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Presented by:Christopher J. GoncalvesDirector, International EnergyWashington, D.C.

Presented to:XVII Annual Latin American Energy ConferenceMay 13 & 14, 2008La Jolla, CA

Energy Disputes in the Americas:Bringing Method to the Madness

Confidential

Agenda

» Revisiting International Arbitration

» Retrading Energy Profits and Value

» Global Energy Dispute Drivers

» Latin America’s Dispute Leadership

» Regional Dispute Hotspots

» A Method for the Madness

» Determining Damages

» What’s Next?

Confidential

Is Latin America Reconsidering International Arbitration?

Confronted with new investment treaty claims related to resource nationalization, regional states increasingly renounce commitments to binding treaty arbitration.

LegalSovereignty

TreatyArbitration

2 ALBA = The ALBA (AlternativaBolivariana para las Américas), is a proposed alternative to the U.S. sponsored Free Trade Area of the Americas (FTAA, or ALCA in its Spanish initials).

» Several countries have announced that they will no longer honor ICSID1decisions, asserting that domestic laws are cardinal and that ICSID favors multinationals:

» May, 2007: Nicaragua, Cuba, Venezuela and Bolivia jointly announced exit from ICSID during a summer in favor of ALBA.2

» June, 2007: Bolivia’s ambassador to the US affirmed exit from ICSID.» August, 2007: Venezuela’s energy minister renounced international arbitration.» December, 2007: Ecuador’s foreign ministry announced exit from ICSID.» May 8, 2008 (last Thursday): Meeting in Caracas, twelve nations (Argentina, Bolivia, Brazil, Chile,

Colombia, Ecuador, Guyana, Paraguay, Peru, Uruguay, Surinam, and Venezuela) stated joint intent to create a new regional institution to replace ICSID (El Universo, May 12, 2008).

» So far, the sentiment against arbitration relates principally to ICSID and treaty arbitration and does not address commercial arbitration under ICC3 or AAA / ICDR.4

1 ICSID = International Center for the Settlement of Investment Disputes.

3 ICC = International Chamber of Commerce.

4 AAA / ICDR = American Arbitration Association / International Centre for Dispute Resolution.

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Or Simply Fighting about How to Slice a Growing Profit Pie?

Increasing investment and higher energy prices are enlarging the profit pie and increasing the Latin American energy “value” under dispute

* Foreign Direct Investment

2002 2003 2004 2005 2006

Crude Price, FDI* and Arbitrations

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40

80

120

0

50

100

150

200

No. of ClaimsUSD

Price of Brent Crude (USD / BBL)

FDI into Latin America (Trillion USD)

ICC + ICSID Arbitrations in Latin America

» Rising energy prices fuel resource nationalism policies through which producer nations seek to redefine investment terms.

» Some publicly traded oil companies are keen to protect reserves and have been willing to accept a smaller slice of the profit pie to do so.

» Higher energy prices also encourage private parties to redefine the terms of trade with commercial counterparties, through renegotiation and/or commercial arbitration.

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Commercial Disputes Far Outnumber Investment Disputes

Number of Global Energy Claims (All Countries)*

Number of Latin America Claims (All Sectors)*

0

10

20

30

40

50

60

70

80

2002 2003 2004 2005 2006

ICCICSID

10

60

110

160

210

2002 2003 2004 2005 2006

ICCICSID

Worldwide commercial energy disputes and Latin American commercial disputes (for all sectors) filed with ICC far outnumber investment treaty claims filed with ICSID.

* ICSID data from list of clams at ICSID website. ICC data from Statistical Reports in annual Arbitration Bulletins. Statistical information from AAA and UNCITRAL was not available.

» Although it gets less press, commercial dispute activity dwarfs the highly publicized investment dispute activity.

» In Latin America, commercial dispute activity has maintained a healthy clip while investment disputes have slowed.

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Contract Enforceability and Arbitration Frequency

Number of Large Arbitrations (Investment and Commercial)**

Contract Enforcement Rating (1 is best)*

BoliviaGuatemala

PanamaPeru

Brazil

VenezuelaEcuador

Mexico

Argentina40

60

80

100

120

0 5 10 15 20 25 30 35

Legal Tradition and Contract Enforcement Support Arbitration

» Contract enforceability is one of several explanatory factors.

