The Power and the Money

Energía solar en la madre patria

Spain, you might have heard, is a sunny place.

Strangely, the designers of Spain’s early renewable policies did not realize this. They established a feed-in tariff, in which utilities have to buy all generated renewable electricity at a fixed price. They set the price based on German policy. But Spain, remember, is sunnier. And the cost of solar power was plummeting. The cost to utilities grew all out of control.

The Socialists pulled off the first walk-back in 2010, when they limited the feed-in tariff to the first quarter-century of a plant’s life and tossed in a  €0.55 per megawatt-hour grid access charge. They were sued, but the investment tribunals found for Madrid.

Then Rajoy gets elected. Rajoy’s gotta Rajoy, and subsidies had hit €3.5 billion, so in December 2012 he reformed the system again. He repealed the feed-in tariff, but made the repeal retroactive. Combine that with a 7% electricity tax, and he managed to push a bunch of solar producers into the red. Spain got sued again, but this time the investment tribunals forced the government to cough up damages. 

Lest you think that the People’s Party would relent, they went yet one better in 2015 and slapped a tax on anyone who installed solar panels. OK, not technically a tax, technically a grid access fee. But effectively a tax. In addition, the law banned anyone with solar panels over 100 kW from selling electricity at all. 

But now Rajoy is out and Pedro Sánchez is prime minister. Moreover, solar power costs less than one-sixth of what it did when Spain began subsidizing it. Noises are being made about repealing the sun tax. At the very least, the sunny country might let market forces rip. Solar costs are down 41% since 2013. (See left: the dotted line is 20¢ U.S. per kilowatt-hour.)

Still, low costs can be a problem for solar producers, especially in Spain, where most renewable producers need to sell on the spot market. When the sun is shining, solar installations can bid the cost down to zero if there are enough of them. They can even drive it negative, if conventional producers are willing to pay customers to take their electricity in order to avoid spinning down their plants. 

So market forces will not be enough without a market redesign making it easier for solar producers to sign long-term contracts with off-takers. It is not merely a matter of removing the burdens the People’s Party placed on the industry. I have no idea how much thought the Socialists have put into this problem or whether their rickety surprise coalition is prepared to enact reforms.

We can hope. 

Criticism of the Trump letter to Panama is missing the point

The Trump Organization recently sent a letter to the president of Panama in regards to a legal dispute over a Trump-branded property. The letter listed some putative irregularities in the legal proceedings and asked the President of Panama to intervene lest his government be held responsible for denying justice to the Trump Organization. The threat, made quite explicit, is that the Trump Organization would then haul Panama up in front of a panel at the International Center for the Settlement of Investment Disputes (ICSID).

Vox wrote the following:  “Even if Varela decides to do nothing about this specific dispute, he could now feel obligated to curry favor with Trump in other ways to make up for the issue and keep US-Panamanian relations stable. That could lead to his government approving specific policies to placate Trump or perhaps covertly acting to ensure that the Trump Organization secures favorable business deals in Panama in the future.”

In other words, Vox and others fear that President Trump’s personal connection to a private venture means that American foreign policy is being perverted to produce private gain. 

So is that what is happening? Is this a case of the Trump Organization using the fact that its principal is also President of the United States to muscle a small country for private gain? Well, to know that you need to answer three questions:

1. Would the Trump Organization have sent the letter if Donald Trump weren’t President of the United States?
2. Will the Panamanian executive react differently to the letter than it would have if Donald Trump weren’t President of the United States?
3. Will the United States government take actions against Panama that it would not have taken had Donald Trump not been President of the United States?

The answer to the first question is “yes.” As a colleague of mine at Brookings wrote:

Details of the case a bit unclear, but foreign investors complaining they've been mistreated in local courts (and that this reflects poorly on investment climate) is pretty common... More generally, aggrieved investors will complain to anyone who will listen

— geoffrey gertz (@geoffreygertz) April 9, 2018

The answer to the second question so far is, “We don’t know yet.” But probably not. President Varela does not have a lot of power to intervene and the Trump Organization does not have a particularly good case to bring to ICSID. 

Which brings us to the third question. Will the Trump administration use the vasty power of the United States to twist Panama’s arms? To which the right answer is: probably, but what else is new? I wrote an entire book about the rather egregious ways American administrations of all ideological stripes twisted the arms of small countries in fights with American investors. The Obama Administration did that to Argentina when its government tried to ignore an ICSID decision. (Obama later went after Argentina on behalf of U.S. creditors.) And Geoffrey Gertz has found that American investors still rely on official U.S. support to get their way with foreign governments. If the administration leans on Panama to aid the Trump Organization it would be following a long-standing American tradition.

To be honest, the Trump Administration is more likely to fail at getting its way than earlier administrations. First, the current President speaks so loudly and is so unpopular that it would be hard for any foreign government to easily acquiesce. Second, the current President is unpopular at home and actions that might have slid under the radar will get much play. 

So stop worrying that Trump corruption will pervert American foreign policy or create some sort of American empire run for the benefit of an investing class. That ship sailed in the 1890s.

What you should worry about is not Trump leaning on foreigners to benefit his private businesses. You should worry about foreigners favoring Trump’s private businesses to benefit their interests. There is evidence that the Philippine government is doing exactly that and we all know about the Russians.

I doubt that President Varela will do much in this particular case (not least because he can’t do much) but others in other countries will. The tail will wag the dog.

Worthwhile Euro-Canadian initiative: globalization can be progressive

In April of 2016, I posted about a European initiative to reform investment tribunals. I thought it an excellent idea. The idea would be to make the tribunals more like real honest-to-goodness courts, with due process and precedent and all.

Well, now that proposal is enshrined in law in the new European trade deals with Canada and Vietnam. Better still, the Canadians and Europeans are looking to broaden the system, inviting even more countries to participate. It is refreshing on two counts. First, cooperation in this world of increasing deglobalization. Second, it is a progressive multilateral institution, one which might make the world a marginally fairer place.

Nice.

Reforming investment tribunals

 One of the advantages of living in Washington, D.C., is the chance to go to presentations and roundtables organized by the capital’s myriad think tanks. Cato is one of the best. I’m sure that statement surprises some of our readers, but it’s true. They get a lot of good people to talk about interesting issues.

In this case, the interesting issue is the horribly-named ISDS. That’s the acronym for investor-state arbitration, a subject this blog has written a lot about. Basically, the system allows foreign investors to sue governments when those governments are alleged to have expropriated (or at least damaged) their investments. The arbitral rulings are then enforced in national courts, meaning that a British investor “wronged” by the Ecuadorean government can sue for damages in an American court and have that court attach Ecuadorean assets or income streams … including, potentially, PetroEcuador’s oil sales or the proceeds from any foreign bond sales organized by the Ecuadorean government. It’s a powerful tool. And I would argue that it’s much better than a world where investors go back to their home government and ask it to bitch-slap the government that “wronged” them until it pays up.

(Of course, that still happens with some regularity, but that’s a different subject.)

The thing is, the system is profoundly undemocratic and exceedingly odd. First, the tribunals are essentially ad hoc. The parties to the dispute choose at least two of the typical three arbiters, often they choose all three. The arbiters are generally selected from a small rotating group of people … who also often act as counsel in other arbitration proceedings. (It’s like your judge in a civil was also a similar plaintiff’s lawyer.) There’s no appeal process. Decisions are (usually but not always) published but proceedings are confidential. And the system is molasses slow. It’s a goddamned mess.

