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One of the hot topics today in the energy arena is the expropriation of natural resource extraction rights by governments in South America. In fact, the issue is neither new nor unique to that region. As early as 1937, a newly elected government in Bolivia confiscated Standard Oil’s facilities. In response, the United States, while not intervening militarily, withheld loans and technical assistance. In the 1940s, Venezuela’s new leader, Peres Alfonso, signed the first “50-50 agreement,” reserving to the state 50% of all oil profits. During the 1970s, Libya renegotiated its oil and gas lease contracts and ultimately asserted a national monopoly on hydrocarbon production. Andy Stern, Who Won the Oil Wars?, at 36, 95 (2005). Even today, we see Yemen expelling a Hunt Oil Co./Exxon Mobil Corp. consortium after negotiating and signing a lease-extension agreement. Eric O’Keefe, “Oil Companies file Arbitration against Yemen,” New York Times, Nov. 24, 2005. As in the past, the current cycle of expropriation is caused both by economic and political factors. In the early 1970s, developing and socialist countries mounted a still-unresolved effort in the United Nations to establish recognition of their right to expropriate foreign investments. This concept of “permanent sovereignty” asserts a right to transfer ownership of natural resources to the citizens of the country in question. See Nico Schrijver, Sovereignty over Natural Resources: Balancing Rights and Duties, at 33-164 (1997). As a result of the prior expropriations and the development of the concept of permanent sovereignty, the number of bilateral investment treaties (BITs) began to increase. BITs offered developed companies a means to protect their investors, while giving developing countries a means to attract investment. See Kenneth J. Vandevelde, “The Economics of Bilateral Investment Treaties,” 41(2) Harv. Int’l. L.J. 469 (2000). In the 1960s and 1970s, a major innovation in international investment law was the creation of the International Center for the Settlement of Investment Disputes (ICSID). See Convention on the Settlement of Investment Disputes between States and Nationals of Other States of 18 March 1965 done at Washington, D.C., 575 U.N.T.S. 159. ICSID provides a venue for arbitration of disputes between investors and state governments. The present era of international investment law (beginning in the late 1980s and early 1990s) has seen a veritable explosion in the number of concluded BITs. See Lucy Reed, Jan Paulsson & Nigel Blackaby, Guide to ICSID Arbitration, at ix (2004). While commentators have posed many reasons for this change, two are particularly noteworthy. One was the loss of alternatives to private foreign investments as a source of capital. With the debt crisis of the 1980s and resulting federal deficits in the United States and other countries, the availability of capital significantly diminished. The second reason was the significant drop in oil prices in the mid-1980s. On account of these two factors, developing countries were openly seeking to create a favorable environment to attract foreign investment. While fewer than 400 BITs were concluded in the 30 years between 1959 and 1989, during the next 15 years some 2,000 BITs came into existence. United Nations Conference on Trade and Development, Trends in International Investment Agreements: An Overview, U.N. Doc. UNCTAD/ITE/IIT/13, 33. Recently, some developing countries have come to see these agreements as poor bargains in which they surrendered sovereignty and subjected themselves to costly arbitrations without appreciable benefit. With the rise in the price of oil and gas and the increased nationalistic fervor in South America, neither BITs nor arbitration clauses have stopped host nations from reconsidering their current agreements. See Letter to the Editor by Ecuadorian Ambassador to the United Kingdom Teodoro Maldonado in The Economist, 24 June 2006, at 16; Franz Chavez, “Bolivia: The Story Behind Gas Nationalisation,” Inter Press Service news agency, May 13, 2006 (quoting Bolivian President Evo Morales’ statement that “the Bolivian State could refuse to respond to an international court of arbitration”). The current activity in Bolivia, Ecuador and Venezuela is illustrative of how this new round of political and economic factors has resulted in a wave of expropriations. Rising prices have given producing countries the economic leverage to unilaterally demand change. Coupled with the political realities in these countries, their leaders can claim mandates to redress what they perceive to be one-sided agreements. Ferment in Bolivia Bolivia is the poorest country in South America. The Bolivian economy is highly reliant on its natural resources, including an estimated 52 trillion cubic feet of natural gas. Beginning in around the third quarter of 2003, protesters stepped up demands for the nationalization of this resource. The protesters blockaded the capital, La Paz, demanding that the government reject a gas-extraction contract with the Pacific LNG consortium that provided for an 18% government royalty rate. As a result of the protests and the state’s armed response, more than 30 people died and many more were wounded. The sitting president stepped down in October 2003, but the protests continued. Eventually, the government increased its own royalties on production to 50%. U.S. Department of Energy, EIA Country Analysis Brief: Bolivia, 4. Running for election as president last year, Morales promised to nationalize Bolivia’s natural resources. On May 1 of this year, he kept his promise by signing a decree recovering ownership of hydrocarbons for the Bolivian state. Amid popular celebrations in the streets, military units and government engineers occupied 56 energy installations in the country. “Bolivia gives