» Dispute frequency among countries does not correlate well to market size or levels of FDI, but dispute frequency may reflect:» Improvements in the

international framework for dispute resolution,

» Greater volumes of energy investment and commercial transactions,

» Higher energy prices and profit levels,

* Rating is from the World Bank Doing Business index. Countries are ranked among 178 countries on 10 variables, one of which is the ease of enforcing contracts.

** From American Lawyer – June 2007

Countries with deep legal traditions and high contract enforcement ratings appear to support greater levels of international arbitration.

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Energy Investment Disputes Have Boomed with Energy Prices

ICSID Energy Claims*

ICSID Claims by Region*

Price BrentClaims Filed

$/BBL

* Source: EIA, ICSID

$/BBL

» Oil & Gas claims filings have jumped from zero to 9 in 2007 (70% of energy).

» Power claims have ranged from 23% to 50% of energy investment claims over the last 3 years.

» Regionally, Latin America has accounted for the lion’s share of energy investment claims, representing 56% of all claims since 2000.

» Eurasian regional claims surpassed Latin America in 2007.

Since 2000, the rapid ascent of energy commodity prices has been accompanied by greater numbers of ICSID investment claims in the energy sector.

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4

6

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14

1995 1997 1999 2001 2003 2005 20070

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AmericasME, AfricaEurasia

All Regions

Claims Filed Price Brent

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1995 1997 1999 2001 2003 2005 20070

10

20

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Oil GasPowerOther Energy

All EnergyPrice Brent

Confidential

Latin America is the Global Leader in Energy Investment Disputes

137 Concluded ICSID Claims

127 Pending ICSID Claims

ICSID currently reports 264 total investment claims, with 76 energy claims that are increasingly concentrated in the Oil & Gas sector and the Latin America region.

50 Pending Energy Claims (39%)

26 Concluded Energy Claims (19%)

Oil & Gas13 (9%)

Power8 (6%)

Other5 (4%)

Non‐Energy

111 = 81%

Non‐Energy

77 = 61%

Oil & Gas28 (22%)

Power21 (16%)

Other1 (1%)

ME/Africa

7 (27%)

Eurasia

9 (35%)Americas

10 (38%)

ME/Africa

4 (8%) Americas

31 (62%)

Eurasia

15 (30%)

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Latin America’s Largest Disputes are “Energy Intensive”

Energy Share ofLatin American Disputes

Latin America77 (34%)

Rest of World151 (66%)

A June, 2007 survey of lawyers involved in international arbitration suggests that Latin American investment and commercial disputes represent 34% of all large global arbitrations outstanding in 2005 – 2007 – of which 60% were in the energy sector.

Latin American Share ofGlobal Disputes

Energy Share ofGlobal Disputes

Energy 46 (60%)

Other 31 (40%)

Energy 37 (25%)

Other114 (75%)

Source: AmericanLawyer.com – June 2007. Information collected from 50 firms on 117 treaty arbitrations estimated at $100 MM or above and 111 contract disputes above $200 MM . Information was collected on active cases between Jan. 2005 – June 2007 and dispute values were approximated by counsel.

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Oil & Gas Claims Outweigh Power Disputes

Two‐thirds of the value of large Latin American energy arbitration claims for 2005 – 2007 was accounted for by oil and gas.

Power $9 Billion (34%) Oil/ Gas

$18 Billion (66%)

Large Latin American Energy Claims

Breakdown of Large Latin American Energy Claims

Source: AmericanLawyer.com – June 2007.

ICSID ICC AAA UNCITRAL LICA TotalCommercial 0 10 2 4 0 16Treaty 25 0 0 4 1 30Total 25 10 2 8 1 46Settled 3 6 0 1 0 10

» The total value of Latin American energy arbitration claims was estimated at $27 billion for 46 large claims.

» Of this total, 10 claims for $6 billion were settled for a combined $1.8 billion (or 35% of the original claims’ value on average).

» Approximately $3 billion each of the original Oil & Gas and Power claims were settled, accounting for 32% and 19% of the respective original claim amounts.

» As of June 2007, 36 large claims valued at $20 billion remained outstanding.

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Energy Dispute Hotspots and Trends: Argentina

Large Latin American Arbitration Claims (over $100 MM in estimated value) were concentrated in groupings of investment and commercial disputes in a few countries.