(Which is why state-to-state bitch-slapping persists, but again, that’s a different subject.)

Few people care in the United States, but in Europe ISDS is a big deal. In part, that’s because Europeans are more concerned with the way the system appears to be biased towards large imperial corporate power. (In practice, the bias is less clear: governments win more than they lose. But I would argue that it nonetheless exists.) But it’s also because European governments are getting hit with seats suits; thirty at last count for poor beleaguered Spain. And Germany has been smacked with a €3.8 to €4.7 billion claim over its nuclear policies.

While I was writing The Empire Trap, I had a long conversation with Steve Haber about the arbitral system. I suggested that the system would be a lot better if it more resembled an actual judicial system, with standing courts, open proceedings, real appeals and reliance of precedent. He agreed … but added that the idea was a Nirvana thesis. Wasn’t gonna happen. He was right four years ago.

And if European governments hadn’t started getting hit with suits, he would still be right! But they did, and the European public noticed, and the European Commission was seized with the issue. Which is why I got to hear Rupert Schlegelmich, the Director General of Trade, present the European reform proposals at Cato. 

The Commission’s proposals would basically turn ISDS into the Investment Court System (ICS): a real genuine court system like the one I proposed to Steve in 2012. The Europeans would write this new system into all new bilateral investment treaties (BIT). Any BITs signed by the European Union would then supersede any old BITs signed by European national governments.

First, the European proposal would enshrine a “right to regulate” in order to insure that the system could not be used to overturn legitimate public concerns, the way the Phillip-Morris, for example, has tried to use ISDS to force Australia to pay it for losses incurred by that country’s cigarette-labeling laws.

Second, it would define “fair and equitable treatment” of investors as the following:

1. No outright denials of justice;
2. No manifest arbitrariness in state actions;
3. No discrimination on manifestly wrongful grounds;
4. No abuse, meaning coercion, duress or harassment.

Third, it would define expropriation as the following:

1. Causing substantial deprivation for the investors;
2. Causing more than an economic impact on their interests;
3. Not including “normal regulatory activities” concerning “health, safety and the environment” unless they were “manifestly excessive.”

Finally, it would create a permanent court with judges appointed by E.U. governments. Said judges (like all real judges) could not serve as lawyers in other investment disputes. Cases would be allocated randomly among the judges. And there would be full transparency in all proceedings, including video.

Wow! Sounds great. But then came Miriam Shapiro to point out with a smile that there was still a lot of daylight between the U.S. and E.U.

The United States, she pointed out, agrees with Europe that it would be a great idea to improve the selection of arbiters so as to put them “above reproach” and let tribunals rapidly dismiss frivolous cases. She also allowed that Washington would smile upon greater transparency.

She then pointed out some wrinkles where it might be hard to find common ground. Frex, how early on can the new court dismiss frivolous claims? Can states provide binding guidance on treaty interpretation before cases are brought? Who pays attorneys fee? Current tribunals can award that to one side or another; the European proposal will award those to the winner. What will the special mechanisms to make it easier for small companies to sue look like? And will there be a binding review clause to evaluate the new system after five years?

But … you can forget an American administration signing on to an appeals mechanism, even if Congress likes it. Simply put, governments win at arbitration and the U.S. wins a lot. Like, always. An appeals process could change that. From Washington’s position, what ain’t broke don’t need fixing.

Anyway, interesting stuff. If the European reform happens, it will be yuuuge, another move from global governance to something more like actual global government. Which may be why, like D.C. statehood, I’m skeptical that the European proposal will fly.

Ecuador can be trusted, says ICSID

On October 5th, 2012, a split ICSID tribunal awarded Occidental Petroleum $1.8 billion ($2.3 billion with interest) for the assets the Ecuadorean government expropriated in 2006.

The Correa administration did not just take Oxy’s stuff for the hell of it. Or even necessarily for the money. (Although that probably was a factor.) Rather, the ostensible reason was that Oxy had sold a 40% stake in it operations to a Canadian company (Encana) in contravention of Ecuadorean law, which clearly stipulated that all such sales required ministerial approval. The ICSID tribunal decided that expropriation was disproportionate to the offense (Ecuadorean law being mum as to the penalty) but knocked 25% off of Oxy’s interest in determining compensation.

Ecuador, understandably, has filed to annul the decision. Oxy asked to be allowed to enforce the decision (i.e., go after Ecuadorean assets and income streams in foreign courts) while the annulment proceeded. They said that they earned 12.6% on their assets while the tribunal granted then only 4.2% interest, and so they were losing money.

And here it gets interesting: the Ecuadorean attorney general stated that Ecuador “does not adopt the same controversial position as the Argentine Republic in ICSID proceedings – i.e. that the enforcement obligations under Article 53 of the ICSID Convention are conditioned upon an award-creditor having recourse to a domestic enforcement procedure in the host-country. Rather, Ecuador’s position as a matter of law, is that ICSID awards are not subject to judicial review by local courts and that the obligation of Ecuador to comply with an award is not conditional upon recourse to a domestic enforcement procedures.” Moreover, the government acknowledged that the award was binding even though the country’s Constitutional Court has declared the Ecuador-U.S. bilateral investment treaty to be unconstitutional. Finally, ICSID pointed out, in somewhat annoyed terms, that Oxy was just making stuff up when they claimed that Ecuador had failed to pay past judgments. Rather, it had only lost two: in one with Duke energy it paid and with another with Oxy it placed part of the award in escrow while a further arbitration determines if the award was too large.

In short, ICSID found that Ecuador has a track record of paying in the past and has promised to pay in the future.

From a putatively Bolivarian government, this is rather interesting.

It also puts that Ecuadorean debt default and buyback of 2009 in a rather different light. Was it a sign of an irresponsible government defaulting for the hell of it ... or a sensible decision for a country locked into a currency union to rid itself of foreign debt when it was still cheap to do so?

YPF and Argentina inch towards settlement

One problem with blogging is that there are things that I do not post about, because it conflicts with teaching. Sometimes case method teaching involves laying out all the clues to a mystery and then letting the students solve it in class. That limits, obviously, what I can give away on the interwebs. The YPF nationalization has been loaded with those sorts of limits. 

The YPF saga, however, may be drawing to a close. We have growing indications that Repsol and the Argentine government may be coming to a settlement. The number being tossed around is $5 billion, which is a bit above the $4.4 billion that it would have cost to purchase 51% of YPF right before the expropriation. Now, $4.4 billion may not be fair. YPF’s price in New York peaked at $39.88 in January 2012 before sliding to $21.95 in the lead-up to the expropriation. $39.88 would imply that 51% of the company was worth $8.0 billion. In fact, the price was $28.41 as late as March 30, implying a value of $5.7 billion for a 51% stake. (By March it was clear to everyone that Repsol and President Fernández were at loggerheads, but it was not clear that she was going to expropriate.)

Repsol’s share of YPF, however, did not drop from 57.4% to 6.4% after the nationalization. Immediately after the takeover, the Eskenazi family defaulted on loans from Repsol that they had used to finance part of their share in YPF, which raised Repsol’s share back to 12.4%. Repsol, therefore, only lost 45% of YPF. 45% of YPF was worth $7.06 billion in January 2012 and ... wait for it ... $5.03 billion on March 30.

There were rumors that Sinopec (or CNOOC) was going to buy 57% of YPF for $15 billion ($13.4 billion for 51%) but those are unsubstantiated. Other sources report that the Chinese companies thought $10 billion was too high. Reports of a $12 billion sale to CNOOC later proved unfounded. (Click the first link in this paragraph.)