foreign operators 180 days to renegotiate or leave,” May 5, 2006, International Gas Report, Issue 548, at 1 (2006 WLNR 862864). Morales declared that the nationalization would not take the form of “expropriations,” but rather the “negotiations of new contracts that will give ownership to the State.” Sujatha Fernandes, “Trade Treaties and Challenging US Hegemony in the Americas,” ZNet, June 12, 2006, www.zmag.org/content/showarticle.cfm?SectionID=20&ItemID=10421. Shortly thereafter, when Bolivian soldiers surrounded gas-extraction facilities operated by the Brazilian national gas company Petroleo Brasileiro S.A. (Petrobras), the reverberations fanned out. The chairman of the Spanish energy company Repsol YPF S.A. was quoted as saying, “We were told there would be time for negotiations, but obviously this was not the case.” Jonathan Wheatley, “Presidents to meet over gas crisis in Bolivia,” Financial Times, May 2, 2006. While popular with citizens, these activities have caused a slowdown of infrastructure investment in Bolivia. Petrobras, for example, recently announced that it was scuttling its plans to invest $5 billion over the next five or six years in Bolivia. See Hal Weitzman, “Petrobras to invest $5bn in Bolivia’s Gas Sector,” Financial Times, Feb. 13, 2006; Hal Weitzman, “Petrobras halts Bolivia investment plans,” Financial Times, March 30, 2006. Jose Sergio Gabrielli, chief executive officer of Petrobras, said, “We’re not putting down a dime until the entire situation is well defined.” On May 3, after the military takeover of its operation, Petrobras cancelled its investment plans for production expansion in Bolivia. Alexandre Spatuzza, “Petrobras cancels Bolivian investments, speeds up LNG import plans,” Oil & Gas BNamericas, May 3, 2006, available at www.bnamericas.com/story.jsp?idioma=I�or=9�icia=352478. If Bolivia could take this kind of action against the state oil company of Brazil, it does not take much to imagine how it will treat companies from countries not having a populist leader like Brazil’s President Luiz In�cio Lula da Silva. It is safe to say that Ecuador has followed the populist trend seen in Bolivia and Venezuela. After massive street protests, a new government took over in April 2005. Social unrest concerning the state’s share of oil revenues led to a mid-August 2005 interruption of production that lasted several days. The economic impact of this production slowdown, coupled with an erosion of investor confidence, has put Ecuador on the watch-list of sovereign credit ranking organizations. See The Coface Group, Country Risk Trends, @ratings Newsletter, October 2005, at 4. Repercussions in Ecuador Ecuador hit the headlines again with its April 2006 legislation effectively ensuring that the government will have a significant increase in its hydrocarbon revenues. Reform to the Hydrocarbons Law No. 2006-42 of April 19, 2006. Ecuador has also annulled its contracts with Occidental Exploration & Production Co. and others. Occidental had invested $900 million in Ecuador, making it one of the country’s most important foreign oil companies. As a result of the annulment, the United States broke off negotiations with Ecuador on a free-trade agreement and Occidental filed a request for arbitration with ICSID. Occidental’s position is that the annulment of the contract is in retaliation for Occidental’s having defeated Ecuador in an earlier arbitration over value-added tax payments. The problems in Ecuador are not limited to Occidental. Ecuador has introduced the concept of “extraordinary income,” which consists of the difference between the price of oil at the time of the investment contract and its price at extraction. A minimum of 50% of this extraordinary income must be paid by investors to the state as a “participation.” This mechanism was likely adopted in an attempt to avoid the tax stability clauses contained in many of resource-extraction contracts. Presidential elections are scheduled in Ecuador for October of this year, so making any judgments about the future for Ecuador is risky. Whether these elections will represent a new chapter in Ecuador’s treatment of foreign investment remains an open question. Action in Venezuela Venezuelan President Hugo Chavez has been the most vocal critic of free-market economics. On Dec. 28, 2005, Venezuela’s tax agency for mines and hydrocarbons, Servicio Nacional Integrado de Administracion Tributaria, notified Petrobras that it, along with its three consortium members, had to pay significant back taxes. Twenty-one other companies received similar notifications. By the end of March 2006, companies such as Chevron Corp., BP PLC and Total S.A. paid millions of dollars in settlements of these back taxes. Companies with operating contracts with state oil company Petr�leos de Venezuela S.A. (PDVSA) also were informed they had until March 2006 to transform their contracts into joint venture agreements giving PDVSA a majority stake. Rather than submit, some companies, such as Exxon Mobil Corp., sold their stakes. Venezuela’s position was best articulated by its energy minister, Rafael Ram�rez, who said, “We don’t want them to be here, then.” If Venezuela needs Exxon Mobil, he added, “we’ll call them.” Simon Romero, “A Tangle in Caracas for Exxon,” N.Y. Times, April 1, 2006, at C1. Early in April 2006, Venezuela took over fields operated by ENI SpA and Total when they failed to reach agreements to transform their contracts into these joint ventures. Venezuela also warned foreign oil companies that they may face additional tax increases. And the recent increase in heavy crude royalties may be just the beginning. Perhaps the best indication of the situation in Venezuela came from deputy oil minister Bernard Mommer, who recently announced that “[t]he only guarantee you have is political.” He elaborated: “The government can promise you whatever they