Hassi Messaoud told Econoff in mid-April that the Algerians
had developed an attitude whereby they considered signed
contracts to be a starting point for negotiations. Anadarko,
similarly, expressed uncertainty about investing in the El
Merck fields until the taxation issue is resolved.


5. (C) Another major U.S. energy firm, which expressly
requested its case not be raised directly by Secretary Bodman
with Minister Khelil at this time because its negotiations
with the Algerians are ongoing, told us that it had recently
encountered similar contractual problems regarding change of
ownership. Under a 1987 Algerian law, a foreign company must
notify the Ministry of Energy if it plans to sell any of its
holdings; if there is no response within three months, the
deal goes through automatically. Historically, this
procedure was accomplished at the working level, involved
little more than a rubber stamp, and required little if any
transfer costs provided the new owner continued operations as
specified in the pre-existing contract. In this particular
case, however, the Ministry of Energy informed the company 10
months after its notification that in order for the transfer
of ownership to be approved, the company would be required to
pay a USD 20 million lump sum, waive any claims against the
windfall profits tax, provide a parent company guarantee for
the sale, and establish an abandonment escrow account that
would revert any forfeited holdings to Sonatrach.


6. (C) The greatest sticking point for this firm, however,
was the ministry's demand that it repay under its "gross
negligence and woeful misconduct" clause for the "lost"
revenue that was the result of equipment failure last year,
when production ceased for three months. The company noted
that these revenues were hardly "lost," as they remained in
the ground to be extracted at a future date. As a result, it
is currently disputing Algeria's claim that it pay a USD 150
million fee, which would set what it feels to be a dangerous
precedent regarding equipment failure for its operations
worldwide. When company representatives approached Minister
Khelil about the transfer, he said he "might just take the
blocks, pay what he thinks they're worth, and sell them to
the Europeans who are interested." He reportedly then
commented "that it may be discriminatory, but I am the
Minister and I can do it."

BUREAUCRATIC IMPEDIMENTS,
BRAIN DRAIN INCREASING
--------------


7. (C) Concurrent with the uncertainties about taxation and
the sanctity of contracts has been an increasingly
bureaucratic and technically lacking regulatory environment,
which the new hydrocarbon legislation aimed to improve.
One Anadarko engineer told us that ALNAFT -- the new agency
established under the hydrocarbon amendments responsible for
awarding energy contracts -- has merely added a new layer of
bureaucracy but that all of the same people are making
decisions. Brain drain in the Ministry of Energy and
Sonatrach has created enormous staffing troubles at ALNAFT
and its sister agency, ARH, which is responsible for health
and environmental matters. Regulators with sufficient
experience are leaving to work as independent energy
consultants or take higher paying positions outside of
Algeria, such as in the Persian Gulf.

BAOSSEM BIDDING WOES
--------------


8. (C) An American owner of a drilling company who has
worked in Algeria for the last 15 years told us that one of
the biggest impediments to development in Algerian energy
infrastructure has been its "baossem" bidding process.
Energy Minister Khelil imposed the system based on his
20-plus years of experience in the World Bank. Under
baossem, every bid that is put out for tender receives both a
technical and a financial score. Baossem obligates the
government then to choose automatically the lowest bid that
meets the base technical requirements. New technologies tend
to be systematically undercut as a result. The system, he

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remarked, has given Algeria a shoddy physical infrastructure
likely to stunt the energy sector's long-term development.
In the end, the drilling company owner lamented, the
Algerians have "gotten what they've paid for."


9. (C) Meanwhile, citing the East-West highway project that
was awarded on a similar basis, the drilling company owner
emphasized that the system had hardly rid Algeria's bidding
process of corruption. Former Sonatrach representative to
OPEC Dr. Abderrahmane Hamrour underscored this point to
Econoff in mid-April. Hamrour, who stressed his close
contacts with Sonatrach CEO Meziane, said that he had been
offered a job to work with Minister Khelil but demurred
because of what he suspected were his corrupt practices.
(Note: Khelil has thus far remained relatively immune from
the scandal engulfing Brown Root Condor, the
Sonatrach-Halliburton joint venture under investigation for
corruption. However, rumors continue to swirl in Algiers
that he is likely to get caught up in the scandal over BRC's
no-bid contract for the deluxe new headquarters of the
Ministry of Energy. End Note.)

COMMENT
--------------


10. (C) As the driving force for the original 2005
hydrocarbon law, Khelil once seemed intent on opening up
Algeria to robust foreign investment that would force
Sonatrach to evolve into a commercial competitor or risk
losing business. After President Bouteflika pushed through
amendments that restored, and in some ways enhanced,
Sonatrach's de jure preeminence in Algeria's hydrocarbon
development, Khelil bluntly told Ambassador last September
that the amendments had been made for strictly political
reasons and were beyond his control. Thus, Khelil's
about-face on Algeria's hydrocarbon legislation, including
his recent public endorsements of the windfall taxes, has
come as something of a surprise. Some of his rhetoric may
reflect an effort to keep his job or maneuver for a better
one, or perhaps simply embody the bravado that comes from
being the minister who oversees the golden goose of the
Algerian economy. It was under Khelil's stewardship of the
ministry, after all, that the country witnessed the
staggering rise in its foreign exchange holdings that enabled
it to pay off its international debt. Given the current
political climate, Khelil's harsh guidance to U.S. firms may
also reflect an effort to foil his perceived close relations
with the U.S. (Two of his children live in the U.S. and
Khelil owns a house in Potomac, Maryland.)


11. (C) That being said, it may be that Algeria's energy
policy is completely driven by the military/intelligence
"Pouvoir" (power),in which case Khelil's advice at the end
of the day is moot. Similarly, if the conspiracy theories
about Khelil's involvement in corrupt practices are true, all
bets are off. But as an old hand at the World Bank and a
onetime champion of greater competitiveness in Algeria's
energy sector, Khelil should understand the necessary
enablers for sustainable private investment and the critical
role foreign firms have played in Algeria's energy
development -- not to mention the dangers of overly
heavy-handed state intervention. U.S. energy companies in
Algeria have lamented to us that their message is not getting
through. As the Ministry of Energy has thus far rebuffed
Ambassador's March 10 official request to discuss these
points with Khelil, Secretary Bodman's planned meeting with
him poses an excellent opportunity to voice these festering
concerns.
FORD