I doubt that the Chinese wanted to pay much more than the ~$9 billion that Repsol’s 57% stake was worth around the beginning of 2012, assuming that they really wanted to buy at all.

In short, if current rumors prove correct, Repsol will have taken a roughly $2 billion hit below a reasonable valuation of its stake. 

Will Repsol accept? Given that arbitration will take a very long time (with an uncertain outcome), taking $5 billion now seems reasonable. They could gamble on a favorable judgment, of course, but why? Rough calculation: say Repsol receives $7.06 billion in 2020, plus interest charges of $2.74 billion. (That uses the 4.188% rate that Occidental received in its dispute with Ecuador, compounded annually. See page 317 of the ICSID decision.) That means Repsol can choose between a certain $5.0 billion now and an uncertain $9.8 billion in seven years. As long as Repsol’s discount rate is above 8.4%, then it is better to take the cash now.

(FWIW, Bloomberg reports that Repsol has a yield of 5.2% and an inverse p/e of 6.7%. Those numbers imply a hurdle rate for new projects way above 8.4%. And waiting for an ICSID judgment against Argentina is at least as risky as other investment projects. This applies even though it is quite possible that ICSID would eventually award Repsol more than $9.8 billion; waiting is still risky.)

The Repsol settlement, if it happens, will not be an exception. Argentina has been recently settling its outstanding expropriation claims, even when the Argentine government has a good moral case. The reason for the sudden spate of settlements has been Argentina’s need for external credit combined with strong U.S. opposition to granting such credits unless the country settles with American claimants.

But why settle with a Spanish company? The American energy secretary announced that the United States supports Repsol, but that is not a reason to pay: the U.S. has already eased up on Argentina at the IADB. Even if the country feared ICSID (which in the long-run it should) there is no reason to pay now when you can pay in 2020 ... 8.4% is below Argentina’s borrowing rate!

But without a settlement, Repsol can throw wrenches into the Vaca Muerta development plans. Worse yet, there is the possibility that its legal actions could delay Argentina’s return to international capital markets. So that gives Argentina an incentive to settle. And if it can do so near the lower end of its plausible compensation (45% × $8.63 billion that YPF was worth the day before the expropriation = $3.88 billion) so much the better.

Not a terrible compromise, I do not think.

Observatorio argentino 23: Secret treaties, 21st-century Argentine style, are very boring

Over the past month, a giant flap in Argentina has emerged over alleged secret clauses in the YPF-Chevron agreement to develop the Vaca Muerta tight oil fields. The trigger was a New York Times article titled “An Odd Alliance in Patagonia.” The key paragraph:

Argentine oil officials said that the Chevron-YPF deal will shield the American company from financial loss connected to a change in the political winds. After the company invests $1.2 billion, 18 months later it can withdraw from operations without penalty and continue to receive net profits of 50 percent of the production from the initial wells in perpetuity.

After the Times story, other stories came out about “secret clauses” in the Chevron-YPF deal. They included:

1. Jurisdiction under foreign law;
2. Access to arbitration at the International Chamber of Commerce (ICC) in Paris;
3. A security deposit of $100 million for Chevron.

Unfortunately (but predictably) the agreement is not public. Here is the only mention on the YPF website. Below is what YPF’s latest 6-K filing has to say about it:

Investment Project Agreement

On July 16, 2013, the Company and subsidiaries of Chevron Corporation have signed an Agreement for the joint exploitation of unconventional hydrocarbons in the province of Neuquén. The Agreement contemplates, subject to certain conditions, an expenditure of up to 1,240 million dollars by Chevron for a first phase of work to develop 20 km² (4,942 acres) of the 395 km² (97,607 acres) corresponding to the area dedicated to the project, located in the aforementioned province and which includes the Loma La Lata Norte and Loma Campana areas. This initial pilot project contemplates the drilling of more than 100 wells.

Together with what has already been invested by YPF in the aforementioned area, this new input will result in a total investment of 1,500 million dollars in the pilot project, where 15 drilling rigs are already currently operating and more than 10 thousand barrels of oil equivalent per day are being extracted.

After the signing of the Agreement and once certain conditions precedent are satisfied, Chevron will make the initial expenditure of 300 million dollars (which will have the benefit of a guarantee by YPF for the following ninety days until the implementation of all associated documentation for the rest of the Chevron financing, including the contribution of 50% of the project rights by YPF).

In a second stage, after the finalization of the pilot project, both companies expect to continue with the development of the entire area, sharing the investments 50% each.

Likewise, the Agreement contemplates, in a non-binding manner, the subsequent definition of the terms and conditions for the joint exploration of unconventional hydrocarbons in the provinces of Neuquén and Mendoza.

Not too informative. The opposition has sued to make the Chevron agreement public. (In fact, the Argentine politician behind the suit, Senator-elect Pino Solanas, plans to take the issue to a higher authority.)

OK, so is this a bad deal for YPF?

Probably not. First, there is nothing weird about a clause allowing Chevron to give up its role as an operator while retaining an ownership interest. Imagine that you are the manager of company in which you own stock. You can quit your management job while continuing to hold the stock. It would, in fact, be odd if you couldn’t. The problem here is that the Times made it seem as though this clause somehow protects Chevron from political risk.

Second, the fact that the agreements are made under New York law with recourse to ICC arbitration does protect Chevron from political risk (at least as long as Argentina either exports the hydrocarbons or needs American-controlled credit) ... but the clause is also utterly standard in these sorts of things.

Third, YPF denied (as part of its SEC filing!) that any cash security deposits will be made. (More SEC info can be found here.) I tend to believe YPF. After all, $100 million is really not a whole lot of security to offer against a $1.24 billion investment.

I would believe that YPF may have included clauses to protect Chevron against legal action by Repsol in America or Spain, should such actions succeed. But even if true, that would be less-than-shocking.

In short, there is not a lot to see here. Nicaragua this is not.

Fuzzy math from Argentina, or the importance of interest

We all know that Argentina publishes dodgy economic statistics. This post is not about that.

Recently, Argentina agreed to pay dollar bonds with a face value $506 million to five companies that have successfully taken it before investment tribunal alleging expropriation. The reason Argentina wants to settle is simple. Argentina needs international credit, but unless the Obama administration relents in its determination to punish Argentina for expropriation, it will not get it. So Buenos Aires has arranged a settlement, paying five companies $506 million for claims worth $677 million. 

The thing is, when I went to the data to find out how much Argentina owed the five companies involved in the settlement, it turned out that the judgments came to only $460 million. (Except for Vivendi, the source is Table 11.1 in The Empire Trap. The Vivendi data come from page 8 at this link.)

Which means one of three things:

1. Argentina overpaid, and the $677 million number is wrong;
2. More companies are involved than Bloomberg reported;
3. The companies were collecting interest on their unpaid judgments ... at a maximum rate of 7.7%. (The actual rates are lower; the 7.7% assumes that interest started accruing in 2008, when in fact the claims started to accrue interest at dates ranging from 2005 to 2008.)

I vote for option (3).

In other words, Argentina managed to convince the companies to give up their interest claims, but paid the basic settlement. That is not a great outcome for them, but it is not terrible. And it gets Argentina back into the Obama administration’s good graces ... with the result that official credit again flows.

Still, I cannot help but think that the companies could have pushed for a harder bargain. It is true that Argentina did nothing that would have been illegal under domestic American law. But it is also true that Argentina did break its (stupid) treaty obligations. And it is true that the Obama administration had its companies’ backs.