want-it’s not binding.” If a company can’t live with that, he continued, “don’t go there. That’s my answer.” Thomas Catan & Andy Webb-Vidal, “Caracas warns oil companies of more tax increases,” Financial Times, April 10, 2006. As we have seen, there are various actions states are now asserting that can negatively affect foreign investors’ interests. The investors’ options for responding include: Negotiating an amendment to the existing investment agreement such that it no longer falls within the regulatory instrument in question. Negotiating elements outside of the investment agreement to offset the negative effects of the regulation on the investment. Seeking diplomatic pressure on the host country to withdraw or further amend the regulatory actions. Seeking damages through international arbitration. These responses can be pursued together or sequentially. The first two require the cooperation of the host government. Such negotiations can include modifying the investment agreement so that it falls outside the regulation, e.g., negotiating an amendment to an investment agreement in Ecuador such that it is no longer a “participation contract.” Investors may also look to other elements, such as transportation tariffs or equity acquisitions, to offset the losses caused by the regulation. Similarly, the state can lend its share of the “regulatory income” back to the investor, with such income recovered only from the investor’s share of production. (Companies should be cautious that their proposals and negotiations do not constitute acquiescence by conduct, or a waiver of rights, to pursue other actions should a solution not be reached.) If arbitration is necessary, however, the investor may arbitrate for a breach of contract under the existing contract arbitration clause. If there is a relevant BIT, the investor may choose to arbitrate for a breach of international law under the BIT. The BIT arbitration route would require the investor to show that the regulation violates its legitimate expectations by an arbitrary impairment to its investment without justifiable basis. However, the investor must be careful in initiating arbitration because, in some circumstances, the arbitration first invoked could preclude any further arbitral option. It must be remembered that in any such arbitration, it is unlikely that the investor would obtain specific performance. Rather, it would be entitled to monetary damages. The method of calculation of damages is within the arbitral tribunal’s discretion. As the Occidental-Ecuador saga demonstrates, moreover, an arbitration brought by an investor is often viewed as an affront by a host government, which can seek to retaliate by responses ranging from loss of future opportunities, contract cancellation or full expropriation. Before initiating any arbitration, the investor should review any possible grounds for potential retaliation, and decide carefully when it has passed the point where negotiation is possible, so that it will be committing itself to an arbitral solution. A matter of timing While investors argue that these renegotiations or expropriations have been misguided, the South American countries may have timed their actions correctly. The best time for producing countries to alter the rules in their favor is when the price of oil is high and foreigners need to invest. These countries are gambling that the multinationals will stay on as contractors even under the new, unfavorable terms. This may prove a good bet. This arguably is the third time that Bolivia has nationalized its oil industry, and the second time for Venezuela. Yet investors keep coming back. Investors are witnessing a perfect storm of nationalistic fervor combined with a huge increase in the price of oil. The combination of these factors has given producing states maximum leverage. Having leaders like Chavez in power who are not afraid to use this leverage exacerbates the situation by encouraging other countries to also consider renegotiating or expropriating at will. Indeed, on April 29, Chavez, Morales and Fidel Castro signed a document, underreported in the news, called the People’s Trade Agreement (PTA), available at www.globalpolicy.org/socecon/trade/ 2006/0429pta.pdf. This PTA is touted as a “new approach” in furtherance of Chavez’s precept of a “Bolivarian Alternative for the Americas” indicating an international political statement against liberal economic systems. As Venezuela, Bolivia and Ecuador are taking advantage of these factors, other countries may not be far behind. A different election outcome in Peru could have resulted in a further expansion of this “renegotiation” cycle. This leverage will exist until a drop in investment causes political leaders to modify this strategy. A significant drop in the price of oil could have much the same effect. Until then, many investors will acquiesce as long as they are still given some profit potential. Other companies, however, will not tolerate such unilateral taking. Thus, while producing countries will achieve lucrative changes, they will also see a substantial rise in investment arbitrations. During the last 19 years, investment treaty arbitrations have increased from one to a cumulative total of at least 225. This figure is as of December 2005. See UNCTAD, “Investor-State Disputes Arising from Investment Treaties: A Review,” U.N. Doc. UNCTAD/ITE/IIT/2005/4, highlights. Occidental in Ecuador and Hunt/ Exxon Mobil in Yemen are just two examples of what will continue to be an expansion of international arbitrations in response to the current wave of state actions. Time will tell how long this process continues. Michael S. Goldberg is a partner with Baker Botts in Houston and chairman of the firm’s international dispute resolution group. Dev Krishan is an associate in the firm’s London office.

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