ICSID tribunal awards ConocoPhillips USD 8.7 billion plus interest in dispute with Venezuela

ConocoPhillips Petrozuata B.V., ConocoPhillips Hamaca B.V., ConocoPhillips Gulf of Paria B.V. and ConocoPhillips Company v. The Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/30

An ICSID tribunal awarded over USD 8.7 billion plus interest to ConocoPhillips for Venezuela’s unlawful expropriation of three oilfield investments made by Netherlands-based subsidiaries of U.S. corporation ConocoPhillips. The tribunal issued its award on March 8, 2019, nearly six years after its September 2013 decision on jurisdiction and the merits. The award also comes nearly one year after an ICC tribunal awarded over USD 2 billion in a separate contract-based claim against Venezuela related to two of the three oilfield investments implicated in this case.

Background and claims

In the mid-1990s, ConocoPhillips invested in three projects—the Hamaca, Petrozuata and Corocoro Projects—involving the production, partial refining and marketing of extra-heavy oils from the Orinoco Oil Belt.

In 2007, Venezuela attempted to restructure the projects into companies in which affiliates of Petróleos de Venezuela, S.A. (PDVSA), Venezuela’s state-owned oil company, would own 60 per cent of the shares, thereby aligning ConocoPhillips’s investment with the legal and fiscal requirements applicable to all other companies with oil activities in Venezuela. ConocoPhillips rejected the terms of this restructuring deal and subsequently exited the Venezuelan market, after which PVDSA nationalized the projects.

On November 2, 2007, ConocoPhillips initiated arbitration against Venezuela, claiming unlawful expropriation and a violation of the fair and equitable treatment standard contained in the Netherlands–Venezuela BIT (the BIT). ConocoPhillips sought over USD 21 billion in compensation, while Venezuela contended that the investor was entitled to only USD 515 million.

In 2013, a majority of this tribunal found that Venezuela failed to negotiate in good faith for just compensation as required by BIT Article 6(c). In 2017, the tribunal filed an interim decision in response to Venezuela’s third application for the tribunal to reconsider its 2013 decision. In the 2017 interim decision, the tribunal clarified it did not find a lack of good faith on the part of Venezuela in its negotiation efforts but rather that Venezuela failed to negotiate an offer in compliance with the BIT’s requirements of just compensation and market value.

Choice of law – BIT compensation standard and contractual standard

Venezuela argued that ConocoPhillips should not be able to claim damages outside the limits established by the Association Agreements (AAs) for the projects’ original contracts and Venezuelan law at the time of the investment because these conditions placed a limit on ConocoPhillips’s expected profit and the state’s expected liability under the BIT.

The tribunal noted that, because the claim was initially brought under BIT Article 6, the AAs and Venezuelan law were not directly applicable. However, because the compensation for ConocoPhillips’s rights and assets must include what the investors were entitled to if there had been no expropriation, the tribunal determined that compensation needed to take into account both the BIT standard and the provisions of the AAs.

Venezuela carries burden to prove project costs, ConocoPhillips carries burden to prove output prices

The tribunal upheld all expected costs connected with the project. For output prices between 2007 and 2020, the tribunal accepted actual sale prices, rejecting both Venezuela’s preference for lower prices and ConocoPhillips’s contention that the crude would have sold at higher prices if managed by the investor during the relevant period. For post-award output, the tribunal determined that prices for future output would start at the 2020 average and increase at a flat rate for each subsequent year.

Windfall Profit Tax constitutes “discriminatory action” in Petrozuata AA

The tribunal determined that the Windfall Profits Tax (WPT) implemented by Venezuela should not be included in ConocoPhillips’s valuation of reasonable expected profits because the AAs clearly gave Venezuela authority to modify the tax regime in connection with increases in oil prices and any WPT exemptions would have been granted solely at Venezuela’s discretion. However, the tribunal also determined that the WPT constituted a “discriminatory action” under the Petrozuata AA because it authorized Venezuela to apply exemptions unequally to enterprises within the oil industry.

Discount rate overview and relevant factors

With these considerations in mind, the tribunal determined the expected profit and dividends ConocoPhillips would have received over the duration of the projects. First, the tribunal rejected Venezuela’s contention that ConocoPhillips’s original internal rate of return (IRR) of 20 per cent is the appropriate discount rate. Instead, it adopted ConocoPhillips’s position that once the IRR, or “hurdle rate,” was passed, it is essentially irrelevant and should not be used because it is merely the minimum level of return expected by ConocoPhillips. The tribunal also determined that Venezuela’s borrowing costs did not affect the discount rate analysis other than by increasing political risk because financing for oil projects is project specific and generally operates outside the general constraints of Venezuela’s economy.

Expropriation and taxation effect on discount rate

The tribunal noted that “the discount rate should not serve as a premium for unlawful acts committed by the host State and detrimental to the investment” (para. 906). However, the tribunal also noted that expropriation with “just compensation” is permitted under the BIT and thus ConocoPhillips assumed some risk of expropriation. As a result, the tribunal included in the discount rate the risk of any difference between “just compensation” and full reparation for loss suffered through expropriation.

17.25 per cent discount rate used by the tribunal

The tribunal ultimately used ConocoPhillips’s 2006 discount rate of 13 per cent as a baseline, determining that it represented the expected risks of the projects more than any alternative presented by the disputing parties. The tribunal reduced it to 9.75 per cent to account for risk already accounted for due to reduced production and higher costs. Combining the cost of capital (risk-free rate and industry risk) with the discount rate of 9.75 per cent and the tribunal’s margin of discretion resulted in a discount rate of 17.25 per cent.

Interest rate

The tribunal noted that applying a risk-free rate—as argued by Venezuela—would allow Venezuela to retain expropriated dividends and earn higher profits, while ConocoPhillips “would have to be content with the most minimal rate available on the money market” (para. 816). The tribunal instead used ConocoPhillips’s cost of equity as pre-award interest reduced to reflect the tribunal’s findings on higher than expected costs.

In contrast, the tribunal focused on the investors’ reduced opportunity to invest in the oil industry to determine the post-award interest rate. As a result, the tribunal adopted the industry risk premium of 5.5 per cent (compounded annually) for post-award interest.

Total award

Ultimately, the tribunal awarded USD 8.4 billion for unlawful expropriation in violation of BIT Article 6 and USD 286 million for “discriminatory actions” taken in violation of the Petrozuata AA. The tribunal also awarded ConocoPhillips 40 per cent of its legal costs, amounting to over USD 20 million. Lastly, the tribunal declared the entire amount awarded net of taxes.

Notes: The tribunal was composed of Eduardo Zuleta (president, appointed by the chairman of the ICSID Administrative Council, Colombian national, replacing Kenneth Keith, New Zealand national, who resigned from the tribunal in 2016), Yves Fortier (claimants’ appointee, Canadian national) and Andreas Bucher (respondent’s appointee, Swiss national, replacing Georges Abi-Saab, Egyptian national, who resigned from the tribunal in 2015). The award is available in English at https://www.italaw.com/sites/default/files/case-documents/italaw10402.pdf.

Gregg Coughlin is a Geneva International Fellow from University of Michigan Law and an extern with IISD’s Investment for Sustainable Development Program.

TAGS: ISDS, Expropriation, ICSID, Venezuela, Oil & Gas