So I am not sure why they did not hold out for interest. Thoughts?

The United States no longer cries for Argentina

The Bush administration generally supported Argentina in its long battles against its creditors. After President Kirchner successfully played hardball with the IMF, President Bush took him aside in New York urged him to “keep negotiating firmly with private creditors.” President Bush jokingly introduced Kirchner at a U.N. meeting by saying, “Here comes the conqueror of the IMF!”At a later meeting with the Argentine leader in January 2004, Kirchner convinced the already-sympathetic U.S. president to support his position by reminding him that Enron’s creditors took an even bigger haircut (86%) than the one Kirchner was demanding (65%).

There were multiple ways the Bush administration could have supported the creditors — helping them coordinate, lending verbal support to the Global Committee of Argentina Bondholders (GCAB), supporting Congressional efforts to sanction Argentina — but it took none of them. In fact, the Bush administration (in contrast to earlier Reagan policy) actively supported Argentina against its creditors in American courts. (The link is to a 2006 paper from a conservative legal foundation, which was apoplectic about the policy.)

But now, the Obama administration is taking a much harder line! The United States has decided that it will not file an amicus curiae brief on behalf of Argentina as its latest dispute winds its way to the Supreme Court. As a result, the IMF has also decided to back away from its support for Argentina. This a reversal for the United States: you can read an April 2012 brief favoring the Argentine position here.

I have no idea how this will shake out at the Supreme Court, but the Obama administration appears to have lost patience with Argentina. My guess is that the exasperation actually stems from the Argentine refusal to pay its ICSID judgments rather than any particular sympathy for the creditors.

But regardless of the cause, it is a big change in U.S. policy, and it spells trouble for Buenos Aires.

Ecuador attacks Chevron in Argentina: world governance runs both ways

I hate the word “governance,” but it is useful. After all, there are things that are governed without a single government. When those multiple governments are hierarchically ordered (even if legally sovereign) then I prefer the word “empire.” But sometimes imperial institutions can run both ways.

The bilateral treaties that govern the investor-state arbitration system tend to be unequal. Consider for example the U.S.-Ecuador treaty. The United States exempts Ecuadorean investors from using anything but U.S. courts in the following sectors:

• Air transportation
• Banking
• Customhouse brokers
• Government grants
• Government insurance and loan programs
• Energy and power production
• Insurance
• Maritime services and maritime-related services
• Mining on the public domain
• Ocean and coastal shipping
• Ownership of real property
• Ownership and operation of radio and television stations
• Ownership of shares in the Communications Satellite Corporation
• Primary dealership in United States government securities
• Provision of common carrier telephone and telegraph services
• Provision of submarine cable services
• Use of land and natural resources

Meanwhile, the Ecuadoreans exempt:

• Traditional fishing (not including fish processing or aquaculture)
• Ownership and operation of broadcast radio and television stations

Quite a difference! Looks pretty damn imperial, no? You can kinda understand why President Correa wants to withdraw from ICSID and abrogate the investment treaties.

Thing is, these treaties are ultimately enforced not by ICSID or some other sort of world-government-in-drag, but national courts. And the same conventions that allow national courts to enforce foreign rulings (the way Argentina lost its ship in Ghana) can be used to establish extraterritorial jurisdiction. That can do it a bit to reduce the imperial feel to the international system that protects property rights. The Ecuadoreans, in short, can use foreign courts to enforce their laws.

Last year, Ecuadorean courts levied a $18.2 billion damage claim against Chevron for polluting watersheds in the country. Ecuador’s legal team knows that ChevronTexaco doesn’t have many assets in Ecuador, so its strategy is to go around the world looking for Chevron assets that it can attach. (You can read a copy of the plan from the legal team here. They call it the “Invictus memo.”) In February, Chevron won a preliminary victory when it got an arbitration tribunal to take its side. Problem is the ruling applied only to Ecuador.

So it was big news in October when the U.S. Supreme Court ruled [CLARIFICATION: It was not a ruling per se; the SCOTUS decided not to hear an appeal, thus allowing the plaintiffs to proceed] that Ecuador could freely continue its search for Chevron assets. A week later an Ecuadorean court let the plantiffs seize $96.3 million owed to Chevron by the Ecuadorean government (yes, that would be in effect Ecuador taking cash from itself) and all licensing fees owed Chevron from the use of its logo. And now ...

... an Argentine judge has given the plantiffs all of Chevron’s shares in Chevron Argentina, all of Chevron Argentina’s dividends, its 14% stake in the Oleoductos del Valle pipeline, 40% of its bank deposits and 40% of the revenue from future Argentine crude sales!

How much is the above worth? Well, I don’t know how much cash-on-hand Chevron Argentina enjoyed and it’s safe to assume that they won’t be paying any dividends as long as the judgment is in place, but it is possible to calculate the value of its crude production. (Oleoductos del Valle loses money.) The June domestic price of crude in Argentina was US$467 per cubic meter. (If you click the link and download the data, you’ll find that the price didn’t vary much.) Using production data from January through September of 2012, you’ll find that Chevron Argentina will produce crude worth about $833 million in 2012. 40% of that is $333 million; not a bad chunk of change. Of course, the Ecuadorean government will only get about 35% of that, since the income is actually due the plantiffs and their lawyers. Still, $117 million per year is nice, and if the precedent holds it could wind up with a lot more than that as more Chevron assets are attached around the world.

Eventually the Ecuadorean government might even net enough to pay off Occidental.

Ecuador loses round one to Occidental

Ecuador just lost at ICSID, where the panel ruled that it owes Occidental $1.77 billion, plus interest at 4.2% compounded annually back to May 16th, 2006. If the Ecuadorians paid right now, they would owe $2.4 billion. If they delay, it will add up at the six-month LIBOR, compounded monthly. (FWIW, Occidental initially asked for $3.4 billion, but companies always highball their claims.)

What now? Ecuador will attempt to have the award annulled on the basis of some procedural or factual error. If they fail at that, then they will pay. The reason is simple: Ecuador is an oil exporter and its export sales can be attached. There won’t be the need to go fishing around the world for small change (or sailing ships) the way Argentina’s creditors need to do. It gets better: Ecuador exports crude to be refined for the home market! If it thumbs its nose at ICSID, not only will it lose export revenues, it will see domestic gasoline prices spike upwards hard. (Of course, Ecuador has been working overtime to try to get Chinese or Venezuelan interests to finance a refinery expansion.)

Ecuador might, however, pay Oxy and stiff the other claimants. There have been some declarations in this direction. Depends on how much they think China cares about its stake.

Few appreciate how Saudi Arabia undergirds the viability of this system. Ecuador exports 212,000 bpd to the United States. That is not a lot, but its sudden disappearance could upset a tight market ... except for the fact that Saudi Arabia stands every-ready to step in with its extra capacity.

Next up: another entry in the long China-doesn’t-have-an-empire series.

Observatorio argentino 17: Where do we stand in the courts?

As debtors attempt to use U.S. courts to collect on Argentina, the verdict is mixed but mostly negative. Good luck with that ship thing.

The biggest blow occured on March 1, 2010, when the U.S. Supreme Court ruled that Argentine pension funds in the United States could not be attached. Actually, there was no ruling as laymen understand it, but the Court denied an appeal, and so that was that. The next day the Argentine pension agency repatriated $200 million. (The actual chain of events was an attachment order by Judge Griesa in New York, that the Second Circuit Court of Appeals tossed out in October 2009.) Soon afterwards, on March 8, Griesa ruled that billions in pension assets were “immune from attachment, restraint and execution.” A second attack on $105 million in Argentine central bank assets failed in June of this year for different reasons: central bank reserves are immune under the Foreign Sovereign Immunity Act of 1976 (FSIA).