Source: AmericanLawyer.com – June 2007

# Claims $MM # Claims $MM # Claims $MMCommercial 1 1,230 ‐ ‐ 1 1,230 Treaty 20 9,526 8 4,006 12 5,520

Total Energy Power Oil/ GasArgentina

Treaty disputes have arisen in relation to government actions in response to the economic/ currency crisis in 2001 – 2002.

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Energy Dispute Hotspots and Trends: Ecuador



Treaty disputes have arisen in relation to alleged breach of international agreements and seizure of oil interests.

# Claims $MM # Claims $MM # Claims $MMCommercial 1 1,000 ‐ ‐ 1 1,000 Treaty 7 4,100 3 1,300 4 2,800

EcuadorTotal Energy Power Oil/ Gas

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Energy Dispute Hotspots and Trends: Venezuela


Source: AmericanLawyer.com – June 2007Economist.com: Exxon’s wrathful tiger takes on Hugo Chávez, Feb 14th, 2008.

A mix of commercial and treaty disputes, but with fewer treaty claims than expected driven by foreign producers’ and Venezuela’s willingness to renegotiate. One year after PDVSA doubled its ownership of heavy‐oil projects, ConocoPhillips pulled out and filed arbitration. ExxonMobil is now pursuing both investment and commercial arbitration.

# Claims $MM # Claims $MM # Claims $MMCommercial 3 2,769 ‐ ‐ 3 2,769 Treaty 1 1,000 ‐ ‐ 1 1,000

VenezuelaTotal Energy Power Oil/ Gas

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Energy Dispute Hotspots and Trends: Brazil



Commercial disputes are driven by alleged deprivation of governance rights, government interference, and contract breach.

# Claims $MM # Claims $MM # Claims $MMCommercial 3 2,460 3 2,460 ‐ ‐ Treaty ‐ ‐ ‐ ‐ ‐ ‐

BrazilTotal Energy Power Oil/ Gas

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Energy Dispute Hotspots and Trends: Central America / Caribbean



Treaty disputes have arisen in relation to government actions in response to the economic/ currency crisis in 2001 – 2002.Treaty disputes have arisen in relation to alleged breach of international agreements and seizure of oil interests.Commercial disputes have arisen related to alleged breach of contract (i.e., Atlantic LNG vs. versus Gas Natural).

# Claims $MM # Claims $MM # Claims $MMCommercial 4 1,599 2 425 2 1,174 Treaty 2 830 1 680 1 150

Central America / CaribbeanTotal Energy Power Oil/ Gas

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Energy Dispute Hotspots and Trends: Mexico



Commercial disputes have arisen in the oil and gas industry due to alleged contract interference. (i.e., The JV of Siemens AG and SK Engineering and Construction vs. Pemex).

# Claims $MM # Claims $MM # Claims $MMCommercial 3 1,940 ‐ 3 1,940 Treaty ‐ ‐ ‐ ‐ ‐

MexicoTotal Energy Power Oil/ Gas

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A Method for the Madness

Each claim is unique and the damages methodology should offer the tribunal a bridge from the merits to the quantum award.

Nature and Timing of the Expropriation

Nature and Timing of

Commercial Harm

BIT* and Trade Agreements Provide for FMV** at time of

Expropriation

Contractual Dispute Resolution Provide a

Wide Array of Options

Investment Merits

MethodologyInvestment Awards

Commercial Merits Commercial Awards

* Bilateral Investment Treaty** Fair Market Value

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Categories of Energy Investment Disputes

Each dispute is unique, but there are a few categories of energy investment disputes that present shades of complexity related to establishing the merits and calculating damages.

Investment Claim Categories Typical Characteristics Voluntary Compensation Examples

Pure Expropriation

• Clear cut, sudden seizure (full or partial) of reserves, infrastructure, and/or commercial assets

• Rarely disputed

• Voluntary compensation increasingly common, (in‐kind, asset swaps)

• Bolivia (Nationalization Law and Executive Decrees)

Backdoor Expropriation

• Rapid, compelled expropriation and/or or asset impairment

• Indirect government actions (e.g., regulatory, environmental)

Creeping Expropriation

• Gradual, phased expropriation through government actions (e.g., regulatory, commercial, tax)

• Expropriation / impairment usually disputed

• Voluntary compensation rare

• Sometimes accompanied by prior investment impairment actions

• Venezuela and Ecuador (tax, regulatory, labor)

• Argentina (currency, regulatory, commercial)

Confidential

Categories of Energy Commercial Disputes

There is a wide array of commercial disputes, but a few categories stand out in relation to establishing the merits.

