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### Viewing cable 09QUITO1080, NOBLE ENERGY FEARS DISPUTE WITH GOE

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
09QUITO1080 | 2009-10-30 18:06 | 2011-05-02 00:12 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Quito

`

    VZCZCXYZ0001
    RR RUEHWEB

    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
    SIPDIS
    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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