Thing is, all hope is not lost. The Second Circuit tossed the decision not on the grounds that pensions are an essential state function and not commercial activity, but because the Argentine government had not had a chance to use the recently-nationalized funds for any purpose at all. (Really, it makes sense: read the decision.) 

Still, it looks grim for creditors. The Second Circuit declined to interfere with Argentina’s payments to creditors who accepted its restructuring deal: so much for the court orders I referred to in the last post. And that ship in Ghana? Argentina is gonna get it back.

In other words, the creditors are gonna keep going around the world hassling Argentina but it amounts to a hill of beans ... unless two things happen. One, Argentina suddenly needs to borrow on world markets again. Two, ICSID rules against Argentina. It is weird for ICSID to take on a debt case, but it seems to have done so ...

Argentina beats ICSID! Seriously, Argentina beats ICSID. Regularly.

In April, I had the honor to attend a conference on international investor-state arbitration held at the London School of Economics. (Below is a picture of me on the roof of the LSE after the conference. Yes, the weather was as bad as it looks.)

There I had the good luck to meet a law professor from William and Mary named Susan Franck. Susan has done a lot of excellent work, but what struck me the most was the time and effort she’s put into verifying all the “stylized facts” that people believe about investor-state arbitration. A stylized fact is a fact assumed to be true for the purposes of argument. Economists love ‘em. So do politicians. (Frex, the sylized fact that most U.S. federal spending fits the normal conversional definitions of wasteful.) But stylized facts aren’t always actual facts.

One big stylized fact about investor-state arbitration is that governments always lose. It isn’t hard to see where that comes from. By most reasonable standards, international investment law is an ass. Companies can freely renegotiate contracts with governments, but governments cannot renegotiate with companies. There are few outs for contingencies short of foreign invasion, and maybe not even then. On the other side, it isn’t hard to believe that most of the time the governments are wrong (like, you know, these guys) and deserve to lose.

Only they don’t lose most of the time. Susan found that governments won 58% of cases. Investors won 38%, and the remainder were settled. (She also found that the average claim was for $343 million, whereas the average award came to only $10.4 million. Go figure.)

So how’s Argentina doing? Well, not too badly. Of its post-2001 cases, 33 have been decided. Argentina won eight, or 24%. Of those eight, it won five in arbitration. Two were annulled and one was overturned by a U.S. district court. It lost nine (27%) ... but annulment hearings are pending in five of those nine. If you put those five into the net-yet-decided category, Argentina’s win percentage goes up to 32%, against a lose percentage of 16%.

Of course, 32% + 16% = 48%. Argentina settled a remarkable 52% of its post-2001 cases! Of these 16 settlements, five (31%) were in electricity, three (20%) in natural gas production and distribution, two (13%) in water and sewer systems, and an additional two (13%) in telecoms. The final one was the Unisys contract mentioned in an earlier post.

The settlements aren’t public,  but we do know a little, thanks to Wikileaks. AES owned several power plants, and dropped its suit once the Argentine federal Congress and the Buenos Aires provincial legislature ratified new rate agreements. Pan-American Energy (a subsidiary of BP) sued at ICSID over the pesification of domestic hydrocarbon contracts and the imposition of an oil-export tax. It dropped its claim after Chubut province agreed to renegotiate its E&D concession, presumably by enough to compensate it for the federal takings. If I may take the risk of presenting my own stylized fact, the other settlements were likely similar: rate hikes or other informal compensation, in exchange for a suspension of the international suits.

The bottom line is that Argentina has not done too badly at ICSID and other arbitrations. Its wins outnumber losses two-to-one, and it settles half its cases, as far as we know without direct compensation. What this implies about the unwillingness of the Fernández administration to pay up in its five unequivocal losses, including one pre-2001 case (for a total liability of $427 million) is left as an exercise for the readers.

It is not unreasonable to cry for Argentina in most of its cases at ICSID

Bernard Guerrero asks: “You mentioned in an earlier post that Argentina had justice on its side with regards to the various ICSID cases. How so?”

An excellent question! Short answer: most of Argentina’s cases are a direct result of the 2001 devaluation. The Argentine government acted prudently and responsibly in the aftermath of that economic collapse. In the face of 1.2 million job losses, and riots in the streets, it was entirely reasonable to freeze rates, cancel contracts, default on debt, and pesify dollar-denominated bank accounts. (The scale of the turn-of-the-century Argentine depression is immense.) Such actions were legal under Argentine law, and would have been legal in the United States. (FDR confiscated gold back in the day.) Unfortunately, the Washington Convention and associated bilateral investment treaties are more restrictive, which gave foreign companies operating in Argentina the right to sue for damages from the price freezes.

In other words, until Repsol, none of the Argentine cases at ICSID involved straight-up opportunistic property seizures without fair compensation. Rather, they involved emergency measures taken in the midst of a Depression-scale crisis. The companies could not have possibly expected the real value of their tariffs to quadruple in the middle of a 20% crash in GDP and 10% plunge in employment, which is what sticking to the original contracts would have meant. Argentine law sees things that way. American law sees things that way. European Union law sees things that way. But international law, as codified in the Washington Convention of 1965, does not. That is unjust.

Longer answer: Of Argentina’s 46 post-2001 arbitration cases, 32 are a direct result of the 2001 devaluation. If you add in the three cases brought by bondholders, that number rises to 35. Most of the remainder are contract disputes, which also come out of the turn-of-the-century Argentine depression: frex, a cancelled contract with Unisys to modernize the judiciary’s IT systems, or an abandoned project with Impregilo S.p.A. to build a highway. 

It is not hard to find the texts (or at least decent summaries) of the ICSID decisions. Latin Arbitration Law is a good source. UNCTAD also maintains a good database. The Investment Treaty Arbitration site has a list of cases, with all intermediate and annulment decisions. Finally, an easy-to-use list with summaries of the outcome can be found at the IIAPP website. I also recommend the Kluwer Arbitration Blog and (if you can get access) the Investment Arbitration Reporter.

All of the Argentine cases reject expropriation claims, but provide compensation for lost revenues due to contract violations. You can see the frustration by the Argentine lawyers when they argue that expropriation law should not apply in these cases. In fact, most of the arbitral decisions have a very sympathetic tone towards the Argentine arguments. But the law is the law, or at least what the arbitrators say that the law is, and that is that.

To be fair, Argentina has not done badly at ICSID. (If there is interest, I will put up another post with some data about that.) But it is understandable that the government feels that most of the post-2001 cases should not have been brought at all. This is not to support the YPF nationalization, or to claim that Argentina is run by a saintly government interested only in the public good. (To give one egregious example, Argentina settled the Unisys claim for $8 million in April 2007 ... but made no move to actually pay.)

It is to say that there is something wrong with the international system. It was designed to protect natural resource investors against predatory states without the need to call on their home governments. It is becoming a system of unlimited liability which essentially locks governments in to the letter of their initial contracts in a rigid way with no parallel in any domestic legal system on the planet.

In fact, the standards have been getting stricter, to the point where governments are required to grant a “guarantee of stability in a secure environment, both physical, commercial and legal” that may, for some countries, be impossible ... and is certainly more protection than that granted to domestic investors.

