GOE NEGOTIATING OIL CONTRACTS - AGAIN: FIRMS AGREE

C O N F I D E N T I A L QUITO 000764

SIPDIS

TREASURY FOR MEWENS
DEPT FOR WHA/EPSC FAITH CORNEILLE

E.O. 12958: DECL: 08/20/2018
TAGS: EPET EINV ECON EC
SUBJECT: GOE NEGOTIATING OIL CONTRACTS - AGAIN: FIRMS AGREE
TO USE SERVICES MODEL

REF: A. QUITO 351

B. QUITO 681

Classified By: Ambassador Heather Hodges, Reasons 1.4 (b) and (d).


1. (U) Summary: President Correa held high level talks with
the leaders of international oil companies to restart oil
contract negotiations after he had suspended them in April.
Chinese, Spanish, and Brazilian oil companies have agreed on
the framework for new production contracts and to a
transition to a services contract model. In a separate
development, U.S. oil company City Oriente turned its
concession over to Petroecuador on August 1 and received 95%
of a $69 million payment August 7. End Summary.


2. (C) President Correa met August 7-8 with the heads of
three of the four main foreign oil companies operating in
Ecuador - Andes (Chinese),Repsol (Spanish),and Petrobras
(Brazilian). All three apparently agreed on the framework
for new production sharing contracts and to transition to
services contracts. A meeting between Correa and Perenco
(French),the fourth oil company currently operating under a
production sharing contract, has yet to take place. (Murphy,
a U.S. company, is a minority partner in the Repsol
consortium, while another U.S. company, Burlington, is a
minority partner in the Perenco consortiums.)


3. (C) Oil contract renegotiations between the GOE and the
foreign producers were suspended by Correa in April (reftel
a). Petroleum company sources report that when Correa
unexpectedly terminated negotiations, they had been close to
agreeing with Petroleum Minister Chiriboga on the key
economic provisions for new production sharing contracts.
Correa reportedly suspended the talks because they did not
include a clear timeframe or plan to transition towards oil
services contracts. Correa has expressed a strong preference
for the services contract model, since that would allow the
GOE to capture the benefits of price increases and retain
control over the oil. However, the government's initial
model services contract was roundly rejected by the oil
companies, and in June, Repsol and Perenco stopped paying an
extraordinary income tax imposed by the government.

Contract Basics
--------------


4. (C) Repsol and Murphy both told econoff that they are
pleased that negotiations have restarted, and provided some
information on the provisions discussed with Correa. They
reported that the proposed new production sharing contract is
basically the same as what Repsol and its consortium members
had negotiated before the April suspension. As noted in
reftel a, one of the key provisions in the new production
sharing contracts would be some relief from the windfall
income tax by raising the reference price above which
"extraordinary revenue" must be shared with the state. The
new agreement would also reduce the government's share of
extraordinary income from 99% to 70%. For the Repsol/Murphy
consortium, the new reference price would be $42.50/barrel,
compared to the current $25/barrel. In the suspended April
negotiations, the reference price had been $45.50, so the
companies conceded a bit on this point in their discussions
with Correa. (Note: According to rough Embassy
calculations, based on prevailing oil prices, Repsol's income
per barrel would be roughly the same under the notional new
contract as under the current 50% windfall tax.)


5. (C) The international arbitration provisions established
in the contract was a sticking point in the previous
discussions, and had not been resolved when talks were
suspended in April. The GOE has repeatedly insisted that it
would not accept international arbitration before the World
Bank's ICSID. Correa instead is now proposing arbitration
under UN rules (UNCITRAL) to be held in Chile. The
international oil companies appear to be willing to accept
UNCITRAL arbitration.


6. (C) According to the Repsol and Murphy representatives,
Correa was clear that he expects the consortium to move
quickly to a services contract, although he did not provide
specifics on how it would be structured. The companies
believe a services contract could be workable, but noted that
negotiating one is complicated. A major sticking point will
be reimbursing the companies for their expenses. (Under a
production sharing contract, the companies absorb the
investment and operating costs out of their production share,
while in a typical services contract the companies are paid a
per barrel service fee, and the government absorbs the
operating and investment expenses.) Most critical is the
question of how to reimburse the companies' unamortized
investments accrued under their current production sharing
contracts. Repsol has $700 million in unamortized investment
in Ecuador, and would prefer an upfront payment from the GOE.
However, it is likely the GOE would ask for some type of
payment plan over time as paying off each company's
investment up front would be too costly.

City Oriente Departs Ecuador
--------------


7. (C) On August 1, City Oriente, a small U.S. oil company,
turned its concession over to Petroecuador in return for a
$69 million payment from the GOE as compensation for its
unamortized investments (reftel b). Ninety-five percent of
the amount has been paid, with a final payment scheduled for
the end of November. City Oriente had been offered the
option of remaining in Ecuador under a services contract,
provided it was willing to accept compensation over time for
its unamortized investment. It preferred to take the cash
and leave.

COMMENT:
--------------


8. (C) President Correa has once again changed course in his
relations with the petroleum sector, the fifth abrupt change
in his tenure. Petroleum sector representatives believe that
the GOE was pushed back to the negotiating table when Repsol
and others filed for arbitration and stopped paying the
government's 99% windfall profits tax. In fact, Repsol is no
longer paying even the 50% share required by law. Another
expert believes the GOE is learning that state-owned
Petroecuador, which is corrupt and inefficient, is unable to
exploit even its own oil fields, as evidenced by flat
production in spite of increased investment. Therefore the
GOE recognizes the need for private companies to renew
investment as soon as possible to maintain and possibly
increase total petroleum production. Although Correa wants
to immediately switch to service contracts, it will likely
take some time to iron out the details of this type of
agreement and the transition could be lengthy.
Hodges