US embassy cable - 04QUITO2327

C O N F I D E N T I A L SECTION 01 OF 03 QUITO 002327 
 
SIPDIS 
 
DEPT PLEASE PASS TO USTR BENNETT HARMAN 
 
E.O. 12958: DECL: 08/24/2014 
TAGS: ETRD, EPET, ECON, EC, Oil Sector 
SUBJECT: THE PROCURADOR STRIKES BACK AT OCCIDENTAL PETROLEUM 
 
REF: 8/23/04 MEMMOTT-HARMAN TELCONS 
 
Classified By: Ambassador Kristie A. Kenney, Reason 1.5 (b) and (d) 
 
1. (U) See paragraph 11 for an action request. 
 
2. (C)  Summary.  Ecuador's Procurador (Solicitor General) 
may be seeking to terminate Occidental Petroleum's (Oxy) 
Block 15 participation contract for alleged violations of the 
hydrocarbon law.  If the allegations are upheld, Oxy's Block 
15 contract could be terminated and the assets would revert 
to state-owned Petroecuador.  The Procurador initiated his 
investigation of Oxy shortly after Oxy won a $75 million 
international arbitration award against the GOE.  The 
Ambassador conveyed the USG's extreme displeasure at this 
action to the Ministers of Trade, Economy, Foreign Affairs 
and Government, as well as to President Gutierrez.  Though 
there may be technical grounds to justify the Procurador's 
action, it smacks of retaliation.  While criticizing the GOE 
for the abuse of its legal system and explaining that it 
could result in serious trade implications, the Ambassador 
also encouraged the GOE to discuss with Oxy an amicable 
resolution to all its pending issues with the GOE.  End 
Summary. 
 
Retaliation or Coincidence? 
--------------------------- 
 
3.  (U) The Procurador (Solicitor General) admitted to the 
press that he started the investigation of Occidental 
Petroleum (Oxy) shortly after the July international 
arbitration decision against the GOE, awarding $75 million to 
Oxy (through 12/31/03) in value-added-tax (VAT) drawbacks. 
Yet, he claims this latest action has nothing to do with that 
decision.  He is also investigating Canadian oil company 
EnCana, which has its own VAT drawback case before 
international arbitrators.  Last week, under apparent 
pressure from the GOE, the GOE-appointed arbitrator resigned 
in the EnCana arbitration.  He also was the GOE-selected 
arbitrator in the Oxy international arbitration and joined 
the other two arbitrators in the unanimous decision against 
the GOE. 
 
4.  (U) The Procurador seeks to nullify Oxy's contract with 
the GOE on the basis that Oxy failed to comply with 
Ecuadorian law by transferring 40% of its block 15 assets to 
Canadian oil company EnCana without Ministry of Energy 
authorization and 33 other alleged violations of the law. 
Under Ecuador's hydrocarbon law, if Oxy transferred its 
contractual rights to EnCana without Ministry of Energy 
authorization or is a repeat violator of the law, the 
contract can be terminated (caducidad) and the area under 
contract would be immediately returned to the state, with all 
equipment, facilities, etc. transferred to state-owned 
Petroecuador, without cost.  Upon the Minister of Energy's 
declaration of caducidad, the oil company will have between 
30 and 60 days to resolve any alleged violations. 
 
Oxy's Position 
-------------- 
 
5.  (C) Econoffs met August 23 with Oxy's Ecuadorian 
President and GM Jerry Ellis, who said that while Oxy "could 
have done things better" with respect to the transfer, Oxy 
did materially comply with the law.  Ellis said Oxy notified 
then Energy Minister Pablo Teran in October 2000 about the 
proposed transfer of 40% of Oxy's economic interest in block 
15 to a subsidiary of EnCana.  In January 2001, after an 
exchange of letters and information between Oxy and the 
Ministry of Energy (MOE), Teran sent a letter to Oxy that 
said, according to Ellis, that Oxy should seek the MOE's 
approval at the time of the transfer of legal title to 
EnCana.  Ellis said that EnCana fulfilled its preconditions 
for the transfer this year and Oxy sent a letter to the MOE 
and Petroecuador on July 15 seeking authorization of the 
transfer.  Ellis claims that Oxy has not assigned any rights 
and obligations under the Block 15 participation agreement to 
EnCana.  He left Quito on August 24 for Oxy's corporate 
headquarters in Los Angeles to discuss the matter. 
 