Practical upshot? Hard to say ... but the illegitimacy of most of the claims against Argentina will make life much harder for companies with a decent case in a straight-up expropriation. (You can guess which firm I might be talking about.) That is not, I think, a good thing ... but I may be wrong.

Observatorio argentino 16: The plot thickens, as does the oil

 This will be a quick post. I’m running on fumes, and will be for at least another month. (Then a brief respite, with serious fume-running to follow after August. But for excellent reasons!) That said, there are two things happening in the Argentine gas fields, which are related to the YPF expropriation saga and time-sensitive. So read on!

First, you can expect the Argentine government to announce in the next few days about $20.3 billion dollars in new shale gas investments in the Vaca Muerta fields. Eleven different companies — Chevron, ConocoPhillips, Ecopetrol, EOG, ExxonMobil, Shell, Sinopec, Statoil, Talisman, Vale do Río Doce, and Venoco — are supposed to drill more than 12,000 wells in an area covering 2,400 square miles. For reasons unknown to me, the traditional comparison seems to be Rhode Island: that’s an area twice the size of said state. (It’s also roughly eight New York Cities.) The biggest investors are ConocoPhillips and Talisman, who will jointly put in about $4.3 billion. Together, the projects are expected to produce 11 mcf per day, which is roughly what Argentina currently imports.

The companies are negotiating the deals with the government. YPF, the newly nationalized company, owns roughly 40% of the 12,000 square miles covered by Vaca Muerta. It will be a majority partner in the new fields. So, negotiations with provincial governments, the federal government, and the federally-owned YPF. But ... the companies are also negotiating with Repsol. Directly. Even though Repsol now is only a tiny minority partner in YPF. Which brings us to development #2.

Second, Repsol is suing Argentina in New York. It has now declared that it is looking for punitive damages. On one hand, this makes little sense. American judges will have little reason to bring action against the country unless and until there is an adverse ICSID judgment. But when you look at through the eyes of some unnamed French oil executives, who are willing to explain why they would have done the same thing, the strategy becomes clear.

Their explanation? The lawsuits aren’t aimed at YPF or the Argentine government. They are aimed at anyone who might want to do business with YPF or the Argentine government ... because they will be wandering into a legal minefield. And if they (including even Sinopec) do business in the United States, that is something that they would seriously want to avoid.

Thus ... negotiations with a company that technically no longer controls its Argentine assets, and owns only a 5% stake.

Yes, it is legal terrorism. It is fighting dirty. But heck, it makes for fun watching.

ADDENDUM: The lawsuit will also make it almost impossible for the nationalized YPF to raise funds in the United States. Considering the mess that Argentina is in regarding foreign exchange, that is going to be a serious problem. The Argentine government may not need foreign financing to fund its activities, but the businesses and people resident in Argentina increasingly do. Thus, capital controls ... and a headache for YPF if it cannot borrow in hard currency.

La madre patria contra la Argentina

 War in the River Plate! Spain attacks Argentina!

OK, not really. But Spain and Argentina are really going into it over threats that the latter might nationalize Repsol’s oil holdings. In fact, things are so bad that the Spanish foreign minister needed to specify that his country’s position “is not bellicose.” But the minister also said, “Whatever attack on Repsol that violates the prinicipal of legal security will be taken as an attack on Spain.” 

Minister José García-Margallo then added, “[Spain] will take the measures that it considers appropriate and ask for the support it considers necessary from its partners and allies.” The deputy prime minister, Soraya Sáenz, upped the ante. “Spain will defend its interests with all means available.” Now the prime minister himself has threatened a boycott of Argentine soya and beef. The European Union has announced its support for the Spanish government.

The threats may have worked. President Fernández of Argentina had been expected to announce the nationalization on Thursday, but instead limited herself to an anodyne statement that she was “ready to pay all the prices that must be paid” to keep the economy growing. Se then added some words about the triumph of Argentine-made chocolate. YPF shares soared. Repsol shares, not so much.

So what is going on? Putatively, President Fernández wants YPF to invest more. YPF is reluctant, because of Argentine price controls and export restraints. In 2011, YPF’s net income was $1.23 billion, down from $1.46 billion in 2010. So the fight is over $1.2 billion per year. The move has populist appeal.

Can Argentina get away with expropriation? I suspect that most of the talk about trade boycotts is bluster. Perhaps Spanish law allows for unilateral boycotts, but it would create a mess. Spain and Argentina signed a bilateral investment treaty in 1991. It calls for arbitration; sanctions without following the process laid out by the treaty would be illegal unless Argentina categorically states that will not pay compensation ever. Moreover, Spanish consumers do buy 31% of Argentina’s primary product exports to the European Union, but without an E.U. boycott the Spanish government cannot do anything without kissing the single market goodbye. If sanctions are going to be imposed, it won’t be quickly.

Spain’s problem is that ICSID won’t be that directly effective, since Buenos Aires wants the company to increase production aimed at the domestic market. Unless YPF exports its production, enforcement efforts will be even slower than the already slow arbitration process. (The Argentina-Spain BIT slows things even more, since it requires some attempt at local remedies before going to arbitration.) Thus, I suspect, the blizzard of diplomatic threats.

On the other hand, there are some threats that Madrid can credibly make. It can push Argentina to pay its debts to other governments. It can add its voice to the U.S. against Argentina in multilateral lending organizations. It can threaten to support the U.K. in the Falklands. And it can try to eject Argentina from the G20. These are the threats that probably made President Fernández think twice.

Economically, expropriation does not make a whole lot of sense. Argentine needs $250 billion or more to develop the shale fields: tying yourself up in legal knots and wrecking your reputation for $1.2 billion a year is not worth it. Moreover, YPF is currently worth only $8.6 billion. It seems like a big risk to take for the $4.3 billion it would take to get control of the enterprise. In fact, Argentina could get control for even less by sticking to its plan to expropriate the 25.46% of the company owned by the Eskenazi family, which is Argentine. Since the Eskenazis borrowed heavily to finance their stake (at the request of the Argentine government), an expropriation for them would be a bailout ... and cost little of nothing. Of course, Argentina would also assume the Eskenazi’s debts, but half of those are owed to ... Repsol. (Default!) Argentina would still need to get the additional 24.55% needed to gain control of the enterprise, but that would cost only $2.1 billion. The central bank has $47.3 billion in reserves, and there are very few institutional barriers keeping the government away from that money.

It is not as simple as that, of course. The government would need to do some leaning on the Eskenazi family, in order to get them to refrain from exercising their repurchase agreement with Repsol. (Basically, if Repsol looses control of YPF, it has to buy the Eskenazi’s stake at $38 per share ... implying a market cap for the company of $14.9 billion.) The current share price is depressed.

What will happen? Argentina is going to nationalize: it makes political sense. The nationalization will be with enought compensation to keep Spain from going to the mattresses with sanctions. (Or going to war! Not. And not.) It might even be enough to keep Repsol out of court. Considering how Argentine provinces have been yanking concessions, Repsol will likely prefer to settle.

Caveat? President Obama met with President Fernández today. We do not know what was said, although they said that nothing was said. That may have settled things, although I would still bet on expropriation with negotiated compensation. (Yes, I just bought some YPF stock.)

The empire strikes back, weakly, and after long delay

 “With regards to provisions in several FTAs that give foreign investors the right to sue governments directly in foreign tribunals, I will ensure that foreign investor rights are strictly limited and will fully exempt any law or regulation written to protect public safety or promote the public interest.”