Commercial Claim Categories Typical Characteristics Merits Issues Examples

Contract Breach

• Alleged breach of commercial agreements by state entities or private actors ‐‐ especially re: sale/purchase prices andquantities.

Reasonableness& Practices

• Alleged violation of recognized or contractual standards for commercial reasonableness, best practices, prudent practices, international standards, etc.

Commercial Change

• Alleged unforeseen or unforeseeable changes in regulation, commercial rules, market prices, etc.

FSAs, PPAs, ESAs, EPC in:

• Brazil

• Chile

• Venezuela

• CA / Caribbean

• Mexico

• Contract clarity

• Intent of parties

• Market context and change

• Foreseeability

• Applicable Standards

• Reasonable Performance

• Commercial Equity / Balance

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Determining Investment Damages

Investment claim methodologies should match the unique circumstances and time perspective involved in the merits of each expropriation claim.

Investment Damages Time Perspective Valuation Methodology

Pure Expropriation

• Expropriation date typically clear cut

• FMV as of the date of expropriation is accepted approach (using DCF valuation, market multiples, and / or comparables)

• Ancillary considerations (investment, book, replacement value)

Backdoor Expropriation

Creeping Expropriation

• FMV valuation should address instances and timing of expropriation and/or impairment

• May require individual valuation of specific assets and operations affected at each step in the expropriation process

• Date of initial expropriation and/or asset impairment typically disputed

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Determining Commercial Damages

Commercial claim methodologies vary widely due to the unique nature of each commercial claim, but contract damages and/or counterfactual analysis and calculation of lost profits or commercial harm are common.

Commercial Damages Time Perspective Quantification Methodologies

Contract Breach

Reasonableness& Practices

Commercial Change

• Disputes typically concern dates on which commercial harm was suffered.

• Start date based on alleged breach of contract, alleged violation of applicablestandards of practice, oralleged (unforeseeable)commercial change.

• Calculation of contractual damages as stipulated in the contract, or

• Analysis of commercial agreements and market conditions to establish what should have occurred under the agreements ʺbut forʺ the alleged contract breach, violation of applicable standards, and/or (unforeseeable) commercial change, plus

• Calculation of lost revenue or profits by comparing counterfactual analysis of what should have occurred under the agreements to what actually did occur.

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Never Assume Anything

In DCF and commercial analysis, tribunals dislike speculation and prefer well‐founded, documented foundations.

» Establishing solid assumptions can be tough when asset valuation or commercial damages are calculated as of a date for initial expropriation, asset impairment, or commercial harm that is several years back.

» Industry expertise and relevant regional market experience can be used to establish credible parameters for:

» Global or end‐market demand and prices;» Supply chain infrastructure availability and

transportation costs;» Refining, processing, liquefaction, and regasification

costs;» Price netbacks at contractual pricing points;» Production profiles and sales volumes;» Tax and accounting requirements and standards;» Financing conditions and costs;» Foreign exchange assumptions, etc.

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The Issue of Interest

» Disputed dates for effective expropriation, investment impairment, and/or commercial harm as the starting point for interest damages

» Claimant and respondent perspectives on the time value of money since those dates

» Simple versus compound interest, with tribunals increasingly supporting compound interest

» International conventions versus local country rules and regulations

» Reasonableness, balance, and equity

» Ultimately: suitable interest rate for the nature of the claim (risk free, LIBOR, Prime, cost of debt, WACC, etc.)

From the moment of expropriation or commercial damages, the application of interest damages should also be tailored to the claim.

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What’s Next

» Investment treaty disputes continue to be argued through arbitration even in the countries that have exited ICSID, but it remains to be seen how claims will be adjudicated, awarded, and paid.

» Private commercial or contract arbitration activity remains substantial and, generally, beyond the purview of states.

» Dramatic change in energy markets and prices will continue apace and will drive the need for investment and commercial dispute resolution.

» Investors and their lenders will reconsider sovereign counterparty risk.

If Latin American nations increasingly repudiate international arbitration, how will international investment and commercial disputes be resolved in the future?

» More flexible, dynamic investment and commercial terms will evolve to minimize future disputes with both sovereign and commercial counterparties.

christopher goncalves - navigant · 2 alba = the alba (alternativa bolivariana para las américas),...

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