6.  (C) Ellis said that 15 of the 33 other violations were 
for failure to file reports in a timely fashion.  These 
reports fell through the cracks when the responsible employee 
was transferred to Russia.  He claimed the other violations, 
like drilling without permits, were minor, citing drilling 
operations that were authorized to begin on January 1, but 
were actually begun on December 31, as an example of the 
minor nature of the breach.  Other claims include over 
drilling.  Ellis said that fines have been paid for most of 
the violations.  In some cases, administrative procedures 
have not been completed.  Still, the hydrocarbon law does 
provide for sanctions, including caducidad, for repeated 
violations of the law. 
 
EnCana's in Trouble Too 
----------------------- 
 
7.  (SBU) EnCana (nearly 50% U.S. investor owned) has 
problems too.  It has set up a data room for potential 
purchasers interested in its Ecuadorian assets.  The 
Procurador's accusations regarding the transfer from Oxy 
casts doubt on the legality of the transfer of Oxy's Block 15 
assets to EnCana and on any sale of EnCana's Ecuadorian 
assets.  EnCana tells us that it has also been cited for 
seven violations of the hydrocarbon law.  Press reports 
suggest that all or most other oil companies operating in 
Ecuador are also under investigation, and some analysts 
believe Ecuador is seeking to use these investigations to 
re-negotiate its contracts with all the private oil companies. 
 
Embassy Action 
-------------- 
 
8.  (SBU) The Ambassador raised the Oxy issue with Trade 
Minister Baki on August 23.  She explained to Baki that the 
GOE's apparent retaliation against Oxy for the VAT decision 
could have serious implications for Ecuador's free trade 
negotiations and ATPDEA benefits (ref telcons).  The 
Ambassador conveyed the same message to Minster of Economy 
Mauricio Yepez later that afternoon and again on August 24 to 
Minister of Government Baca.  She also raised the issue 
during her visit with the Minister of Foreign Affairs 
Patricio Zuquilanda.  The Ambassador spoke with President 
Gutierrez on August 24, expressing the USG's concern about 
the Procurador's actions and irresponsible statements to the 
press.  Ambassador suggested Gutierrez form a commission to 
resolve the matter, noting that Oxy would be willing to sit 
down and talk (as Oxy had previously relayed to the Embassy). 
 
9.  (C) The ministers had also agreed to raise the issue with 
President Gutierrez and all concurred that it reflected 
poorly on Ecuador and its investment climate.  Baki called it 
an outrage.  Baca said he had tried to dissuade the 
Procurador from taking the action, telling him it was 
unacceptable.  Even if there were grounds to investigate, 
Baca said, the Procurador was wrong to go to the press before 
giving Oxy a chance to respond.  Yepez suggested forming a 
commission to sit down with Oxy to resolve the Procurador's 
allegations and the VAT drawback case, which the Procurador 
has appealed to the court in London.  Yepez opined that a 
commission would limit the influence of the Procurador, tone 
down the rhetoric and provide an opportunity for resolution 
on all pending matters between Oxy and the GOE.  The Foreign 
Minister noted to the Ambassador that his press comments 
focused on finding solutions in a calm environment. 
 
Comment 
------- 
 
10.  (C) Clearly, the Procurador is retaliating against Oxy 
as a result of the VAT arbitration decision.  This course of 
action flies directly in the face of what Ecuador is trying 
to accomplish -- reach a free trade agreement and attract 
foreign investors, particularly in the oil and energy 
sectors.  That said, the Procurador might well have technical 
grounds to pursue actions against Oxy and, possibly, other 
private oil companies.  Still, the most egregious allegation 
against Oxy is the failure to get prior authorization before 
the transfer of some assets to EnCana, an accusation that Oxy 
vehemently denies.  The GOE has not, and cannot credibly 
claim that the proposed transfer from Oxy to EnCana would 
adversely affect Ecuador's interests.  Both are reputable, 
responsible companies and both are among the biggest 
taxpayers in Ecuador. 
 
Action Request 
-------------- 
 
11.  (C)  A strong signal must be sent to the GOE, that 
government retaliation against U.S. companies that win 
arbitration cases is unacceptable.  We urge Washington 
interlocutors to engage the GOE to express our extreme 
displeasure at the abuse of the legal system against U.S. 
companies (including in the cases of BellSouth, Duke Energy 
and, potentially, ChevronTexaco) and to reiterate that 
continuing abuses will have serious bilateral implications. 
At the same time, we urge Washington to encourage Oxy and the 
GOE to discuss the pending matters, perhaps along the lines 
suggested by Minister of Economy Yepez.  Post has already 
begun the process and will continue to vigorously press for a 
speedy resolution of the current problems and more 
responsible behavior by the Procurador and other GOE 
officials in the future. 
KENNEY