—Senator Barack Obama, on the campaign trail in 2008

The Argentine decision to avoid paying ICSID expropriation judgments is finally coming back to haunt it. A few weeks ago, the Obama administration announced that it would begin to vote against credits for Argentina from multilateral lending organizations. A few days ago, the administration announced that Argentina will no longer be eligible for duty-free access to the U.S. market under the Generalized System of Preferences (GSP).

Argentina exported $477 million to the U.S. under the GSP in 2011, mostly cheeses, candy, leather, strawberries, wine, and lithium. Removing GSP will cost Argentina $17 million per year, assuming, of course, that it continues to export the same amount.

The Presidential authority comes from the Trade Act of 1974, so named at a time when Congress did not give legislation stupidly cutesy names but called laws what they were. Subchapter V mandates that a country which “has nationalized, expropriated, or otherwise seized ownership or control of [American-owned] property” and “fails to act in good faith in recognizing as binding or in enforcing arbitral awards in favor of United States citizens or a corporation” will not qualify for the GSP unless ...

1. “Prompt, adequate, and effective compensation has been or is being made to the citizen, corporation, partnership, or association”;
2. “Good faith negotiations to provide prompt, adequate, and effective compensation under the applicable provisions of international law are in progress”;
3. “A dispute involving such citizen, corporation, partnership, or association over compensation for such a seizure has been submitted to arbitration under the provisions of the Convention for the Settlement of Investment Disputes, or in another mutually agreed upon forum.”

No country has ever been punished for expropriation under the Trade Act. That may be because no country before now has ignored ICSID rulings. In 2005, CMS Gas received $133.2 million. In 2006, Azurix received $165.2 million. (The awards will accrue interest as long as they are unpaid.) In September 2007, Argentina lost its petition to annul the award against CMS. In May 2008, CMS sold its claim to Bank of America. (More accurately, it sold the claim to a subsidiary of BofA called Blue Ridge Investments.) By then, the $133 million award had grown to $180 million, counting interest. (That is a lot of interest!)

We don’t know how much Blue Ridge paid , but the State Department estimated that it paid around $54 million for the claim and CMS’s 23% stake in the TGN pipeline company. Blue Ridge’s original plan was to flip the claim as quickly as possible. (The Wikileaks cable is fascinating in that regard: Blue Ridge wanted to threaten Argentina with the possibility of selling its claim to a vulture fund that would take them to court in the United States; Argentina apparently planned to use its control over pipeline rates to force Blue Ridge to sell its claim to a government crony.)

About 16 months later, the Azurix case reached the end of the line when an ICSID appeals panel refused to annul the judgment against Argentina. Soon after, in September 2009, Azurix filed a petition to suspend Argentina’s GSP preferences. Blue Ridge signed on. The petition then ground its way through the USTR bureaucracy ... and finally, now,  Argentina is facing sanctions.

There are two points to make about Argentina’s recalcitrance. First, the country has done remarkably well at ICSID. Several decisions have been annuled by ICSID review panels. In at least one case, against a British company, the D.C. Circuit Court ruled that since the contract specified that the company had to first exhaust all local remedies, their decision to go direct to arbitration vacated a $185 million award. Second, in terms of justice, pretty much all the companies going up against Argentina are in the wrong. But that’s a subject for a different post ... as is the question of whether President Obama is living up to the position stated in the epigraph of this post. (He is.)

Do the companies have options other than getting the U.S. government to go to bat for them? If they were natural resource exporters, then the legal remedies would be fairly powerful: ultimately, Argentina would lose the ability to sell production from the expropriated assets. These are service companies, however. It isn’t clear that the courts will rule their way, and it isn’t clear that Argentine has many assets that the courts can seize. (Short version: since the Argentine central bank was not using its New York funds for commercial purposes, creditors could not go after them. I am not a lawyer and cannot say if that would apply in an expropriation case, but I suspect that it would.) Getting the U.S. government involved in muscling Argentina may be their best way forward.

But it is a sign that the arbitration system may crack when used for cases other than natural resource companies. Back to the 1970s!

Is Venezuelan heavy oil less risky than French nuclear power?

 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.

Old evil vendepatria PDVSA saves new socialist PDVSA!

 On the turn of the New Year, the International Chamber of Commerce (ICC) awarded ExxonMobil $907.6 million in its dispute with PDVSA over the Venezuelan government’s nationalization of its interest in the Cerro Negro project in the Orinoco oil belt. The press has been pretty quick to call it a victory for PDVSA, considering that the company initially claimed that its investment was worth $12 billion. Exxon, they say, received only book value for its investment, and Chávez has run away with the store.

Is that true? My job here is to argue that it’s not. Exxon received from PDVSA what it was contractually entitled to get. The standard used by the ICC was the market value of the assets, not book value. The assumptions used to calculate that market value, however — chief among them estimates of the expected future price of oil — were limited by a clause in ExxonMobil’s 1998 association contract that effectively put a ceiling on the value of the company’s investment.

In the words of Steven Bodzin: “So for all the rhetoric about how the Old PDVSA sold out the patria etc. etc., the only reason the New PDVSA was able to do so well in arbitration was because of clever bargaining by the Old PDVSA?”

I’m going to briefly walk through the Orinoco value chain. Then I’ll briefly describe some key features of the Cerro Negro contract. Finally, we’ll run some numbers.

Let’s start with Cerro Negro. The project is in the Orinoco oil belt — but keep in mind that until 1956 it was actually called the Orinoco tar belt. (The “faja bituminosa del Orinoco.”) The crude oil there is “extra heavy,” meaning that its specific gravity exceeds that of water. At room temperature, the stuff is gunky and practically solid. Put it into a beaker and turn it upside down; the oil will stick.

That creates a bit of problem in terms of transporting the stuff. There are three solutions. The first is to heat it up and sent it out in special ships. That’s expensive and really only done for oil intended to be made into asphalt. The second is to mix the extra-heavy gunk with lighter crudes and export it. Venezuela’s “Merey” blend is a mix of 61.8% gunk and 38.2% lighter “Mesa” crude. (That’s nice, because it means you can calculate a market price for the gunk.) The third is to build an “upgrader,” where you partially refine the gunk, mix it with a diluent and then export the resulting “synthetic crude.”

The Cerro Negro project covers 115 square miles and includes an upgrader. Its costs, therefore, are not low. The cost to get the extra-heavy crude out the ground isn’t that high. Wikileaks documents indicate that it is around $4 per barrel, but it isn’t as though that number is top secret: Bernard Mommer, formerly the People’s Vice-Minister for Hydrocarbons and currently the Bolivarian Republic’s representative on OPEC’s Board of Governors, estimated them at $3.60. Upgrading costs, on the other hand, are significantly more expensive: Mommer reported them to be $9 per barrel. That comes to a total production cost of $12.60 per barrel of syncrude.

Production costs aren’t the only costs, of course. In 2002, the Bolivarian Republic hiked royalties from 1% to 17%. In 2006, it hiked them again, this time to 33%. That same year, it raised the income tax rate from 34% to 50%. Taxes and royalties, therefore, are very substantial.

When Hugo Chávez converted the Cerro Negro oil extraction project into a majority-PDVSA joint venture in May 2007, ExxonMobil rejected Venezuela’s (undisclosed) compensation offer and went to arbitration. It went to arbitration in two forums: the ICC and ICSID. The ICC arbitration was based on ExxonMobil’s association agreement, which established the Cerro Negro venture between ExxonMobil (41.67%), PDVSA (41.67%), and BP (16.66%). Article 15, “Consequences of Certain Governmental Actions,” stated that Exxon could take PDVSA to arbitration if PDVSA refused to “restore the economic benefit that the foreign party would have received had the discriminatory action(s) not occurred.”

