So I’ve been looking through the ICC decision against Venezuela. A few things are different from my back-of-the-envelop analysis. As I expected, they did not consider the change in royalty rates to be a taking. On the other hand, they did decide that ExxonMobil deserved compensation for the income tax hike. The panel included only lifting costs of $3.84 per barrel, not including depreciation. (I’m still trying to work out why they did not include upgrading costs.) These things, of course, raise the value of the project.
So what drove the value of compensation back down? The answer is that the tribunal selected a discount rate of 18%. How did they arrive at that number? First, they received expert testimony (provided by the Venezuelan side) that the “hypothetical return that could be gained if a willing buyer were found for the project prior to any events giving rise to the indemnity” would be 19.8% This was backed up by a report from Gaffney, Cline & Associates stating that an 18% return would be reasonable. Finally, the tribunal noted that the average long-term historical return for ExxonMobil shareholders was 18.4%, while the shareholders of the five larges companies earned 17.1%. (Page 428 of the decision. It’s a long decision.)
Is that a reasonable number? Well, EDF builds nuclear power plants in France. When the cost estimate for the Flamanville plant rose from €3.3 billion to €4.0 billion, EDF announced that the cost of electricity from the plant would rise from €46 per megawatt-hour to €54. From those numbers (plus data on the typical capacity utilization rate of a nuclear reactor in France) it is pretty easy to calculate the company’s cost of capital:
(This estimate is actually a bit low, since Flamanville is on the sea, and will therefore probably have a higher capacity utilization rate than the average for the French reactor fleet.)
It seems to me that if a French state-owned company uses 13% to evaluate big energy projects in France, then 18% is a reasonable rate to apply to an American private company evaluating a big energy project in Venezuela.
The ongoing ICSID arbitration is not bound by the ICC decision, of course. But the fact that the ICC included the income tax in its decision makes it less likely that ICSID will decide to give ExxonMobil more money. Unless they decide that the royalty changes were a taking, which I still very much doubt, the fight will all come down to the discount rate.
I should add here that it seems that Exxon spent $24.9 million to pursue the arbitration. (Page 459.) I am sure that it’s spending at least as much at ICSID. This stuff ain’t cheap, but I do think it beats calling in the gunboats or the CIA.