SPANISH REPSOL AGREES TO NEW OIL CONTRACT WITH

C O N F I D E N T I A L QUITO 001058 SIPDIS DEPT FOR WHA/EPSC FAITH CORNEILLE E.O. 12958: DECL: 11/14/2018 TAGS: EPET ENRG EINV ECON EC SUBJECT: SPANISH REPSOL AGREES TO NEW OIL CONTRACT WITH GOE; U.S. PARTNER MURPHY RESISTS REF: A. QUITO 996 ¶B. QUITO 983 ¶C. QUITO 681 ¶D. 07 QUITO 1091 Classified By: DCM Andrew Chritton, Reasons 1.4(b) and (d) ¶1. (C) Summary: On November 6, Spanish oil company Repsol reached agreement to sign a new transitory production sharing contract with the Government of Ecuador (GOE),following statements from the Minister of Petroleum that the GOE would terminate its contract for not concluding oil negotiations quickly enough. Repsol's Taiwanese and Chinese consortium partners also agreed to the contract. However, Murphy Petroleum, a U.S. minority partner in the consortium, is not willing to accept the GOE's terms, and Repsol will offer to buy out its 20% share. End Summary. ¶2. (U) Repsol operates Block 16 in the Amazon region, which produces approximately 58,000 barrels of oil per day, as 35% owner of a consortium that also includes Taiwanese Overseas Petroleum and Investment Corporation (31%),U.S. Murphy Oil (20%),and Chinese Sinochem (14%). In addition to Block 16, the group operates the smaller Tivacuno and Bogi Capiron fields. The group's current contract ends in 2012. Correa's Tactics -------------- ¶3. (C) On October 31, new Petroleum and Mines Minister Derlis Palacios announced that Repsol's contract would be terminated because it had not concluded negotiations for a new oil contract quickly enough. President Correa repeated this in his November 1 radio address, stating that Repsol would have to leave the country because the company had decreased production and not agreed to a new contract. (Note: Neither mentioned any notional legal grounds for terminating the contract.) Local Repsol Communications Manager Federico Cruz told us the announcements were a complete surprise to Repsol, and that the company had been negotiating with its counterpart GOE team without problems. Repsol responded publicly that it hoped to continue negotiating with the GOE and to finalize an agreement as soon as possible. (Note: The GOE also threatened Brazilian Petrobras with expulsion in early October; the company finally reached agreement with the GOE October 17 (ref A).) Repsol Reaches Agreement with GOE -------------- ¶4. (C) On November 6, partners Repsol, Sinochem, and the Overseas Petroleum and Investment Corporation reached agreement with the GOE on a new transitory production sharing contract, following intense negotiations over a period of several days. All three parties had reasons to reach agreement more easily than Murphy, which rejected the accord. In addition to Block 16, Repsol also owns a number of gas stations in Ecuador and has ship-or-pay commitments with the privately funded Heavy Crude Pipeline (OCP),making its stake in Ecuador greater than simply oil operations. Industry experts believe that the government-owned Chinese and Taiwanese companies have strategic interests in increasing petroleum production that override purely financial business interests. ¶5. (C) The new contract would increase the GOE's production share from 17 to 36%, according to the Ministry of Petroleum and Mines. The windfall tax would be reduced from 99% to 70%, with the base price rising from $25.5/barrel to $42.5/barrel. The Repsol-led consortium would be required to invest $316 million. The agreement would extend Repsol's contract until 2018 (for six years),but the consortium would still need to negotiate a service contract within the next year. In keeping with the GOE's aversion to the World Bank's ICSID as an arbitral forum, the new agreement would use Hague Court rules, but with arbitration in Chile. Upon signing the new contract, Repsol would have to drop its current contract arbitration claim. Murphy Rejects Accord -------------- ¶6. (C) Ignacio Herrera of Murphy Oil confirmed that the company is not willing to accept the GOE proposal because it is not financially viable and does not compensate for previous payments under the "windfall income tax". Herrera explained that the consortium's contract calls for compensation by the GOE for any fees or taxes that are imposed after the contract was signed, and that the windfall tax is such a fee. Murphy does not mind paying the fee, he said, but must be compensated by the GOE. In addition, the deal would only delay uncertainty for one year. Murphy had been willing to "meet in the middle," Herrera explained, but Correa "is forcing everyone to accept his terms." Herrera complained that Correa is beginning a process of nationalization "just like Chavez," and said that Murphy is "fed up" with dealing with the GOE due to Correa's inflexibility and failure to honor contracts. Ecuadorian investments comprise less than 10% of Murphy's production and reserves, and are "not worth the effort," Herrera stated. ¶7. (C) Any new contract requires unanimous agreement between all consortium partners. Repsol representative Cruz noted that a senior Repsol executive would be going to Houston November 8 to make an offer to Murphy to buy out their share of the consortium so the other members of the consortium could go forward. Comment -------------- ¶8. (C) Correa's announcement that Repsol would have to leave the country is another instance of his strong-arm methods of negotiating with foreign companies. Repsol had been willing to transition to a service contract and was negotiating with the GOE team without major issues, according to Repsol, but apparently was not moving fast enough, probably in part because of Murphy's reluctance to bend any further. ¶9. Correa's demands and tactics have frustrated Murphy Oil, who we expect will accept Repsol's offer and leave Ecuador. The final major operator negotiating with the GOE is French-owned Perenco and minority U.S. partner Burlington (now owned by Conoco-Philips). Conoco was in the process of trying to sell its assets in Ecuador and subsequently filed for international arbitration over the windfall income tax (ref D). A Burlington representative said the company would likely reject a GOE proposal and wouldn't give up its arbitration claim. If Perenco is willing to buy out its share, Burlington would probably leave as well. Following the departure of City Oriente in August (ref C) and the likely departure of Murphy, Burlington's departure would represent another step in the withdrawal of older U.S. investors from the Ecuadorian oil sector, although Noble Energy operates a natural gas field and Canadian-registered Ivanhoe Energy, which has an important U.S. dimension, is prepared to make a sizeable investment in the oil sector (ref B). HODGES