What were the lost economic benefits? Well, at the prevailing oil price for Venezuelan blends in 2007 (and assuming a 9% nominal discount rate and 2% inflation) Exxon would have earned an average of $325 million per year (nominal), with a net present value of $3.0 billion. That’s a lot more than $907.6 million! So was Exxon robbed?

Well, no. The first (and minor) point is that in 2007 it was far from clear that high oil prices were going to last. When ExxonMobil signed the contract in the late 1990s, Venezuelan oil was bouncing around $16 per barrel. So it is possible that Venezuelan lawyers might have persuaded the arbitration panel to use a lower oil price, under the assumption that prices might have crashed. If that had been the case, I would unhesitatingly call the $907 million result a victory for the Revolution.

The nice thing, however, is that we don’t need to resort to hair-splitting. Article 15 of the association agreement tells us the price the arbiters had to use:

… after the first period of six consecutive months during which the price of Brent crude oil is in excess of the threshold price [$27 in inflation-adjusted 1996 dollars], Lagoven CN [PDSVA’s subsidiary in the Cerro Negro venture] will not be required to compensate any foreign party for any discriminatory action(s) with respect to any fiscal year in which the average price of Brent crude oil is in excess of the threshold price, and such foreign party received net cash flow commensurate, after taking into account the effect of the discriminatory action(s), with a reference price for the production produced by the parties that bears at least a reasonable relationship, adjusted for quality and transportation differences, to the threshold cash flow for such fiscal year.

Translation: the highest possible oil price that can be used to value damages in the event of expropriation is $27 per barrel in 1996 dollars, or $37.50 in 2007 dollars. Moreover, that’s the highest price — Venezuela, after all, doesn’t sell Brent but rather lower-priced blends. That price can be marked down to adjust “for quality and transportation differences.” E.g., the arbiters can pick a lower one.

Ah hah! Brilliant! When Brent traded at $37.50, Mesa crude traded at around $32. At $32 per barrel (adjusted for 2% inflation), Exxon would have expected to earn an average of $95 million per year through 2035. At a nominal discount rate of 9%, that would value ExxonMobil’s investment at $865.8 million. It only takes a little tweaking of the discount rate or oil price to get us to the figure that the ICC finally came up with. 

What does this imply for the results of the upcoming ICSID arbitration? Damned if I know. That arbitration is against the Bolivarian Republic, not PDVSA. So Article 15 doesn’t apply. Rather, the relevant document is the bilateral investment treaty that defines what the Venezuelan government can and cannot do. Moreover, it is possible that ExxonMobil will be able to argue not only that the 2007 expropriation was illegal, but that the big royalty and tax hikes the year before were also illegal under the Netherlands-Venezuela bilateral investment treaty. My gut feeling is that Venezuela is going to win, but I’m not sure why exactly I suspect that will be the case.

To sum up, then, this case was not a victory for the Bolivarian Republic. Rather, it was a victory for the PDVSA negotiators who wrote Article 15 of the association agreement back when the plain old Republic of Venezuela invited foreign companies in to develop the Orinoco oil belt. ExxonMobil got basically the maximum that it could have expected to get. So what was that initial $12 billion claim all about? Well, as Michele Bachmann would mispronounce, nothing but chutzpah.

Venezuela cede

  The Bolivarian Republic just settled with the Argentine owners of Ternium over Sidor, its Venezuelan steel unit.  The Venezuelan government nationalized Sidor in 2008.  Chávez offered $800 million.  Ternium scoffed and asked for $4 billion.  They just decided upon $1.97 billion.  Is that a fair price?

Ternium bought Sidor for $1.79 billion in 1997 and subsequently invested a lot of money, but that doesn't really tell you anything.  On the other hand, Sidor enjoyed revenues of $2.4 billion in 2007.  At a discount rate of 10 percent, the agreed-upon price implies a Sidor profit margin of 8 percent, which is consistent with the steel industry's average margin during the 2001 recession.  Conversely, at a profit margin of 16 percent, about what the industry earns in a boom, the implied discount rate is 19 percent ... which seems reasonable for a high-risk area like Venezuela.  (Bernard?) 

Upon announcement of the deal, the price of Ternium shares jumped 49 percent, to $15.67.  That said, the stock peaked at $45.18 on July 2, 2008, before sliding to $34.01 on August 8, and then collapsing to $4.65 by November 20.  The problem with interpreting that price collapse as evidence that the offered price isn't fair?  President Chávez announced the nationalization in April. 

In other words, the price appears to be fair.  Another demonstration of the power of ICSID?  Perhaps. We don't know if the Venezuelan government offered more money out of fear of an adverse arbitration result, or if it offered more money at the urging of the “semi-dictator” of Argentina, or it offered more money because the President of the Bolivarian Republic decided that it was simply the right thing to do. 

But we do know that the foreign oil companies can go to ICSID, and that Caracas seems to be a bit worried about the prospect.  We also know that Cemex is pursuing the ICSID route.  So we will see if the empire strikes back at the Revolution.

P.S.  FWIW, Argentine embassy accounts in France remain frozen.

By the power of ICSID

  How vulnerable are Latin American nations to international arbitration? 

Venezuela makes the answer easy to find.  The Bolivarian Republic owns $14.5 billion in direct investments abroad, mostly Citgo refineries and gas stations.  It also enjoys $22.9 billion in accounts receivable, mostly for oil delivered by not paid for.  Some of that are debts incurred by the Petrocaribe countries, but most of it is with the United States, and it is all potentially attachable in a settlement.  (The liquid assets are probably owned by the central bank, which has $39 billion in reserves, and are considered immune.)  Blocking those accounts receivable is the 21st-century equivalent of parking a gunboat in the harbor.  Hugo needs to tread very carefully, and considering that Cemex is still being run from Monterrey, it looks like he has been.

How about Argentina?  Mecon gives the answer for 2007 right here, on page 15.  The Argentine government owns $8.2 billion in foreign assets.  Sounds vulnerable!  It's not, however.  $6.0 billion consists of “créditos por financiación de entes binacionales.”  The big one is the  Yacyretá dam on the Paraguayan border, an $11 billion project.  I suppose one can imagine a world in which ... uh ... no, I can't really imagine a world in which foreign investors in Argentina could go after Yacyretá.  And given that it loses money, I'm not sure that they'd want to.  Another $1.5 billion represents Argentina's paid-in capital to multilateral lending organizations like the IMF and World Bank.  In theory, I suppose, that money is very vulnerable to an adverse ICSID (aka CIADI in Spanish) ruling, considering that ICSID is part of the World Bank group.  In practice, I don't know of any cases where the a multilateral institution has reassigned capital from a national entity to a private interest.  I don't even know how that would work, accounting-wise:  the multilateral entity would need to find cash to pay the private investors for its shares, since only governments can hold capital stakes in multilaterals.  That would get beyond messy right quick.  In short, Argentina isn't all that vulnerable to the postmodern imperialism of the 21st century.  So why not nationalize the airlines?

What about Ecuador?  Sadly, its central bank does not make the figure easy to find.  It does not track Ecuadorean foreign direct investment at all.  And what it does track is not broken out into public v. private, save for central bank reserves.  (Which is an odd concept in a dollarized economy, but the number is there.)  I'm still stumped.