The era of petroleum arbitration mega cases: commentary on Occidental v. Ecuador, ICSID award, 2012.

• Author: Garcia, Julian Cardenas
• Position: International Centre for Settlement of Investment Disputes - I. The Award through II. Observations on the Award, p. 537-564

1. THE AWARD A. The Facts B. The Tribunal's Reasoning II. OBSERVATIONS ON THE AWARD A. The Execution of an International Farmout Agreement B. Proportionality Analysis and Investment Arbitration C. Reduction of the Amount of Compensation Caused as a Consequence of Investor's Wrongful Acts and Tax Measures III. CONCLUSION Occidental v. Ecuador arbitration award announced on October 5, 2012,1 represents the largest ICSID award in history in the new era of mega cases in international arbitration related to the oil industry. (2) The idea of mega cases refers to the amount of claims and compensations awarded which makes "ordinary" amounts that swing in the hundreds of millions and billions of U.S. dollars, in arbitration cases dealing with expropriations, tax reforms or environmental accidents in the oil and gas sector. (3) This, for sure, may surprise the general public, politicians and mass media, however, having in mind factors such as the current prices of commodities, the devaluation of the U.S. dollar and the current value of investments in natural resources producing high rates of returns, these larger amounts should not be unexpected at all.

   But, considering the relevance of these figures in the economy of states and corporations, the ideal of a fair and efficient system of transnational dispute resolution is not exempted of risks. One of this is that since these claims are so large, split decisions will probably dominate international awards, instead of decisions strictly decided under applicable laws. (4) In these mega cases, we are witnessing a trend of arbitrators trying to find a balance between the expectations of foreign investors and host governments facing the dilemma of "too big to fail" using the law in a way that tries to favor both parties. (5) This position may work in some cases, but in others would be criticized when the solution provided by the arbitrator lessens the expectation of fairness of a community of states and investors who sought the settlement of the dispute through a specialized panel, in this case, a specialized panel deciding petroleum industry disputes avoiding unclarity and uncertainties.

   From a historical perspective, the case Occidental v. Ecuador is anchored in the wave of expropriations and tax legislation reforms that occurred in Latin America after 2000, as oil prices increased. (6) The rise in oil prices expanded litigation and arbitration between host states and international oil companies in situations where oil and gas contracts failed to adapt to the new realities of the market, and renegotiations called for by governments were unable to result in an agreement under the new conditions. (7) Ecuador, as well as Venezuela, Bolivia and Argentina are among the Latin American countries with an increased number of cases being filed before the International Centre for Settlement of Investment Disputes (ICSID) related to the oil and gas industry. (8) The Occidental case is particularly relevant due to the substantial size of the award from a complex claim arising from the performance of a farmout agreement, the breach of a petroleum participation contract, and the state violation of a bilateral investment treaty (BIT). (9) Ecuador was ordered to pay Occidental $1.77 billion, plus interest, for .expropriating Occidental's interest in a participation contract over "Block 15" in the Ecuadorian Amazon. (10)

   The ICSID Tribunal, composed of Mr. L. Yves Fortier (President), Mr. David Williams, and Professor Brigitte Stern, unanimously found that Occidental violated national law and breached the participation contract by transferring rights under a farmout agreement to a foreign investor, AEC, without the authorization of the Ecuadorian government. (11) However, the tribunal found that the reaction of Ecuador through the unilateral termination of the contract was disproportionate to Occidental's breach, thus finding that Ecuador not only violated Ecuadorian law and customary international law, but also that Ecuador failed to accord a fair and equitable treatment standard and that the administrative sanction was a measure that "tantamount to expropriation" under the U.S.-Ecuador BIT. (12)

   Despite the unanimous decision concerning the liability of the parties under the case, the Tribunal reached a split decision on the principles that were applied to calculate the quantum of the award relating to: (i) whether the assignment of rights meant that claimants could only claim a percentage of the fair market value of the participation contract; (ii) whether the effects of the tax legislation enacted by the Ecuadorian government after the participation contract was entered into force should be taken into account in the calculation of damages; and (iii) how much the claimants' damages should be reduced in light of OEPC's contribution to its own losses. (13)

   The case created some optimism among oil and gas corporations because of the amount of compensation awarded under standard provisions of a BIT, especially in light of existing skepticism on the effectiveness of these treaties. (14) However, the possibility of enforcing these decisions against states is still unclear, although Ecuador has previously complied with arbitration awards despite political declarations of their officials. (15) The decision has also generated some criticism caused by what has been qualified as a non-rigorous application of law by the strong dissenting opinion of Arbitrator Stern, concerning the calculation and attribution of damages imposed on Ecuador, which may echoed in the pending annulment procedure already filed by Ecuador before the ICSID. (16)

   In Section I, this Article intends to present an overview of the facts and the tribunal's reasoning in this award. Section II will provide commentary on the possible impacts of this decision for the petroleum industry in terms of the assignment of rights, the application of the proportionality analysis in international investment law and the expectations of foreign investors for compensation in cases where investors have incurred in violations of national law.

1. THE AWARD.

   The Award dispatched on October 5, 2012, provides the decision on liability and compensation to a foreign investor in a dispute that lasted six years. (17) Although this is above the average duration of a regular ICSID case, it is similar to other complex oil and gas disputes in front of the ICSID which range among five to six years. (18) The arbitration started in May 2006, when the Secretary General of the ICSID acknowledged receipt of the Request for Arbitration presented by Occidental Petroleum Corporation and Occidental Exploration and Production Company (respectively, Occidental and OEPC), two U.S. companies incorporated in Delaware and California, against the Republic of Ecuador and the Empresa Estatal Petroleos del Ecuador (PetroEcuador)." (19)

   The dispute concerned the termination of a 1999 participation contract entered into by Occidental and PetroEcuador "for the exploration and exploitation of hydrocarbons in Block 15 of the Ecuadorian Amazon," (20) one of the richest oil regions in the country. (21) ICSID obtained jurisdiction through both PetroEcuador's consent to arbitration in the participation contract (22), and Ecuador's consent to arbitration in a 1993 treaty with the United States concerning the encouragement and protection of investments. (23)

   1. The Facts

   Occidental has had a presence in Block 15 since 1985 as a service contractor for the CorporaciSn Estatal Petrolera Ecuatoriana (now PetroEcuador), whereby Occidental provided substantial services for the initial development of Block 15. (24) In 1993, shortly after Occidental began production from Block 15, "Ecuador amended its [hydrocarbons law] to allow the negotiation of 'participation contracts."' (25) The participation contract was "essentially a type of production sharing agreement" where the state and contractors share in the production of crude oil and all of the expenditures are borne by the contractor. (26) Thus, "[t]his contractual model gave producers a stake in the production that made exploration risks more palatable[,]" thereby "guarantee[ing] Ecuador a profit from its production share, since it no longer had any expenses associated with oil production." (27) The new conditions promoted negotiation with foreign investors, and Occidental was among the companies interested in participating in the oil exploration and production activities in Ecuador. (28)

   Subsequently, Occidental signed a participation contract with PetroEcuador in May 1999 and began increasing daily production of Block 15 from approximately 28,000 barrels per day to allegedly over 100,000 barrels per day, which production level then remained constant through 2006. (29)

   This increase of production was not an exclusive success of Occidental. In October 2000, Occidental entered into a farmout agreement with Alberta Energy Corporation "AEC", through the related entity AEC International (collectively referred to as AEC), which "was looking to expand its investments in Ecuador" for the performance of exploration and production activities. (30) Occidental sought this agreement to provide the necessary funds, as well as to diversify and reduce its exposure following a current and common practice in the upstream petroleum...