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Cablegate: Noble Energy Fears Dispute with Goe

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DE RUEHQT #1080/01 3031857
ZNR UUUUU ZZH
R 301855Z OCT 09
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC 0278
INFO RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHBO/AMEMBASSY BOGOTA
RUEHCV/AMEMBASSY CARACAS 0097
RUEHGL/AMCONSUL GUAYAQUIL
RUEHLP/AMEMBASSY LA PAZ OCT QUITO

UNCLAS QUITO 001080

SENSITIVE
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DEPT FOR WHA/AND AND EEB/IFD/OIA
DEPT PLEASE PASS TO USTR FOR BHARMAN

E.O. 12958: N/A
TAGS: EINV EPET ENRG ECON EC
SUBJECT: NOBLE ENERGY FEARS DISPUTE WITH GOE

REF: QUITO 644; QUITO 579; QUITO 332; QUITO 905

1. (SBU) Summary. Noble Energy, the last U.S. company
operating in the oil and gas sector in Ecuador, fears the GoE may
soon initiate a process to terminate the contract of one of its
subsidiaries, claiming breach of contract. Noble has 100%
ownership of a fully-integrated gas-to-power project in Ecuador
through its subsidiaries Energy Development Corporation Ecuador Ltd
(EDC) and Machala Power. Noble has encountered difficulties with
the GoE over issues with both subsidiaries, but its immediate
concern regards its EDC gas operations. In 1996, EDC was awarded a
30-year concession for exploration and production of gas in Block 3
in the Gulf of Guayaquil. So far, EDC has invested over $270
million in working the concession. The dispute centers on whether
EDC has complied with its contractual obligations regarding
development plans for the block. Separately, Noble is looking to
sell Machala Power. End Summary.

Background

2. (SBU) In 1996, EDC signed a 30-year contract for gas
exploration and production in the 864,000-acre Block 3 concession,
located in the Gulf of Guayaquil. In 1998, EDC submitted a
Development Plan for the Amistad Field, covering approximately
12,000 acres of the Block 3 concession, which was approved by
government authorities. At that time, Amistad Field gas reserves
were estimated at 200-400 Billion Cubic Feet (BCF). Given the
GoE's acceptance of its plan, EDC moved forward with drilling.
Based on the technical data acquired through the drilling, EDC
lowered the estimate of gas reserves in the Amistad Field to 30
BCF. Despite the low reserve estimates, EDC proceeded with
investments to allow for extraction and transportation of the gas,
building an off-shore production platform, a 42-mile gas pipeline,
and a gas storage facility on-shore. In 2002, to create a market
for the Amistad gas, Noble constructed the 130 MW Machala Power
plant using two GE single turbines; the plant began operation in
August of the same year.

3. (SBU) After drilling three additional wells in 2004, EDC
had five productive wells operating and the estimate for gas
reserves in the Amistad Field was revised upward to 200 BCF.
According to Noble, development of the Amistad Field was
technically complex and challenging. At that point, based on
technical information, EDC concluded that the Amistad Field had
been properly developed and attention was focused on the production
of gas to supply the Machala Power plant.

The Troubles Begin

4. (SBU) EDC's contract requires that it submit a Development
Plan to the GoE following the exploration period of its contract.
In October 2008, the contract period for exploration of Block 3
expired, and EDC submitted a development plan for the entire Block
3 concession. The GoE rejected EDC's plan, prompting EDC to submit
another plan in April 2009. This latter plan amended its initial
1998 development plan and covered only the developed reserves of
the Amistad Field -- 8 sub-blocks of Block 3. The remaining 62
sub-blocks (approximately 90% of Block 3 territory) were to be
devolved to the GoE. The government also rejected this plan.
According to EDC, the GoE is now considering the initiation of a
process to terminate EDC's contract for its gas concession,
claiming a breach of contract by the company. This legal process
would provide a basis for government seizure of EDC's assets. The
GoE followed a similar legal process when it seized the assets of
Occidental Petroleum in 2006 and French oil company Perenco earlier
this year (Ref A).

5. (SBU) Should the GoE decide to move against EDC, we
understand that the process would commence with a letter from
PetroEcuador to the Ministry of Non-Renewable Natural Resources
(formerly Ministry of Mines and Petroleum) requesting that EDC's
contract be terminated based on a breach of contract by the
company. EDC would have 10 days to respond. EDC's contract has
a provision calling for international arbitration at the
International Center for Settlement of Investment Disputes (ICSID).
The company's lawyers are reviewing the implications for EDC of
Ecuador's decision in July 2009 to withdraw from ICSID (Ref B).
Another complicating factor for EDC is the GoE's insistence that it

renegotiate its contract in the form of a service contract, in line
with the country's new Constitution and draft Hydrocarbon Law,
which does not allow for international arbitration of investment
disputes.

The Company's Perspective

6. (SBU) According to EDC's Vice President and General Manager
John Tomich, Noble believes EDC is fully in compliance with its
contractual obligations based on the GoE's acceptance of its
initial development plan for the Amistad Field in 1998. Noble
sees the GoE's stance as an attempt to force the company to invest
in further gas exploration and development because the government
lacks the resources to do so. Part of what may be prompting the
government to press EDC is their belief that the gas reserves in
Block 3 are much larger than EDC had indicated. Tomich claimed
that certain officials within PetroEcuador have told Ecuadorian
President Rafael Correa that Block 3 holds vast gas reserves,
despite no scientific evidence to support these claims. The only
proven reserves are those explored and developed by EDC in the
Amistad Field, which have been confirmed through independent
auditing.

7. (SBU) The GoE is looking to significantly expand domestic
gas production to reduce the country's reliance on imported gas and
reduce government outlays for gas subsidies. Currently, EDC is the
only gas production company operating in Ecuador. The only other
source of natural gas in Ecuador is as a by-product of petroleum
extraction, which is mostly lost to flaring. However, the
Venezuelan petroleum company PDVSA is reportedly drilling an
exploratory natural gas well on the island of Puna in the Gulf of
Guayaquil.

8. (SBU) EDC is aware of two companies that have purchased
Chinese made gas liquefaction plants with the intention of locating
them near the EDC gas terminal in Machala, but has not been
approached by the GOE regarding gas supplies for these plants.
According to EDC, reserves in the Amistad Field are only sufficient
to supply Machala Power. Tomich explained to Emboffs that given
the current political and economic climate in Ecuador, Noble does
not intend to increase its local investments, noting that it would
cost around $150 million just to drill 3-4 additional exploratory
wells, from which it could take years to see results.

Machala: Hoping PPAs Will Keep Payments Coming

9. (SBU) Despite continuing payment problems, Tomich gave a
more upbeat assessment of Machala Power's situation. After Machala
Power's receipt of $60 million in back payments in early 2009 as
part of an agreement to withdraw its international arbitration
case, unpaid invoices from the GoE have again accumulated to around
$20 million (Ref C). However, Tomich explained that part of the
difficulty in collecting on invoices in the past has been that
Machala was last in line for payment because its power was sold
exclusively on the spot market. On September 30, Machala Power
entered into Power Purchasing Agreements (PPAs) with 20
distributors. Although Machala Power will be selling its power at
a reduced price through the PPAs, it is expecting the distributors
to pay close to 100% invoicing. Tomich also noted that the
relatively new Minister of Electricity and Renewable Energy,
Esteban Albornoz, appeared to be reasonable and pragmatic.

10. (SBU) With the payment issue still not totally resolved,
Machala Power has not moved to implement Phase II and Phase III of
its contract for installation of a combined-cycle turbine and
additional single-cycle turbine. Each new phase would boost energy
output by roughly 90 MW, increasing Machala Power's total
generation capacity to around 310 MW. Noting that Phases II and
III would cost a couple hundred million dollars to implement,
Tomich said Noble was not inclined to take on this additional
investment, adding that Noble would prefer to sell Machala Power.
Another EDC employee later told Emboff that Noble would like to
sell Machala Power before the delay in implementing Phases II and
III creates a problem with the government.

11. (SBU) Comment. Given the GoE's recent history of disputes
with foreign investors and its recent decision to
terminate/renegotiate all of its bilateral investment treaties so
as to, among other things, eliminate national treatment (Ref D),
EDC's concerns seem justified. In an October 23 meeting with
Emboffs, Julio Gonzalez, Under Secretary for Hydrocarbon Policy at

the Ministry of Non-Renewable Natural Resources, described the
status of negotiations with EDC as "bad." Should the GoE move to
seize EDC's assets in the near-future, Ecuador would be embroiled
in yet another international arbitration case, further eroding its
image among foreign investors, and bringing to an end major U.S.
investment in Ecuador's gas and oil sector. End Comment
HODGES

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